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            july 24, 2019

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Baltic Exchange decision on IMO 2020 could irk opponents, end up in court


The Baltic Exchange Index (BIC) council has made a final decision on the new International Maritime Organization (IMO) regulation that caps sulphur content in marine fuel to 0.5 per cent from January 2020.
BIC says its decision will not be a major change and will not cause a material disruption in the Forward Freight Agreement (FFA) market. This sentiment is echoed in the Baltic member responses to the IMO 2020 consultation paper, reported London's Lloyd's List.
The long-awaited decision by the Baltic Exchange about how to handle the 2020 sulphur cap is likely, however, to spark controversy.
Following the BIC's decision, Lloyd's List has been told that critics are considering legal and regulatory options. Furthermore, there are questions about how the decision will be implemented by FFA clearinghouses, in particular, the German Stock Exchange (ECC).
The BIC unanimously decided that the benchmark vessel in dry bulk time-charter indices will be "non-scrubber-fitted". It further decided that this qualified as a "scheduled change" that would not create a material disruption to the physical and derivatives markets.
What this means in practice is that, as of January 1 2020, the Baltic dry bulk time-charter indices will be priced based on a benchmark ship that is burning IMO compliant fuel.
Several market participants in the FFA trading community have argued this alters the nature of the financial contract they entered into when buying FFAs settling in 2020 or later.
They believe that because of the likely spread between high sulphur fuel oil (HSFO) and IMO 2020-compliant very low sulphur marine fuel (VLSFO), the value of those FFAs will drop because the reference ship using VLSFO will be less competitive than a scrubber-fitted ship.
They have argued that the post-January 1, 2020, reference ships should be scrubber-fitted and burning HSFO, and that a temporary parallel index should be created to track non-scrubber-fitted ships until open FFA positions are settled.
FFA trades are 'zero sum' and every million dollars lost by one participant is gained by another. The FFA market participants' argument in opposition to the BIC decision is logically one that would be posed by FFA buyers, who would lose if FFA values fell, not FFA sellers, who would gain.
The BIC specifically cited claims from Baltic panelists, including most capesize panellists, that "they would be unable to reliably provide prices for a scrubber-fitted vessel based on the current penetration in the market".
In a summary of member responses to its IMO 2020 consultation paper, the Baltic specifically cited Principle 7 of the IOSCO Principles for Financial Benchmarks, which mandates that "data used to construct a benchmark determination" should "be based on prices, rates, indices or values that have been formed by the competitive forces of supply and demand in order to provide confidence that the price discovery system is reliable" and "be anchored by observable transaction".
The BIC's assertion that its decision will not be a major change and will not cause a material disruption in the FFA market is echoed in the Baltic member responses to the IMO 2020 consultation paper, which were released on a selective and anonymous basis by the Baltic.
From a practical perspective, a key question going forward will be how FFA clearinghouses handle the BIC decision. The clearinghouses have a fiduciary duty to FFA buyers and sellers. The affected FFAs are cleared through three exchanges: SGX in Singapore, Nasdaq in the United States, and EEX in Germany.
The EEX asserted it had "the power to order suitable measures to safeguard the proper settlement of exchange transactions in the event that the relevant benchmark changes significantly or is no longer provided. This provision includes the use of alternative benchmarks if appropriate and possible".
Although it agreed that adding the wording 'scrubber-fitted vessel' does "not create a significant change in the benchmarks, having no significant change does not mean that there will be no effect on the rate reported". EEX said it had yet to reach a conclusion on that issue, and on what course it would take.

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