Drewry and the World Container Index have published a White Paper that explains how index-linked contracts work, the first definitive guide on the subject since widespread adoption commenced two years ago.
The White Paper, which is FREE to download from Drewry’s web site, examines the causes of recent container freight rate volatility and how index-linked contracts can help mitigate the impacts of such instability. It explains how these new contracting arrangements work with reference to current models in use and summarises the extent of industry adoption thus far. “This White Paper is a must read for any organisation considering the use of index-linked contracts,” said Drewry’s freight rate research manager Martin Dixon. “It lifts the veil on a much misunderstood subject that has the potential to transform the way in which container shipping is contracted.”
Persistent freight rate volatility is forcing container shipping to consider alternative forms of shipper-carrier contracting arrangements that enable the contract rate to vary relative to an external index. Index-linked contracts are a response to the failure of traditional fixed-rate forms of contracting to provide the necessary space, volume and price protections. “Freight rate volatility will continue to be a feature of container shipping for some time to come,” added Dixon. “How industry participants adapt to this change of circumstances will be fundamental to the future of container freight contracting and shipper-carrier relations.”
Enabling the contract rate to vary relative to an external index serves to reduce any possible divergence between contract and spot rates, so addressing the drivers of contract default. Meanwhile, the resultant exposure to wider market volatility can be mitigated through the application of dampeners, floor and ceiling limits or hedging. The White Paper goes onto explain that index-linked contracts bring other benefits, such as reduced shipper tender costs and carrier cost of sale. Adoption is growing rapidly. In May the Federal Maritime Commission (FMC) confirmed that 61 index-linked contracts covering US trades had been filed with the organisation in 2012. Drewry estimates that around 50 index-linked contracts have been signed on the Asia-Europe trade so far this year. “It is quite conceivable that by 2020 the vast majority of containerised ocean freight will be transacted on the basis of index-linked contracts,” added Richard Heath, director of the World Container Index. “Contracts will be negotiated on the basis of discounts or premiums to benchmark indices, relative to service level needs.”