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CME water futures highlight innovation on sustainability issues

Nasdaq Veles California Water Index futures debuted in December to offer risk-management tool

26 January 2021

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While participation in carbon markets is perhaps the most prominent way the derivatives industry is responding to global sustainability and climate concerns, it's certainly not the only way. The latest proof of that comes from CME Group's recently launched California water futures contract, an innovative product that helps discover water prices and manage risks for end-users.

CME Group began providing futures on the Nasdaq Veles California Water Index (NQH2O) for public trading on 7 December. The benchmark powering this innovative, cash-settled water futures contract uses rights leases and sales transactions across the five largest and most actively traded regions of California to provide a volume-weighted average price of freshwater in the region.

"This futures contract is the first of its kind, providing a host of end-users such as farmers, commercial businesses and municipalities with a new tool to discover water prices with greater transparency and to manage their related risks—all of which can help to more efficiently align supply and demand of the resource," said Tim McCourt, CME Group's global head of equity index and alternative investment products.

A liquid, transparent futures market will help to create a forward curve for this vital resource so water users can hedge price risk. Further, these futures contracts allow agricultural producers to plan ahead for changing cost of the water they need for large-scale irrigation, while also allowing a commercial end user, like a manufacturer, to better navigate business and financial risks when water prices fluctuate.

Since launch through 22 January, there has been a total of 156 Nasdaq Veles California Water Index futures traded, equivalent to 1,560 acre feet or 508.2 million gallons. "It takes time to develop and build a new futures market, especially one as unique as water. The interest we have seen early on for these contracts is encouraging," McCourt said.

Admittedly, while one futures product cannot address the entire spectrum of risks related to water scarcity, it’s certainly a start. At a basic level, the contract is focused only on the price of water in California and cannot reflect trends in the rest of the U.S. or in other countries like China, which uses even more water than America does. Yet, it’s worth noting that California is home to the nation’s largest and most actively traded spot water market with approximately $1.1 billion in transactions in 2019.

The launch of CME Group's innovative water futures contract is proof of the industry's commitment to helping build a more sustainable global economy. And at a time when businesses and communities around the world face increasing water risks, this market-based solution can be an important part of the solution.

Commissioner Rostin Behnam of the U.S. Commodity Futures Trading Commission, who created a Climate-Related Market Risk subcommittee at the agency and helped author a report on climate risk in the financial system, applauded the product's debut as "a really good thing" that will "help stakeholders manage the risk that is going to continue to present itself to us."

Behnam and other market regulators have called for further innovation in derivatives markets to respond to a wide array of environmental and sustainability issues. For its part, CME Group is committed to exploring sustainability issues and providing all market participants with the risk management tools they require.

The launch of these futures complements CME Group’s growing suite of sustainable, environmental, social and governance (ESG) products, including its E-mini S&P 500 ESG Index futures launched in late 2019. As socially responsible investing continues to gain momentum, investors are increasingly looking for opportunities in the market that align with their values. The introduction of Water and ESG Index futures help underscore how CME Group is meeting participants’ needs for sustainable investments.

Visit CME Group's website for more information on the Nasdaq Veles California Water Index futures.

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