Supply chains—the interconnected web of infrastructure processes, and practices that underlie the sourcing, manufacturing, transportation of goods —are vital to the smooth functioning of the American economy. In the past they have been somewhat invisible, but the pandemic and its consequences have made clear their importance to daily lives, livelihoods, and basic day-to-day convenience and well-being.
Supply Chain Indices (SCI) will allow organizations to hedge their supply chain risk by taking positions in traded financial derivative instruments in a similar way that many organizations currently manage other business risks such as currency risk and interest rate risk. The approach considers the geographic exposure of an organization’s supply chain as well as the sector in which the organization operates, in an attempt to balance the desire for a hedge that is customized to the supply chain risk profile of a particular organization with the desire for agglomeration effects to occur that support market liquidity in benchmarks. The concept outlined in this note was inspired in part by a supply chain index conceived by Federal Reserve Bank of New York economists in Benigno, Giovanni, Groen, and Noble (2022) and by research on LIBOR reform and benchmark design outlined in Duffie & Stein (2015).
The Covid pandemic has raised public awareness of both the nature and increased likelihood of catastrophic events occurring. For example, according to a June 2021 report by the United Nations, at no other point in history have agri-food systems faced more hazards such as megafires, extreme weather, unusually large desert locust swarms, and emerging biological threats, as during the pandemic. Nor have they been seen at such frequency, intensity, and complexity.
The Biden Administration, through the U.S. Department of Transportation, has laid our broad changes to address supply-chain shortfalls designed to enhance the resiliency of supply chain and to address future disruptions. The February 2022 USDOT Freight and Logistics Supply Chain Assessment responded to Executive Order 14017: America’s Supply Chains. The proposals put forward in the Assessment by the White House include investments in both physical and digital infrastructure to support America’s supply chain resiliency. The concept and opportunity outlined in this note, at the nexus of financial markets and supply chains, would complement these proposals.
“ This has been a very tough quarter, primarily due to supply chain and production challenges in China, so we need to rally hard to recover!” – Tesla CEO Elon Musk. June 13, 2022
This note proposes the establishment of a publicly observable traded derivative market that cash settle against an underlying set of benchmarks, SCI. The derivatives could serve to offer a potential hedge, or partial hedge, for larger organizations whose revenues suffer largely uncontrollably from supply chain disruptions during catastrophic events. To our knowledge, indices such as SCI do not currently exist, moreover new sources of previously unavailable input data that has become available in recent years due to advances in satellite data which we exploit.
The hedge could be executed by the organization proactively for example, in anticipation of implementation of a new piece of regulation or legislation. A hedge could also be executive reactively, for example, upon the occurrence of an unanticipated disruptive geopolitical event.
For the avoidance of doubt, the hedge would not necessarily ensure that the goods are able to be delivered to the business or the end consumer. However, if the framework is well designed, the hedging market could provide an economic gain in the form of financial compensation to organizations that could offset revenue shortfalls or be used to pay increased logistical or transportation costs in the event of supply chain disruption. A successful supply chain risk hedge would effectively transfer the financial impact of an organization’s supply chain risk to the capital markets.
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