Hedging your bets

The obscure art of derivatives trading – long used in bulk commodities – has finally come to the world of container shipping.

The first trade on the Container Freight Swap Agreement (CFSA), developed by UK broker Clarksons Securities, took place in January between European shortsea shipping line Delphis and global investment bank Morgan Stanley.

The derivative is an over-the-counter cash swap that is to be settled against the Shanghai Shipping Exchange’s recently created Shanghai Containerised Freight Index (SCFI), with the settlement arrived at by taking an average on the rate over a four-week period.

The SCFI has “all in” spot rate levels for 15 routes in and out of Shanghai, gained from rate quotes from 15 deepsea container carriers and 15 freight forwarders and major slot purchasers. A comprehensive index is also taken from an average of these 15 routes through a weighting system (see table below).

Ben Gibson, on Clarksons’ freight derivatives desk, tells IFW that there were likely to be two types of customer: “Firstly, there be will investors from financial institutions who may operate in a number of ways: as proprietary traders speculating in the market; as traders taking positions on behalf of their clients involved in container shipping; or as hedgers themselves looking to take cover against shipping debt the bank may have.

“The second type of customer is a hedger, who is looking to use the derivative to reduce his overall exposure to market movements by taking a position on paper that is the exact opposite of where he wants the market to go.

“If I was a carrier and had exposure to freight rates dropping, then I would sell a paper taking a position on rates dropping, and the perfect hedge is one which cancels out of the loss of earnings through freight rates dropping.

“It’s a form of insurance, and some customers want to eliminate as much risk as possible. This helps them to lock-in stability – it provides stability in their income streams.”

He is also at pains to press home the point that derivatives trading on container freight rates has nothing to do with actually moving boxes between Asia and Europe. “You can’t cash-in your contract for teu slots – this is simply a cash instrument.

“For freight forwarders, it’s an extra tool. If they are buying space and selling it on, it gives them the opportunity to insure against that, as a shipper would. However, many freight forwarders don’t do that, they block-book space and act as agents for their customers or the lines, and this allows them to offer a risk management function.

“Then they can say, ‘this is the rate that we are getting at the moment, but that may fluctuate – by taking a paper position we can manage against that risk’. That is a value-add they can offer their customers.”

The trick for Clarksons was to indentify a neutral partner that could create the index, and guarantee the participants’ integrity, and its own integrity.

“We already had a relationship with the Shanghai Shipping Exchange. The key feature of its index is that it solves the question of neutrality by getting the information from both carriers and their customers,” says Gibson

The Shanghai Shipping Exchange is a not-for-profit body set up by the Chinese government to provide information and an exchange premises for international shipping. The SCFI liner panellists comprise CMA CGM, Coscon, China Shipping, Hanjin, Shanghai HaiHau Shipping, Hapag-Lloyd, Jin Jiang, K Line, Maersk, MOL, NYK, OOCL, PIL, Sinotrans and SITC.

“On the non-carrier side, the panellists are more Chinese than you might expect, but we felt that it was vital we had input from the demand side of the business. We hope the panel will be extended to include more multinational forwarders,” he adds.

The shipper and freight forwarder panellists are Orient International Logistics, UBI Logistics, JHJ International Transportation, SIPG Logistics, Shanghai Orient Express International Logistics, Shanghai Huaxing International Container Freight Transportation, Shanghai Jinchang Logistics, Shanghai Shenda International Transportation, Shanghai Viewtrans, Shanghai Richhood International Logistics, Shanghai Ever-leading International, Shanghai Asian Development International Trans Pudong, Sunshine-Quick Group, Cosco Logistics and Sinotrans Eastern.

“It’s early days,” admits Gibson. “What we are doing is talking to a lot of users, and there’s been a lot of interest.

“What held us up offering this before was the lack of a benchmark in container shipping. We have been looking at this for some time, but we needed the right index to be able to settle.”

Clarksons initially looked at containership charter rates as a possible benchmark, but found that the market wasn’t as volatile as bulker charter rates.

“You need volatility for a derivatives product to work,” says Gibson, “and the freight rates market has that sort of volatility.”

Indeed, a cursory glance at the recent history of freight rates on the 15 routes covered by the index (see table) bears this out.

Click on table to enlarge

The last 12 months has seen some of the most extreme swings on the mainline Asia-Europe trades, from a reported all-in level of $350 per teu this time last year, to a reported $2,000-plus spot rate per teu last week.

The next stage is to bring more customers into trading in derivatives, but that will also rely on a clearing house becoming involved, which will take away a lot of burdensome administrative procedures.

“At the moment, the market is 100% over-the-counter – both parties are able to trade with each other once credit terms have been cleared, which means it is quite a long process to get a deal done. Generally it takes about a fortnight to go through all the compliance.

“Early in the second quarter, it is envisaged that we will be able to bring a clearing house into the market, which has cash in it to cover all the trades. That will open up a huge range of counterparties."