Fancy a Gamble?
Hedging, OTC trading and Derivatives have arrived in the container market. Ben Hackett
The age of hedging on freight rates has arrived in container shipping. It is now possible to enter the derivatives market using the Shanghai Container Freight Index (SCFI) which covers spot rates for 15 trade lanes. The SCFI was established by the Shanghai Shipping Exchange, (SSE) on Oct. 16, 2009 with the combined, but weighted 15 routes, based on Shanghai and set at an index of 1,000.
Derivatives are a financial instrument - an agreement between two parties - that has a value determined by the price of something else. It is a financial contract with a value linked to the expected future price movements of the asset it is linked to – in this case a freight rate on a given route. There are many kinds of derivatives, with the most notable being swaps, futures, and options. However as derivatives can be placed on any sort of security, the scope of possible derivatives is nearly endless. Thus the real definition of a derivative is an agreement that is contingent on a future outcome of the underlying.
And where can we go to gamble? Singapore. The Singapore Exchange (SGX) cleared four over-the-counter (OTC) Container Swap contracts at the beginning of August. An OTC contract is a bilateral arrangement, where two parties agree on how a particular trade or agreement is to be settled in the future. It is usually from an investment bank to its clients directly. Forwards and swaps are prime examples of such contracts. It is mostly done via the computer or the telephone. They can also be done privately without going through an exchange. Transparency and regulation are two key missing items.
This is what is normally called the Fourth Market, which has no reporting requirements. These trades are not asset linked. They are worthless other than being betting instruments. A clearing house, such as the SGX, insures a futures contract, but not all derivatives are insured against counter-party risk. If a deal is heavily leveraged and it goes wrong, huge losses can be incurred, and if it goes right, huge profits. Just like roulette.
According to the announcement by the SGX, the launch of the contracts is expected to support the nascent container freight derivatives market by managing counterparty credit risk. Participants of the contract are able to gain access to SGX AsiaClear’s large pool of counterparties without the need to set up credit agreement with individual counterparty.
The clearing services for the four Container Swap contracts cover the following four major container freight routes from the Shanghai port to: North Europe, Mediterranean,US West Coast and US East Coast. The contracts are based on the SCFI. Contracts will be written on the level of the freight rate at some point in the future, thereby acting as a hedging system.
Whilst this is not a port to port transactional tool, it does mirror the industry well in that Shanghai is at one end of the largest trade routes in the world and freight rates in Europe and North America are essentially based on a range of ports. In theory a shipper using the spot market can hedge the forward freight rate movements and thereby giving himself a fixed rate for up to six months.
The first trade of a container freight swap agreement based on the Shanghai Shipping Exchange’s SCFI took place between Morgan Stanley and Delphis, whose subsidiary Team Lines operates container feeder ships in Europe. This was announced by Clarkson Securities Ltd., the derivatives broking arm of Clarkson PLC. A further one was announced by CSAV. What is interesting is that smaller shipping lines that have put their toes in the water, perhaps to hedge against dropping freight rates whilst larger ones have been very critical of the tool. A question is why we are not seeing any of the global shippers hedging their freight costs. Perhaps they are more risk averse.
Currently the length of the contracts is 3 to 6 months, but we may see this extended out a year or more as the market develops. The bottom line is that this is a gamblers part of the market. Remember that some carriers lost a fortune in 2008 hedging on the price of bunker fuel.
