How to build an index-linked contract
In this chapter, we’ll explore the parameters you need to build an index-linked contract to ensure it is both fair and effective. Index parameters are the specific variables and benchmarks that determine how freight rates are adjusted. The parameters define how pricing is structured, ensuring that rate movements are based on current market movements and agreed criteria. We’ll split parameters into two categories base and advanced.
Base parameters
Index reference
This is the market index that will be used as the benchmark for adjusting freight rates within the terms of the contract. The index should be a neutral data source that both parties agree to use as the basis for all rate adjustments; to help ensure pricing decisions are objective and market-based rather than subjective.
For example, “this contract references the Xeneta Container Prices for China to North Europe as the basis for all rate adjustments."
Adjustment frequency
This is how often rate adjustments based on the index will take place during the contract period. The adjustment frequency determines how closely your contract rates will follow market conditions, balancing market responsiveness with administrative simplicity.
For example, "rate adjustments will occur on the 10th day of each calendar month based on the changes compared to the previous month's index value."
Starting price model
This is the approach used to establish the initial base rate for the contract, which serves as the foundation for all future adjustments. The starting price establishes the reference point from which all future adjustments will be calculated, directly affecting the overall cost structure throughout the contract duration.
For example, “the starting rate will be set at $1,200 per FEU, which represents a ~5% discount from the current index value of $1,263 for Shanghai-Rotterdam."
Discount/premium Model
This is the methodology for calculating how contract rates will be positioned relative to the index (either above or below). This model defines your competitive market position and determines how index movements will translate into actual rate changes.
For example, “this contract will maintain a fixed 7% discount from the index value throughout the contract term, ensuring rates remain competitive while preserving predictable margins."
Minimum adjustment triggers
These are the conditions that will initiate a rate adjustment if the minimum threshold is met. Adjustment triggers avoid small index changes between regular adjustment periods requiring a change in the index rates, protecting both parties from administrative overheads.
For example, "if the index moves by more than 10% in either direction between scheduled adjustments, an adjustment will be triggered."
Advanced parameters
Rate guardrails (Floor and Ceiling)
These are upper and lower limits on rates (ceilings and floors) that establish boundaries for potential price movements. Rate guardrails protect both parties from extreme market conditions, ensuring rates never become unsustainable for either the supplier or shipper.
For example, "Regardless of index movements, rates will never fall below $800 per FEU (floor) or exceed $2,000 per FEU (ceiling)."
Volume Commitments
This is the agreed amount of cargo the shipper commits to move under the contract terms. Volume commitments help logistics providers allocate capacity efficiently while giving shippers priority service and preferred pricing.
For example, "The shipper commits to moving 2,000 FEUS annually, with quarterly minimums of 450 FEU to ensure balanced capacity utilization."
Short-term Market Adjustment Mechanism
This is a parameter that allows for adjustments based on short-term market rates when they significantly diverge from long-term rates. This mechanism helps address disparities between short-term and long-term rates during volatile periods, keeping indexed rates aligned with real-time market conditions.
For example, "If the spot market rate exceeds the indexed contract rate by more than $1,000, a temporary adjustment of 50% of the difference will be applied."
Flexibility Clauses
These are provisions that allow for modifying contract parameters under specific circumstances. Flexibility clauses provide a framework for adapting to unexpected or significant market changes without requiring complete contract renegotiation.
For example, "if extraordinary circumstances result in market movement of more than 30% within the quarter, trigger an index rate adjustment immediately."
Dispute Resolution Mechanisms
These are procedures for resolving disagreements related to rate adjustments or contract interpretation. These mechanisms ensure conflicts can be resolved efficiently without disrupting operational continuity or damaging business relationships.
For example, "Any disputes regarding rate calculations will first undergo a joint review within 5 business days, followed by third-party arbitration if unresolved."
Currency Management
This is the chosen approach for handling currency fluctuations in international shipping contracts. Currency management protects both parties from exchange rate volatility that could impact the effective cost or profitability of services.
For example, "all rates will be denominated in USD, with any local currency charges converted at the published IMF exchange rate on the day of invoicing."