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  • QA 186
    Question:
    Under PTBF contracts, what if shippers 'fix' the price without actually owning the physical coffee that is to be supplied?
    Background:
    In Q&A 185 you explained the financing issues that importers can face on Price To Be Fixed (PTBF) contracts when shippers 'fix' ahead of the final buyer in a strongly rising market. But how can the importer be sure that the shipper actually has the physical coffee when he fixes?
    Asked by:
    Academia/Press - United Kingdom
    Answer:

    The underlying principle of trust that governs PTBF transactions presupposes that shippers only 'fix' for coffee they own. For any shipper to 'fix' prices without owning the physical coffee is highly speculative and, could be extremely dangerous for the importer who arranges the fixation. *

    If a shipper were to ask for the price to be fixed without having the green coffee in stock, he becomes fully exposed to market volatility. If things go badly wrong (prices rise strongly) and if as a result the shipper defaults (does not ship the green coffee he sold), then the importer who arranged the fixation would be in serious difficulty! He would have to cover the entire loss on the futures sale the shipper asked him to engage in. In a rising market defaulted contracts can be devastating to importers, not only on PTBF but also if bought/sold outright.

    Of course PTBF buying and selling will continue also when volatility is high because, in a real sense, the exercise actually incorporates hedging into market pricing.  The issue is that margins on the under-lying futures are paid immediately and not recovered until shipment has been made and payment is received. A potential risk is that an occasional shipper may be fixing contracts without owning the coffee to be shipped.

    To avoid this some on the import side have therefore either switched from buying 'seller's call' to buying 'buyer's call', or have reduced the period during which 'seller's call' price fixing may be done. For example not until within the 30 days prior to physical shipment as this will give some comfort that the shipper is not speculating on the fixation - say April shipment only to be fixed during the month of March. **

    In the end however it comes down to the fact that the international trade in coffee is based on trust. Few importers will therefore enter into distant forward or multiple shipment PTBF transactions with shippers they do not know extremely well…

    * The PTBF principle assumes shippers 'fix' the sales price as and when they obtain the physical green coffee to be shipped, not before. The fixation establishes the price at which the shipment will be invoiced. The buyer 'fixes' as and when he considers the price to be right, or when the last permissible date for fixing falls due. In his case the fixation establishes the actual cost of the green coffee to be received. The importer is the intermediary in all this: fixing for the shipper means he sells the stipulated futures position - fixing for the buyer means he buys the stipulated futures position. The two transactions cancel each other out - see section 09.02 of the Guide for a detailed explanation of how PTBF trading works in practice.

    ** Seller's call = the seller decides when to fix. Buyer's call = the buyer decides when to fix.

    Posted 28 March 2008

    Related chapter(s):
    Related Q & A:
    Q&A 051, 054, 171, 185