European Commission Directorate General Internal Market and Services' Consultation
Document on the Regulation of Indices
Response by
The Baltic Exchange
38 St Mary Axe
London EC3A 8BH
United Kingdom
Interest Representative Register ID Number 257962010025-13
Chapter 1. Indices and Benchmarks: What they are, who produces them and for which
purposes
(1) Which benchmarks does your organisation produce or contribute data to?
The Baltic Exchange publishes on a daily basis the Baltic Exchange Dry Index (BDI), the
Baltic Exchange Capesize Index (BCI), the Baltic Exchange Panamax Index (BPI), the Baltic
Exchange Supramax Index (BSI), the Baltic Exchange Handysize Index (BHSI), the Baltic
Exchange Dirty Tanker Index (BDTI) and the Baltic Exchange Clean Tanker Index (BCTI).
Each of these indices are built up from a number of components which are benchmark rates
for individual international shipping routes. There are in total 30 routes covered in the dry
bulk market and 31 routes covered in the tanker markets. In addition the Baltic compiles and
publishes forward curve rates for the freight derivatives (Forward Freight Agreement) market
and options volatilities for the purpose of mark to market and CCP margin calls.
In addition the Baltic publishes a series of weekly benchmark prices for the sale and
purchase of ships and for ship recycling. There are 6 reference prices for sale and purchase
and 6 for recycling.
All contributors to the benchmarks are shipbroking members of the Baltic Exchange, though
the information is widely available within the global shipping marketplace, including to nonmembers, subscribers to the data, those accessing it via information vendors and those
receiving it in the normal course of business from broker members of the Baltic Exchange.
(2) Which benchmarks does your organization use? What do you use each of these
benchmarks for? Has your organization adopted different benchmarks recently and if so
why?
Members of the Baltic and other market participants use most of the rates which are
published, but some are more important than others. For example the average of four key
routes in the Capesize (172,000 DWT) market, known as the 4 timecharter average (4TC), is
often used as a benchmark for the value of a Capesize ship in the global marketplace. This
rate may then be used as part of the pricing mechanism for a charter party (contract) for a
ship chartered on period (ie for a set period of time, typically one or two years rather than for
a specific trip). Similar average rates and processes are often used for charters in the
markets for smaller ships, Panamax (74,000 DWT), Supramax (52,0000 DWT), Handysize
(28,000 DWT). This process is growing in the tanker market, but overall is less prevalent.
In the case of both the dry bulk and the tanker markets the benchmarks are widely used as
the basis for settlement of derivatives contracts which are traded OTC via specialist brokers,
but which are largely then passed to one of a number of clearing houses for credit
management and settlement. There are an array of contracts and periods traded in the
derivatives market and in some cases options thereon. The most liquid contracts are for the
Capesize and Panamax 4TC and for the dirty tanker TD3 (a round trip of a Very Large Crude
Carrier - VLCC- cargo from ME Gulf to Japan), though a significant number of others trade
regularly. Settlement rates are normally, though not in each case, the average of the daily
rate for the month, which is calculated by the Baltic Exchange and distributed on the final
day of each month. Where the rates are used in physical period charter business the exact
formula used is of course decided by the two parties to the charter, with the assistance of
their broker.
(3) Have you recently launched a new benchmark or discontinued existing ones?
The market is best served by having a stable series of price benchmarks which can be used
over the long term, making it possible to trade FFAs up to four years into the future and to
settle period contracts in the physical market which in some cases go forward ten or more
years. However, the Baltic is committed to ensuring that its benchmark routes and the
associated vessel descriptions reflect the reality of the actual marketplace. We are therefore
committed to occasional adjustments to descriptions which may be implemented at short
notice as "minor changes", or to more significant modifications which require a long process
of consensus-building with the membership, the derivatives market and the CCPs. In
addition a long notice period may be required and a parallel run to establish the
mathematical relationship between the old and the new may be carried out. Discontinuing a
little-used reference price is a simpler process following consultation with the industry.
Within this calendar year we have created two new benchmark routes, TC14 which is a
clean product tanker route form W Coast USA to Europe and a new Supramax route N
China to Indonesia for a coal cargo to S China. In September 2011 we suspended route
TD11 and replaced it with TD19, a similar but redefined route. This was a result of the
imposition of EU sanctions against Syria, making the load port specified for TD11 illegal.
(4) How many contracts are referenced to benchmarks in your sector? Which persons or
entities use these contracts? And for which purposes?
About 25 different freight derivative contracts (for a number of periods each) are traded for
settlement on Baltic benchmarks.
FFA market volume are variable but in recent years have averaged 20,000 lots per week in
the dry bulk sector and 25,000 lots per month in the tanker sector. This represents 20,000
days of timecharter per week in the dry sector and 125 million tonnes of oil transportation per
month in the tanker sector.
Options volumes are between 2,000 and 4,000 lots in a typical week in the dry sector.
It is impossible to quantify the amount of business conducted in the physical market based
on Baltic benchmark rates and indices except to say that we are aware that it is now a very
prevalent mechanism. One of the main appeals is that a floating rate charter carries with it
only very modest credit risk and a party wishing to establish either fixed returns or fixed
costs is usually able to do so by using the FFA market.
The benchmarks are used mainly by owning or chartering interests, both as indicators of
returns and market trends and more specifically in contracts (charterparties) and in FFAs.
Heavy users are also operators of ships who are effectively traders who charter in vessels,
sometimes against cargo commitments they have made and sometimes on a more
speculative basis. The large commodity trading interests which are now based in
Switzerland, the USA and increasingly in Singapore, are significant users. Owners may
operate from a variety of countries, including the UK, Denmark, Norway, Greece,
Switzerland, Monaco, Germany, Singapore, China, Hong Kong, Japan, Korea etc.
The majority, but far from all of these users, are members of the Baltic Exchange.
The forward curve benchmarks are used for mark to market of both physical and derivative
forward exposures, as well as for CCP margin calculation.
(5) To what extent are these benchmarks used to price financial instruments? Please
provide a list of benchmarks which are used for pricing financial instruments and if possible
estimates of the notional value of financial instruments referenced to them.
The following are the contracts routinely traded in the freight derivatives market for which the
Baltic Exchange provides both a daily forward curve price and an end of month settlement
price.
Dry Bulk Contracts
Capesize 4 Time Charter Average ( A straight average of routes C8_03, C9_03, C10_03,
C11_03)
Individually traded Cape Routes
C3 Tubarao/Qingdao, 160,000 mt or 170,000 mt 10 per cent iron ore
C4 Richards Bay/Rotterdam, 150,000 mt 10 per cent coal
C5 W Australia/Qingdao, 160,000 mt or 170,000 mt 10 per cent iron ore
C7 Bolivar/Rotterdam 150,000 mt 10 pct coal
C8_03 Trans Atlantic round voyage duration 30-45 days.
C9_03 Delivery Amsterdam-Rotterdam-Antwerp range or passing Passero, 3-10 days ahead
of the index date, redelivery China-Japan range, duration about 65 days.
Panamax 4 Time Charter Average ( A straight average of routes P1A_03, P2A_03,
P3A_03, P4_03)
Individually traded Panamax Routes
P1A_03 Basis a Baltic panamax 74,000 mt dwt for a trans Atlantic (including ECSA) round of
45/60 days on the basis of delivery and redelivery Skaw-Gibraltar range.
P2A_03 Basis a Baltic panamax 74,000 mt dwt not basis delivery Skaw-Gibraltar range, for
a trip to the Far East, redelivery Taiwan-Japan range, duration 60/65 days.
P3A_03 Basis a Baltic panamax 74,000 mt dwt for a trans Pacific round of 35/50 days either
via Australia or Pacific.
Supramax 6 Time Charter Average ( A weighted average of routes S1A, S1B, S2, S3,
S4A, S4B) Descriptions of basket routes below.
Individually traded Supramax Route
S7 Delivery Cape Comorin / Haldia range including Sri Lanka for a trip of 20/30 days
redelivery China.
Handysize 6 Time Charter Average ( A weighted average of routes HS1, HS2, HS3, HS4,
HS5, HS6) Descriptions of basket routes below.
Tanker Contracts
TD3
260,000mt, Middle East Gulf to Japan.
TD5
130,000mt, West Africa to USAC.
TD7
80,000mt, North Sea to Continent
TD8
80,000mt, Crude and/or DPP Heat 135F, Kuwait to Singapore
TD9
70,000mt, Caribbean to US Gulf
TD17
100,000 mt crude. Baltic to UK-Cont.
TD19
80,000mt, cross Mediterranean.
TC2
37,000mt, CPP/UNL Continent to USAC
TC4
30,000mt, CPP/UNL Singapore to Japan.
TC5
55,000mt, CPP/UNL naphtha condensate, Middle East/Japan
TC6
30000mt CPP/UNL Algeria/Euromed Skikda/Lavera
TC14
38,000 mt CPP/UNL/Diesel U.S.Gulf to Continent.
It is difficult to calculate the exact value of transactions in the freight derivatives market
which are benchmarked against Baltic indices. For an accurate result we would need access
to a record of every transaction. However, we estimate that in the dry bulk market in the 12
months to 1 November derivative transactions have been valued at USD 8.6 billion, with
current open interest valued at USD 2.0 billion.
In the case of tankers we estimate the value of transactions in the 12 months to 1 November
to be USD 3.44 billion and the current open interest to be USD398 million.
(6) How are benchmarks in your sector set? Are they based on real transactions, offered
rates or quotes, tradable prices, panel submissions, samples? Please provide a description
of the benchmark setting methodology.
The shipping marketplace is arguably problematic from the point of view of benchmark
production. Each vessel is different in some small or large degree. It may be a better or
worse design from an efficiency point of view. It may be new or older tonnage which will
have an impact on its attractiveness because of perceived risks and running costs. An owner
may be seen as a high quality owner or a lower quality owner. The vessel or owner may
have a good (or bad) record with record to Port State Control inspections and detentions. In
addition, load ports and cargoes vary in terms of their desirability from the point of view of
the owner, or their costs. Some cargoes are considered dangerous and high risk (eg Nickel
Ore, which has a tendency to liquefy in certain circumstances) while other cargoes, such as
grain, may be more appealing to owners.
The shipping marketplace is a private market. Owners and charterers usually negotiate
through a broker for a transaction based on either a Voyage rate (a $/tonne rate for the
shipment of the commodity) or a Timecharter rate (a $/day rate for the use of the ship). In
each case both parties will consider what they know of available vessels and cargoes within
the window of availability required (the Laycan) and will therefore make a determination as to
the current commercial rate. Fixtures remain uncertain for a time as there are usually
"subjects" to be resolved, ie matters outstanding which need confirmation, usually from the
owner. This may for example be an issue of precise specification of the ship or the
willingness of the owner to carry certain cargoes or load or discharge at certain ports.
Once a fixture has been fully finalised and subjects lifted, information about the transaction
may become widely know in the marketplace. On the other hand it may not be disclosed
since there is no obligation to do so and neither party may have an interest in disclosure.
Equally the transaction may have been negotiated on the basis that it is P and C (Private
and Confidential), in which case both parties and the broker(s) involved have an obligation
not to disclose information.
In practice a considerable amount of reasonably accurate information does become
generally available to the market. The Baltic Exchange publishes a daily fixture report
summarising known information and also a daily market report, both covering the dry sector.
However, there is no suggestion this represents complete information and there are
occasions when it is not entirely accurate and may be corrected later. The tanker sector
trades in a somewhat more standardised way with most business being fixed on a voyage
basis and with relatively fewer participants the market may be considered somewhat more
transparent.
It should also be understood that although it is important to provide the benchmarks at a
specific time on a daily basis which are used for settling derivatives contracts and other
benchmark-based transactions, not all routes will be fixed every day, or even have business
quoted with any real reliability.
Thus the Baltic Exchange has developed a carefully defined methodology for the production
of its benchmarks which reflects the difficulties in reporting this complex market and which
exploits certain characteristics of it which allow for the production of credible and reliable
indices on an impartial basis.
As explained above, in the international shipping market there is no reliable reporting of bids,
offers and transactions, and such transactions take place on a truly global basis . More
significantly, no two transactions can be considered to be identical. This is particularly in the
timecharter market, but it remains true also in the voyage market
The advantage in this matter which is enjoyed by the global shipping marketplace is the
presence of truly independent, competitive, commission-earning brokers. Many persons in
the shipping market will describe their profession as that of a shipbroker. A person working
for a commodity house who is responsible for contracting the tonnage they require will call
himself a shipbroker. Equally the representative of an owner, where working directly for the
owner or in a separate but tied company, will also be a shipbroker.
However, the bulk of business is in the end transacted through intermediaries which are
competitive shipbroking firms. These firms are paid purely on the basis of a commission for
each transaction they negotiate. They do not invest in the market and therefore, critically,
represent a neutral and independent source of information on the market. This situation may
well be completely unique to shipping.
The Baltic prices its benchmarks only on the basis of contributions from a panel of
competitive shipbrokers who are members of the Baltic Exchange and who agree to provide
their professional assessments of the prevailing market rate each day at the time of
submission. Baltic panellists are selected on the basis that they have specific expertise in
the routes they report and are capable of making appropriate assessments of the prevailing
open market rate, taking into consideration appropriate factors. Such factors would include
available vessels and cargoes, current negotiations, recent fixtures (adjusted as appropriate
to reflect the benchmark trip), market sentiment etc. We avoid using panellists who have a
limited scope of business or are heavily reliant on a small number of clients and might
therefore be subject to untoward influence. The panellist is guided by the Manual for
Panellists which provides guidance as to factors which should or should not be considered in
providing assessments.
For each route the Baltic creates and publishes a mathematic average of all of the
submissions.
(7) What factors do you consider to be the most important in choosing a reliable benchmark?
Could you provide examples of benchmarks which incorporate these factors?
Baltic benchmarks are neutral and reliable because the source of the information, the
panellists, do not trade the market on their own account. The Baltic also keeps all
contributions confidential, which protects the panellists from any potential attempt to
pressure them over their returns. The Baltic Exchange of course is also a neutral and
independent party.
Chapter 2. Calculation of Benchmarks: Governance and Transparency.
(8) What kinds of data are used for the construction of the main indices used in your sector?
Which benchmarks use actual data and which use a mixture of actual and estimated data?
As discussed above, although actual transactions may be an influence or even the definitive
factor for a broker making a submission, the panellist is asked to provide his or her
assessment of the prevailing open market rate. All inputs are therefore estimates.
(9) Do you consider that indices that do not use actual data have particular informational or
other advantages over indices based on actual data?
In the case of the shipping market the lack of transparency means that the exclusive use of
actual transactional data would produce a very partial result. It would also not permit the
necessary expert adjustment to bring each transaction in line with the actual benchmark,
recognising that the marketplace is far from standardised. Any requirement to use actual
data would be impractical.
It would also expose the market to manipulation as participants would be inclined to make
certain transactions known and keep others secret.
(10) What do you consider are the advantages and disadvantages of using a mixture of
actual transaction data and other data in a tiered approach?
This would make no sense in the shipping market if carried out on a mathematical basis as
the relationship between each actual transaction and the benchmark ship or voyage needs
expert assessment and analysis. Some of this analysis is mathematical and some is more
subjective, but it cannot be reduced to a formula.
(11) What do you consider are the costs and benefits of using actual transactions data for
benchmarks in your sector? Please provide examples and estimates.
As discussed, we consider that there are no benefits and infinite costs. This is because at
any given time the picture of known transactions is a partial and incomplete one. One of the
advantages of the Baltic's panellist method is that the panellists are able to filter out
information which they consider is not reflective of the true market, eg a fixture based on an
old, unrepresentative ship, a ship which has failed on subjects and is therefore "distressed"
(ie needed to find a cargo quickly at almost any price), a cargo whose expected ship has had
an accident en route and is therefore in urgent need of refixing. Using actual data without
any filter would often allow these short term and unrepresentative distortions to be captured
in the benchmarks.
Equally if a tight filter is applied, there may be lengthy periods where a specific trip is not
fixed at all on the defined basis.
Shipping is a very mobile business, with the number of staff needed in any chartering
operation being small. This means that if a regulator imposes a burden which is considered
to be undesirable then it would be easy for shipping activities to relocate away from the EU
shipping centres to the already growing centres of Singapore, Hong Kong, China, Japan,
Korea and India. Many in shipping would regard an obligation to disclose confidential
business, even on an anonymous basis, to be unacceptable.
(12) What specific transparency and governance arrangements are necessary to ensure the
integrity of benchmarks?
The Baltic Exchange has appropriate transparency and governance arrangements in place.
There are established, documented and appropriate criteria for the appointment of
panellists. Inputs from panellists are reviewed on a daily basis by a team of experienced
shipbrokers working at the Baltic. They are able to contact panellists to discuss their
contributions with them should the input appear surprisingly high or low or be obviously
erroneous. The Baltic team are not authorised to alter panellist inputs and do not instruct
panellists to make a change. They do review the thinking with the panellist to ensure that all
appropriate factors have been considered. Any change is made only at the behest of the
panellist. Note is kept of conversations. Each year every panellist is visited by a member of
the freight market information team and a discussion is held to ensure that the appointment
of the panellist remains appropriate. This will mean confirming that the panellist continues to
see enough business in the routes reported and maintains sufficient staff to meet the
panellists obligations. The accounting firm Moore Stephens reviews annually to ensure all
such "audit" visits have been carried out and also routinely tests the computer systems each
quarter to ensure that the calculations of all the benchmarks, indices and averages are
accurate.
The overall process of management of the indices is the responsibility of the board of the
Baltic Exchange and is supervised by a committee of the board know as the Freight Indices
and Futures Committee, which includes staff of the Baltic and industry representatives as
well as Directors of the Exchange. Regular review includes consideration of charts made
anonymous showing the inputs of each panellist over the period. This enables the
Committee to establish if the performance of any panellist requires further review.
Committee members are all experienced shipbrokers, derivatives traders or brokers.
(13) What are the advantages and disadvantages of imposing governance and transparency
requirements through regulation or self-regulation?
Although the Baltic Exchange is a self regulated organisation which also provides a degree
of regulation of the shipping marketplace operated by its members (especially via the Baltic's
Code of Conduct), the success and use of its indices is in the end a commercial decision by
market participants. The indices are used because they are perceived to be independent,
reasonably accurate reflections of the market, appropriately constructed and managed, fit for
purpose and available at reasonable cost. In the event the market consensus moved away
from this view there are many other providers who already publish freight rates or could do
so. The barriers to entry are low.
There are no particular advantages to changing a system which at present functions to the
satisfaction of the industry and where the industry has a choice should it be unhappy.
(14) What are the advantages and disadvantages of making contributing data or estimates to
produce benchmarks a regulated activity? Please provide your arguments.
Contribution of data to the Baltic benchmarks is at present a voluntary activity. Panellists
must be members of the Baltic Exchange and there is a cost associated with this. They are
granted free access to the classes of data to which they contribute, but there is a burden and
therefore a commercial cost associated with contributing to an index. There are also
perceived benefits, largely in terms of status and reputation.
Nonetheless is it is not always seen as a net benefit to a broking firm to contribute to the
index production process. If the burden of responsibility is increased, fewer will choose to
contribute.
Making contribution compulsory in response would be a very complex process involving the
imposition of an entire regulatory and authority structure over a process which currently
works well. In addition, shipping is an extremely mobile marketplace where much of the
business has already migrated to new centres in Asia. Any increase in the burden and cost
of business in Europe will accelerate this process.
It is noted that draft additions to the Market Abuse Directive make it an offence to
provide a misleading contribution to a market benchmark even in the case of bona
fide error. Many participants will choose not to contribute at all if this drafting as
adopted.
(15) Who in your sector submits data for inclusion in benchmarks? What are the current
eligibility requirements for benchmarks' contributors?
Contributions are only from experienced competitive shipbroking firms who do not have their
own money invested in the market. They must be members of the Baltic Exchange and must
be sufficiently expert in the routes on which they report to provide a rate on a daily basis.
They must also have sufficient staff to ensure they can make returns every day. Brokers
who are reliant on business from a narrow range of sources are not selected as panellists.
(16) How should panels be chosen? Should safeguards be provided for the selection of
panel members, and if so which safeguards?
Panels should be chosen wherever possible from among those who do not have direct
financial interest in the market, but who do routinely have access to a good understanding of
market levels.
Much can be achieved through clarity and communication. The Baltic publishes in its Manual
for Panellists its selection criteria for contributors and makes this information widely available
to the industry. It can receive (usually informal) advice from market participants as to any
concern about an individual panellist (usually to the effect that they do not see sufficient
business to be an appropriate panellist), or support for an approach to a potential new
panellist.
Consideration of the appointment of a panellist can include both qualitative and qualitative
analysis of their business.
All panellists are members of the Baltic Exchange and subscribe to the Code of Conduct
which makes it clear that the wilful provision of misleading or erroneous information is an
offence.
(17) How should surveys of data used in benchmarks be performed? What safeguards are
necessary to ensure the representativeness and integrity of data gathered in this way?
Contributions should be routine and electronic. Audit trails can then be automatically
maintained. Once a contributor has been appointed to a panel they should be obliged to
contribute each time the benchmark is priced. This will avoid the obvious peril of the third
party (benchmark publisher staff normally) being in a position to "cherry pick" rates.
Contributions from intermediaries should always be kept confidential so that they are
protected from any attempt to influence them by their clients.
(18) What are the advantages and disadvantages of large panels? Even in the case of large
panels could one panel member influence the benchmark?
The Baltic has established a minimum panel size of 5 panellists for any physical market
pricing. In the case of the forward curve information this is not always possible, but this data,
although important, is less critical as it does not normally form the basis of an actual
transaction.
In some cases certain routes involve more than 20 panellists, but we consider this to be too
many and are making efforts to reduce the roster over time. A maximum of about 12
panellists allows effective management and review. The minimum number of 5 is intended to
ensure that the market is properly and fully reflected as not all brokers will each day have
access to complete information. It is not based on any assumption about the desire to
manipulate or the practicality thereof. Nonetheless it is clear that there is a balance to be
struck. A larger panel makes review and management more cumbersome, but reduces the
impact of any attempted manipulation. In other words manipulation will be harder to spot but
will have less impact. In our view the key is to have the right quality of contributor rather than
any specific number, and an appropriate method for choosing them which can be properly
audited. In recent times we have sought to expand the geographic coverage of the panels,
which tends to increase the number of contributors.
Detailed review of contributions, either in real time or post facto is also important.
It is unwise to design a process (eg the number of panellists) to reduce the impact of
manipulation by one or more parties. The selection process and criteria are the place to
protect against this.
(19) What would be the main advantages and disadvantages to auditing of panels? Please
provide examples.
We consider real-time review and audit to be a useful method in the rather opaque shipping
market. In most markets where a panel is used, the audit process would need to be
developed based around the reporting rules and the nature of the market. If for example the
panel is required to report on their own actual transactions taking place within a certain
window, it would be fairly easy to audit records. In the event more subjective judgement is
called for then any later audit is largely meaningless, even if detailed records are kept.
Nonetheless it is important to review comparative historic inputs to see if any pattern can be
seen which causes concern. Equally it is important regularly to review the panellists to
ensure that their business continues to meet the baseline qualifications which were the basis
for their original qualification.
(20) Where indices rely on voluntary contributions, do you consider that there are factors
which may discourage the making of these contributions and if so why?
Any increased regulatory burden and sanction is likely to discourage the best qualified from
contributing. Any attempt to impose a regulated responsibility for contributions risks either
driving businesses out of the jurisdiction or reducing the quality of contribution.
It is noted that draft additions to the Market Abuse Directive make it an offence to
provide a misleading contribution to a market benchmark even in the case of bona
fide error. Many participants will choose not to contribute at all if this drafting as
adopted.
(21) What do you consider to be the advantages and disadvantages of mandatory reporting
of data? Please provide examples.
There would be considerable advantages to mandatory reporting of price data on concluded
trades in highly liquid, standardised and commoditised markets provided of course that a
large proportion of transactions throughout the 24 hour period were captured. This would
therefore require a global initiative.
In opaque, truly global markets such as shipping, where the commodity being traded is far
from standardised, mandatory reporting seems impossible to implement. If such a proposal
were implemented within a limited arena such as the EU it would encourage migration of
business away from the jurisdiction. In shipping there is no industry-wide consensus in
favour of greater transparency and since there is no widespread discontent with the
benchmarks available, little incentive for change.
(22) For entities contributing to benchmarks which are regulated by financial regulation, what
would be the advantages and disadvantages of bringing their benchmark submissions under
the scope of this framework?
No Response
(23) Do you consider that responsibility for making adjustments if inadequate data is
available should rest with the contributor of the data, the index provider or the user of the
index?
This function is best done by the contributor of the data. If some contributors have less data
available than others, then they will need to exercise more judgement. However, any
judgement calls will be moderated by the contributions made by those with access to more
data. If the index provider exercises judgement then there is no moderating effect from a
third party. It gives the provider too much power or responsibility. It is also noteworthy that
the index provider is not usually "in the market" and is therefore not in an expert position.
This would be true of the Baltic, BBA, the Oil Price Reporting Agencies etc.
It is not possible for the user to exercise judgement as to the correct outcome as the
purpose of a benchmark is almost always to offer an independent data point.
(24) What is the formal process that you use to audit the submissions and calculations?
Baltic Exchange staff review submissions on a daily basis and call back contributors for
consultation in the event the rate contributed appears outside the range for the market. This
may be because of error in submission, because not all relevant factors have been properly
considered or because the panellist is aware of market factors not being considered by
Baltic staff. Following such consultation the panellist may choose to amend his rate.
However, this decision rests with the panellist alone.
Each panellist is visited by Baltic staff once per annum and a review of the quality of their
inputs relative to other panellists is conducted. In the event it is clear that they remain
qualified to be panellists because of the quality of their contributions and the overall shape
and resource level of their business, then they are re-appointed as panellists. Accounting
firm Moore Stephens reviews to ensure that this audit process is completed.
Once each quarter Moore Stephens checks the calculation of rates and indices to ensure
that the computer system used is not introducing any errors.
(25) If there are any weaknesses identified in the audit, who are they reported to and how
are they addressed? Is there a follow up process in place?
Weaknesses can be reported to the Freight Indices and Futures Committee and or to the
Chief Executive for review and action.
(26) How often are submissions audited, internally or externally, and by what means? Do
you consider the current audit controls are sufficient? What additional validation procedures
would you suggest?
Submissions are reviewed on a routine and daily basis.
The performance of panellists is reviewed with them annually and approximately once per
quarter by the Freight Index and Futures Committee.
Accountants Moore Stephens audit the calculation processes once per quarter.
These controls are considered sufficient.
(27) What are the advantages and disadvantages of a validation procedure? Please provide
examples.
The daily review, audit or validation process carried out by the Baltic Exchange ensures that
there is focus from the contributing panellist on the matters which need to be considered. In
the event this was not carried out there would be a real risk of contribution quality declining
through inattention and ignorance.
The process allows the panellist to reconsider contributions, especially in the event Baltic
Exchange staff are able to provide additional market information regarding recent fixtures or
negotiations, or to defend the input provided. For example staff may suggest that a particular
fixture known to have taken place is relevant, or the panellist may argue that it needs to be
considered only partially relevant because of the age of the ship or delivery area or unusual
cargo contemplated.
(28) Who should have the responsibility for auditing contributed data, the index provider or
an independent auditor or supervisor?
The most important factor is the establishment of clear guidelines and processes for the
creation of the index. Only when this has been put in place can an audit be useful as only
then will it be clear what and audit might usefully check or test. The index provider should
then consider what audit might add value and confidence to the process and should make
use of third parties to audit as and when value can be added.
It is important to understand that with many indices and benchmarks, audit will necessarily
be limited to processes and systems as it will not be possible meaningfully to audit the
source market data itself.
The index provider will need to consider what audit is appropriate recognising the nature of
the market and the data provision process chosen.
(29) What are the advantages and disadvantages of making benchmarks a regulated
activity? Please provide your arguments.
The production of benchmarks should not be a separate regulated activity. To the extent that
production or contribution is already by or from a regulated entity then it may be possible to
expand the role of the regulator to ensure that this aspect of the business is appropriately
supervised with the objective of assuring impartiality and accuracy. However, benchmarks
have generally evolved from a normal commercial process where for whatever reason a
business or industry body finds that it would be useful and in the interest of transparency to
publish certain information. Over time this information becomes important because it is seen
as a useful guide, and may then be used for additional purposes. However, if the method is
suspect, even if the outcome is of interest, then the index will likely go no further and may
wither and be abandoned. A third situation is where an index is not seen as useful for any
wider purpose, but continues to serve the narrow interest for which is was created.
The introduction of regulation would presumably mean either that industry bodies and
market participants would simple not create new indices because it would be a regulated
activity, or the regulator would have to intervene at a later stage to impose regulation on a
specific index. In any case the vast majority of indices are produced with very little hope of
significant financial return and the increased cost of regulation would be a further
disincentive to create benchmarks. It must be recognised that there are vast numbers of
benchmarks and indices produced, most of which are not used directly for any financial
transaction. They survive or disappear based on whether they are perceived to be useful
and whether the provider has any success in monetising them.
There is also a distinction between the original purpose of an index and the use to which it is
put. If the PMI for a medium sized economy is used to generate spurious arguments about
the health and prospects for that economy, this is not the fault of the index provider. The
Baltic Exchange Dry Index is often cited as being a leading indicator of economic activity.
However, the Baltic has made no claim for this. It is dangerous for a regulator to assume the
purpose to which an index is put is in some way the responsibility of the provider.
The Baltic has been able to develop a commercial model where CCPs are charged licence
fees for the use of Baltic data including forward curves. However, before the CCPs came
into the market there was nothing to prevent bilateral transactions being fixed based on
Baltic rates without any payment to the Baltic. In the physical market many transactions are
concluded based on Baltic Exchanges rates among parties who have no business
relationship with the Baltic. It would therefore be completely unreasonable to impose a
regulatory burden on the index provider when it is often receiving no revenue from many of
the instances of use of the data.
Chapter 3: The Purpose and Use of Benchmarks
(30) Is it possible and desirable to restrict the use of benchmarks? If so, how, and what
are the associated costs and benefits? Please provide estimates.
Most providers of benchmarks would like to restrict their use so that they can monetise their
intellectual property more effectively. However, since most of the data is at best daily and
often less frequent that that, it leaks quickly into the public domain. It is much easier to
monetise real-time index calculations because continuous supply is needed.
Moreover, it is also impossible to control the interpretation of indices. The Baltic Exchange
makes no assertion about the relevance of the BDI to global economic growth, though many
others do make that assertion.
Having established that the benchmark is available in the public domain, it seems very
difficult in an environment of freedom of contract, and one where contracts can be concluded
anywhere in the world between any parties, to envisage any form of control.
(31) Should specific benchmarks be used for particular activities? By whom? Please provide
examples.
No response
(32) Should benchmarks developed for wholesale purposes be used in retail contracts such
as mortgages? How should non-financial benchmarks used in financial contracts be
controlled?
There is little prospect of general control on the choice and use of benchmarks. However,
the matter becomes of interest where an already regulated process is involved.
Where a retail financial service involves the use of a benchmark it is clearly the responsibility
of the supplier of the service to consider carefully the appropriateness, reliability and
construction of the index used. Having established this principle then it would be reasonable
for a regulator to take an interest in the same matters.
Where a financial or business contract between two companies uses a benchmark for
whatever purpose (whether a government inflation figure, a market benchmark such as the
BDI or a real estate pricing benchmark) then it is for the parties to satisfy themselves as to
the appropriateness and method of the benchmark. Any benchmark provider has a
responsibility to offer a clear description of the production method employed, and perhaps
even an analysis of its strengths and potential shortcomings.
Where a benchmark is used in a largely professional but nonetheless regulated activity such
as derivatives transactions, then the industry regulator is already in place and may intervene
as required to control the way in which benchmarks are used and the choice of benchmark.
However it must surely be the responsibility of the market participant to understand the
nature of the trade and of the regulator to intervene as needed.
(33) Who should have the responsibility for ensuring that indices used as benchmarks are fit
for purpose, the provider, the user (firms issuing contracts referenced to benchmarks), the
trading venues or regulators?
The index provider has a normal commercial responsibility for the product. If the product is
not of sufficient quality then it will not be widely used. The provider in any case will find that
he has a responsibility to all users of the data to ensure that there is no negligence involved
in the production of the rate. However, the responsibility of the provider must end with the
production process. He cannot be held responsible for the uses to which his data is put,
especially where there may not even be any licence arrangement in place between the
provider and the user.
Trading venues generally are not party to the contracts which they facilitate, so it does not
seem reasonable for them to be responsible. You might argue that where a trading venue
establishes an entirely new contract then there is a responsibility to investigate the
benchmark being used (if any). However, in many cases trading venues are migrating (in a
process set to accelerate) existing OTC markets to formal venues. In this circumstance, they
clearly have a more limited responsibility for the choice of index or benchmark. Ultimately the
responsibility must be with the buyer and seller to establish that the benchmark used reflects
properly both in its specification and production method, the transaction they wish to
conclude. The provider cannot possibly have any responsibility for this.
Chapter 4: Provision of Benchmarks by Private or Public Bodies
(34) Do you consider some or all indices to be public goods? Please state your reasons.
Where indices and benchmarks are provided and published by Governments and supragovernment bodies then they are public goods. Examples would be official inflation figures,
growth figures etc.
Other benchmarks are provided by normal commercially-run organisations (including
industry bodies where the cost of production is effectively spread among the members) and
they must be free to commercialise their intellectual property as best they can in the normal
competitive environment. This is not a public good. To define it as such would be to
introduce very considerable disincentive to incur the cost of production in the first place.
There may be possible exceptions where the benchmarks rely on some form of official
backing or government-sourced data.
(35) Which role do you think public institutions should play in governance and provision of
benchmarks?
Where the benchmarks are produced and selected in the normal commercial way, and are
subject to normal rules of competition, there is no need for a role to be played by public
institutions.
Commercial and public users of benchmarks are free to select those which they feel meet
their needs in terms of production process, benchmarking aim and commercial terms. It
should be recognised that the barriers to entry in the production of all kinds of indices and
benchmarks are extremely low.
Nonetheless it is clear that in the case of LIBOR a certain set of benchmarks has established
an extremely dominant position in the market. Whether as a function of that market share or
other factors, abuse has also clearly taken place. However, this is a rather unusual position
and it is possible that there is already sufficient regulatory power available. The banks
contributing to LIBOR are all subject to banking regulation, while the entire arrangement has
potential for scrutiny by competition authorities. Ultimately if there has been fraudulent
behaviour then this is clearly already subject to potential criminal sanctions.
It is debateable whether any further legislation would be beneficial if the existing powers of
supervision are fully exercised.
(36) What do you consider to be the advantages and disadvantages of the provision of
indices by public bodies?
Benchmarks covering unregulated, global markets such as shipping could not realistically be
provided by government bodies as it would require some form of compulsion in the release
of data about transactions which are commercially sensitive and confidential. This would
imply a global legislative effort and subsequent policing.
(37) Which indices, if any, would be best provided by public bodies?
No response.
Chapter 5: Impact of Potential Regulation: Transition, Continuity and International
Issues.
(38) What conflicts of interest would arise in the provision of indices by public bodies? What
would be the best way of avoiding these conflicts of interest?
The key to the provision of independent indices is the understanding and checking of the
data source. It is almost inevitable that in the case, say, of rate reporting from the banking
industry, that data risks being tainted by the motivation and commercial position of the
provider. Provision of indices by public bodies will not necessarily avoid these conflicts.
There is no obvious evidence of manipulation originating with those providing or calculating
the benchmark.
(39) What are the likely transition challenges, costs and timelines for relevant benchmarks?
Please provide examples.
The shipping market indices provided by the Baltic Exchange are modified from time to time
according to an established approach. However this requires both a known system of rules
and also an industry consensus.
The Baltic changes its indices from time to time to ensure that they remain in line with the
real physical marketplace. Minor changes can be implemented on relatively short notice
since taken alone they do not have a significant impact on the benchmark. For example
recent changes would include modifications to the relative delivery date for a ship (the
Laycan).
Major changes (such as the redefinition of a ship's size) are implemented after extensive
consultation with the industry and with clearing houses. Normally a parallel run is provided
and then an adjustment factor is published by the Baltic Exchange which is applied to all
Open Interest by the CCPs. Clearing Houses usually have contractual authority to apply
such changes. It is of course a matter for the contracting parties as to how long term
contracts between two commercial entities are treated or what provision for change is made
in the contract. The Baltic seeks to avoid continuing to provide "old" rates for long periods as
the reason for change is usually changes to the physical trading pattern, making the "old"
rate difficult to report accurately or meaningfully.
(40) How do you consider that the adoption of new benchmarks could be ensured? Is this
best framed in terms of encouraging or mandating the use of particular benchmarks?
Normal commercial judgement is probably the only way to determine which are the best
benchmarks for a particular purpose. Commercial transactions vary from commercial lending
to personal mortgages, to complex instruments with returns based on multiple benchmarks.
It would surely be very difficult to decide which benchmarks and which transactions should
be made the subject of a mandate.
(41) How can reforms of the regulation of benchmarks be most easily implemented?
No response.
(42) What positive or negative impacts, if any, do you see on small and medium-sized
enterprises of the possible regulation of indices, and how could any negative impacts be
mitigated?
The Baltic Exchange is a small enterprise in financial terms, though with a global brand
name. Directly and indirectly it derives most of its revenues from the provision of its
benchmarks. Government intervention in the production or distribution processes (which are
not subject to any consistent complaint) would be potentially devastating, with unpredictable
consequences.
The costs of compliance with regulations which have yet to be specified are of course
unknown, but would potentially be high.
In order to cover such costs the Baltic might well be forced to modify its commercial terms,
including those which allow broker members to distribute the data to clients without charge.
Removal of this privilege would cause a substantial number of members to resign. They
would therefore also be ineligible to contribute to the benchmarks thereby defeating the
objective.
Assuming regulatory changes imposed additional costs on the Baltic or damaged its
commercial model then it is likely the shipping market would look elsewhere for its
benchmarks. This would probably be sourced outside the EU.
(43) Are there other impacts which should be considered? If so please specify the nature of
these acts and provide evidence.
Recognising that the global shipping market place is at present migrating its centre of gravity
to the Asian timezone, and assuming the impossibility of global legislation, 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.
(44) In which countries are benchmarks used in your sector produced? From which countries
are data used for the production of benchmarks in your sector sourced? In which countries
are benchmarks used in your sector used?
Benchmarks are produced in London and Singapore, sourced from data provided by
shipbrokers in UK, France, Greece, Denmark, Norway, Italy, USA, Singapore, India,
Australia, China, Hong Kong, Japan and Korea. They are used to varying degrees
throughout both the advanced and the emerging economies.
(45) Are there non-EU benchmarks which could serve as substitutes? Are there non-EU
benchmark providers which could produce similar benchmarks?
The Shanghai Shipping Exchange has recently launched a series of benchmarks which are
poorly modelled on the Baltic indices. They would like these to become a substitute. There
are also multiple other benchmarks and indices provides by brokers and consultants which
could already be used. The barriers to entry are low.
(46) Are there international benchmarks which could serve as substitutes for national
benchmarks?
National benchmarks are not relevant in shipping except in the case of cabotage, which is
purely domestic shipping.
The Baltic Exchange
14 November 2012