Proposed EU regulation “potentially devastating,” says the Baltic Exchange

The Baltic Exchange is getting increasingly concerned that business will move out of Europe with the EU’s plans to tighten regulation of the financial markets. The Baltic sees itself as the heart of world trade; established in the mid-18^th century, it continues to be a prominent player even today, publishing daily indices that are commonly used to settle contracts and set freight rates for up to three quarters of global seaborne trade.

The EU wants to put in place systems to eliminate what it sees as market manipulation. The European Commission is reviewing trade data and how it is used to set benchmarks; if these include shipping indices, says the Baltic, some maritime companies would leave for Asia. 

Brussels’ intention to regulate is seen by many as a natural fallout of the recent scandal over the rigging by a dozen well known banks of the London Interbank Offered Rate (Libor).  As a result, the EU wants to propagate new rules on the compilation of market indices, and has invited market stakeholders to comment on the possible new rules.

“Any attempt to impose a regulated responsibility for contributions risks either driving businesses out of the jurisdiction or reducing the quality of contribution,” the Baltic Exchange said in a submission to the EU. “Government intervention in the production or distribution processes would be potentially devastating, with unpredictable consequences.”

"What concerns us is ... the idea that we might get caught up accidentally in regulatory change which is being imposed across the piece," CEO of the Baltic Exchange Jeremy Penn says. The Exchange feels that its time-tested system of self-regulation makes it a special case, and that shipping- a private, global market- should be treated differently. “Unilateral action by the EU would either support the production of rival indices in Asia or drive the Baltic Exchange production process outside the jurisdiction," Penn said.

In summer this year, Barclays was fined $465 million by US and British authorities for manipulating the benchmark Libor. Penn says that, although there are issues with some benchmarks, “it would be a great shame if there was some assumption that all markets should be treated in the same way. The risk is they make it very difficult for the Baltic to produce what are well respected, heavily used benchmarks."

The Baltic Exchange's indices and rates were launched in 1985 and are put together by a global panel of shipbrokers- who do not trade in the market. The Baltic’s dry freight index, the BDI, is an undisputed global benchmark. "It is a fair reporting system that is robust and has passed the test of time for almost 30 years," says Professor Nikos Nomikos of the  Cass Business School. 

The larger threat of EU regulation may be faced by the couple of hundred ship broking firms in London. With an estimated $1.5 billion turnover on UK operations alone, any dilution of the Baltic’s importance will almost certainly have a fallout here. Shipbrokers in London say that the Baltic is independent and should be left alone. They fear that the rise of Asia is a threat to their businesses in any case, and the EU’s moves will only make matters worse. 

"The opportunity for third parties to produce alternative benchmarks is there at any time," Penn 
says.
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Baltic launches the BALTEX

The Baltic exchange, home of the bellwether Baltic Dry Index and others, will soon roll out a new index – the Baltex. The UK’s Financial Services Authority (FSA) has authorised its subsidiary Baltic Exchange Derivatives Trading Ltd (BEDT) to run a Multilateral Trading Facility to offer trading in Forward Freight Agreements (FFAs). The Baltex, a central screen based trading solution for the dry FFA market, will go live shortly, a Baltic press release said after a meeting of their Board on May 4.


Baltic Exchange chairman Mark Jackson said, “In establishing and funding the Baltex system, the Baltic continues its core role in facilitating the development of the shipping marketplace in all its forms. This is the right response to broad market developments and emerging regulatory change.”

Baltic Exchange chief executive Jeremy Penn said that the Baltex would be the only FFA trading platform authorised by the FSA, adding, “We are pleased to have finally received the FSA’s approval and Baltex will be opening for business very soon. We have held back the launch to allow companies wishing to participate enough time to deal with the formalities of signing documentation.”

FFAs are essentially derivatives- risk management tools that derive their value from underlying assets. In the shipping industry, the underlying asset is the freight rate for a specific physical trade route. FFAs are meant to allow interested parties to hedge exposure to the freight market and so manage their risks. Started in the early 90’s, FFAs today have evolved into more complex instruments today in line with other derivates markets; like other derivates markets, they have attracted many speculators as well.

The Baltic Exchange says that the Baltex will be “underpinned by the highest supervisory and compliance standards”, and a high level of market support. “This is a trading system created by the shipping market and presents a unique opportunity for all freight derivatives stakeholders to benefit from faster execution and a more efficient transmission to clearing. It has been designed to attract new financial and commodity-orientated participants who prefer to trade in a regulated environment,” a statement says.

The Baltex, developed over the last two years, will trade Dry Bulk voyage FFAs and Time Charter FFAs- both Trip and Average- for frequented trade routes. Based on technology developed by Elysian Systems , the BEDT run system screens will provide FFA prices live; the system will also support straight through processing to international clearing houses across the world, displaying real time information to participants but keeping the trader’s identity secret to all except the nominated broker. The Baltex will have a custom made screen layout with warnings and can be modified to individual trading needs. It will also have a ‘view only’ function for those who want to see market conditions without trading. The exchange hopes that the genesis of the user friendly system, developed in collaboration with the market, will make it a popular choice for brokers, ship owners and other interested parties.

FFAs conventional thinking says is that the market for FFAs will soon come to surpass the underlying physical market in terms of dollar value. Critics point out that the mismanagement of broader derivates was responsible in large part for the near collapse of the international financial system that hit the world recently- and that FFAs are today used similarly by many, more for speculation rather than hedging risk. That may be true, but FFAs are here to stay anyway; perhaps a well regulated Baltex will help keep malpractices out of the system.