HEX will initially offer monthly contracts based on one location, Helsinki, although it may expand to other locations across the Nordic region, depending on client demand.
The exchange will start publishing its index, based on the monthly mean daily average temperature, once trading starts. This index is calculated by taking the mid-point between the minimum and maximum temperature of the day, which, when combined with the averages for the month to date, form a cumulative average for the month.
HEX said it has focused on average temperature rather than the usual heating degree-/cooling degree-day format, as it believes that average temperature has the benefit of consistency all year round. Although targeted initially at energy companies, Kiviniemi said the index is likely to prove relevant to a wide range of other market sectors.
Kiviniemi added that HEX has not been discouraged from developing the exchange-traded product, despite Liffe’s failure to trade more than one contract since its December launch. “Although our index is similar, we have a very different market structure to Liffe,” Kiviniemi said.
“If an energy company wants to buy Liffe weather futures, it has to go through a market-maker," Kiviniemi added. "HEX will allow energy companies direct trading member status, which avoids unnecessary third-party complication.” HEX will also act as the clearing counterparty.
As a result of Liffe’s failure to kick-start its weather futures offering, some market participants have questioned whether the $4.3 billion weather risk market is ready for an exchange-traded product.
“There is a real need for standardised weather products, since OTC [over-the-counter] weather risk players can’t take all the risk in the market, so they have to hedge their own exposures," countered Kiviniemi. "And for these purposes exchange-traded contracts are a good basic tool."
While HEX now has the go-ahead from Finland’s financial regulators, the exchange initially encountered regulatory difficulties, as the authorities had little knowledge of the products, Kiviniemi added. The contract was in development for 18 months.
The week on Risk.net, July 7-13, 2018Receive this by email