During market stress periods including the COVID-19 pandemic, pricing of NDFs often diverges from onshore FX markets. In most cases NDFs price more depreciation than onshore markets in the initial phases of markets stress. The sometimes very large deviations in NDF pricing can have consequences for the real economy and nonresident holdings of local currency assets by making hedging expensive.
The Indonesian rupiah experienced extreme onshore-offshore price differentials during the taper tantrum and the COVID-19 pandemic. In Tokyo, an important regional hub for NDFs, KRW and INR are also the most traded currencies, followed by IDR and TWD. KRW and INR are the most widely traded NDFs in London, the world’s largest market for NDFs. Daily NDF trading in three Asian currencies (INR, KRW, TWD) accounts for 55% of global NDF trading volume.
B. Results
Once the company has its forward trade it can then wait until it receives payment which it can convert back into its domestic currency through the forward trade provider under the agreement they have made. An NDF is a powerful tool for trading currencies that is not freely available in the spot market. By understanding how they work, their benefits and risks and how they differ from DFs, you can use them to diversify your portfolio, hedge your currency risks or speculate on the exchange rate movements of these currencies.
The agreement’s unique feature, where financial institutions settle the difference based on currency movements, underscores the efficiency of NDFs in safeguarding international transactions. An example of an NDF is a contract between a U.S. importer and a Chinese exporter to exchange USD for CNY at a fixed rate in 3 months and settle the difference in cash on the settlement date. If in one month the rate is 6.3, the yuan has increased in value relative to the U.S. dollar. If the rate increased to 6.5, the yuan has decreased in value (U.S. dollar increase), so the party who bought U.S. dollars is owed money.
Advantages of Non-Deliverable Forward Contracts
This allows us to differentiate between time-zone induced and concurrent spillovers. Subsequent emerging market stress episodes include in 2015 a sell-off in EM equities and oil, in 2016 a rapid depreciation of the CNY, and in 2018 a drop in EM equities, oil prices and the CNY. The impact of these episodes on Asian FX markets varied, depending on exposure to the underlying drivers of stresses.
Segmentation is strongest in the rupee, for which NDFs do not trade onshore at all and DFs trade predominantly onshore, followed by the New Taiwan dollar, won, renminbi, real and rouble. In India, the sense that onshore markets had lost market share led the Ministry of Finance to commission a group of experts (Standing Council on International Competitiveness of the Indian Financial System (2015)). Supporting the Standing Council in its investigation of markets, the Indira Gandhi Institute of Development Research Finance Research Group (2016, p 29) suggested that domestic banks in India be allowed to participate in the NDF market. A non-deliverable forward (NDF) is a cash-settled, and usually short-term, forward contract. The notional amount is never exchanged, hence the name “non-deliverable.” Two parties agree to take opposite sides of a transaction for a set amount of money—at a contracted rate, in the case of a currency NDF. This means that counterparties settle the difference between contracted NDF price and the prevailing spot price.
The Non-Deliverable Forward Market
The owner of this website may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on links posted on this website. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear), with exception for mortgage and home lending related products. SuperMoney strives to provide a wide array of offers for our users, but our offers do not represent all financial services companies or products. J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor. 2 Some NDFs traded in Brazil settle in reais (Garcia and Volpon (2014); Kohlscheen and Andrade (2014)). In almost all jurisdictions, central clearing of NDFs, though not legally mandated, is being encouraged by higher margins for non-cleared NDFs.
For example, the borrower wants dollars but wants to make repayments in euros. So, the borrower receives a dollar sum and repayments will still be calculated in dollars, but payment will be made in euros, using the current exchange rate at time of repayment. The global financial industry is replete with corporations, investors, and traders seeking to hedge exposure to illiquid or restricted currencies. By offering NDF trading, brokers can attract this substantial and often underserved client base. Given the specialised nature of NDFs, these clients are also likely to be more informed and committed, leading to higher trading volumes and, consequently, increased brokerage revenues.
Appendix 3: Coefficients on error correction terms; daily data Period: 2012 – Apr 2020
In other words, the information set of onshore investors is fully present in the KRW NDF market, leaving no residual new information in the onshore forward price discovery. Second, for the MYR the granger causality runs only from onshore forwards to the NDF market. Interestingly, this was the case even before the collapse of NDF markets following Bank Negara Malaysia regulation in 2016. For the MYR onshore spot market, we find a switch in the direction of spillovers with the 2016 Bank Negara Malaysia measures. Before the measures, the direction of influence was from NDF to onshore spot.
As of May 2020, the DNDF is primarily a monetary policy tool for Bank Indonesia with limited secondary market activity and non-resident participation. Against this backdrop, countries in Asia have made different choices in their approach to NDF markets. Korea has a generally open capital account but maintains limits on non-resident KRW borrowing from banks in Korea and registration requirements for non-resident portfolio investors.
A non-deliverable forward (NDF) is usually executed offshore, meaning outside the home market of the illiquid or untraded currency. For example, if a country’s currency is restricted from moving offshore, it won’t be possible to settle the transaction in that currency with someone outside the restricted country. But, the two parties can settle the NDF by converting all profits and losses on the contract to a freely traded currency. They can then pay each other the profits/losses in that freely traded currency. NDFs provide liquidity and price discovery for currencies with limited or no spot market activity.
- According to the DTCC data (see below), trading of NDFs on electronic platforms has risen considerably in the last few years.
- Non-deliverable forwards (NDFs) are forward contracts that let you trade currencies that are not freely available in the spot market.
- Against this backdrop, countries in Asia have made different choices in their approach to NDF markets.
Apart from the six surveyed currency pairs, NDF markets are active in a number of other currencies. The DTCC data (see below) show that the Indonesian rupiah, Malaysian ringgit, How To Create A Crypto Exchange To Launch Your startup and Chilean and Colombian pesos also have sizeable NDF trading. Results on spillovers between NDFs and onshore markets in the literature are mixed and most studies are dated.
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The rouble has followed the first path.5 It was made fully convertible in mid-2006 amid current account surpluses, large foreign exchange reserves and official ambitions for its international use. Among our six currencies, the rouble NDF has the smallest share among the different instruments used for RUB trading (Graph 1). Bloomberg stopped publishing a separate exchange rate series for the rouble NDF in 2014, citing its price convergence with the deliverable forwards. Large price dislocations in currency forwards have real economic consequences. For example, when NDF pricing makes hedging currency risks stemming from local currency bond investments expensive, it can prompt foreign investors to sell bonds. In 2018, Bank Indonesia introduced a domestic NDF (DNDF) settled on a net basis in IDR (instead of USD for the offshore NDF) to deepen the onshore market.
Non-Deliverable Forward (NDF) Meaning, Structure, and Currencies
According to the DTCC data (see below), trading of NDFs on electronic platforms has risen considerably in the last few years. The share of NDF trading on swap execution facilities (SEFs) reached 15% for the rouble, about 30% for the rupee, won and New Taiwan dollar, and 45% for the real and renminbi in September 2016 (Graph 6, left-hand panel). This increase in centralised NDF trading occurred without a requirement that FX products be traded on such platforms (FSB (2016)). This analysis should interest policymakers concerned about spillovers from an offshore NDF market to the onshore market.
