Container Swaps - A New Horizon in Freight Derivatives

A Container Freight Swap Agreement (CFSA) is an intuitive risk management tool that allows hedging against price movements in the volatile Asian containerised export markets.

By using container swaps, participants transporting seaborne containerised goods are able to stabilise future costs and crystallise future margins in a flexible and cost-efficient manner.

The following introduction should help you to gain a firm understanding of the uses and users of container swap agreements.

An introduction to Container Swaps

Click Start to view the slides and audio of our recent webinar on Container Swaps

Click here to download a PDF version of the FIS Container Swaps Presentation

Who uses container swaps?

There are three main categories of participant who most commonly trade CFSAs; those who are net long of physical seaborne, containerised transport, those who are net short the market and those with no physical exposure, who seek to profit from market volatility by trading the pure swap.

In the case of containerised transport, a freight forwarder or end-end user/importer is usually said to be net short the underlying. That is, they do not yet have delivery of the product and are concerned that container freight rates will rise over the course of the export and shipping cycle.

A shipowner or operator, on the other hand, is net long the underlying, since they own or operate the underlying vessel and containers and might thus be concerned should the box freight market rate fall.

Speculators are most often represented by traders in investment banks. These traders use complex quantitative analysis in order to speculate on either short or long term movements in commodity markets as well as opportunities for arbitrage. Increasingly these traders can also use hedging tools against physical market exposure as they venture more and more into underlying physical business.

How are container swaps traded?

A container freight swap usually takes the form of a cash-settled agreement between two parties with an equal and opposite opinion of the future of the market. The parties agree on a price in US$ per container for a given number of containers on an agreed route during a specified period. At the end of the contract period the parties settle the difference in cash between the predetermined contract price and the actual spot market price.

If the market strengthens, and box rates increase, then the buyer of a CFSA (the long position) benefits, since by entering the agreement they have effectively paid less, in advance, for the goods than they would have done trading on the spot market. The buyer of the CFSA has successfully hedged against an increase in price of the underlying physical market.

Conversely, if the market softens, and box rates decrease, the seller of the CFSA benefits since they have effectively sold the goods, in advance, at a higher rate than they would have done trading on the spot market. In this case the seller of the CFSA has been successful in hedging against a decrease in price of the underlying physical market.

Indices and Settlement

The Shanghai Containerised Freight Index

These agreements are currently available over-the-counter with clearing at LCH.Clearnet against the Shanghai Containerised Freight Index (SCFI).

The Shanghai Containerized Freight Index (SCFI), which provides the final spot price against which all container swap agreements are settled, measures composite container box rates across 15 Shanghai export routes and is published on a weekly basis at 07:00 GMT. It is comprised of 30 volunteer panellists: 15 global shipping operators and 15 local freight forwarders. The Shanghai Shipping Exchange (SSE) administers the Shanghai Containerized Freight Index (SCFI).

Whilst the SCFI assesses 15 Asian export routes in total, LCH.Clearnet currently clears only four of these routes:

•     Far-East-US west coast (Contract Code: CEW)
•     Far-East -US east coast (Contract Code: CEE)
•     Far-East-Mediterranean (Contract Code: CNM)
•     Far-East -North Western Europe (Contract Code: CNW)

The contract lot sizes are 1 twenty-foot container (1TEU), for the European routes (CNW & CNM) and one forty-foot container (1FEU), for US routes (CEW & CEE). The pricing of these lots is measured in USD/TEU and USD/FEU respectively.

Container swap contracts cleared by the LCH are settled Asian style. This means that the final price at which the contracts are executed is calculated from the average of the index values published by the SCFI for the contract route over the contract period.

For example, let us assume that the SCFI is published 3 times during the month of July and that the prices for the Far-East to North Western Europe are published at 1300 USD/TEU, 1320 USD/TEU and 1315 USD/TEU respectively. The price at which contracts for the month of July are thus settled will thus be 1312.66 USD/TEU, representing the average of those three values.

The SCFI reflects the spot rates of Shanghai's export container transport market, which includes freight rate assessments of 15 individual shipping routes and a comprehensive index. The freight indices show the ocean freight and surcharges of individual shipping routes on the spot market on shipping routes covering all trade routes from Shanghai to the Mediterranean, US west coast, US east coast, Persian Gulf, Australia/New Zealand, West Africa, South Africa, South America, West Japan, East Japan, Southeast Asia, Korea, Taiwan and Hong Kong. For more information, please see http://en.chineseshipping.com.cn/html/scfi.asp.

The World Container Index

From September 2011, container freight swap traders will have another index option for trading and settlement - the World Container Index. Developed by Drewry Shipping Consultants and The Cleartrade Exchange, the WCI is the first Europe-based assessment of container freight rates and index production and is scheduled for launch later this year. The index will provide a new and important facility for the global market to hedge their freight rate risk and see major improvements in forward price discovery through the container derivatives market.

Significantly, the new index will be the first of its kind to report weekly freight rates on backhaul as well as headhaul routes and will provide increased efficiencies in hedging strategies for freight users dealing in bulk, commoditised and recovered cargoes. The index has been made available to a small number of lead organisations for final testing and feedback prior to launch for trading on September 1, 2011.

Contracts will be available with at least one clearing house at or soon after the launch date and subscriptions to the index will be available from August 22, 2011.

WCI Route Assessments

The WCI has also confirmed that it will collect and publish weekly market assessments for the following routes:

Shanghai to Rotterdam; Rotterdam to Shanghai; Shanghai to Genoa; Genoa to Shanghai; Shanghai to Los Angeles; Los Angeles to Shanghai; Shanghai to New York; New York to Rotterdam; Rotterdam to New York; Los Angeles to Rotterdam and Rotterdam to Los Angeles.

WCI Methodology

The WCI assessments are reports of the value of agreed freight rates between major container lines and shippers or freight forwarders. Only freight rates that are agreed between participants and on which cargo is, or is expected to move will form the assessments. Rates for quotes, tariffs, estimates, bids or offers are excluded. Rates are collected from organisations based in Asia, Europe and North America.

The rates reported by the index are spot rates with a validity of seven days to one calendar month from the date the assessment is reported. Agreed freight rates are to be reported in USD per Forty Foot Equivalent Unit (FEU), equivalent to a 40ft-long 8ft 6in-high ISO maritime container as a Full Container Load.

The value of agreed freight rates is defined as the total ocean freight including bunker adjustment factor and all other applicable surcharges, plus terminal handling charges when it is common market practice to include them, but excluding any surcharges related to inland transportation.

For further information on the World Container Index, please click here.