- Building FFA volumes
The stars are aligned for growth in freight derivative volumes. That’s the view of Will Chin, SGX’s head of commodities, who is extremely buoyant about the near-term prospects for FFA volumes in the dry bulk market.
The current geopolitical climate is being buffeted with uncertainty. Tension over trade wars has roiled markets from across Europe to Asia, putting a strain on underlying global economic growth.
While the macro global growth picture looks less than stellar going forward, the tide seems to have turned for the better for freight as a whole. A positive freight rate story is beginning to emerge after years of lacklustre growth. Therefore, a greater need for cargo owners to hedge their freight is combining with a generation of increasingly shipping derivative savvy traders. According to Will Chin, the stage is set for FFA volumes to rise.
However, with weekly dry FFA volumes trading on average at 21,440 lots per week so far this year, versus 23,125 lots per week in 2017, what makes SGX so positive that there will be significant trading volume growth?
It’s quite simple, says Will Chin. “Freight follows the cargo, and a lot of activity is moving eastwards.”
Having created a successful and highly liquid iron ore futures market whose annual 1.6bn tonne volumes represent 98% of the global seaborne trade, SGX has now set its sights on building on this success and bringing in more cargo interests to the FFA market.
“Freight is the integral glue that underpins the transportation of cargo from point A to B,” says Will Chin. “We are pointing out to iron ore traders how a successful physical iron ore trading strategy needs to incorporate a successful freight trading element, especially in times of rising freight rates.”
Iron ore growth
In just 10 years Singapore, a nation which neither produces, consumes nor even transships iron ore, has become the main trading hub for a US$ 100bn trade. A big part of SGX’s success in playing a key price discovery role in this sector has been down to its geographical positioning, relationships to bridge Chinese and Western participation, and ability to leverage its brand and reputation to offer a robust market infrastructure option.
Today Singapore is home to not only the big iron ore producers and traders such as Vale, BHP, Rio Tinto and Glencore, but also to the overseas offices of countless Chinese steel mills. Coupled with international banks and robust legal system, the Lion City is a key commodity trading hub for iron ore, steel and coal, in addition to hosting a large and growing community of maritime participants.
SGX has a network of offices across the Asia region, including Shanghai, Beijing, Hong Kong and Tokyo. These offices are spearheading a drive to educate the Asian market as to how shipping risks can be hedged. Roadshows and seminars are taking place around the region, speaking to the hundreds of owners, funds, steel mills and traders involved in the dry bulk trade and “connecting the dots.” The big push is to bring physical shipping participants and iron ore traders into the FFA market.
According to Will Chin, the Chinese market for FFAs can be split into two camps: on one side, those who got their fingers burnt trading freight derivatives in the 2008/09 market collapse. They have exited the markets amidst the spectacular nature of the boom-bust scenario and have blamed their losses on the speculative nature of the FFAs even though the real problem is the lack of an appropriate risk management framework in how derivatives should be traded.
On the other hand, there are those who are learning about FFAs or have touched derivatives in other markets and are open to the idea that a well-managed freight derivative trading strategy is essentially an insurance policy which can provide optionality in managing freight price volatility and subsequently a company’s cash flow.
“There is very strong and burgeoning Chinese interests in shipping as China flexes its economic muscle and play a bigger role in world trade, with more than 90% of cargo movement undertaken via the sea. Freight activity is one of the oldest indicators of macroeconomic activity, and there are more shipowners, funds and traders looking at shipping than ever before,” says Will Chin, adding that SGX enjoys relationships with many of them through not only its iron ore business, but also its equities and listings business.
The recent changes to the Baltic Dry Index (BDI), removing the less volatile handysize element, could also open the door to more liquidity in the FFA market as fund managers and Chinese investors look to gain exposure to the bulk shipping market via the well-known BDI.
Impact of One Belt One Road
Another reason to be optimistic about FFA growth, according to Will Chin, is the maritime element of the One Belt One Road project. This ambitious infrastructure development will mean more vessels ploughing the maritime silk road and moving the bulk commodities needed to construct the huge ports and terminals planned. A crucial aspect of owning, managing and operating a fleet of vessels will be the consideration of how price risk is managed. This is especially important given the elevated level of freight rate volatility.
“Freight rates is by far the most volatile of commodity prices, with no close competitor,” says Will Chin.
LNG in the mix
But it is not just combining freight with iron ore liquidity that offers opportunities for SGX. Singapore is emerging as a central trading hub for LNG cargoes. With the Baltic Exchange set to go live with its LNG freight index this autumn, SGX is excited by the prospect of playing a key role in the transition of the industry from long-term contracts indexed to oil, through delivering an additional layer of transparency in LNG freight pricing.
“The LNG market is evolving very quickly. Amidst strong and rising global LNG demand, we are seeing shifts in the demand and supply landscape in surging US exports and China becoming the number two LNG importer in 2017. Spurred on by an increasingly flexible contract structure with destination clauses being relaxed, the rise in spot LNG trades will see interest for LNG freight rates,” says Will Chin. “We think that by bridging cargo and shipping interests we can push the boundaries of what’s possible beyond the individual silos and get a new product community to think about how they can better trade LNG along the different freight routes.”
However, like any exchange, SGX launches many new contracts, some of which will inevitably fail. What makes Will Chin so positive that an LNG freight contract will work and achieve adoption?
“We see this as being very similar to the iron ore market 10 years ago. For any new product to work the market first needs to satisfy itself that the benchmark number is credible and to coalesce around this number. The Baltic’s pole position in the world of maritime indices and market leadership in shaping consensus is a key ingredient in forging integrity in the numbers and we are looking forward to the publication of the Baltic’s LNG assessments.”
He notes that SGX takes a cautious approach when launching new products:
“We don’t launch hundreds of products and see what sticks. Success for us is defined by working closely with the industry to identify a risk management need, and sweating the details of the why what and how to make the product work. Ultimately the litmus test is whether or not we’ve delivered a product which is useful from a risk management perspective.”
With the Baltic now involved in the container market through the FBX Global Container Index, is the stage set for the container shippers and carriers to start incorporating derivatives into their supply chain risk management strategies?
There are still many hurdles to leap before container derivatives can become a reality, not least the fact that there are only a few big players on the sell side (i.e. the owners of cargo space) whilst there are a huge number of shippers on the buy side. At the same time, the big shippers have the ability to pass on freight rises to consumers.
But Will Chin believes that despite the derivatives industry’s unsuccessful past attempts to create a container freight futures market, the technological revolution, coupled with squeezed profit margins, mean that companies are becoming more open-minded to the concept.
Some users in the industry are signalling the need for container FFAs notes Will Chin. “While we validate the thesis, we will need to explore how we can create a credible benchmark and gain adoption in physical contracts. When this happens, we could start to see OTC container derivatives take off.”
SGX has seen its market share in the FFA clearing market grow significantly in the past 18 months, rising from 25% to over 60% in June. 2017 saw the exit of rival clearer LCH Clearnet from the sector and SGX has been successful in attracting many of its customers.
“Clients want longevity in their clearer. They want to know that you’re going to be around in the next 10 years. Nobody wants to go through the process of being forced to change their clearer again. There is no better way to demonstrate that than getting in bed with the Baltic”.
It is clear that SGX sees freight as an important part of its strategy to build its commodities portfolio and is here for the long-run. As China continues to open up and reshape the commodities market, SGX significance as a global trading freight hub will likely gain prominence in the region for international investors seeking to mitigate their exposure to the region.
- Seaview Sailing Weekend
Come and enjoy a weekend of sailing and socialising on the Isle of Wight. The Seaview Sailing Weekend is open to company teams (three or more people) as well as individuals of all abilities teaming-up. Split into six short races aboard Mermaid boats, sailors range from expert to learner, offering competition at all levels.
There will be ample opportunities for comparing notes and socialising from arrival on Friday, 7 September evening through to lunch on Sunday, 9 September including around a three-course dinner at the Yacht Club on Saturday night with late bar, tombola and prize giving. To find out more, email Philip Bacon, AM Nomikos (UK) Ltd.
Photos from previous events can be found here.
Recent entries in the Regatta include:
Lykiardopulo & Co
Howe Robinson Shipbrokers
Holman, Fenwick & Willan
Peter Dohle Schiffahrts
- Loch Ness Challenge for Sailors’ Society
Set in the wilds of the Highlands, Sailors’ Society’s Loch Ness Challenge will test your endurance and team working skills to their limit as you canoe just under 60 miles in four days as part of a team of two.
You’ll take in some of the most breathtaking and iconic sights that Scotland has to offer as you paddle along the Great Glen Canoe Trail from Fort William to Inverness, including the length of the infamous Loch Ness.
The Sailors’ Society’s is asking each team of two for:
- a registration fee of £100 per person
- a minimum team fundraising donation of £3,000 (£1,500 per person)
Download the Loch Ness Challenge brochure here.
- Not by the letter
In a recent arbitration decision, a tribunal rejected the general principle that the obligation on a buyer under a sale contract to open a letter of credit is a condition entitling the seller to terminate if breached.
Generally, an obligation on a buyer to open a letter of credit in accordance with the contract is a condition which, if not performed in time, allows the seller to terminate the contract and claim damages.
The usual position was set out in Trans Trust SPRL v. Danubian Trading Co  2 QB 297 in which the court stated that, where a contract is concluded, “the stipulation for a credit is a condition which is an essential term of the contract…the provision of the credit is a condition precedent…to the obligation of the seller to deliver the goods. If the buyer fails to provide the credit, the seller can treat himself as discharged from any further performance of the contract and can sue the buyer for damages for not providing the credit.”
An unpredictable turn
In London Arbitration 12/18, the buyer had to open a letter of credit within two banking days from the date of the contract. There was a dispute as to the date the contract became effective but the tribunal held that even if a letter of credit had not been opened two days from the date of the contract, the seller was not entitled to terminate.
This is a questionable decision and a definitive judgment from the courts would be welcome
The tribunal reviewed the case law and considered that there was no authority for the proposition that a requirement under a contract for a letter of credit was always to be regarded as a condition. Whilst such a requirement would often be a condition precedent for the seller to perform its obligations (e.g. to load the goods on a vessel) it would not necessarily be a condition allowing termination if the buyer did not comply with the time requirements stipulated in the contract.
On the basis of the facts before them, the tribunal considered that the requirement to open a letter of credit within two days should be regarded as an intermediate term. The first shipment date was over three weeks from the date by which the letter of credit was required to be opened and the sellers themselves had acknowledged that there was a risk of delay in setting it up. In the circumstances they considered that a failure to provide the letter of credit two days after the contract date would not deprive the sellers of substantially the whole benefit of the contract so as to allow termination.
The decision (although not binding on other tribunals) suggests that there is uncertainty as to when a contractual requirement to open a letter of credit will be (i) a condition entitling the seller to terminate if it is not met or (ii) an intermediate term. Further, if it is an intermediate term, it is not clear at what point (and how far from the shipment period) a seller would be entitled to terminate if the letter of credit is not opened.
This is a questionable decision and a definitive judgment from the courts would be welcome. In the meantime, sellers should exercise caution before terminating a contract following a failure by their buyer to open a letter of credit. They could find themselves held in repudiatory breach if the provision of a letter of credit is not regarded as a condition, or if they terminate too soon. It may assist sellers to make clear in the contract that the buyer’s provision of a letter of credit is a condition of the contract (although a tribunal may not uphold the label applied by the parties).
HFW can assist with any difficult decisions as to whether and when a contract should be terminated following a buyer’s failure to open a letter of credit.
Brian Perrott and Lee Forsyth are Partner and Associate respectively at global law firm HFW. Contact Mr Perrott on +44 (0)7876 764032 or by emailing firstname.lastname@example.org. Contact Mr Forsyth on +44 (0) 20 7264 8799 or by emailing email@example.com.
- Fehr Cup 2018
On 27 June, the Baltic Exchange held the annual Fehr Cup at Surbiton Racquet & Fitness Club. Richard Fehr reviews for Baltic Briefing.
On one of the nicest days for Fehr Cup tennis in many a year, 14 pairs representing nine Baltic firms met at the Surbiton Racquet & Fitness Club to do battle for the 83rd year since the competition started in 1935. Under the watchful eye of Perry Perera, the referee, the main event went without a hitch – the highlight of the first round being a three setter between Howe Robinson 3 (Harvey McLennan &Louis Worrell) and Affinity (Ben Pusey & Charlie Bulow), the latter finally overcoming their gallant opponents 5/7 6/4 6/3.
Following a sumptuous spread laid on by the Club, the Semis and Final were played in a competitive and friendly manner, the latter under the experienced eye of umpire Costas Maramanedes. It was a matter of great regret to all that Affinity had to withdraw through injury and concede victory to last year’s winner and No 1 seed Galbraith’s (Charles Dashwood and Christian Burmester).
In a reduced American Tournament, Howe Robinson 3 (Guy Hindley & Daniel Jessel) headed Section 1 and Howe Robinson 2 (Alasdair Duke & Hector Llewellyn) topped Section 2.
Thanking the Club for their hospitality, Richard Fehr, grandson of the Cup’s presenter and former Baltic Chairman Frank E Fehr CBE also paid tribute to Perry Perera for all the hard work he put in organising the tournament, Costas Maramanedes for his on-the-day organisation and Catharine Bacon whose camera seemed to be clicking all day.
Finally thanks were made to the players for providing such an entertaining day.
To view photos from the event, click here.
- Baltic Wine Society: Spanish Tasting
On Wednesday 5 September the Baltic Exchange Wine Society welcomes back wine expert David Hughes to host a celebration of the emerging wine regions of Spain.
Guests will be welcomed with a glass of Reserva Cava followed by a further six wines of varied styles of grape, accompanied by a selection of tapas.
The event is priced at £15 for members, £20 for non-members (prices exclude VAT) which includes all seven wines and tapas.
Seats are limited so those interested in attending should register their interest in good time by emailing firstname.lastname@example.org
To view the flyer, click here.
- Member Update: 4 July
The following individuals have applied for Membership under an existing member company:
Company Individual Maritime and Port Authority of Singapore Ms W W Wan Simpson Spence Young Ltd Mr H P Oppl
The following individuals have applied for Retired Membership:
Mr A J Watts Williams
Mr G J Woodward
Any comments should be passed to Karen Karanicholas by 11 July 2018.
- Supramax reporting change
As of 2 July 2018, the Tess 52 derived 6TC value is now published using the new methodology as previously announced. The new methodology is as follows:
Derived 6TC value = Tess 58,000 10TC – 293
6TC Forward assessment = Tess 58,000 10TC BFA – 293
Please find below circulars relating to the Supramax change:
Any questions or comments should be directed to email@example.com