Meanwhile, post-trade transparency and regulation of multilateral trading venues were implemented for US residents in October 2013. The fixing date is the date at which the difference between the prevailing spot market rate and the agreed-upon rate is calculated. A non-deliverable forward (NDF) is a forward or https://www.xcritical.com/ futures contract in which the two parties settle the difference between the contracted NDF price and the prevailing spot market price at the end of the agreement.

Synthetic foreign currency loans

For instance, in the smaller markets of Chile and Peru,5 where the central bank measures not just turnover but also net positions, the data show a sharp turnaround in positioning in May-June 2013. The left-hand panel of Graph 1 shows stocks of long positions in the Chilean peso and Peruvian new sol. The larger stock of positions in Chile declined by $9 billion between end-April and end-June 2013. The smaller position in Peru declined by $2 billion between end-May and end-August. NDFs were used to reduce net exposures, while non deliverable forwards the Peruvian data show a decline in turnover consistent with the London data for October 2013 discussed below.

Non-Deliverable Forward – NDF Meaning

One interpretation of the revival is that credit and legal concerns since 2014 have prolonged the life of the rouble NDF. In 2013, the concentration of liquidity in offshore markets (including the NDF) was ascribed to concerns about the enforceability of collateral arrangements in Russia (HSBC (2013)). In early 2014, a series of financial sanctions on certain Russian individuals, defence firms, energy firms and banks were reported to have led non-financial firms to use NDFs rather than DFs (Becker (2014)).

Supporting Economic Development and Integration

The renminbi, with its idiosyncratic internationalisation, is not travelling either path. Certainly, the Chinese authorities have not allowed unrestricted non-resident access to the onshore forward market. Instead, they have permitted, within still effective (although leaky) capital controls, a pool of renminbi to collect offshore that can be freely traded and delivered offshore (Shu et al (2013)). A three-way split of the renminbi forward market has resulted, with an onshore market (dating to 2006), an offshore NDF market (dating back to the 1990s) and an offshore deliverable, or CNH, market (since 2010). A different exercise is to ask how global factors affect pricing in the two markets. Consistent with the discussion above, we use observations on global factors that match the observations on domestic forwards.

Risks Associated with NDF Trading

Hence, to overcome this problem, an American company signs an NDF agreement with a financial institution while agreeing to exchange cash flows on a certain future date based on the prevailing spot rate of the Yuan. Nonetheless, different policies towards such restrictions have led to different paths in NDF market development. The Korean won NDF bulks large in trading in that currency owing to official constraints, and its turnover may be spurred by renminbi developments while its liquidity gains from ongoing market centralisation.

Non-Deliverable Forward (NDF) Meaning, Structure, and Currencies

The remaining sections of Table 2 make clear that the strength of the relationship varies across the six currency pairs (though it is highly statistically significant in all cases). Segmentation is strongest in the Indian rupee, followed by the renminbi,3 the Brazilian real, the Korean won, the New Taiwan dollar and finally the Russian rouble. NDFs enable economic development and integration in countries with non-convertible or restricted currencies.

• NDFs are primarily used in markets where the currency is not freely tradable or faces certain restrictions.
• Its deliverable and non-deliverable markets persist in parallel even as arbitrage joins them and markets deepen.
• Swaps are commonly traded by more experienced investors—notably, institutional investors.
• Likewise, the increase in NDF trading in Moscow reduced the segmentation between onshore and offshore rouble markets.
• One cannot convert Chinese Yuan to dollars, so it makes it difficult for American businesses to settle the transaction.
• Similar increases in NDF trading occurred during a bout of CNY turbulence in January 2016.

Understanding Non-Deliverable Forwards in Forex Trading

Analysis of the two subsample periods shows that the NDF’s influence seems to increase during market stress. During the global financial crisis, the NDF tended to lead the onshore market. A rise in the influence of the NDF was even more noticeable in May-August 2013 (eight out of nine cases). In India, the impression that the offshore NDF drove the domestic market in summer 2013 has reportedly prompted consideration of opening up the domestic market to foreign investors (Sikarwar (2013)).

Access to Restricted Currencies

The role of such traders may have contributed to the suspicion with which some policymakers are said to view NDFs (IGIDR Finance Research Group (2016); see also Ibrahim (2016)). Apart from the renminbi, NDFs grew in line with turnover in EME currencies. As a hedging market, they grew along with the increased trading of swaps and forwards in the broader global FX market (Moore et al (2016)). In an NDF deal, two parties agree to swap currencies at a set rate on a later date, but they don’t actually exchange the currencies. This happens because those special currencies can’t be easily traded, so handing them over is hard or even impossible. However, not too much should be read into this finding, no matter how sophisticated the econometrics.

Anna Yen, CFA is an investment writer with over two decades of professional finance and writing experience in roles within JPMorgan and UBS derivatives, asset management, crypto, and Family Money Map. She specializes in writing about investment topics ranging from traditional asset classes and derivatives to alternatives like cryptocurrency and real estate. Her work has been published on sites like Quicken and the crypto exchange Bybit.

See also the results of Eichengreen and Gupta (2013), who find that larger, more liquid markets felt more pressure during the tapering episode. As Graph 3 shows, the widening of the band and the tendency for actual trading to occur near its edges make for substantial basis risk. When the NDF settles at the fixing rate, this can be 1 percentage point higher or lower than the rate at which the renminbi can actually be sold onshore. From the standpoint of a firm trying to fix the dollar value of profits to be remitted from China, a 1% gap between the NDF and the actual rate of exchange can produce unwanted volatility. Since the band’s widening, the CNH has averaged an absolute difference from the Shanghai close of just 0.1%, much narrower than the 0.7% absolute gap between the Shanghai fixing and close.

By providing synthetic access without physical delivery, NDFs circumvent issues like capital controls and illiquid local markets. 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. In the six currencies singled out by the Triennial, which account for two thirds of all NDFs, turnover increased at a faster pace, by 8.7%. Growth was much stronger in exchange rate-adjusted terms (30.9%, Table 1) than in current dollar terms, owing to depreciation against the dollar of the real, rupee and rouble.

Indeed, BRL NDF turnover would have doubled in the absence of BRL depreciation. By contrast, the substantial decline in CNY NDFs and the rapid growth of KRW and Taiwan dollar (TWD) turnover owed little to movements against the US dollar. 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, and Chilean and Colombian pesos also have sizeable NDF trading. A Non-Deliverable Forward (NDF) is a derivative contract used primarily in the foreign exchange (forex) market.

Implied volatility in the CNH tends to be very low, and market participants report a reach for yield among investors who bet on the stability of the renminbi/dollar rate. The liquidity thereby generated in the CNH market, however cyclical, has attracted asset managers, including some hedge funds, to switch from NDFs. The costs to Korea of maintaining won NDFs may decline with the changing market structure. The continuing existence of the NDF market alongside deliverable forwards no doubt exacts a cost in terms of lower liquidity from the division of the forward markets. However, it is possible that the change in the NDF market to more transparent trading and centralised clearing will make NDF markets deeper and more liquid.