In a path exemplified by the Korean won (KRW), NDFs gained in importance in a policy regime with restrictions on offshore deliverability. In a second, represented by the liberalised rouble, the NDF maintained its minor role amid financial sanctions and policy uncertainty. China has taken a unique, third path of currency internationalisation within capital controls. For the renminbi, deliverable forwards (DFs) have been displacing NDFs offshore.

While the company has to sacrifice the possibility of gaining from a favourable change to the exchange rate, they are protected against an unfavourable change to the exchange rate. What happens is that eventually, the two parties settle the difference between a contracted NDF price and the future spot rate for an exchange that takes place in the future. Unlike traditional forward contracts, NDFs do not involve the physical delivery of currencies at maturity. Instead, the parties settle the contract in cash based on the difference between the contracted exchange rate and the prevailing market rate.

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Asia accounts for the most traded NDF currencies worldwide, with the largest volumes in the Korean won (KRW), Indian rupee (INR), and New Taiwan dollar (TWD). For these currencies, NDF volumes exceed turnover in other foreign exchange products including spot transactions. In Asia, sizeable NDF markets also exist for the Chinese yuan (CNY) and the Indonesian rupiah (IDR), and to a lesser extent for the Malaysian ringgit (MYR), Philippine peso (PHP), and Vietnamese dong. This is what currency risk management is all about and the result of a non-deliverable forward trade is effectively the same as with a normal forward trade.

• NDFs were pricing substantial depreciation for the IDR and PHP during short episodes in the fall of 2016.
• During the COVID-19 market turbulence the DNDF – NDF spread reached record levels with the NDF market pricing more depreciation (Figure 17).
• For the TWD deviations between onshore and offshore implied interest rates are larger than for KRW, but smaller than for the other currencies.
• We estimate that outstanding DNDFs auctioned by BI were in the range of USD1 to 4 bn prior to COVID-19.

NDFs are customizable, offering leverage and flexibility to suit different needs and preferences. 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 Build An App Like Exodus Cryptocurrency Wallet developments while its liquidity gains from ongoing market centralisation. The rouble NDF is lingering with a low market share despite full convertibility of the currency, possibly due to credit constraints and political developments. At the same time, renminbi DFs are displacing the NDF, thanks to currency internationalisation.

Where To Find NDF Liquidity

Convertibility risk is a concern given that DNDFs are settled in domestic currency at maturity. In the case of Brazil, concerns about convertibility during stress episodes led to large discounts on DNDFs relative to NDFs (Garcia and Volpon 2014). As said, an NDF is a forward contract wherein two parties agree on a currency rate for a set future date, culminating in a cash settlement. The settlement amount differs between the agreed-upon forward rate and the prevailing spot rate on the contract’s maturity date. In certain situations, the rates derived from synthetic foreign currency loans via NDFs might be more favourable than directly borrowing in foreign currency.

Korea embraced NDFs by allowing domestic financial institutions to participate. In contrast, Malaysia enforced regulation to limit MYR NDF trading and took measures to deepen onshore FX markets. China is following yet another path with the offshore deliverable CNH market.

NDFs VS NDSs: Understanding Functional Differences

The difference in implied interest rates of NDFs and onshore forwards in Asian currencies are close to zero on average (Figure 9) suggesting that deviations are eventually arbitraged. During stress episodes, however, implied interest rates in the onshore and offshore markets have at times differed widely, most notably in Indonesia with interest rate differentials of +/-50%. In these four currencies, deviations are greater to the downside, meaning higher implied interest rates and hence depreciation pressure in the NDF. This asymmetry could be consistent with a stronger reaction to negative news in the NDF or central bank foreign exchange intervention in the onshore market that cushions depreciation pressures.

Starting in February 2020 when Indonesia experienced large portfolio outflows and IDR depreciation pressures, BI increased sales of DNDFs to close to USD 8 bn (Figure 16). This compares to net portfolio outflows of USD 2.4 bn in February and USD 7.9 bn in March. DNDF transactions have largely moved in tandem with the rupiah exchange rate, rising when the rupiah is under depreciation pressure. The VECM approach sheds light on the long-run equilibrium relationship between NDF and onshore markets, the adjustment toward that equilibrium in case of perturbations, and the influence of changes in lags of one variable on the other. For the latter, there is a directional spillover interpretation in the sense of Granger causality.

How To Value Interest Rate Swaps

The share of NDFs in RUB forward trades in London bottomed out in October 2014, and has since risen slightly in the three subsequent semiannual London surveys (Graph 4, left-hand panel). The microstructure of NDF trading is evolving under the global force of legal and regulatory reforms of derivatives markets. NDFs have started the transition from a decentralised, bilateral microstructure to centralised trading, disclosure and clearing. Disclosure of derivatives transactions (including NDFs) has become mandatory in many jurisdictions (CPMI-IOSCO (2015), FSB (2016)). Centralised NDF clearing took off in September 2016 when US, Japanese and Canadian banks began to post higher required margins for uncleared derivatives. 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.

For the TWD deviations between onshore and offshore implied interest rates are larger than for KRW, but smaller than for the other currencies. NDFs are contracts for the difference between an agreed exchange rate and the actual spot rate at maturity, settled with a single payment for one counterparty's profit. They allow hedging and speculation in a currency without providing or requiring funding in it.

How Are NDFs (Non-Deliverable Forwards) Priced?

Some countries, notably Korea, maintain few restrictions on onshore financial institutions’ participation in the NDF market, resulting in close integration between offshore and onshore markets. Other countries retain more restrictions, with Malaysia taking some of the strongest policy measures to limit ringgit trading to onshore markets. Indonesia introduced a domestic version of NDFs (DNDFs), settled in local currency, as an alternative to USD-settled offshore NDFs. Section III surveys the range of policy approaches to NDF markets in Asia and section VI discusses DNDFs. Policymakers pay close attention to NDF markets recognizing potential implications for financial stability and onshore financial markets.

NDFs are commonly used in scenarios where either one of the currencies involved is non-convertible or when there are currency restrictions in place. They are particularly prevalent in transactions with currencies from emerging market economies where volatility and regulatory constraints are more common. Because NDFs are traded privately, they are part of the over-the-counter (OTC) market. It allows for more flexibility with terms, and because all terms must be agreed upon by both parties, the end result of an NDF is generally favorable to all. The domestically traded and domestic currency-settled NDF market disappeared four years after liberalisation in 1983 (Debelle et al (2006)).

List Of NDF Currencies

Relative to other foreign exchange products—spot, outright forwards, swaps, options—NDF trading volumes are large for INR, KRW, and TWD (Figure 2). For these currencies, NDF volumes far exceed all other FX products including spot trading. This underscores the importance of NDF markets for price discovery and relevance from policymakers’ perspective. If the company goes to a forward trade provider, that organisation will fix the exchange rate for the date on which the company receives its payment. The exchange rate is calculated according to the forward rate, which can be thought of as the current spot rate adjusted to a future date.

In these currencies, it is not possible to actually exchange the full amount on which the deal is based through a normal forward trade. An NDF essentially provides the same protection as a forward trade without a full exchange of currencies taking place. Divergent trends in NDF trading among the six emerging market economy (EME) currencies identified in the Triennial highlight three distinct paths of FX market development.