Forward Freight Agreements

Abstract

From the early 1990s a new market for trading the forward value of freight emerged, primarily as a response to the needs of market players who were aware of the deficiencies of the BIFFEX contract as a hedging instrument. These players wanted a hedging tool which would provide a more precise match to their exposure in the physical market and, hence, a more accurate hedging mechanism. Since the first recorded trade of a forward freight agreement (FFA) in 1992, the market has grown at almost an exponential rate and, according to market sources, in February 2008 the total value of trades in the market was worth US$125 billion, which represents a 150 per cent increase compared to 2007.¹ In this chapter, therefore, we describe the structure and functioning of the FFA market, the trading practices, documentation and type of contract used in the trades, applications and uses of FFAs for risk management and speculation, as well as how to deal with issues such as settlement risk and basis risk.