Saturday, November 08, 2008
Michelle Wiese Bockmann and Neville Smith - Friday 7 November 2008
THE freight derivatives market will learn on Monday of any major defaults from Friday’s monthly settlement deadline for October trades, following the collapse in physical bulk carrier rates last month.
November 7 was the last day traders had to settle forward freight agreements trades for October.
But many faced significant losses after wrongly betting that bulk carrier rates would rise in October, in a Chinese-led, post-Olympics bounceback that would boost demand for iron ore shipments.
Clarkson Securities chief executive Alex Gray said on Friday that the feared settlement day meltdown had so far failed to materialise.
“We haven’t seen that yet. There are going to be issues because the reality of freight is that not everyone pays on time.
“In any other month, people would say that’s alright, but because of the financial turmoil and the turmoil in shipping they are saying this month it isn’t alright. I expect that’s what we’ll confront.”
The scale of potential defaults would come down to whether or not principals decided to wait for late payments or hit the panic button, Mr Gray said.
The latter approach “will make a mess into a much bigger mess”.
Trading in FFAs was virtually at a standstill last week, ahead of the November 7 settlement deadline.
Many of the October FFA positions had been taken out before the Olympics in August, when rates were 10 or as much as 20 times higher than current levels, and optimism for an fourth quarter upturn was high.
But the unravelling global financial crisis saw rates plunge in October - capesize rates dropped 85% alone to just under $6,000 per day - triggering several bankruptices.
Clearing house LCH Clearnet told Lloyd’s List that all its October FFAs had been settled with no defaults.
LCH Clearnet, used by 20 clients to clear dry bulk freight derivatives, settles around 70%-80% of all dry FFAs.
Most concerns in the derivatives market now centre on over-the-counter trades, settled bilaterally between counterparties.
Between 20%-30% of FFA trades were conducted OTC before the financial crisis in September. That figure then dropped to less than 10% as traders questioned the creditworthiness of their traditional counteparties.
Brokers moved last week to ‘net’ off about $400m worth of FFA trades from October settlements, to cut the counterparty default risk. The deal was arranged with another clearing house, NOS.
Mr Gray said the market should be reassured that the netting facility appeared to be working but cautioned it was no panacea.
“It doesn’t help if you are due to be paying October-November-December and have a contract which is due to be paying out next year,” he said.
“You are left in a situation where you pay out in the hope [the counterparty] will still be around next year to pay you. Such are the discomforts of OTC trades.”
But he said the pressure on the market and degree of nervousness at the settlement proved the worth of clearing, where initial and daily margins are paid to guarantee trades.
“No matter what the carnage - big or small – the ultimate winner in managing freight risk going forward will be cleared FFAs. That’s a point worth making with a sledgehammer.”
As adapted from Lloyds List