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Lack of investment, rate volatility and low transparency are leading some players in the air freight industry to consider the introduction of a derivatives trade.
In a presentation at the World Cargo Symposium in Doha, Eric Hasham, head of market development for NYSE Euronext, argued that the industry could only benefit from creating a commodity index which allowed trades in forward contracts.
“Indices play an important role for companies seeking forward planning certainty around prices, by allowing, for example, industry players to sell spot and forward contracts based on present pricing,” he said. “Such selling can enable companies to more reliably project future revenue streams and earnings. Such pre-sold revenue streams can even be used, in some cases, to finance asset purchases.”
Pointing to examples in the energy, metal and dry bulk sectors, he argued that the development of Forward Freight Agreements (FFA) gave carriers, forwarders and shippers protection against the volatility of freight rates. FFAs, he said, “are now a multi-billion dollar global business”.
Currently, there are no indices in the air cargo market which lend themselves perfectly to futures trading, as it requires a wide pool of contributors from across the industry as well as weekly or daily pricing. But several players have shown interest in moving towards an index that could be used in the financial markets.
Ram Menen, head of Emirates SkyCargo added his support to the idea. “It’s a good thing but the mindset has to change. It can help with the planning process and could decrease volatility. It would also allow both forwarders and shippers to hedge – it would open the field completely and create more transparency.” But, he added: “A number of things need to happen first. You need to create an index when the marketplace is normal.”
Mr Hasham cited advantages including market intelligence and risk management. He added that the benefits of derivatives contracts enabled long-term hedging and pricing at low cost, cutting counter-party risk through clearing, which would allow for wider market participation and tighter market prices. “Twelve times the underlying volumes of oil are traded through futures contracts,” he noted.
However, while derivatives have been used successfully in many industries, including in dry bulk and tanker markets, which are used for commodities that already have vast derivative markets, they have been widely derided in container shipping, a comparable industry to air freight.
A couple of years ago, in the aftermath of the collapse of Lehman Brothers and the subsequent plummeting of container volumes and freight rates, some of the major freight brokerage companies – Clarksons Securities, GFI Group and Freight Investor Services among others – began doing the rounds, touting derivatives as the new risk-management tool that would save the world’s major liner trades from the excessive freight rate volatility that followed the onset of the recession.
As is the case in air freight, key to establishing a derivative market was the need for independent indices, by which the respective forward freight rates bought and sold by the counterparties would be later settled. That obstacle was effectively surmounted with the establishment of the Shanghai Containerised Freight Index – for which 15 carriers and 15 logistics companies that are regular purchasers of sea freight deliver their average weekly spot rates on a range of container shipping routes out of Shanghai. It has been joined by the World Container Index, developed by Drewry in collaboration with Cleartrade Exchange, an “over-the-counter” marketplace that handles derivative swaps.
Brokers selling derivative products began extolling the virtues of a system that would allow shippers and forwarders to hedge against steep rate increases, and give carriers a chance to protect themselves against sudden declines in spot rates. Certainly, it made for a lot of column inches throughout 2010, especially after US bank Morgan Stanley and Belgian logistics firm Delphis, which owns European feeder operator Team Lines, concluded the first swap on five containers May 2010.
But there has been very little appetite since. Shortly after the establishment of the SCFI, then-Maersk chief executive Eivind Kolding dismissed it as a freight rates casino, a blow from which it has been hard to recover, although supporters justifiably point out that a casino is exactly what some liner trades most resemble at the moment.
Nonetheless, derivative trading has failed to gain any traction in the container trades. Part of the problem may be shipping’s natural conservatism – that carriers and shippers alike prefer the devil they know, no matter how uncontrollable he appears to be – but another aspect is clearly a deep distrust about a mechanism developed by a financial sector that many blame for much of the world’s – and the industry’s – problems.
“The idea that some banker is urging me to use something as a risk management tool, when where we are today is because they failed to have any sort of risk-management tools themselves, is not an attractive one,” the owner of a large sea freight buying firm told The Loadstar.
Mistrust of the banking industry aside, currently the idea seems to have more supporters than naysayers in the air freight industry. The first step will be a rigorous index – and some observers believe that an advance towards e-freight could accelerate the process.
If you have an opinion on the use of derivatives in either sea or air freight, please contact The Loadstar.
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Comment on this article
Michael KusuplosMarch 26, 2013 at 11:14 pm
” Such selling can enable companies to more reliably project future revenue streams and earnings. Such pre-sold revenue streams can even be used, in some cases, to finance asset purchases.”
If there is anyone out there that believes that this type of action would not have any adverse impact on our industry, I’d like to meet them. Why you ask? I have a couple bridges for sale that I’d to interest them in! Beware of those selling Snake Oil!
Alex GrayMarch 27, 2013 at 9:32 am
Whilst your well-researched and balanced article quotes an unnamed sea freight buyer as having a negative view of risk management, the likelihood is that he or she benefits from the use of derivatives wherever they look; From mortgage payments to supermarket pricing, from the cost to fill the car with petrol to their electricity bill, derivative usage is evident everywhere every day.
Uptake of derivatives by those exposed to the container freight market may be slow but this is an industry going through considerable change. The Shanghai Containerised Freight Index (SCFI) is the most commonly quoted reference point in container freight pricing and the number of contracts that now use this index as a pricing mechanism for index-linked contracts on container movements is growing rapidly.
Having been the innovators of the dry bulk, tanker and container freight derivatives products, we have identified that the process of index linked contracts is an important first step. It is only when this platform of trust and reliability is established that a vibrant and effective derivatives market can emerge.
The “optionality” which has been an enduring feature of the performance of both carriers and sea freight buyers since the inception of the container industry will eventually be entombed in history books – together with the comments of your sea freight buyer. The message to the air freight industry is a clear one; establish an index and don’t be diverted by those with a vested interest in opacity.