Summary
¦ Rates on Asia-Europe trade rose by more than US$1,600 per TEU (20ft equivalent unit) in the year to March.
¦ The end of the Liner Conferences in Europe has increased competition.
¦ Traditional freight contracts can be too unwieldy to manage volatile rates.
¦ Freight derivative products have been applied to the dry and wet bulk shipping markets for some years.

With record-making losses for container shipping lines hitting the headlines in 2009, many column inches have been written about the continued volatility of the container shipping market. Rates on the Asia-Europe trade have rebounded dramatically since March 2009 – having risen from around US$400 per TEU (20ft equivalent unit) to a high of over US$2,000 in March 2010, which has provided some respite for the lines, but a growing level of unease amongst shippers. Many companies found the low rates that had been achievable in early 2009 now pulled away as carriers tightened capacity.

The end of the Liner Conferences in Europe, under which two or more shipping companies agreed rates on specific routes, has sharpened the competitive environment and, as such, the effects of supply and demand on prices are felt more keenly. A huge growth in ship supply, where new capacity on order has at times reached 60% of the existing vessel pool, has ceased to be matched by dependably regular double-digit growth. Times have changed and the new environment has only amplified the volatility already existing in the market.

Managing freight exposure

Traditional freight contracts are often too unwieldy to manage this increased volatility. Whilst both carriers and shippers recognise a need for stability, neither has been prepared so far to accept the risk that comes with it. Clarkson Securities (CSL), a pioneer of freight derivatives in the bulk markets, felt this need could be met by the development of a freight derivative product which offered market participants the ability to manage their freight exposure.

Freight derivative products have been very successfully applied to the dry and wet bulk shipping markets for some years. A freight derivative is a stand-alone financial transaction alongside the underlying physical market which provides a cash flow to offset losses in the physical market. If a shipper is forced to pay a spot rate to guarantee his cargo is shipped, then he can use a derivative to provide a fixed rate and still maintain the normal commercial relationship with the carrier.

By working in partnership with an existing index provider, the Shanghai Shipping Exchange (SSE), CSL has helped develop the new Shanghai Container Freight Index (SCFI) as the market benchmark. It has also launched the Container Freight Swap Agreement (CFSA) product which allows counterparties to manage their price risk exposure, leaving them free to concentrate on their traditional core objectives. CSL executed the first CFSA trade based on hedging the forward price of a TEU from Shanghai to Europe in January 2010 and, more recently, concluded the first cleared trade via LCH.Clearnet. The advent of clearing will allow counterparties to trade without any practical credit risk and will greatly increase the number of participants in the market.

Trials

CSL has seen the most interest and biggest volume in the new product coming from the financial sector and logistics providers. These two groups, which will effectively be supplying derivative cover to their clients, are currently engaged in exploratory trades and trial positions. Furthermore, the development of an industry forum – the Container Freight Derivatives Association (CFDA) – will work to raise awareness and promote the trading of these products globally, whilst addressing any issues as they arise. The CFDA will hold an introductory meeting in Shanghai on September 14, with the choice of speakers designed to show how shippers, carriers and freight forwarders can use these products in their own businesses.

Shipping lines are entering into their own studies of the SCFI index and the cover that a CFSA can provide. We need to reach out to market participants and guide them through the process of managing risk towards a better understanding of how the volatile physical markets can actually work in their favour. Given the inherent uncertainty in the freight market at the moment and the potential negative impact the introduction of new tonnage and faltering macro-economic situation could have on rates this year and in the future, we expect to see increased take-up of container freight derivative products from the market.