Forward freight agreements could end risks from volatility in air freight market

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The air cargo market could see significant disruption in the way capacity is bought and sold with the launch of forward freight agreements (FFAs).

Brokerage Freight Investor Services (FIS), working with the TAC Index, is offering airlines and forwarders a range of contracts that will help both sides manage risk and balance budgets.

Brokers in the FFA markets can identify a forward spot rate, which the forwarder can buy, protecting it against a change in the spot market rate. It can then book with any carrier at the carrier’s spot rate.

If the FFA contract rate is lower than that month’s index average, the buyer will be repaid the difference.

The model could put an end to the risks of volatility which characterises the air cargo market.

For an FFA to work, it requires a well-developed freight rate index, in which the market has confidence – something the TAC Index has now achieved.

Its MD, Peyton Burnett, explained the model to The Loadstar: “For illustrative purposes, let’s assume HKG-FRA is currently trading at HK$20/kg. But it is forecast to be HK$25/kg in six months’ time. Using an FFA contract, parties can hedge against any difference in this forecast by locking in a price six months’ forward; with two parties either side of the trade at HK$25/kg.

“Move forward six months and the index spot price is actually HK$27/kg; otherwise known as the settlement price. One party will have made HK$2/kg and the other would have lost the equivalent. The hedging party would then be able to use the HK$2/kg cash to buy on the spot physical market. A simple hedge.”

Michael Gaylard, head of strategy at Freight Investor Services, added: “Users want to move away from a fixed price due to the price volatility. There is a desire to see how this works; to figure it out on an accounting basis.

“There are very few markets left which don’t have this, and definitely nothing the size of air cargo. Air cargo is an enormous market that really stands out – although one of the problems it might face is that it is quite fragmented.

“It is also a very traditional business. But there is a younger element coming forward and they do seem to be more accountable to the balance sheet.”

FIS claims the industry is looking for a “new way of managing the associated risks and increasing the visibility of forward price levels through index-linked pricing”. It said: “There is no industry standard for forecasting price and this is where FIS and TAC Index are futureproofing air cargo contracts by providing a platform for risk management”.

It added: ”The buying and selling of air cargo is a complex and high-risk undertaking. FFAs are, by contrast, a simple instrument which require no involvement with the risks associated with physical freight.”

Mr Burnett believes FFAs push markets forward – so much so that in bulk shipping, which is a 20-year-old mature FFA market, contracts trade up to seven years in advance.

He said: “This is a lot better than current air cargo physical contracts, which might trade six months to one year in the future. Remember, these FFA contracts are actual trades, not just forecasts. Financial institutions would strongly favour aircraft purchases backed by FFAs over forecasts.”

While FIS has made a name for itself in the FFA market in bulk shipping, the container industry has been reluctant to use FFAs.

Some air freight executives have argued that the air cargo market is not suited to FFAs, citing surcharges and different products that could distort the data.