There are basically two types of freight derivatives namely (a) freight futures (also called cleared contracts) and (b) OTC forward freight agreements (FFAs). Both types of freight derivatives are cash settled. Freight derivatives usually reference various freight rate indices published by the Baltic Exchange (for "dry" and "wet" contracts) and Platt's (e.g. Asian Wet contracts).
Freight derivatives evolved as the need of ship owners and charterers (ship hirers) to hedge against the volatility of freight rates (which is a factor of price thus profit). They allow the users to hedge against risk of a certain type of voyage over a certain period of time and a specific route (or combination of routes). Users of freight derivatives include shipowners, ship operators, oil companies and commodities trading companies.
Increasingly, they also allow investors to speculate on the freight markets. Investment banks, financial trading houses and hedge funds have trading desks specialise in freight derivatives.
A Brief History of Freight Derivatives
The history of freight derivatives can be traced to the establishment of the BIFFEX and the creation of the BFI on 1 January 1985. The BFI was a basket of freight routes and recorded the movements in dry cargo freight rates. OTC swaps on individual routes began to be traded in early 1990fs as users looked to hedge against risks relating to specific routes.
The Baltic Tanker and Dry Bulk Indices
The 'wet' tanker routes, TDI and the TCI were added in February 1998. The BFI was split in 1999 into the BCI and the BPI and the BHMI was added in November 1999. In January 2003, the BLPG was introduced.
Forward Freight Agreements (FFAs)
FFAs are cash settled privately negotiated bespoke financial contracts between two parties whereby one party agrees to pay the other party an amount equal to the difference between the contract price of the underlying index (e.g. one of those discussed above) or the contract rate of a specified route and the settlement price of the index or the route.
Freight Derivatives Trading
Freight derivatives are often traded over-the-counter through FFABA broker members (see list below) but screen-based trading is possible and becoming popular. Freight derivatives trades can be "given up" for clearing to one of the clearing houses that support such freight derivatives trades (see below list).
FFA Master Agreements
The most widely used OTC agreements are the "principal-to-principal" master agreements published by the Forward Freight Agreement Brokers Association (FFABA) and ISDA.
For transactions using the ISDA master agreement, the 2005 ISDA Commodity Derivatives Definitions also provide confirmation templates and additional provisions in Sub-Annex I. Sub-Annex A (which is Section 7(1)(c) of the 2005 ISDA Commodity Derivatives Definitions) sets out certain reference prices relating to freight derivatives.
In addition to a master agreement structure, the FFABA 2005 standard contract also incorporates provisions the 1992 ISDA master agreement (without the schedule).
Freight Derivatives Clearing Services
Clearing services are provided by IMAREX/ NOS, NYMEX/LCH.Clearnet, Clarkson Investor Services and the Singapore Stock Exchange.
FFABA Freight Derivatives Brokers
- Clarkson's Securities
- Simpson, Spence & Young
- Freight Investor Services
- BGC Partners
- BRS Futures
Freight Derivatives Exchanges & Associations
- International Maritime Exchange IMAREX
- Norwegian Futures and Options Clearinghouse NOS
- New York Mercantile Exchange NYMEX
- Forward Freight Agreement Brokers Association (FFABA)
- International Association of Independent Tanker Owners (Intertanko) and its useful collection of presentations.
Freight Derivatives Links
- BIMCO and its marvellous collection of maritime documentation including a really good archive.
- 7th Annual Dry Freight Derivatives Forum, 18-20 September 2007, Athen (Embrace the Future with Derivatives)
Last updated June 2009
The above notes are intended to highlight issues and provide only general outlines and not intended to be comprehensive nor legal advice. Where applicable, the same should be read in conjunction with, and are qualified in their entirety by, the full provisions of the relevant ISDA provisions and definitions. They shall never be used in place of professional advice. We accept no responsibility for any loss arising from any action taken or not taken by anyone using this material or using this material in conjunction with any ISDA documentation in reliance thereof. If you have any question, please contact us.^