Container derivatives set to revolutionise the market
New scheme could help reduce forwarders exposure to rate fluctuations
Derivatives in shipping are nothing new. The concept of optionality is an ancient one and in the modern freight market, tradeable swaps have been available since the late 1990s, trading in significant volume since the mid-2000s.
These products are used by shipowners as well as commodity producers and consumers to hedge their price risk.
They are also traded by financial institutions, often in combination with other derivatives, to exploit market inefficiencies.
Until now, one frontier was left – the container market. Previous attempts by the Baltic Exchange to construct a market around vessel charter rates foundered and it was left to shipbrokers to offer a workable and robust product.
2010 has seen the emergence the Container Freight Swap Agreement (CFSA), an intuitive risk management tool that allows hedging against price movements in Asian containerised export markets.
There are three main categories of participant who would most commonly trade CFSAs; those who are net long of physical seaborne containerised transport (the shipowner or operator); those who are net short the market (the shipper or freight forwarder) and those with no physical exposure, who seek to profit from market volatility by trading the pure swap (normally traders in investment banks).
How do container swaps work?
By using container swaps, participants transporting seaborne containerised goods are able to lock-in future costs and crystallise future margins up to 23 months ahead in a simple and flexible manner.
A container freight swap is a cash-settled agreement between two parties with an equal and opposite opinion of the future of the market.
The parties agree on a price in US$ per container for a given number of containers on an agreed route during a specified period. At the end of the contract period the parties settle the difference in cash between the predetermined contract price and the actual spot market price.
If the market strengthens, and box rates increase, then the buyer of a CFSA (the long position) benefits, since by entering the agreement they have effectively paid less, in advance, for the goods than they would have done trading on the spot market. The buyer of the CFSA has successfully hedged against an increase in cost of the underlying physical market.
Conversely, if the market softens, and box rates decrease, the seller of the CFSA benefits since they have effectively sold the goods, in advance, at a higher rate than they would have done trading on the spot market.
In this case the seller of the CFSA has been successful in hedging against an increase in cost of the underlying physical market.
CFSAs are currently available over-the-counter with clearing at LCH.Clearnet in London and SGX AsiaClear in Singapore.
The index used for settlement is the Shanghai Containerised Freight Index (SCFI), administered by the Shanghai Shipping Exchange.
The SCFI measures composite container box rates across 15 Shanghai export routes and is published weekly.
It is comprised of 30 volunteer panellists, 15 global shipping operators, including Maersk Line, COSCO and CMA CGM and 15 local freight forwarders including Exel and Sinotrans.
Whilst the SCFI assesses 15 Asian export routes in total, LCH.Clearnet and SGX currently offer clearing on four of these routes: Far-East-US West Coast; Far-East-US East Coast; Far-East-Mediterranean; Far-East -North Western Europe.
So where do we go from here?
This is a market still in its infancy. To date there have been a handful of reported trades, mostly for demonstration purposes between financial institutions. For the real players – shipping lines, forwarders and shippers – to get involved, more liquidity is needed. For that to happen the process of education must continue and quicken.
The exact amount of liquidity needed to see the market take off is difficult to gauge. A handful of active traders on either side of the market could be enough for a liquid market but the same handful only trading once a year wouldn’t be very useful.
FIS is already working with two large container lines which have expressed serious interest in trading container swaps and has also talked with UK and international shippers and freight forwarders.
The feedback received convinces us that all three groups see the benefits and have a view on when they will start trading.
Although professional buyers and sellers of freight could easily run a derivatives book alongside their day to day business, some preparation is needed.
The important thing to remember is that this preparation is free. Signing up for clearing, conducting due diligence on the market and the SCFI can all be done now.
When the potential payback is to fix margins and control costs in a volatile market, that seems like a worthwhile investment.
Arthur Worsley is a container swaps broker with Freight Investor Services.
These products are used by shipowners as well as commodity producers and consumers to hedge their price risk.
They are also traded by financial institutions, often in combination with other derivatives, to exploit market inefficiencies.
Until now, one frontier was left – the container market. Previous attempts by the Baltic Exchange to construct a market around vessel charter rates foundered and it was left to shipbrokers to offer a workable and robust product.
2010 has seen the emergence the Container Freight Swap Agreement (CFSA), an intuitive risk management tool that allows hedging against price movements in Asian containerised export markets.
There are three main categories of participant who would most commonly trade CFSAs; those who are net long of physical seaborne containerised transport (the shipowner or operator); those who are net short the market (the shipper or freight forwarder) and those with no physical exposure, who seek to profit from market volatility by trading the pure swap (normally traders in investment banks).
How do container swaps work?
By using container swaps, participants transporting seaborne containerised goods are able to lock-in future costs and crystallise future margins up to 23 months ahead in a simple and flexible manner.
A container freight swap is a cash-settled agreement between two parties with an equal and opposite opinion of the future of the market.
The parties agree on a price in US$ per container for a given number of containers on an agreed route during a specified period. At the end of the contract period the parties settle the difference in cash between the predetermined contract price and the actual spot market price.
If the market strengthens, and box rates increase, then the buyer of a CFSA (the long position) benefits, since by entering the agreement they have effectively paid less, in advance, for the goods than they would have done trading on the spot market. The buyer of the CFSA has successfully hedged against an increase in cost of the underlying physical market.
Conversely, if the market softens, and box rates decrease, the seller of the CFSA benefits since they have effectively sold the goods, in advance, at a higher rate than they would have done trading on the spot market.
In this case the seller of the CFSA has been successful in hedging against an increase in cost of the underlying physical market.
CFSAs are currently available over-the-counter with clearing at LCH.Clearnet in London and SGX AsiaClear in Singapore.
The index used for settlement is the Shanghai Containerised Freight Index (SCFI), administered by the Shanghai Shipping Exchange.
The SCFI measures composite container box rates across 15 Shanghai export routes and is published weekly.
It is comprised of 30 volunteer panellists, 15 global shipping operators, including Maersk Line, COSCO and CMA CGM and 15 local freight forwarders including Exel and Sinotrans.
Whilst the SCFI assesses 15 Asian export routes in total, LCH.Clearnet and SGX currently offer clearing on four of these routes: Far-East-US West Coast; Far-East-US East Coast; Far-East-Mediterranean; Far-East -North Western Europe.
So where do we go from here?
This is a market still in its infancy. To date there have been a handful of reported trades, mostly for demonstration purposes between financial institutions. For the real players – shipping lines, forwarders and shippers – to get involved, more liquidity is needed. For that to happen the process of education must continue and quicken.
The exact amount of liquidity needed to see the market take off is difficult to gauge. A handful of active traders on either side of the market could be enough for a liquid market but the same handful only trading once a year wouldn’t be very useful.
FIS is already working with two large container lines which have expressed serious interest in trading container swaps and has also talked with UK and international shippers and freight forwarders.
The feedback received convinces us that all three groups see the benefits and have a view on when they will start trading.
Although professional buyers and sellers of freight could easily run a derivatives book alongside their day to day business, some preparation is needed.
The important thing to remember is that this preparation is free. Signing up for clearing, conducting due diligence on the market and the SCFI can all be done now.
When the potential payback is to fix margins and control costs in a volatile market, that seems like a worthwhile investment.
Arthur Worsley is a container swaps broker with Freight Investor Services.
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