Baltic Briefing meets Will Chin of the Singapore Exchange (SGX) who explains why he believes that the stage is set for dry Forward Freight Agreement (FFA) volume growth.

The stars are aligned for growth in freight derivative volumes. That’s the view of Will Chin, SGX’s head of commodities, who is extremely buoyant about the near-term prospects for FFA volumes in the dry bulk market.

The current geopolitical climate is being buffeted with uncertainty. Tension over trade wars has roiled markets from across Europe to Asia, putting a strain on underlying global economic growth.

While the macro global growth picture looks less than stellar going forward, the tide seems to have turned for the better for freight as a whole. A positive freight rate story is beginning to emerge after years of lacklustre growth. Therefore, a greater need for cargo owners to hedge their freight is combining with a generation of increasingly shipping derivative savvy traders. According to Will Chin, the stage is set for FFA volumes to rise.

However, with weekly dry FFA volumes trading on average at 21,440 lots per week so far this year, versus 23,125 lots per week in 2017, what makes SGX so positive that there will be significant trading volume growth?

Weekly dry FFA volumes from the Baltic Exchange

It’s quite simple, says Will Chin. “Freight follows the cargo, and a lot of activity is moving eastwards.”

Having created a successful and highly liquid iron ore futures market whose annual 1.6bn tonne volumes represent 98% of the global seaborne trade, SGX has now set its sights on building on this success and bringing in more cargo interests to the FFA market.

“Freight is the integral glue that underpins the transportation of cargo from point A to B,” says Will Chin. “We are pointing out to iron ore traders how a successful physical iron ore trading strategy needs to incorporate a successful freight trading element, especially in times of rising freight rates.”

Iron ore growth

In just 10 years Singapore, a nation which neither produces, consumes nor even transships iron ore, has become the main trading hub for a US$ 100bn trade. A big part of SGX’s success in playing a key price discovery role in this sector has been down to its geographical positioning, relationships to bridge Chinese and Western participation, and ability to leverage its brand and reputation to offer a robust market infrastructure option.

Today Singapore is home to not only the big iron ore producers and traders such as Vale, BHP, Rio Tinto and Glencore, but also to the overseas offices of countless Chinese steel mills. Coupled with international banks and robust legal system, the Lion City is a key commodity trading hub for iron ore, steel and coal, in addition to hosting a large and growing community of maritime participants.

In just 10 years Singapore, a nation which neither produces, consumes nor even transships iron ore, has become the main trading hub for a US$ 100bn trade.

SGX has a network of offices across the Asia region, including Shanghai, Beijing, Hong Kong and Tokyo. These offices are spearheading a drive to educate the Asian market as to how shipping risks can be hedged. Roadshows and seminars are taking place around the region, speaking to the hundreds of owners, funds, steel mills and traders involved in the dry bulk trade and “connecting the dots.” The big push is to bring physical shipping participants and iron ore traders into the FFA market.

According to Will Chin, the Chinese market for FFAs can be split into two camps: on one side, those who got their fingers burnt trading freight derivatives in the 2008/09 market collapse. They have exited the markets amidst the spectacular nature of the boom-bust scenario and have blamed their losses on the speculative nature of the FFAs even though the real problem is the lack of an appropriate risk management framework in how derivatives should be traded.

On the other hand, there are those who are learning about FFAs or have touched derivatives in other markets and are open to the idea that a well-managed freight derivative trading strategy is essentially an insurance policy which can provide optionality in managing freight price volatility and subsequently a company’s cash flow.

“There is very strong and burgeoning Chinese interests in shipping as China flexes its economic muscle and play a bigger role in world trade, with more than 90% of cargo movement undertaken via the sea. Freight activity is one of the oldest indicators of macroeconomic activity, and there are more shipowners, funds and traders looking at shipping than ever before,” says Will Chin, adding that SGX enjoys relationships with many of them through not only its iron ore business, but also its equities and listings business.

The recent changes to the Baltic Dry Index (BDI), removing the less volatile handysize element, could also open the door to more liquidity in the FFA market as fund managers and Chinese investors look to gain exposure to the bulk shipping market via the well-known BDI.

Impact of One Belt One Road  

Another reason to be optimistic about FFA growth, according to Will Chin, is the maritime element of the One Belt One Road project. This ambitious infrastructure development will mean more vessels ploughing the maritime silk road and moving the bulk commodities needed to construct the huge ports and terminals planned. A crucial aspect of owning, managing and operating a fleet of vessels will be the consideration of how price risk is managed. This is especially important given the elevated level of freight rate volatility.

“Freight rates is by far the most volatile of commodity prices, with no close competitor,” says Will Chin.

LNG in the mix

But it is not just combining freight with iron ore liquidity that offers opportunities for SGX. Singapore is emerging as a central trading hub for LNG cargoes. With the Baltic Exchange set to go live with its LNG freight index this autumn, SGX is excited by the prospect of playing a key role in the transition of the industry from long-term contracts indexed to oil, through delivering an additional layer of transparency in LNG freight pricing.

“The LNG market is evolving very quickly. Amidst strong and rising global LNG demand, we are seeing shifts in the demand and supply landscape in surging US exports and China becoming the number two LNG importer in 2017. Spurred on by an increasingly flexible contract structure with destination clauses being relaxed, the rise in spot LNG trades will see interest for LNG freight rates,” says Will Chin. “We think that by bridging cargo and shipping interests we can push the boundaries of what’s possible beyond the individual silos and get a new product community to think about how they can better trade LNG along the different freight routes.”

Singapore is emerging as a central trading hub for LNG cargoes.

However, like any exchange, SGX launches many new contracts, some of which will inevitably fail. What makes Will Chin so positive that an LNG freight contract will work and achieve adoption?

“We see this as being very similar to the iron ore market 10 years ago. For any new product to work the market first needs to satisfy itself that the benchmark number is credible and to coalesce around this number. The Baltic’s pole position in the world of maritime indices and market leadership in shaping consensus is a key ingredient in forging integrity in the numbers and we are looking forward to the publication of the Baltic’s LNG assessments.”

He notes that SGX takes a cautious approach when launching new products:

“We don’t launch hundreds of products and see what sticks. Success for us is defined by working closely with the industry to identify a risk management need, and sweating the details of the why what and how to make the product work. Ultimately the litmus test is whether or not we’ve delivered a product which is useful from a risk management perspective.”

With the Baltic now involved in the container market through the FBX Global Container Index, is the stage set for the container shippers and carriers to start incorporating derivatives into their supply chain risk management strategies?

There are still many hurdles to leap before container derivatives can become a reality, not least the fact that there are only a few big players on the sell side (i.e. the owners of cargo space) whilst there are a huge number of shippers on the buy side. At the same time, the big shippers have the ability to pass on freight rises to consumers.

But Will Chin believes that despite the derivatives industry’s unsuccessful past attempts to create a container freight futures market, the technological revolution, coupled with squeezed profit margins, mean that companies are becoming more open-minded to the concept.

Some users in the industry are signalling the need for container FFAs notes Will Chin. “While we validate the thesis, we will need to explore how we can create a credible benchmark and gain adoption in physical contracts. When this happens, we could start to see OTC container derivatives take off.”      

SGX has seen its market share in the FFA clearing market grow significantly in the past 18 months, rising from 25% to over 60% in June.  2017 saw the exit of rival clearer LCH Clearnet from the sector and SGX has been successful in attracting many of its customers.

“Clients want longevity in their clearer. They want to know that you’re going to be around in the next 10 years. Nobody wants to go through the process of being forced to change their clearer again. There is no better way to demonstrate that than getting in bed with the Baltic”.

It is clear that SGX sees freight as an important part of its strategy to build its commodities portfolio and is here for the long-run. As China continues to open up and reshape the commodities market, SGX significance as a global trading freight hub will likely gain prominence in the region for international investors seeking to mitigate their exposure to the region.