Frequently answered questions about Container Freight Swap Agreements (CFSAs).
Container freight rate volatility is a concern for both shippers and carriers. As the globalization of the supply chain continues, how is the industry addressing the need to manage exposure to container freight rate volatility?
After years of helplessly enduring the ups and downs of freight rates, participants in the container freight industry can now manage their freight risk using a container freight swap agreement, or CFSA.
CFSAs provide market participants a mechanism to hedge against price movements in the Asian containerized export markets.
By using container freight swaps, we are offering clients fixed rate solutions to manage forward price risk.
There seems to be some skepticism in the market due to confusion about how container swaps work. How are prices fixed?
CFSAs are traded in a separate paper market. Rates are fixed in this forward market. The swaps are settled against The Shanghai Containerized Freight Index, or SCFI, which is produced by the Shanghai Shipping Exchange.
The SCFI measures container freight rates across 15 trade routes, and is published weekly.
The index ensures its neutrality by combining data from 30 panelists: 15 global shipping operators and 15 freight forwarders.
What are index linked service contracts, and how do they apply to the swap market?
An index linked service contract is simply a contract for container freight where the rates are linked to an index. The contract has firm commitments for volume, space, and equipment, with executable non-performance clauses.
There is a significant soft cost savings as well. There are no more negotiations mid contract. Carriers and shippers alike can now concentrate on what is important – the execution of their shipments.
If the index also has hedging instruments settled against it, both parties now have the option to manage forward price risk at any point during the contract.
Are there any limitations regarding who can enter into a CFSA?
No, freight forwarders, importers, shippers, carriers, and financial institutions can enter into a CFSA. The majority of contracts are cleared, which reduces credit risk for counterparties and, if desired, allows for anonymity in the marketplace.
Contracts can be written for a minimum of one container, and trade in monthly increments.
How does the clearing process work?
Brokers facilitate trades routes by connecting two parties who have opposite opinions about the future of the freight market. The two parties agree upon (1) a specific number of containers (2) on a particular trade route (3) over a specified period of time and (4) at an agreed freight rate.
Once all the terms are agreed upon, the brokers will send the trades to the clearing members for verification. Once verified, the exchange will post the trade in the respective parties’ accounts, and will manage the daily margin requirements.
How does the CFSA offset the risk of volatile freight rates and protect parties to the trade?
Purchasing a container swap with the opposite profit/loss profile to a physical position causes the profits or losses from each position to cancel each other out.
Whether container rates increase or decrease, the net rate paid/received is therefore fixed.
In the event that a market participant no longer wants to hold a swap position, the position can be closed out in the market.
An initial concern for the container swaps market was lack of liquidity. Is this still a concern?
With any new market, there can be liquidity concerns. This market is no different. As the market develops, liquidity increases.
Why is TSC Container Freight especially qualified to offer container swaps?
Managing forward price risk using hedging instruments is something we do every day in our company’s grain businesses. We can now apply this concept to the container freight market.
We understand the physical container market and the swap market. So we can put that understanding to work to manage container freight rate risk for our clients.