Freight derivatives

Serious Information

A swap freight derivative is a “bet” on whether the market for a type of voyage or a certain period of time over a designated route (or routes) will be higher or lower than the price struck as the basis of the “bet”. The winning party receives the difference between these two prices, multiplied by the agreed contract quantity.

The Baltic exchange is a major exchange for freight derivatives.

The derivative can be used by a company to reduce the risk for rising oil prices or for politcal situations.

Freight derivatives are financial instruments to be used by organisations or individuals as part of a risk management strategy to counter the negative economic affect of freight price alterations that harm the financial prospect of a company. The company can trade in future levels of freight rates, primarily for dry bulk carriers and tankers. Such instruments include exchange traded futures contracts and options on futures contracts, plus OTC (over-the-counter) freight forward contracts like FFAs (Forward Freight Agreements) swaps and swaptions. Cleared freight futures contracts are traded on the Oslo based exchange Imarex (International Maritime Exchange ASA), and in the past used to be traded on BIFFEX and INTEX. Freight derivatives are primarily used by shipowners and operators, oil companies, trading companies and grain houses as tools for managing freight market risk.

Their emergence is a symptom of the growing sophistication of freight and commodities markets and the
appetite of financial institutions for increasing diversification of their investment portfolios.
the market. In response to the increasing sophistication of the freight derivatives market and a demand for uniformity, the Freight Forward Agreement Brokers Association (FFABA) has produced a new 2005 contract that brings the terms on which freight

The derivatives markets are financial markets for derivatives. The market is often divided into two, for exchange traded derivatives and that for over-the-counter derivatives. The legal nature of these products is very different as well as the way they are traded, though many market participants are active in both.

In 1997, weather became another commodity, much like soybeans or heating oil, quantifiable in dollar amounts and tradable on a public exchange.

A derivative is a generic term for specific types of investments from which payoffs over time are derived from the performance of assets (such as commodities, shares or bonds), interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI) or an index of weather conditions). This performance can determine both the amount and the timing of the payoffs. The diverse range of potential underlying assets and payoff alternatives leads to a huge range of derivatives contracts available to be traded in the market. The main types of derivatives are futures, forwards, options and swaps. It is possible for companies to use derivatives to outlay risks in their business. For instance oil companies can buy derivatives to guard against the risk of prices lowering. These would be put under the classification of Energy & Energy Derivatives & Energy Risk Management

Forward Freight Agreement Brokers Association (FFABA)

An independent association of FFA broking Baltic Exchange members formed in 1997 and is serviced by the Baltic.

Aims:

Promote the trading of forward freight agreements (FFAs)
Promote high standards of conduct amongst market participants
Liaise with the Baltic Exchange to ensure production of high quality indices for use by the freight futures industry
Provide a forum for brokers and principals to resolve problems as they arise
Develop and promote use of standard contracts
Develop the use of other 'Over the Counter' and exchange traded derivative products for freight risk management.

Quotes

"In no circumstances enter the derivatives trading market without first agreeing it in writing with me ... at some time in the future it could bring the world's financial system to its knees." Julian Hodge a Banker once said

We view them as time bombs both for the parties that deal in them and the economic system ... In our view ... derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." clamied Warren Buffett The world's greatest stock market investor, known as "the Sage of Omaha", in his Chairman's Letter in the Berkshire Hathaway 2002 Annual Report.

Former Federal Reserve Board chairman Alan Greenspan commented in 2003 that he believed that the use of derivatives has softened the impact of the economic downturn at the beginning of the 21st century.

In 2003 an agreement signed by freight derivative trading members of the Baltic Exchange was set to boost confidence in the growing freight derivatives market.

2002 saw an upsurge in the trading of freight derivatives with freight rates showing continuing volatility. The Baltic Dry Index experienced a 97% rise in 2002 and fluctuations in the tanker market have been even more pronounced - according to the Baltic Dirty Tanker Index rates for VLCCs on the West Africa to US Gulf route between September and January moving between Worldscale 38 and Worldscale 141 - a differential of over US$ 2.5 million in freight costs.

(reference 2)Yet far from showing the spectacular growth some players had been hoping for at the beginning of the year, the volume of trades actually fell, from an estimated 1.2 billion tons in 2004 to 1.1 billion tons in 2005. But if you look deeper, there were fundamental changes to the market that should pave the way for more sustainable growth in the long term.One of the most important of these developments was the change from the old FFABA contract to the new format, FFABA ’05. “This is not exactly an ISDA®contract, but it is much closer to the ISDA®contract than the old version, which can make new entrants from financial markets feel more confident in trading dry freight,”

In 2005 Singapore announced Among a raft of steps, Trade and Industry Minister Lim Hng Kiang announced expanded tax breaks on commodities trading, and said the Government may set up a clearing house for the trading of energy and freight derivative contracts.

Banks lending to the increasingly corporate (but still fragmentized) bulk shipping industry are offering risk management services beyond the basic ship finance, which is generally asset based. Not surprisingly, names like Nordea and Fortis (with large ship finance franchises) are mentioned as participants in the freight derivative markets, along with institutions such as Barclays, SG, and Calyon. Commodity trading arms of firms like Goldman Sachs and Morgan Stanley are also involved in the market. Oil traders, sometimes with sizable marine fuels businesses, also play a role offering fuel derivatives to their shipping customers.

In 2004 in a significant development for the Indian shipping industry as well as commodity traders, importers and exporters, the Multi Commodity Exchange of India Ltd (MCX), in strategic collaboration with the Baltic Exchange, London, introduced freight futures contract for the first time in the country.

Links on websites on subject

http://www.richardsbutler.com/pdf/060329_itc-freight_derivatives.pdf A paper on the freight derivative industry

(reference2): http://216.239.59.104/search?q=cache:RcG9Rq4DN38J:www.prospex.co.uk/pdf/Baltic_3_06.pdf+freight+derivative+2006&hl=en&gl=uk&ct=clnk&cd=6

Another paper suggesting that despite a

http://www.federalreserve.gov/Boarddocs/testimony/2000/20000621.htm Testimony of Chairman Alan Greenspan on Federal Reserve Board's views on the Commodity Futures Modernization Act of 2000

http://www.federalreserve.gov/pubs/feds/2005/200539/200539pap.pdf A paper which claims that

http://www.ise.ie/index.asp The home page of Irish stock exchange

http://www.nasdaq.com/ The homepage of the stock exchange

http://www.cityequities.com/
http://www.moneyweek.com

government_bond information

Other Lonympics sites