Offshore Currency Markets: Non-Deliverable Forwards NDFs in Asia in: IMF Working Papers Volume 2020 Issue 179 2020

A large number of jurisdictions now require public trade reporting for NDFs and other derivatives (FSB (2016)). Volumes of NDFs reported to the DTCC involving US counterparties amounted to 40% of the total trading of our six currencies in April 2016. In particular, Analytical Crm Software Program about a third of NDF trades in the renminbi, rupee, won and New Taiwan dollar were reported for April 2016, and 60% of trades in the real and rouble. Compared with other FX instruments, NDF counterparties are skewed towards non-bank financial firms (Graph 2).

non deliverable forward

In a Deliverable Forward, the underlying currencies are physically exchanged upon the contract’s maturity. This means both parties must deliver and receive the actual currencies at the agreed-upon rate and date. On the other hand, an NDF does not involve the physical exchange of currencies. Instead, the difference between the agreed NDF rate and the prevailing spot rate at maturity is settled in cash, typically in a major currency like the USD.

V. Price Linkages Between Onshore and Offshore Currency Markets

This underscores the effectiveness of the regulation in moving price discovery onshore. In the case of Malaysia, the spot market result is more important than the forward market result given that the former is much larger. Non-deliverable forwards (NDFs) are forward contracts that let you trade currencies that are not freely available in the spot market.

  • However, how do they differ from their counterpart deliverable forward contracts?
  • Data made available through mandatory disclosure have made it possible to study NDF market dynamics at a high frequency.
  • Even without restrictions, arbitrage activity may not operate as fully and immediately as in the textbook case due to risk and costly capital (Shleifer & Vishny 1997).
  • In other words, it is a customizable currency-hedging tool without upfront margin payment.
  • They take various forms including underlying asset requirements for currency positions, restrictions on participants in currency markets, prudential and documentation requirements, and regulation on permissible foreign exchange products.

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. TWD NDF trading surged even more on 11 August, to 486% of the previous day’s volume, or an estimated 3.7 times the April volume. While KRW NDF turnover only doubled, its increase of $10 billion was the largest response of the five currencies. In terms of volume, the responses of the INR and BRL NDFs were the smallest.

NDFs and derivatives reform

Some market participants indicated a preference for NDFs at the time due to convenience. Restrictions on currency positions without underlying asset exposures in onshore markets were an additional concern. Turning to the coefficients on the lagged independent variables, we first analyze the direction of influence between onshore prices at the local market closing time and NDFs at the New York close. Two-way influences between NDFs and onshore FX are present for INR (spot and forward), MYR (spot), and TWD (forward).

non deliverable forward

So far, you understand how non-deliverable forward contracts work and how investors can benefit from them. However, how do they differ from their counterpart deliverable forward contracts? We estimate that outstanding DNDFs auctioned by BI were in the range of USD1 to 4 bn prior to COVID-19.

Disadvantages of an NDF

Similarly, a comparison of pricing between onshore and offshore markets is not normative, but useful to understand differences in market views and investor sets. McCauley, Shu, and Ma (2014), McCauley and Shu (2016) and Reserve Bank of India (2019) provide comprehensive overviews of NDF markets. Recent spillover studies include McCauley, Shu, and Ma (2014) for major currencies and Reserve Bank of India (2019) for INR. We contribute to the literature with a comprehensive and fresh look at Asian currency NDFs that considers recent developments including DNDFs and the COVID-19 pandemic. Our analysis of the direction of influence between NDF and onshore FX markets provides new insights by differentiating between time-zone induced and concurrent spillovers.

non deliverable forward

Non-deliverable forwards (NDFs), also known as contracts for differences, are contractual agreements that can be used to eliminate currency risk. While they can be used in commodity trading and currency speculation, they are often used in currency risk management as well. Basically, the forward contract is a type of non-exchange traded, non-standardized futures contract, whereby a fixed amount (of the non-convertible currency) is settled on a specific due date, and at a specific forward rate. The forward contract is typically settled in the base currency of an investor who receives or pays, at maturity, the difference between the daily rate (reference rate) and the NDF rate, as the case calls for. The difference is settled in the convertible currency on the value date as no payment or account movement takes place in the non-convertible currency.

Why Should A Broker Offer NDF Trading?

NDFs allow you to trade currencies that are not available in the spot market, hedge your currency risks and avoid delivery risk. NDFs allow hedging and speculation for currencies with high exchange rate risk or potential returns. They allow market participants to lock in a forward rate or bet on a future rate movement, managing their currency exposure or profiting from their currency views.

non deliverable forward

A UK company selling into Brazil needs to protect the sterling-equivalent of revenues in local currency, the Brazilian Real. Due to currency restrictions, a Non-Deliverable Forward is used to lock-in an exchange rate. Distinguishing itself from traditional providers, B2Broker has innovatively structured its NDFs as Contracts For Difference (CFDs). While standard NDFs often come with a T+30 settlement period, B2Broker ensures clients can access settlements as CFD contracts on the subsequent business day. This streamlined approach mitigates client settlement risks and accelerates the entire process, guaranteeing efficiency and confidence in their transactions.

The profit or loss is calculated on the notional amount of the agreement by taking the difference between the agreed-upon rate and the spot rate at the time of settlement. NDFs are also known as forward contracts for differences (FCD).[1] NDFs are prevalent in some countries where forward FX trading has been banned by the government (usually as a means to prevent exchange rate volatility). Consider a scenario where a borrower seeks a loan in dollars but wishes to repay in euros. The borrower acquires the loan in dollars, and while the repayment amount is determined in dollars, the actual payment is made in euros based on the prevailing exchange rate during repayment. Concurrently, the lender, aiming to disburse and receive repayments in dollars, enters into an NDF agreement with a counterparty, such as one in the Chicago market. This agreement aligns with the cash flows from the foreign currency repayments.

non deliverable forward

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. Bound specialises in currency risk management and provide forward and option trades to businesses that are exposed to currency risk. As well as providing the actual means by which businesses can protect themselves from currency risk, Bound also publish articles like this which are intended to make currency risk management easier to understand.

Understanding Non-Deliverable Forwards (NDFs)

The British pound and Swiss franc are also utilised on the NDF market, albeit to a lesser extent. Our result of two-way spillovers for INR, in line with the literature, could be due to the Indian trading day having more overlap with the European and US trading day than is the case for East Asia. Since the GFC, violations of covered interest rate parity in the pricing of forwards are common.

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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. This is unsurprising given the close integration of the NDF and onshore forward market for KRW (which results in a large coefficient on the error correction term) and the role of domestic Korean banks and investors in the KRW NDF market.,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,
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