News For Banks - Apr 2008 - UBS Greenhouse Index - Carbon Emission Derivatives - ilija Murisic Keywords: Carbon, CO2, Emission, EUA, CER, climate change, Index ,Kyoto, UBS, derivatives, hybrids, trading, structured products

1. Solutions
Inconvenient truth: now you can hedge against it with the UBS Greenhouse Index
Turning up the heat
New index broadens the choices for investors concerned with
climate change
Unless you are a dairy farmer in Green- If it chooses, this clientele can now focus four-fifths of the combined emissions in-
land, climate change is an inconvenient even more selectively on the human- dex by value, reflecting its greater underly-
truth. For most such inconveniences, induced element in climate change. The ing market volumes. As index components
though, there is a convenient tool for recently launched UBS Greenhouse Index are weighted according to the volume of
hedging their effects. Climate change was (UBS-GHI) is a play on both temperature underlying transactions, new weather con-
the exception until April last year, when trends and, indirectly, on the amount of tracts or carbon reduction schemes could
UBS launched its Global Warming Index carbon dioxide in the air, an important be added to the GHI in future, if justified
(UBS-GWI). Rolling into a single instrument cause of global warming. Half the index by their popularity.
a selection of intensively traded weather by value is based on the existing Global As the existence and pricing of carbon
derivatives, the index offers investors a Warming Index, while the other half reduction schemes depend wholly on
new and handy way of expressing views tracks futures contracts on two princi- human agency, the GHI is a more complex
on regional or national climate trends in pal markets for carbon emissions, the EU instrument than its predecessor. It should
the US. (See News for Banks, Winter 2007 Emission Trading Scheme (40% of the appeal to institutional investors looking for
edition for more details.) index) and the Kyoto Clean Development additional portfolio diversification, reckon
This invitation was taken up with enthu- Mechanism (10%). Thus the index delivers the product’s designers within UBS Invest-
siasm. Since inception, the Global Warm- exposure to temperatures across a selec- ment Bank’s hybrid derivatives trading
ing Index has attracted some $100 million tion of US cities, as well as prices for unit. Other users could include businesses
in contracts. Even more significantly, it has carbon dioxide in the EU and for carbon exposed to the risk of adverse climate
built a new user base for weather deriv- dioxide reductions sold by developing change and those that need to hedge
atives. While traditional weather futures nations to developed ones. against the risk of legislation designed to
tend to be patronized mainly by energy For investors preferring to concen- curb carbon dioxide emissions. You could
professionals and a few specialized hedge trate solely on greenhouse gas emissions, even sell the index short to hedge against
funds, the GWI has pulled in insurers, pen- a family of sub-indices is available that the unlikely risk of global warming going
sion funds, and even retail investors. GWI track either the European emissions trad- into reverse.
investors have been rewarded by a 53% ing scheme or the Kyoto Clean Develop-
rate of return since inception (as at mid- ment Mechanism or both in combination.
Ilija Murisic UBS Investment Bank,
February), as well as minimal correlation As in the emissions part of the parent in- Hybrid Derivatives Trading
with other asset classes. dex, the European scheme accounts for ilija.murisic@ubs.com
UBS News for Banks / Summer 2008 19