What is a Non-Deliverable Forward NDF?

NDFs play a crucial role in risk management for businesses engaged in international trade. By using NDFs, companies can hedge against the uncertainty of exchange rate movements, especially when dealing with currencies subject to restrictions or controls. A Non-Deliverable Forward (NDF) is a financial derivative that allows two parties to agree on the exchange rate for a future currency transaction without the physical delivery of the underlying currencies. An NDF settles with a single cash flow based on the difference between the contracted NDF rate and the spot rate, while an FX swap settles with two cash flows based on exchanging two currencies at a spot rate and a forward rate. NDFs allow you to trade currencies that are not available in the spot market, hedge your currency risks and avoid delivery risk. A deliverable forward (DF) is a forward contract involving the actual delivery of the underlying currency at maturity.

what are non deliverable forwards

NDFs enable economic development and integration in countries with non-convertible or restricted currencies. They encourage trade and investment flows by allowing market participants to access these currencies in a forward market. Additionally, NDFs promote financial innovation and inclusion by offering new products and opportunities for financial intermediaries and end-users. As the name suggests, a deliverable forward contract involves the delivery of an agreed asset, such as currency.

Forward Contracts: The Foundation Of All Derivatives

The volume response was bigger in the currencies of China’s neighbouring economies. The DTCC data show that KRW and TWD NDF trading involving US counterparties saw larger rises in volumes, even though the INR and BRL rates depreciated more (Graph A, right-hand panel). Given the ratio of DTCC turnover to global turnover in April, this implies around $40 billion in global CNY NDF turnover, four times the April 2016 level.

what are non deliverable forwards

An intuitive way to look at the pricing of currency forwards is to back out the home currency implied interest rates using covered interest rate parity (CIP). For example, to obtain the KRW interest rate implied in a KRW/USD NDF one would take the NDF price, the spot price, and the US interest rate as given and solve for the KRW interest rate using the standard CIP equation. The higher the implied interest rate for the home currency, the greater is the forward implied currency depreciation for that currency.

Appendix 3: Coefficients on error correction terms; daily data Period: 2012 – Apr 2020

This represented 19% of all forward trading globally and 2.4% of all currency turnover. Almost two thirds took place in six currencies against the dollar, for which the survey obtained detail. Like forward markets and emerging market currencies in general, a very high share of NDF trading (94%) takes place against the dollar.

  • Unlike traditional forward contracts, NDFs do not involve the physical delivery of currencies at maturity.
  • A non-deliverable forward (NDF) is a cash-settled, and usually short-term, forward contract.
  • In these currencies, it is not possible to actually exchange the full amount on which the deal is based through a normal forward trade.
  • Non-deliverable forwards can be used where it is not actually possible to carry out a physical exchange of currencies in the same way as normal forward trade.

One party pays another the difference between the NDF rate and the spot rate; the payment is usually in U.S. dollars. Besides, NDFs get traded over the counter (OTC), encouraging the flexibility of terms to satisfy the needs of both parties involved. All NDF contracts set out the currency pair, notional amount, fixing date, settlement date, and NDF rate, and stipulate that the prevailing spot rate on the fixing date be used to conclude the transaction. Some market participants indicated a preference for NDFs at the time due to convenience.

The Non-Deliverable Forward Market

For their part, many emerging market firms that had used their unprecedented access to the global dollar (and euro) bond market to fund domestic assets also had exposures to hedge. In a normal FX forward, the
underlying currencies will be delivered by the opposing
counterparties on settlement date. In a NDF, the contract will be
settled in the base currency at the fx fixing rate of that currency
on the settlement or value date. These contracts tend to trade if
there is some friction in the trading of, settlement of, or delivery
of the underlying currency. These frictions could be in the form of
currency controls, taxes, fees etc. NDFs settle by reference to the official central parity rate against the US dollar (the “fixing rate”) set every day at 9.30 am in the Shanghai, China Foreign Exchange Trade System.

what are non deliverable forwards

If we go back to our example of a company receiving funds in a foreign currency, this will be the amount that they are expecting to be paid in the foreign currency. Non-deliverable forwards can be used where it is not actually possible to carry out a physical exchange of currencies in the same way as normal forward trade. If we go back to the example of a business that will receive payment for a sale it has made in a foreign currency at a later date, we can see how a forward trade is used to eliminate currency risk. Currency risk is the risk that a business, investor or individual will lose money as a result of a change to exchange rates. For example, the borrower wants dollars but wants to make repayments in euros.

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Observations for three countries with daily data on domestic trading suggest that the NDF’s share of trading increased in China and India in this episode, but not in Brazil. Data from the Reserve Bank of India show that increases in spot trading volumes in the initial days after the devaluation were comparable to those of the NDF trading reported in the DTCC data, but onshore DFs showed lower increases. Spot trading rose by more than that of NDFs over a five-day period in the case of the real, according to the Central Bank of Brazil. This analysis should interest policymakers concerned about spillovers from an offshore NDF market to the onshore market. In addition, for observers of capital account liberalisation, the diversity in policy choices and NDF market developments offer a natural experiment on paths of currency internationalisation.

what are non deliverable forwards

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)). When the time comes, they simply trade at the spot rate instead and benefit by doing so.

Policymakers have to make tradeoffs involving many different aspects including control, market depth, spillovers, attractiveness to nonresident investors, real economy impacts and prudential considerations. For most emerging market currencies NDF markets are likely to continue to flourish as long as full convertibility is not established. To study whether offshore or onshore markets lead in price discovery, we need to compare NDF quotes with onshore FX quotes at the same time. For most currencies we now find bi-directional influences between NDFs and onshore markets based on the lagged independent variables. First, for the KRW there is only a one-directional relation from NDFs to onshore forwards.

Some nations choose to protect their currency by disallowing trading on the international foreign exchange market, typically to prevent exchange rate volatility. Market participants can use non-deliverable forwards (“NDFs”) to transact in these non-convertible currencies. In this course, we will discuss how traders may use NDFs to manage and hedge against foreign exchange exposure. We will also take a look at various product structures, such as par forwards and historic rate rollovers.

Advantages of Non-Deliverable Forward Contracts

Despite significant financial account liberalization across Asia, most Asian emerging market currencies are only partially convertible and not deliverable offshore. Restrictions take many forms including requirements on underlying asset exposure for currency positions. The Currency Rate Risk Protection Program (CRRP) facility offers non-deliverable forward contracts net settled in pesos to domestic banks. Banks act as an intermediary for customers with hedging needs arising from eligible foreign currency obligations. The CRRP was reactivated in September 2018, but the facility was first introduced in 1997 during the Asian Financial Crisis and last utilized in 2009.

On the whole, deviations are largest for the renminbi and the Indian rupee, as well as the Indonesian rupiah and Philippine peso (Table 4). The liberalised Russian rouble serves as a benchmark, with much narrower differentials. For instance, in the smaller markets of Chile and Peru,5 where the central bank measures not just turnover but also net positions, Distribution Erp For Trading Firm 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.