This note provides a brief overview of the contractual mechanics of the Forward Freight Agreement Brokers Association’s standard contract (“the FFABA”), including a summary analysis of the key changes that the FFABA 2007 contract makes to the previous regime under the FFABA 2005 contract. Although the FFABA 2007 is the recommended version of the contract, it is not exclusive – i.e. parties can still use the FFABA 2005 etc. should they prefer.
Forward Freight Agreements (FFAs) are often described as a ‘bet’ between two parties on whether the market freight rate for a certain type of voyage or a certain period of time over a designated route will be higher or lower than the price struck as the basis of the ‘bet’. They provide a means of hedging exposure to freight market risk through the trading of specified time charter and voyage rates for forward positions. Settlement is effected against the relevant route assessment. The FFABA 2007 incorporates the ISDA Master Agreement 1992 (Multi currency cross-border) without its schedule (“the ISDA Master Agreement”). This version of the ISDA Master Agreement is the most widely used contract form for derivative transactions.
Even though the ISDA Master Agreement is a standard form contract, in practice it is usually tailored to the individual needs of the parties or the trade through the utilisation of an optional attached schedule. This provides for bespoke contracts under the broader ISDA Master Agreement umbrella. The FFABA 2007 contract incorporates the ISDA 1992 Master Agreement with a set of standard elections and no separate schedule, unless the parties have negotiated their own master agreement. As with the FFABA 2005 this is to create a standard form document that ensures market conformity and liquidity.
This note focuses on and highlights below some of the more significant changes made by the FFABA 2007.
a. Contract Quantity – clause 3
The clause now refers not only to ‘Total Quantity’ but also to ‘Quantity by Contract Month’. This additional definition is used when calculating the settlement sum and is important for commercial purposes.
b. Settlement Sum – clause 7
The FFABA 2007 provides an additional element to the calculation of the settlement sum. The settlement sum is now the difference between the contract rate and the settlement rate multiplied by the quantity by contract month. This means that the rate is now determined by reference to the unweighted average and not just the average of the rates.
c. Rights of Set-Off – clause 8(b)
The rights of set off have been increased to include those that are permitted under the ISDA Master Agreement, which gives both parties a right of set-off. Previously a right of set-off was only permitted by the express written agreement of the parties.
d. Netting – clause 9(a)
The FFABA 2007 mirrors the FFABA 2005 with regard to netting provisions. This means that a single balancing payment can be made between parties to cover all contracts that settle on the same day in the same currency. This has the added benefit of avoiding difficulties in certain jurisdictions, eg the US, where the laws of insolvency do not provide for setting off debts owed to an insolvent company, as long as the relevant jurisdiction recognises netting provisions.
e. Automatic Early Termination – clause 9(f)
The revised FFABA 2007 significantly strengthens the position of non-defaulting parties in the event of a default. Under the ISDA Master Agreement, Automatic Early Termination only comes about if the parties specifically agree in the ISDA Master Agreement Schedule, otherwise there is a right to terminate when an Event of Default has occurred but termination is not automatic. The new clause in the FFABA 2007 provides for Automatic Early Termination when an Event of Default occurs. The implication of applying Automatic Early Termination is that where a party has committed an Event of Default under clause 5 of the ISDA Master Agreement, an Early Termination Date in respect of all outstanding Transactions will occur immediately without the necessity to go through the notice procedure as would have been required under the FFABA 2005. The significance of this is that it allows early termination of the contract and makes an Event of Default a much more significant issue having a greater deterrent effect. This probably represents the single most important addition that the FFABA 2007 introduces and should be firmly on the radar for all market participants.
f. Calculation Agent – clause 9(b)
The Calculation Agent is responsible for the mechanical process of calculating the net amount due on the close-out of any given transaction. The amended provision alters the status quo so that the seller is the calculation agent except where the seller is in default in which case this responsibility shifts to the buyer. This provision provides an additional element of fairness and will help to maintain momentum after an event of default.
g. Law and Jurisdiction – clause 15
It is arguably clearer now that English law and jurisdiction applies as FFABA 2007 introduces a free standing provision rather than being tied to the jurisdiction clause in the ISDA Master Agreement. Anyone who trades with overseas counterparties will still need to consider whether they will be able to enforce an English judgment when determining counterparty risk.
h. Partial Invalidity – clause 19
This new severance provision renders the contract valid even if parts of it are declared illegal, unenforceable or invalid.
Like its predecessor, we expect the uptake of the new FFABA to be strong and for it to be generally used without amendment by traders, and so helping to reduce the number of bespoke agreements traded in the paper freight market. The updated FFABA 2007 contains some significant changes that will impact on day-to-day trading in the freight derivative markets. The most significant of which being that in the event of default, the FFA will be subject to Automatic Early Termination.
The new form does raise various issues as highlighted above, particularly for traders who, unlike banks or financial institutions, will probably not be negotiating full ISDA Master Agreements with counterparties. With the automatic incorporation of the ISDA Master Agreement without its schedule, there are accordingly certain provisions (such as the cross default clause or the provisions relating to additional termination events) that will not apply unless amendments are made.
In addition, as with the FFABA 2005, clauses 20 and 21 of the FFABA 2007 aim to apply the ISDA Master Agreement to all existing and future trades unless the parties agree otherwise.
The FFABA 2007 contract remains untested and it is therefore particularly important for banks and traders to understand the potential issues that could arise even if it might not be possible or desirable to amend the contract.