 Forward Freight Agreements (FFAs) are primarily transacted on a cleared basis and will normally be based on the terms and conditions of the FFABA standard contracts as adapted by the various clearing houses. The main terms of an agreement cover: (a) The agreed route. (b) The day, month and year of settlement. (c) Contract size. (d) The contract rate at which differences will be settled.  Commissions are agreed between principal and broker.  The broker, acting as intermediary only, is not responsible for the performance of the contract.

 Freight derivatives provide a means of hedging exposure to freight market risk…  through the trading of specified time charter and voyage rates for forward positions. Settlement is effected against a relevant route assessment, usually one published by the Baltic Exchange.

 Cleared contracts are margined on a daily basis through the designated clearing houses and margins are based on a close-of-play forward assessment published by the Baltic Exchange.  At the end of each day, traders pay or receive the difference between the price of the paper contract and the market index. Clearing services are provided by :  the London Clearing House (LCH),  NASDAQ OMX Commodities (NDAQ),  the Singapore Exchange (SGX) and the  Chicago Mercantile Exchange (CME).

The BFA is a benchmark assessment, published on a daily basis intended for mark to market purposes. Example Baltic Exchange Forward Assessment for Panamax Routes covered: P1a - 74,000 dwt Transatlantic RV - Entire Month Settlement Basis P2a – 74,000 dwt Cont Trip Far East - Entire Month Settlement Basis P3a – 74,000 dwt trans Pacific round voyage - Entire Month Settlement Basis Timecharter average - Entire Month Settlement Basis BFA Panamax is based on the average of assessments made by a panel of FFA brokers.

There are two categories of freight derivatives.  One is privately-negotiated derivatives known as “over the counter” (“OTC”) derivatives or “swaps”.  The other is standardized, exchange-traded derivatives known as “futures” or cleared contracts.  One of the major differences between swaps and futures is the assumption of counterparty risk; that is,  with OTC derivatives the risk of default by either party to the FFA is assumed by the other party to the agreement (the “ counterparty”),  whereas with exchange-traded derivatives the risk of default by either of the parties is assumed by a clearing house, and the parties to the agreement only assume exposure to default by the clearing house.

 Parties seeking to hedge a price risk, i.e. to transfer it to another party which can either be another hedger with an opposite position, or a speculator.  Parties seeking to speculate in a similar exchange environment as above, given that an FFA agreement can be anonymous, and  Parties seeking gains from arbitrage i.e. to take advantage of temporary price differences of the same good in different markets (due to time lags and/or other imbalances).

 Losses of banks and other major players have amounted to billions in the recent past.  Full and complete understanding by the players is of the utmost importance when not involving professionals.  Over The Counter deals may appear less cumbersome but involve credit risks which are covered in the case of exchange-traded derivatives. END