Future Freight Agreement
Freight derivatives first appeared in shipping in the 1980s, when Baltic Exchange introduced BIFFEX (Baltic International Freight Futures Exchange) in 1985. BIFFEX was an official exchange where futures could be bought and sold. BIFFEX was based on an index called BFI, which was the result of daily broker valuations and a mathematical formula, while it worked in the same way as any other futures market (z.B oil). All trades were anonymous and were guaranteed by the London Clearing House, while contracts, trading dates and periods as well as other financial and legal requirements were detailed. Once the commercial account was opened and all requirements were met, the customer could buy or sell future contracts. BIFFEX operated until 2002, because although it had been in a very difficult period for almost 15 years, interest eventually declined due to the use of forward freight agreements (FFA) instead of BIFFEX. As we know very well, shipping is a very risky and volatile sector. In the past, both dry matter and oil and oil markets have fallen sharply or increased in a few days, and forecasts are very difficult (short-term), if not impossible (in the long run). To cope with their market risks, market participants can use different instruments. Fixing a temporary charter ship/naked hull is a traditional solution used to block your income (owners) or your transport costs (charterer) for a certain period of time.
However, this measure is not flexible at all, as the vessel is bound for a long period of time and the exit of a contract can be costly. Fleet diversification is another traditional instrument used by shipowners. By diversifying the fleet, a shipowner participates in several markets where market risks are shared. To overcome the disadvantages of traditional market risk management strategies, a more advanced instrument has recently been developed: Freight derivatives. Let`s look at freight derivatives, their history and use in the marine industry, and how they work. The instruments are billed using various freight price indices published by the Baltic Exchange and the Shanghai Shipping Exchange. On the other hand, compensation contracts are awarded daily through the clearing house provided for this purpose. At the end of each day, investors receive or owe the difference between the price of paper contracts and the market index. Clearing services are provided by leading exchanges such as nasdaQ OMX Commodities, the European Energy Exchange and the Chicago Mercantile Exchange (CME), to name a few. Check out our latest research on the increase in the volume of forward freight due to increasing uncertainties in global shipping. FFAs, the most common freight derivative, are traded under the terms and conditions of the Forward Freight Agreement Broker Association (FFABA).