Trade in freight derivatives, which allow shippers and brokers to hedge risk, is mushrooming as booming demand for sea transport fuels record-high shipping rates. But volatility in the derivatives has claimed several victims, leading some participants to call for tighter rules in a market expected to see turnover of $20 billion this year for dry bulk shipping alone, shipping company executives said.
"This is a new kind of product and we need more regulatory rules to make it work," Frank Tsao, chairman of the Hong Kong Shipowners Association, said of freight derivatives.
"I think it's a good idea to have more products in the financial market. If it is done properly, it will reduce the risk," said Tsao, who is also chairman of the IMC Group of companies, which owns about 50 vessels.
Heavy demand from China for raw materials ranging from soybeans to steel, combined with backlogs at shipyards and bottlenecks at ports, boosted global bulk shipping rates to record levels early this year.
Rates plunged when Beijing imposed economic austerity measures, but recovered sharply when China gradually eased restrictions on lending to importers.
Freight derivatives, where a ship owner or broker takes a position with a counterparty over where freight rates will stand at a point in the future, have been around since the 1980s.
But volume has picked up heavily only in the past year, as volatility fuels demand for risk management and creates speculative opportunities.
"Liquidity is coming in. We've got Morgan Stanley, Barclays Capital, Deutsche Bank, Standard (Bank), now the Royal Bank of Scotland," said R. Raghunath, executive vice president of Noble Chartering Ltd, a unit of commodities trading and shipping firm Noble Group.
Many traders in freight derivatives had their fingers burned earlier this year by the market's extreme volatility, which results in part from large swings in physical freight rates, as well as the participation of speculators.
"I have seen one major player gain $200 million this year, and lose $200 million in two months," said Keith Denholm, commercial director of Pacific Carriers Ltd, a unit of Malaysia's Kuok Group, during a shipping conference last week.
In one high-profile case, Hong Kong-listed bulk shipper Jinhui Holdings Co Ltd lost HK $523.98 million ($67 million) on forward freight agreements in the first half of this year, erasing its first-half profits and making Jinhui one of the very few listed shippers in the red.
The London-based Forward Freight Agreement Brokers' Association said the derivatives market was now bigger than its physical counterpart.
Participants use market information provided by the London-based Baltic Exchange.
Some derivatives are traded "on market" over an online exchange called Imarex. Those transactions are cleared by the Norwegian Futures and Options Clearing House (NOS).
However, most freight derivatives are "off market" deals traded through brokers in contracts known as Forward Freight Agreements.
Clearing-house markets, as opposed to over-the-counter trade, are vital to the development of shipping derivatives, the chairman of the Forward Freight Agreement Brokers' Association was quoted recently as saying.
NOS, the world's only clearing house for freight derivatives, has 70-plus members ranging from shipowners to financial institutions.
NOS said in its third-quarter results that a default by member Navitrans Maritime Inc in July may cause a loss of 58.6 million Norwegian crowns ($9.2 million). It planned a 60 million-crown capital boost to restore confidence after freight futures liquidity tumbled following the default.
A second clearing house for freight derivatives could be created early next year, industry executives said.
They said a number of exchanges and clearing houses, including the Athens Stock Exchange, the London Clearing House and the New York Mercantile Exchange, are in talks with the Forward Freight Agreement Brokers' Association with a view to creating a new body.
"Another clearing house - more competitive and a lot stronger - will bring us back into the (futures) hedging market," Denholm of Pacific Carriers said.