ARC Extreme Climate Facility (XCF) Dr. Richard Wilcox, ARC Director General a.i. 5th International Disaster & Risk Conference IDRC Davos 24-27 August 2014

The ARC Group Structure

• SDFR  pilot  as  input  to  the  Agency’s  Peer  Review  Mechanism (PRM) to apply for Certificate of Good

Standing (CGS) required for insurance with the ARC Ltd

• Objective and independent disaster finance ratings also

facilitate private sector entry and public accountability.

• ARC-XCF will be a data-driven climate protection

scheme, supporting country-level climate

adaptation to build resilience to future climate

shocks

• Members of the ARC Ltd are eligible to participate

in ARC-XCF to access adaptation financing beyond

that afforded by insurance

ARC  Group  provides  Africa’s  climate  change  management  and  adaptation  infrastructure

Sovereign Disaster Finance Ratings (SDFR)

Extreme Climate Facility (ARC-XCF)

OPERATIONAL

OPERATIONAL

OPERATIONAL

IN DESIGN PILOT

ARC 2014

Inaugural pool launched 1st May 2014 with five countries insured for US$ 135 million against drought for a premium of US$ 17.5 million • Kenya, Mauritania, Mozambique, Niger, Senegal Aggregate XL reinsurance structure placed in market providing US$ 55 million in coverage for 2014 policy period ARC Agency starting to work with 8 more countries for 2015 • Aim to reach 20 countries by 2019 by providing

coverage against drought and flood

ARC serves as an operational and concrete example of countries taking innovative steps to reduce climate risk and access private capital

24 ARC Signatories

Context

Estimates give an adaptation investment cost need of USD 14-17 billion per year over the period 2010-2050 for sub-Saharan countries to adapt to an approximately 2C warmer climate by 2050 To date, funds have not been forthcoming in the magnitude required and it is recognised that innovative and diverse sources of financing will be needed As adaptation finance investment grows, it will be critical to have a fair and objective mechanism for its allocation and distribution to help prioritise the geographical location of the available investment flows

XCF

The XCF will be a data-driven financial facility, supported by both private and public funds, that tracks extreme climate shocks and pays out directly to countries to undertake adaptation if event frequency and intensity increases ARC Agency was mandated to develop the XCF concept by the African Ministers of Finance on 30 March 2014 “Requests the Secretariat of the African Risk Capacity Agency to develop a proposal for a vehicle by

which African Governments can gain access to climate financing, linked to increased climate volatility, for adaptation activities and implementation of climate-resilient development pathways”  

(Resolution L15)

Concept

Data-driven financial vehicle that tracks the frequency and magnitude of extreme climate shocks in Africa

• Function: Additional financing for countries already managing their current weather risks through

ARC

• Data-driven: Payments to countries will be entirely data-driven over a 30 year period – if there is

no significant increase in extreme events over current climatology, then no payment is made

• Climate Adaptation: Where payments are made, countries must use those funds to invest in DRR

or climate change adaption measures specified in pre-defined country-level adaptation funds

• Scale: Payment size would increase with extreme event number and magnitude over and above a

severe threshold, corresponding to the degree of confidence that extreme events are increasing,

the climate has changed and that intensified adaptation is needed

• Action: Leveraging ARC’s  existing  infrastructure,  XCF will ensure that countries and the

international community properly monitor climate shocks and are financially prepared to

undertake greater adaptation measures should their frequency and intensity increase

Recent Climate in Africa, 1983-2013

XCF Mechanism

• Designed to access private capital, the XCF would be structured along the lines of a catastrophe bond programme issuing a series of multi-year cat bonds

• Donors would support cat bond coupon payments, while investors provide the capital

• Cat bonds would be parametric, based on an objective, multi-hazard Extreme Climate Index (ECI)

and focus on each climatological region of Africa

• Payments would be triggered from the bond principal should the ECI exceed a set threshold at

bond maturity, indicating a potential change in frequency and intensity of extreme weather

events in the region

• Should they occur, payments would start small and would increase with subsequent cat bond

issuances, growing alongside increasing evidence of observed deviations from the baseline

climatology

• Should extreme events continue to occur countries could stand to receive a predetermined

maximum dollar amount over the 30 year XCF adaptation period

Extreme Climate Index (ECI)

• An objective, weather data-based regional index that tracks extremes in heat, drought,

cyclones, flood and other relevant weather

events over the XCF adaptation period

• If extremes occur during the adaptation

period, the ECI increases with each event

• No or small increases in the ECI would mean

no significant change in extremes from the

baseline period

• An increasing ECI could indicate a change in the climate regime with respect to the frequency and intensity of extremes

ECI: A composite index based on the

average of several underlying extreme

weather indictors including e.g.:1

• % of region in severe drought according to the Standardized Precipitation Index (SPI)

• % of region in severe moisture surplus according to the SPI

• % of region with maximum temperatures much above normal

• etc…

1 The ECI will be based on existing extreme climate indicators, e.g. World

Meteorological Organization, 2009: Guidelines on Analysis of Extremes in a

Changing Climate in Support of Informed Decision for Adaptation, Climate Data

and Monitoring, WCDMP-No. 72; Karin L. Gleason, Jay H. Lawrimore, David H.

Levinson, Thomas R. Karl, and David J. Karoly, 2008: A Revised U.S. Climate

Extremes Index. J. Climate, 21, 2124–2137.

XCF Illustration

• The XCF adaptation period is broken down in to

non-overlapping 5-yr  periods,  or  “financing  windows”

• Each represents an issuance in the XCF cat bond series

• Payments are triggered to eligible countries at

the end of the financing window if the ECI exceeds a pre-specified threshold at the end of

the 5-yr period

• The thresholds are set with reference to the baseline climatology to capture upward shifts

in the ECI and therefore an increase in frequency and intensity of extreme weather events in the region

ECI

XCF Illustration

$5m/ECI Unit

$10m/ECI Unit

$15m/ECI Unit

$20m/ECI Unit

Multi-Hazard Extreme Climate

Index (ECI)

XCF Cat Bond Payment Trigger

Accruing ECI Events per Country:

Graphic Key:

Payment Released at end

of 5-Yr Financing Window

ECI

XCF Illustration

ECI

• Should severe events occur, cat bond attachment levels could shift up to reflect the heightened risk in a potentially new climate regime (as shown in

example). Risk below this level, but above the

original threshold would be funded through an

insurance sub-layer (shown in green)

• Donor capital may be required to fund this sub-

layer should the affordability or interest from the

private sector for the cat bond programme and/or

insurance sub-layer provision decrease

• This model leverages private capital to fund the uncertain risk, particularly during the start of the

30 year adaptation period , with donor funds reserved for more certain/frequent risk

XCF Illustration: Worked Example

$5m/ECI Unit

$10m/ECI Unit

$15m/ECI Unit

$20m/ECI Unit

Multi-Hazard Extreme Climate

Index (ECI)

XCF Cat Bond Payment Trigger

Accruing ECI Events per Country:

(as-needed insurance sublayer, green)

Graphic Key:

Payment Released at end

of 5-Yr Financing Window

ECI

Payment of $190m/Country; attachment level moves

Payment of $220m/Country from

donor-funded sub-layer

Payment of $30m/Country

Replicated for all regions in Africa, with an ECI/thresholds defined uniquely for each region

XCF Structure & Operation

Capital Market

Investors

XCF Ltd

Principal

Coupon (Return + Premium)

Principal Returned

at Maturity if No Triggering

ECI Event Occurs*

Principal to Region if

Triggering ECI Event Occurs*

Premium (Paid by Donors)

Collateral Account

Principal Return

ARC Agency facilitates direct contracting with countries and approves country participation

* Either all or a partial amount of the principal could be triggered depending on the severity/frequency of ECI events during cat bond tenor

and the region or regions in which the events occur

• XCF Ltd would be a second financial affiliate of ARC Agency, a special purpose company that would

enter into direct swap agreements with participating countries and then issue a series of multi-year

cat bonds linked to these agreements to investors

• ARC Agency would be the gateway for country participation in XCF by approving country adaptation

plans and facilitating country interactions with XCF Ltd

Example of possible XCF structure and funds flow:

Region 2 Country 1

Country 2

Country  3…

Region 1 Country 1

Country 2

Country  3…

Region  3… Country 1

Country 2

Country  3…

Back Up Slides

XCF Design R&D Programme

Work to elaborate XCF concept and design its structure and operational principles is planned over an 18 month period, focusing on four core R&D pillars:

Pillar 1: Adaptation Planning & Standards for Climate Resilient Investments

• Ascertain to what extent implementation-ready country-level adaptation plans

exist, and compile best practice for the development of investment-ready

adaption plans

• Identify the absorption capacity for direct climate funding in Africa

In discussion with Climate Development Knowledge Network (CDKN) for a 12 month GBP 250,000 Pillar 1 research collaboration

XCF Design R&D Programme

Work to elaborate XCF concept and design its structure and operational principles is planned over an 18 month period, focusing on four core R&D pillars:

Pillar 2: Extreme Climate Indices and Severe Event Thresholds

• Identify appropriate climate indices and thresholds that could be used to track

increasing severity and frequency of weather extremes across Africa

• Building on the success of Africa RiskView, the XCF indices would need to be multi-

hazard and region-specific in order to effectively track the range weather events

critical to a geographical area

• Cutting-edge climate work would build on existing research in the field of time-

dependent climate change detection to develop thresholds and an objective

threshold-setting methodology that could be applied to signal a statistically

significant shift in a regional climate regime to one more conducive to generating

extreme weather events

Outlining work programme with ARC climate research partners in Africa, US and Europe

XCF Design R&D Programme

Work to elaborate XCF concept and design its structure and operational principles is planned over an 18 month period, focusing on four core R&D pillars:

Pillar 3: Financial Structure

• Using the ARC platform, explore legal structures and domiciles that could be

considered for the XCF,  including  identifying  viable  financing  options  for  XCF’s  long-

term and innovative risk

• Identify market/donor risk appetite and potential size of the facility

• Define work-plan and budget to establish and operationalise the facility

Initial discussions with ARC partners and advisors

XCF Design R&D Programme

Work to elaborate XCF concept and design its structure and operational principles is planned over an 18 month period, focusing on four core R&D pillars:

Pillar 4: Towards a Global Mechanism

• Investigate how a supra-regional XCF could be structured and how the concept

would have to be modified to allow for a global XCF mechanism

• Ascertain country-level interest for an expansion of the XCF beyond Africa

• Assess the additional work required to develop such a global mechanism

Collaboration with the Caribbean Catastrophe Risk Insurance Facility, and outreach to other regional insurance initiatives