In particular, contemporaneously measured major exchange rates figure similarly in both deliverable forwards and NDFs. The only cases where global factors seem to figure much more in the NDF rate are the renminbi, Indian rupee and Indonesian rupiah. The NDF is a key instrument in EME currencies’ offshore, but not onshore, trading (Graph 3; see Ehlers et al (2016) for an analysis of CNY on- and offshore trading). For a full picture of FX instrument composition, we again add exchange-traded turnover to the over-the-counter turnover collected in the Triennial.

non deliverable forwards

In particular, 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. 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)).

Foreign Exchange – Non-Deliverable Forwards Learning Objectives

If foreign investors use NDFs to hedge exposures in local assets in times of stress, sales of these assets in the balance of payment statistics capture their behaviour only very partially. Analysts need not only to follow the money, ie measure capital flows, but also to follow the risk, and newly available data on NDFs can help (Caruana (2013)). Differences between deliverable forward and NDF rates reflect the effectiveness of capital controls. 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.

By allowing market participants to trade these currencies in a forward market, NDFs facilitate the flow of capital and information across borders and regions. NDFs also reflect these currencies’ market expectations and sentiments, which can influence their spot rates and volatility. 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. However, 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.

Disadvantages of NDFs

To prevent outflows, these economies create several barriers for foreign participants. In this mechanism, both parties exchange cash flows typically at the end of each day based on that day’s price moves. For example, let us say that the price moves from 1.20 to 1.212 which is a 1% gain. So, on the $100,000 notional, this marks a gain of $1000 for trader A and a $1000 loss for trader B. Imagine you are a U.S. company that has secured a contract to supply machinery to a Chinese company. The total cost of the machinery is 10 million Chinese Yuan (CNY), and the payment is due in six months.

non deliverable forwards

The NDF market will continue to grow faster than the foreign exchange market as long as authorities try to insulate their domestic financial systems from global market developments, albeit at the cost of lower liquidity. When NDFs serve as a main adjustment valve for non-resident investors in local assets and local firms with dollar debt, they can lead domestic markets. Non-deliverable forwards (NDFs) are a unique type of foreign currency derivatives used primarily in the forex market.

Hedging with NDF

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. The loss or profit gets calculated depending on the notional amount of the agreement. That’s the difference between the spot and pre-agreed rates upon settlement. However, the notional amount in a non-deliverable forward contract is never exchangeable.

  • Nevertheless, either counterparty can cancel an existing contract by entering into another offsetting deal at the prevailing market rate.
  • Market participants include direct and portfolio investors wishing to hedge currency risk and speculators (Ma et al (2004)).
  • 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.

Understanding the principles of a deliverable forward vs. non-deliverable forward contract can help you leverage your investments in the foreign exchange market. Both are forward contracts but with different provisions, and it’s important to be able to distinguish between them. Consequently, since NDF is a “non-cash”, off-balance-sheet item and since the principal sums do not move, NDF bears much lower counter-party risk. NDFs are committed short-term instruments; both counterparties are committed and are obliged to honor the deal. Nevertheless, either counterparty can cancel an existing contract by entering into another offsetting deal at the prevailing market rate. However, not too much should be read into this finding, no matter how sophisticated the econometrics.

Hedging Currency Risk

Her work has been published on sites like Quicken and the crypto exchange Bybit. 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. NDFs are a complex financial instrument and should only be used by experienced investors.

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 deliverable forward (DF) is a forward contract involving the actual delivery of the underlying currency at maturity. A DF is usually used for currencies that are freely convertible and traded in the spot market, such as the euro (EUR), British pound (GBP) or Japanese yen (JPY).

NDF Trading

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)). The strength of this relationship testifies to the robustness of the controls separating the onshore and offshore markets. In India, the sense that NDF Non-custodial Vs Custodial Wallets activity strongly affected the domestic market in August 2013 has led to discussion of how to bring NDF trading into the domestic market (see below). From 2010, the relationship for the renminbi weakened when an offshore deliverable forward market started trading in parallel with the onshore deliverable forward and offshore NDF markets (McCauley (2011, Graph 1)).

non deliverable forwards

In Korea and Chinese Taipei, some domestic financial firms are allowed to trade NDFs (Tsuyuguchi and Wooldridge 2008), Annex A). To gain exposure to these currencies without breaching the restrictions, market participants came up with ‘non-deliverable forwards’. As the name suggests, these are forward contracts but they do not involve the delivery of the underlying currency. 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.

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7 Similar to the unique features of the Australian dollar NDF (domestic trading and AUD settlement), special factors may limit the applicability of the rouble’s lessons. Foreign investors suffered defaults in 1998 on rouble forwards with domestic banks contracted to hedge their holdings of Russian government securities. HSBC (2013, p 121) notes, “A large portion of [forward market] liquidity is still offshore due to credit constrain[t]s among local banks.”

Understanding Non-Deliverable Forwards (NDFs)

Besides, NDFs get traded over the counter (OTC), encouraging the flexibility of terms to satisfy the needs of both parties involved. Two parties must agree and take sides in a transaction for a specific amount of money, usually at a contracted rate for a currency NDF. So, the parties will settle the difference between the prevailing spot rate and the predetermined NDF to find a loss or profit. Another good thing about forward contracts is that it operates under non-standardized terms. That means the involved parties can tailor them to a specific amount and for any delivery period or maturity.


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