A broker was engaged to arrange two connected transactions in forward freight agreements (FFAs): one was to buy the average of the Panamax indices for the second quarter of the year, and the other was to sell the average of the Handymax routes for the same period.
This is known as a ‘spread’, and is entered into when a client anticipates that rates for the two types of ship will move in opposite directions. There are obviously far fewer terms to be negotiated for an FFA than for fixing a ship, and, consequently, a simple mistake can be fundamental to the viability of the whole deal. In this instance the broker mistakenly bought the Handymax FFA rather than selling it.
The customer didn’t want this FFA and didn’t want the Panamax FFA without the Handymax. Regulatory practice dictates that verbal negotiations for derivatives are recorded, and the tapes showed that the broker was at fault. If the FFA contracts were allowed to run, the cost of the mistake would not be known until the end of the second quarter. It was decided to quantify and cap the potential damage by immediately going into the market to sell the two Handymax contracts – one which had been bought in error, and a second one which had been originally ordered to create the ‘spread’. The loss amounted to some US$200,000, which the broker was asked to pay.
This expensive problem, although covered by the Club, could have been avoided if more attention had been paid throughout the negotiations, not just to the details of the individual transactions, but also to the customer’s strategy behind them.