The Development of Tokenized Shipping-Related Derivatives Markets
Forward Contracts and Freight Forward Agreements- Introducing Freight as a commodity
One of the other major instruments being used in the maritime industry is Freight Forward Contract for hedging the risks associated with the volatility of price of cargo shipments.
A forward contract is a private agreement between two parties giving the buyer an obligation to purchase an asset (and the seller an obligation to sell an asset) at a set price at a future point in time. The assets often traded in forward contracts include commodities like grain, precious metals, electricity, oil, beef, orange juice, and natural gas, but foreign currencies and financial instruments are also part of today’s forward markets.
A Forward Freight Agreement (FFA) is a financial forward contract that allows ship owners, charterers and speculators to hedge against the volatility of freight rates. In simple terms, it bestows the contract owner the right to buy and sell the price of freight for future dates.
The two parties involved in a derivatives exchange transaction are, on one side, entities which are willing to bear the risks and, on the other side, those who wish to eliminate it.
Derivatives in the shipping industry are used from a risk management perspective in order to maintain the cash-flows within acceptable price ranges and curb the potential loss of income.
On the other hand, speculators are parties that gladly undertake the risk, which the hedgers minimize, in exchange for a potentially higher profit. The scope of that type of financial stakeholders who receive a high risk by expecting a fast and large gain, when they believe that a wager has high chances of success.
A standardised form of a forward contract is known as Futures
The main terms of an agreement cover
(a) Agreed route
(b) Settlement Date: Day, month and year
(c) Contract size
(d) Contract rate at which differences will be settled
(e) Settlement Index (e.g. BCI C4)
The main reason behind a decision of a shipping firm to get involved with derivatives market is hedging the risk. If a shipping company operates in the wet or dry market, exposure to unanticipated fluctuations is highly unwanted either on the cost or the revenue side, which explains the importance of forward freight agreements (FFA) and forward bunker contracts.
A typical example of such is a shipping firm which is considering to expand their fleet or shipyard construction related activities.
Among the key markets where we are considering the establishment of our index are Shangai Shipping Exchange, Taiwan Stock Exchange, and Labuan Financial Exchange.
Only if market appetite is substantial and interested parties fit requirements , Oceanus considers assigning the operating rights of such market to third party financial institutions/ authorities.
Financial Authorities by transitioning to our own Blockchain-based Ocean Freight Index will be given the opportunity to differentiate both in Asian markets and in the International markets through the establishment of novel freight related derivatives and thus attract Chinese and other interested Asian investors .Ted Huang - Chairman Board of Directors
Why a Blockchain-Powered FFAs Derivatives Market
Blockchain will make Freight Forward Agreement Derivatives more appealing for investors and other speculators by providing for a trusted-public verifiable liquid market with small transaction fees compared to OTC and the ability to short the market in order to profit from a prospective market decline which allows for high leverage ratios. Brokers will be those third parties interested in the intermediation of such financial transactions while Oceanus will bear the responsibilities related to operating the exchange.
FFA Exchange market by decoded as smart contracts and traded via our electronic marketplace powered by the blockchain technology is expected to bring down the cost per lot by around 75% of existing costs as compared to OTC markets.
Unlike a physical freight contract, the derivative model allows for the physical business to be conducted at the spot market rate whilst the derivative market provides each party with a fixed price. By transferring price risk onto the derivative contract, carriers, shippers and logistics providers must only focus on service quality and efficiency and they do not have to worry about the risk factors.
The Agricultural market was the first formalized Futures market, which makes logical sense. A farmer who still has to plant ,grow and then harvest his crops agrees to sell to a willing buyer now at an agreed price. Both parties are happy by locking in their needs. A Farmer has sold his crop and the buyer has his supply secure. The story has that the first “futures” trade took place in the 1700’s when there was a Tulip Bulb shortage in Europe – this also the first market “bubble”
• If you have Freight as in the case of a Ship Owners (you are “long” freight) you will want to hedge against the market going down so you will Sell a Contract.
• If you do not have freight cover as in the case of a Charterer (you are “short” freight) thus you will want to do the opposite and hedge against the market going up whilst you are uncovered so you will Buy a Contract.
A mistake a number of ship owners, in particular, do is try and relate the FFA market to a Charter Party. Remember we are taking about a future market, so it is a price expectation at some time in the future – a month from now or a year from now and so on. There is no physical delivery it is a Financially Settled Contract
Speculation, would be another approach by either BUYING or SELLING a Contract depending on which way you believe the market will go in the future. Mostly Traders seeing an opportunity.
Requirements for establishing a Derivatives Market
- Demand from the underlying market
- Market Volatility
- Large number of Market Participants
- Reference Price/Industry benchmark
- Reliable and Robust
- Cash Settlement
- Accepted by the marketplace
Market Participants in Tokenized Freight Derivatives Market
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