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date: 12 February 2025

Hedging and Financial Tools for Water Managementlocked

Hedging and Financial Tools for Water Managementlocked

  • C. Dionisio Pérez-BlancoC. Dionisio Pérez-BlancoUniversidad de Salamanca

Summary

The management of risky water episodes entails a comprehensive set of instruments that can be broadly divided into two groups: damage prevention and damage management. Damage prevention instruments aim at negating or minimizing the economic damage of water scarcity and water extremes, and they include hard and soft engineering, information and awareness campaigns, and regulations and economic incentives. Damage management instruments aim at compensating damages and facilitating recovery, and they include tort law and hedging and financial tools. The growing interconnections and cascading uncertainties across coupled human and water systems make it increasingly challenging to comprehensively predict and anticipate expected damages from water scarcity and extremes, which is giving higher prominence to the management of damages, notably through hedging and financial tools. Hedging and financial tools are a risk transfer mechanism by which a potential future damage is transferred from one party to another, typically in exchange of a pecuniary compensation (risk premium), albeit they can be also freely provided (e.g., state aid). Hedging and financial instruments are varied and include futures, options, insurance, self-capitalization, reinsurance, private actions such as charities or nongovernmental organizations, state aid, and solidarity funds.

The first section of this document discusses the political context for disaster risk reduction efforts at an international level and provides key definitions. The second section presents a taxonomy for hedging and financial instruments; assesses their strengths and weaknesses, performance, and market penetration levels; and critically reviews reform propositions in the literature toward increasing their performance and adoption. The third section discusses the interconnections between hedging and financial tools and damage prevention tools, as well as how their design can enhance each other’s performance. The last section discusses barriers and enablers for the adoption of hedging and financial tools.

Subjects

  • Management and Planning

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