The size of the voluntary market is also smaller than mandatory schemes, in part because the companies active in the market already emit relatively few greenhouse gases. Still, US-based consultancy ICF International predicts that the global market for voluntary carbon offsets will grow from 10 million tons of CO₂ in 2005 to 400 million tons annually by 2010.

There are several factors driving this bullish forecast, according to Abyd Karmali, ICF's European managing director. First, with climate change a growing public concern, firms can use offsets to enhance their reputations. "Many companies realize that their carbon footprint isn't so bad, so going carbon neutral comes at little cost while the upside can be fairly significant," says Karmali. Second, some industries, such as aviation, expect eventually to be subject to mandatory cap-and-trade schemes, so companies in those sectors are gaining experience by dabbling in voluntary markets. Third, some companies are using greenery to differentiate themselves from competitors, as in the travel groups that now bundle offsets as part of their holiday packages.

Leading offset providers in Europe include 500 PPM and Atmosfair in Germany, ClimateNeutral Group in the Netherlands, and Climate Care and The CarbonNeutral Company in the UK.

According to Karmali, there are two nascent standards that companies should look for in voluntary offsetting projects. Last year, the World Wildlife Fund modified its Gold Standard methodology for validating CDM projects to suit the voluntary market, while a final version of the Voluntary Carbon Standard, developed by nonprofit the Climate Group and the International Emissions Trading Association, will be published later this year. More rigorous verification and accreditation will invariably push up costs, but "given that some of the offsets available are of dubious quality, companies which really value their reputation and brand will naturally migrate towards the higher end of the market," Karmali predicts.

Another group migrating towards the voluntary offset market is hedge funds, following the lead of Cheyne Capital Management, which launched the first fund focused on voluntary credits in 2005. Last summer, the Bank of New York launched the first centralized registry for voluntary credits, hoping that standardized terms and contracts will drive liquidity and attract a broader range of market participants, as it has for mandatory trading schemes.

Weather-risk Markets
"Everybody talks about the weather, but nobody does anything about it," said 19th-century American novelist Charles Dudley Warner. Today, as experts predict that climate change will make weather systems more volatile, capital markets are spawning innovative financial instruments to hedge these risks.

Last year, the number of trades on the Chicago Mercantile Exchange (CME), where most weather-risk products are traded, increased by a factor of four, while their value rose by a factor of eight. (See chart below.) Several new products have been launched recently which track phenomena beyond traditional temperature-based instruments, spurred by the increasing unpredictability and severity of storms.

In 2006, risks of typhoons and earthquakes in Australia, earthquakes in Mexico, and tornadoes and hail in the US were securitized for the first time. Last month, reinsurer Carvill opened trading in derivatives tied to the size and wind velocity of hurricanes on the Atlantic coast of the US.

"The CME is doing a good job of handling basic, bulk weather," says Steve Smith, senior vice-president at ReAdvisory, Carvill's analytical arm. "With the hurricane index, we're adding in the extreme, shock weather. With instant pricing and fast settlement, it has all of the things you expect from a mature financial product, providing a broader appeal beyond just the insurance industry."

Another trend in weather-risk markets, according to Barney Brown, a consultant in the financial markets practice of Detica, is the growing use of hybrid instruments which package together multiple weather factors. In November, for example, ABN Amro and underwriter Catlin sold tranches of a collaterized debt obligation-style security which covers nine different catastrophic risks—earthquakes, hurricanes and windstorms in Europe, Japan and the US. "The only thing that's missing is thunder and lightning, but I'm not quite sure how you can trade that," says Brown.

Insurance Issues
To date, no insurer offers explicit coverage for climate change. The potential damages associated with it, however, are influencing all varieties of corporate policies, boosting premiums for weather-related risks, expanding exclusions for losses associated with climate change and increasing deductibles for weather-related losses.

In these times of heightened sensitivity to an increasingly unstable climate, companies should tell their brokers about all or any improvements, however small, to their properties, says Tom Roche, engineering manager at insurer FM Global. In fact, it's often the seemingly small measures that make a big difference in protecting a building from storm damage. "We talk with clients about putting an extra line of bricks around a property, or building a plant a little bit higher," Roche says. "From a financial point of view, these things are quite simple."

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