The basis for container derivatives is the Container Freight Swap Agreement (CFSA). It is a simple cash settled transaction, a Contract for Differences (CFD). It does not involve any physical deliveries – in this case delivery of containers or slot arrangement. On expiration the difference of the swap price agreed and the settlement price is paid in US Dollar to the relevant party. Container freight swap agreements adhere to general principles of commodity trades and financial products that trade over-the-counter (OTC). Basis for CFSAs is the previously mentioned Shanghai Containerized Freight Index (SCFI) which settles on USD per TEU.
It is January and a freight forwarder needs to ship 750 TEUs (twenty foot equivalent unit) in March. In order to avoid rising freight rates he would like to log in a price today using Container Freight Swaps. The swap rate for March for the Shanghai to Europe route is USD 1900 per TEU today. He phones a broker and bids USD 1850 per TEU for 75 lots (1 lot = 10 TEUs). The broker has got an interested party at USD 1900 to sell 75 lots for March. After very short negotiations (a few minutes) they agree a price of USD 1875 per TEU. The agreed contract will be cleared via the London Clearing House (LCH.clearnet) which guarantees for the performance of this contract (more about clearing in the small guide to contaienr swaps)
From the day the CFSA contract is entered into the March position is evaluated daily mark-to-market basis the daily forward curve provided by the container swap brokers to the London Clearing House. If the position is in the money (profitable) LCH will credit that party the difference and if the position is out of the money (loss) LCH will draw money from that party. The process takes place daily. End March the settlement price, i.e. the average price of the Shanghai-Europe route of the SCFI , is published. In our example the market has fallen to USD 1600 per TEU.
Let’s look at the result end of March:
The seller of the CFSA has gained a profit of USD 206,250 or USD 275 per TEU. The forwarder pays USD 275 per TEU less for his containers which he books with a carrier however the savings compensate for the loss he experiences on his container swap which is also USD 275 per TEU. The bottom line is that the forwarder still pays USD 1875 per TEU, exactly the price he had agreed in January. This shows no matter which way the market would have turned the forwarder had secured his shipment costs and was able to quote his clients freight in advance without being exposed to the volatility risk of the fluctuating container freight rates.