Clearing of FFA Trades

Transcription

1 Clearing of FFA Trades As the freight markets strengthened in 2004, the ugly duckling industry suddenly entered the limelight, attracting new players from the financial sector. A dramatic visage of changes in the shipping business over the past few years has been the advent of increased transparency. In particular, the stringent requirements for listed IPO companies and the requisite risk management needs of outside investors in risk management products have fueled the new trend. In particular, the influ of financial investors into energy markets generally appears to have spilled over into maritime markets. Liquidity in the market in Forward Freight Agreements (FFA s) rose in parallel with the rising rates and shipping companies burgeoning pots of cash. A report by Boston (USA) based consultants Celent pegged the size of the 2004 FFA market in the region of $30 Billion, about $7.5 Billion of tanker freight and $22.5 Billion of dry cargo freight. The size of the actual market in physical freight fitures, not known with certainty, is estimated to be much larger, circa $100 Billion. FFA market proponents epect the paper freight venue, which conducted by brokers over the phone, fa and through screen based systems, to grow. A key element of growth is the infusion of Clearing, bringing a completely new dimension to shipping, with Clearing Houses, which are large wellcapitalized intermediaries, effectively enhancing the credits of owners, charterers and financial investors and guaranteeing the performance of parties to a paper trade. This is in stark contrast to a pure over the counter marketplace where people rely on an intimate knowledge of counterparties. With the Clearing entity guaranteeing the performance of its members (who, in turn, may place trades for customers, directly or through brokers), participation in the FFA market could be epanded to included non-shipping financial players. The Clearing concept was brought to the shipping industry in the mid 1980 s when the International Commodities Clearing House (ICCH) was guaranteeing transactions on the Baltic International Freight Futures Echange (BIFFEX). This clearing mechanism was typical of that for physical commodities trading in Chicago, London and New York. BIFFEX faded away in the mid 1990 s, just as the Forward Freight Agreement (FFA) market was getting going. It was not until the advent of Imare s linkup with the Norwegian Futures and Options Clearing House (NOS), in the post Enron days of late 2001, that the clearing concept came back. As the freight markets soared in 2003 and 2004, participation in the FFA markets increased commensurately, and Imare flourished. The growth of the market in turn attracted two other entrants to the clearing space, LCH- Clearnet and NYMEX, which clear thousands of contracts

2 from diverse markets every day. Unlike the traditional swaps settled directly between counterparties, cleared trades are subject to margin requirements, where a portion of the settlement value is held by a financial clearinghouse. To date, with the eception of small throughput on NYMEX, all of the clearing activity in the freight market has gone through Imare. Imare, a screen based trading system, headquartered in Oslo, offered clearing through the closely allied Norwegian Futures and Options Clearinghouse (NOS) as far back as Initially, clearing was available only to Imare members (now numbering close to ninety large owners, charterers and financial institutions) - the capability has been offered to non members, even where trades are done over the counter, since January Mr. Morten Erik Pettersen, who handles business development at Imare, describes its link with the clearing house, NOS as straight through processing. The CEO of Imare, Tom Even Mortensen, offered the view that the Clearing mechanism must be connected to how people trade, and that he views the close connection between the trading screen and the Clearing mechanism as contributing to liquidity. Imare s Mortensen, eplained that NOS (the Clearing arm tied to Imare) sought CFTC approval so that clients based in the U.S. could trade freight on the Imare screen network. According to Mr. Mortensen, the level of regulation in Norway is comparable to that of the CFTC in the U.S. including the same type of fund segregation requirements, adding that, the whole concept of of CFTC regulation is part of our structure. He says that regulation in Norway is undertaken by the Norwegian Banking and Securities Commission. NYMEX, based in New York, pioneered trading in energy futures in the mid 1980 s, and grew larger with each market gyration and new product wrinkle. Options in energy futures, always traded through a physical pit, came onstream in the late 1980 s. The physical futures and options markets, in turn, were bolstered by the invention of swaps (which necessitated a venue for market makers to lay off their risk). As the swaps market evolved during the 1990 s, along with Echange for Physical (EFP) transactions (where transactions based on NYMEX prices, with an agreed upon differential from the official futures settle to reflect a non standard location or product specification), these transactions could be given up to the Echange- meaning they were eecuted between brokers and then entered into an account as though they had been done in the NYMEX pit. In Spring 2005, LCH ClearNet, representing a consortium of UK and Continent based Echanges and financial institutions, announced that it would begin offering clearing on both tanker and drybulk freight. Market rumours were now suggesting that LCH ClearNet s activities in the freight market would not be commencing until the Autumn.

3 Clearing will not happen instantly. Mr. Philippe Van Den Abeele, Managing Director at Clarksons Securities, offered the following with respect to the timeline: I would not epect freight clearing to be up and running as a proper business before January 2006 as potential users of clearing need to be sold the benefits. Indeed, when asked about the delays at LCH, Clarkson s Van Den Abeele brought up the need to tie systems together and pointed out that not everybody in the chain LCH/ Clearing Members /Introducing Broker 's/clients is ready and postponing was a wise move. LSE spent time with Mr. Joe Raia, an e shipbroker who is the Senior Vice President of Marketing for NYMEX. His responsibilities include overseeing its vast NYMEX ClearPort system, where clearing and trading are performed on more than 150 energy futures contracts- and, now, freight futures. Mr. Raia stressed that NYMEX, regulated by the U.S. Commodity Futures Trading Commission (CFTC), is a Designated Contract Market, which means that swap transactions (such as FFAs) are regulated as though they are futures contractseven if not eecuted by open outcry in a pit. The DCM is also regulated as a futures market, and, importantly, margin funds are held in segregated accounts. According to Mr. Raia, the DCM model allows for intermediation by clearing brokers, which means that it supports the model of brokers handling client orders (rather than clients trading with each other directly). NYMEX sees the freight market paralleling its eperiences in other freight markets, and stresses that its decision to launch its freight market was based on requests from Customers. Its ClearPort system, handling diverse markets including electricity, emissions and traditional energy products, set a record recently, clearing 222,051 contracts in a single day. COSTS The Clearing Houses make their money on volume, imposing a small charge on each trade. From the point of view of a user, the costs will include one or more broker fees in addition to the actual levy for clearing. Users of the market will also be required to post margins in the form of cash or other collateral. NYMEX and Imare margins are public information; at the time of writing, LCH had not yet announced its required margins. In the unmargined over the counter market, without clearing, the costs, in the form of broker commissions, were typically some percentage of the value of the transaction, for eample 0.25% upon initiation, and again upon closing, which could be easily compared with physical brokerage alternatives on the order of 1.25% or 2.5% of freight. In the new world of clearing, it is difficult to make direct comparisons of costs and financial outlays facing traders using the various solutions. The actual Clearing fees (which are very small, on the order of $4 - $8 per contract of 1000 tons or 1

4 day on T/Cs) and the brokerage commissions reflect the actual transaction cost. Margins are not an accounting epense, but nevertheless reflect actual outlays of cash (or other collateral, such as a standby letter of credit or short term debt instruments) covering portions of the contract value. Margins, calculated using the SPAN computer model (developed at the Chicago Mercantile Echange in the early 1990 s) are set so that a deposit can be maintained with the Clearing House. Each Clearing entity will run the calculation with their own parametersmeaning the margins are not uniform. The costs facing traders will be different depending on the circumstances and relationship with the financial entity that is clearing trades. An Imare member trading for its own account would be faced with a fee that includes clearing and eecution. It is also possible for non members to place trades that are cleared through an Imare member. Traders make trades through a broker (or directly with a Counterparty) and then clearing through NYMEX or LCH will face different fees and margins depending if they are a Clearing member. NYMEX margins (and LCH margins, once announded) are flat amounts per lot, but can be changed in response to market volatility. Imare s Pettersen suggested that though its initial margins are high, considerable risk is built in. LSE spoke to a number of large institutions intending to be active once the LCH becomes up and running concerning their epectations for the market, and pricing. Responding to a question on how his bank would be handling margins and fees on LCH clearing, Mr. Mark Hubbard, Commodity Business Development Manager at ABN Amro in London, said: In the main, ABN will charge the standard Initial Margin as determined by LCH - its our (ABN's) clearing fee that will be priced according to the overall relationship profile. Mr. Ben Few-Brown, who handles FFA's at Man Financial's GNI Division, described his firm's role as "...clearing only, being able to clear business that is introduced to us by the brokers, " and also noted that he could not be specific on costs until the LCH makes their margin requirements known. As far margin requirements, he said that his company would look at both the historical price volatility of the freight contracts, and also at the specifics of each clearing customer. He said, "We reserve the right to charge more or less than the LCH benchmark, depending on our relationship and the balance sheet of the customer." The FFA brokerage community includes traditional shipping brokers but also includes financial brokers, such as ICAP, Prebon, Calyon, and GFI. Mr. Adam Sonin and Mr. Dorian Benson, who run the Tanker and Dry sides, respectively, of GFI s FFA desk, spoke to LSE for this article, emphasizing that GFI is working all three of the clearing entities. GFI was acknowledged to have put through the first

5 trade into the NYMEX Clearport system on 30,000 ton cargoes on the Singapore/ Japan route. USER VIEWPOINT In preparing this article, LSE spoke with Mr. Andrew Cazalet, a U.K. based FFA Trader for General Maritime Corporation (operators of 43 tankers- mainly Suezmaes and Aframaes). Mr. Cazalet brings more than two decades of money management and commodities eperience to his role overseeing the firm s activities in the FFA market. He says that the FFA market is used for hedging and aids in the strategic and efficient positioning of assets- a way of fiing T/C s through paper. General Maritime, by virtue of its fleet, is most active in TD5, the Suezma route from West Africa to the U.S. Gulf, and TD7, Aframaes loading in the North Sea for destinations on the North Continent. Cazalet described Clearing as etremely vital, a good thing, far better than our alternative of negotiating separate contracts, containing International Swap Dealers Association (ISDA) terms, with dozens of potential counterparties. He added that the ISDA type contracts would contain provisions regarding the entities credit ratings, threshold amounts of credit, and minimum transfer amounts (to top up the position, in the manner of a maintenance margin call). Conversations with GFI s Mr. Dorian Benson, who handles the dry cargo side, reiterated that the energy markets, where participants have epertise with derivatives and risk management techniques, are the pathway for financial players, or certainly non-shipping people, to enter the freight derivatives markets. In addition to use of the FFA s by ship operators and coal shippers, he talked about the increasing arbitrages between traded coal swap contracts, API2 (coal delivered CIF in Europe), and API4 (coal FOB in Richards Bay) against FFA s on the bellwether Capesize coal route C4 on cargo from South Africa into Rotterdam. Mr. Benson said that people involved in the movement of coal were looking into structured deals, where a freight component is part of a broader financial package. Asked about whether there will be room for three Clearing Houses in the future, General Maritime s Mr. Cazalet suggested a scenario where tanker trades gravitate to NYMEX, dry cargo moves to LCH, and Imare/ NOS continues to handle Clearing for Norwegian and other owners. He said that General Maritime has recently joined Imare/ NOS, and is in the process of putting a relationship in place with a NYMEX Clearing member. He said he epects the FFA business will move in the direction of Cleared solutions and that General Maritime will go where the volume is He said that bigger is better, noting that a default last year on NOS necessitated an additional capital call on members. The involvement of financial investor in the markets is well known. Major investment banks such as Goldman Sachs (J. Aron), Barclays and Deutsche

6 Bank and Morgan Stanley have been acknowledged to be participating in the markets as traders. Hedge Funds are said to be active, although specific names are difficult to pin down. General Maritime s Mr. Cazalet described the FFA activities of hedge funds as threefold- protecting margins where crude oil shipments are involved, hedging and arbitraging trades in listed shipping company stocks, and hedging freight where fuel oil with a delivered component is being traded. GFI s Mr. Sosin was not a liberty to name individual Hedge Funds in the FFA market, but commented that some well known names from his previous eperience in the FOREX markets were actively trading freight. He did indicate that one side of the NYMEX TC4 cargo was a Hedge Fund. The subject of options came up in two contets. Both GFI s Mr. Benson, and General Maritime s Mr. Cazalet discussed options in connection with dry cargo and tankers respectively. Both said that options markets were very limited, due primarily to the lack of grantors (sellers). According to Mr. Cazalet, the bid/ asked spreads were very wide. SIDEBAR - ORDER ENTRY The seamless interface from order entry, through screen based eecution and entry into the clearing system is a big part of the Imare pitch. However, ease of order entry has encouraged eperimentation by brokers into the electronic venue. Major FFA brokers Clarksons, Ifchor and F.I.S. will be launching an order entry system called CIF that can route orders into the LCH Clearnet. GFI, which has been at the forefront of market analytics, has developed its FreightMatch screen in order to complement its voice broking service. SIDEBAR -CROSS MARGINING Cross margining was viewed as another selling point by both NYMEX and by Imare. Referring to capital preservation, NYMEX s Joe Raia eplains that big cargo interests with margins outstanding for energy raw materials trades may see reduced margining in freight. Likewise, Imare s Mr. Pettersen said, Another thing to look at is netting. Imare and NOS have netting between routes, time and the combination, substantially reducing the required margins.

7 Trade Eample TD3: 250,000 tons crude oil, AG/ Japan- late July 2005 Worldscale WS quote 113 Flat rate (2005) Dec contract $ % per metric ton Contract spec Partial Hedge Number of Contracts 1000 metric tons/ lot metric tons hedge 50 contracts (divide by metric tons/lot) Notional Value $ 756,535 (number of contracts number of MT WS flat WS quote) ASSUMPTIONS $ 4.00 clearing fee per lot open position $ 4.00 clearing fee per lot close position 0.20% Broker FFA fee (estimated) open trade 0.20% Broker FFA fee (estimated) close trade MARGINS AND COSTS IMAREX NYMEX LCH-CLEARNET est. IMAREX MARGIN** percent of position 17% $ 128,611 IMAREX INITIATE FEE* percent of position 0.3% $ 2,270 IMAREX LIQUIDATE FEE* percent of position 0.3% $ 2,270 IMAREX INITIATE GIVE-UP percent of position 0.4% $ 3,026 IMAREX LIQUIDATE GIVE-UPpercent of position 0.4% $ 3,026 per lot NYMEX MARGIN clearing member $ 600 $ 30,000 NYMEX MARGIN**** customer $ 810 $ 40,500 NYMEX clearing broker charge varies est FFA BROKER COMM IN 0.25% of transaction $ 1,891 est FFA BROKER COMM OUT 0.25% of transaction $ 1,891 CLEARING FEE IN per lot $ 4.00 $ 200 CLEARING FEE OUT per lot $ 4.00 $ 200 est. LCH MARGIN if 2/3 of NOS $ 85,745 est. LCH MARGIN if 8% of notional $ 60,523 LCH Clearing Broker charge? varies est. FFA BROKER COMM IN 0.25% of transaction $ 1,891 est. FFA BROKER COMM OUT 0.25% of transaction $ 1,891 CLEARING FEE IN per lot $ 4.00 $ 200 CLEARING FEE OUT per lot $ 4.00 $ 200 * for IMAREX members, this is the all in cost, margins based on the SPAN curve ** IMAREX margin would be less for trades farther out in time **** Clearing brokers can charge more depending on circumstance

8 TABLE Regulated By Norwegian Options and Securities (NOS) CFTC Designation Eempt Commercial Market LCH-ClearNet Futures and Security Administation (FSA) Eempt Market Commercial NYMEX Commodity Futures Trading Commission (CFTC) Designated Commercial Market TABLE - What do they trade? NOS- Imare LCH CLEARNET NYMEX TANKER ROUTES TC1 Ras Tanura/ Yokohama TC2 Europe/ USAC TC4 Singapore/ Japan TC5 Ras Tanura/ Yokohama TC6 Algeria / Med TD3 Arabian Gulf/ Japan TD4 West Africa/ US Gulf TD5 West Africa/ US Atlantic TD7 North Sea/ Europe TD8 Kuwait/ Singapore TD9 Carib/ US Gulf TD10D Carib/ USAC TD12 ARA/ US Gulf DRY BULK ROUTES C3 Capesize coal Brazil/ China C4 Capesize coal Richards Bay/ Rott C5 Capesize coal Australia/ China C7 Capesize coal Bolivar/ Rotterdam P2A Panama TC

9 Atlantic to Pacific P3A Panama TC trans Pacific TC Basket Handyma TC Basket Panama TC Basket Capesize STATISTICS NYMEX Echange Financials Calendar year 2004 Top line revenue $ Million Year end 2004 Total assets $ Million Year end 2004 Members Equity $ Million Clearport contracts traded during Million futures contracts ( Million of which are natural gas) Million options contracts (all are natural gas) Representing 138% increase over 2003 volume Clearport open interest end Million ( Million of which are natural gas) Million ( Million of which are natural gas) STATISTICS Imare Calendar Year 2004 Top Line Revenue NK Mill Year end 2004 Total assets NK Mill Year end 2004 Member equity NK Mill Imare Year end 2004 Member equity NK 170 Mill NOS Clearing Calendar Year 2004 Tanker Trades 144,472 contracts (3,835 trades) Calendar Year 2004 Tanker Trades Value US $ Billion

10 Calendar Year 2004 Dry Trades 102,835 contracts (560 trades) Calendar Year 2004 Dry Trades Value US $ 2.29 Billion STATISTICS LCH CLEARNET