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Economic turmoil drives clearing boom

Morten Erichsen, ceo of NOS, on the factors behind the clearing boom

Though FFA trading volumes have declined from last year’s high levels, the percentage of trades getting done on a cleared basis has been increasing. The extreme volatility involved with bulk shipping has shifted the focus of FFA trading from OTC deals to cleared ones. The need to reduce counterparty risk to the smallest level possible combined with the performance guarantees offered by the clearing houses has allowed the major clearing houses to grow their overall businesses.

In 2002 it was estimated that fewer than 5% of all dry bulk deals were done on a cleared basis. That market had developed over the prior 15 years with the parties entering into OTC agreements, where the risk was simply a matter of one party being able to pay the other party when the bill came due. The amount of trades that began to get done on a cleared basis slowly increased into mid-2008, when estimates place cleared trades at about 50% of the entire market. At that point the physical market was heading down – quite rapidly – and FFA prices were following suit.

Counterparty risk therefore became a major concern in FFAs (as well as in the physical market itself) – leading many traders to bypass the usual OTC deals and move into cleared deals. From mid-2007, when the cleared market was estimated to 25%, it took one year to double that figure. In the weeks around mid-September into early October of 2008, the percentage of trades getting done on a cleared basis increased from 50% to 75% – and the number now stands close to 95%. Although the market value of dry bulk FFA trades is down from $150 billion at its peak to about $30 billion today, the clearing process is now a mainstay in FFAs, as the major FFA clearing houses provide a service that the industry cannot flourish without.

Tankers up to 90%

Uncertainty in the market drives trade to clearing

The tanker market developed differently from the dry sector, in that cleared trading has always been more the rule than the exception. The fact that Imarex played the primary role in developing this market since 2001 has ensured that the use of cleared trades has always been a part of the process. Cleared volumes hovered close to the 50% level for the first few years, but now stand closer to 80-90% due to the same concerns over counterparty risk that the dry bulk industry faced. Of these, some 80% are cleared through NOS.

General clearing members

Increased trading and clearing activity has also attracted general clearing members (GCMs) – that is, banks that are set up to clear FFAs on behalf of their clients. Some traders prefer to remain anonymous in the trading world, and therefore have the GCM act on their behalf, or they might just prefer to keep their funds in one central location, a GCM, and then trade various products through that same bank. GCMs offer market participants another way to trade and clear.

The direct connection between the clearing house and the GCMs provides for maximum efficiency in trading and account keeping – thereby limiting the manpower needed to enter all the appropriate data and further providing a one-stop approach to how trades are executed, tracked and marked-to-market. This streamlined process enhances a company’s ability to manage its risk – which is the end goal behind FFAs and the clearing house itself.

Clearing has become the norm

NOS is constantly looking at new ways to serve the market – as well as ideas to branch out into new products other than FFAs. “Once a platform has been developed for a tradable commodity and market participants are comfortable with the rules and protocols of trading that product, NOS is ready to step in and develop clearing models and processes that serve to minimise counterparty risk and simplify the accounting process – thereby inviting increased liquidity to the trading arena.

Cleared trading in FFAs has reached the point of critical mass and therefore will continue to grow hand-in-hand with the overall freight futures market.

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