A clearing house is a fundamental feature of FFA trading because it provides stability to the market by effectively eliminating counterparty risk and ensuring both the buyer and seller fulfil their contractual obligations.
Prior to the financial crash of 2008, the FFA market was largely traded Over-The-Counter (OTC), meaning bilateral trades, where both parties were aware of the identity of their counterparty and both bearing 100% counterparty risk. This meant that if a party to the contract defaulted, there was little recourse for the other side and the risk of financial loss was high. After 2008 it became apparent that the market required clearing and, alongside new EU regulations covering the derivatives market, almost 100% of FFA contracts have since been given up to a clearing house post trade.
The freight market is presently serviced by four clearing houses, CME (Chicago Mercantile Exchange), EEX (European Energy Exchange AG), ICE (Intercontinental Exchange) and SGX (Singapore Exchange). To see which Baltic Exchange freight futures and options are listed on each exchange please click here.
The clearing house stands in the middle of the trade. They will take the opposite position of each trade therefore becoming the seller to the original buyer’s GCM, and the buyer to the original seller’s GCM. This means they take on 100% of the risk themselves, and it is because of the threat of this default risk by the original counterparties that they impose margin requirements.