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China to launch first onshore dry bulk commodity freight derivative

Shanghai Shipping Freight Exchange (SSEFC), China's first freight derivatives exchange, is looking to expand the range of country-specific commodity products by launching a dry bulk commodity forward freight contract this June, according to Wu Di, the deputy president at the firm.

SSEFC was set up in 2013 under the auspices of the Shanghai Shipping Exchange and the June product launch will become China's first dry bulk commodity freight derivative. The contract will provide an alternative way for global market participants to hedge their freight exposure to the China-related shipping routes.

Currently international players mainly use freight derivatives such as forward freight agreements (FFAs) to hedge price volatility in the dry bulk commodity shipping market. These derivatives are settled against the Baltic Dry Index (BDI) and its sub-indexes, a global benchmark created by the London-based exchange for gauging the cost of transporting raw materials such as coal, iron ore and grain.

However, SSEFC is looking to create China-specific pricing products as part of its broader remit to develop Shanghai as an international financial and shipping centre in addition to promoting the internationalisation of the Chinese currency.

"BDI serves as a gauge for the global market. We hope this new product could serve as a China benchmark, effectively reflecting the physical market related to China," says Wu. "The contract will be the world's first physically delivered dry freight derivative, as opposed to FFAs which are all cash-settled."

Physical delivery in this context means providing the shipping capacity when the contract is due. The contract is quoted in dollars but it will be traded and settled in renminbi and the target clients are Chinese and international ship owners, non-vessel carriers and cargo owners, hedgers, and retail and institutional investors.

"Though the performance of the global freight market has been depressed over the last couple of years, China will still play an important role in this sector," says Wu. "Chinese enterprises were not used to derivatives for hedging their risk, but they are becoming increasingly aware of this area."

Jason Yang, a Shanghai-based FFA specialist at Seamaster Chartering, agrees with Wu that SSEFC's new product may emerge as a threat to the FFA business, but he says FFAs have certain advantages preferred by some users.

"The basic difference is that FFA is cash-settled and SSEFC's contract features physical delivery. Financial settlement is more flexible and convenient for traders," says Yang. "SSEFC's contract doesn't designate shipping routes which means it is at the disposal of charterers, but ship owners don't want their vessels to sail to dangerous places such as war zones. The transactions will likely result in legal disputes and these concerns will potentially keep market participants from trading the contract."

Seamaster Chartering is a Shanghai-based freight broker authorised by the Baltic Exchange to conduct renminbi FFA brokerage business in China.

So far SSEFC has developed three freight derivatives products: a physically settled coal forward freight contract (specifically for coal rather than the general dry bulk product that is due to be launched) designed for the domestic shipping line between Qinhuangdao and Shanghai; and two cash-settled products: an international container forward freight contract settled against the Shanghai Containerized Freight Index (SCFI) and a coal contract settled against the China Coastal Bulk (Coal) Freight Index (CBCFI).

As of May 15, the coal contract with physical delivery has an open interest of 141,911 contracts while the cash-settled container and coal products have open interest of 24,775 and 13,459 contracts respectively.

"The next step is to study the possibility of launching crude oil freight derivatives," says Wu. "We expect the introduction of crude oil futures contracts by Shanghai Futures Exchange will drive the demand for freight derivatives, but a massive growth will only be seen if the oil market gets liberalised in China or a large number of international players can participate in the trading."

While it remains to be seen if foreign players will be active in the region, Zhang Yongfeng, deputy head of the international shipping research department at Shanghai International Shipping Institute, is conservative on the outlook of Chinese players' participation in the freight derivatives market: "Most Chinese enterprises have neither good understanding nor enough experience of trading derivatives. So far they are more comfortable with long-term contracts of affreightment (COAs) than freight derivatives products in terms of hedging freight exposure."
Source: Asia Risk