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

Second, for the MYR the granger causality runs only from onshore forwards to the NDF market. Interestingly, this was the case even before the collapse of NDF markets following Bank Negara Malaysia regulation in 2016. For the MYR onshore spot market, we find a switch in the direction of spillovers with the 2016 Bank Negara Malaysia measures. Before the measures, the direction of influence was from NDF to onshore spot. This underscores the effectiveness of the regulation in moving price discovery onshore.

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. 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. The intent of the CRRP is to serve as a hedging facility that prevents corporates, notably importers, from buying USD on the spot market for future requirements, in turn reducing depreciation pressures on the peso.

The Fundamentals of Deliverable vs. Non-Deliverable Forward Contracts

From September 2016, large banks in the United States, Japan and Canada must post both initial and maintenance margins for NDFs and higher margins for those not centrally cleared. 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. Historically, the Bank of Thailand also enforced a ban on NDF quotation by international banks that had business activity in Thailand, similar to Bank Negara Malaysia. For currencies where both DTCC and BIS data is available, BIS data is larger by a factor of 2 to 4. DNDFs tend to price in less depreciation than NDFs when the rupiah faces depreciation pressures.

  • The borrower could, in theory, enter into NDF contracts directly and borrow in dollars separately and achieve the same result.
  • During market stress periods including the COVID-19 pandemic, pricing of NDFs often diverges from onshore FX markets.
  • NDFs account for the largest share of trading by instrument for INR, KRW, and TWD.
  • Similar increases in NDF trading occurred during a bout of CNY turbulence in January 2016.
  • 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)).

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. NDFs and onshore forward and spot exchange rates are linked in long-run equilibrium relationships, as one would expect with at least partial market integration. Appendix 2 shows estimates for the long-run cointegration regressions in levels. Most intercepts are close to zero while the coefficients on the dependent variables are close to one, suggesting that onshore and offshore prices are close to equal in the long run.

Deliverable Forward vs. Non-Deliverable Forward

Median volatility of Asian NDFs is larger than volatility of onshore deliverable forwards. Asia accounts for three of the top four NDF currencies by volume globally according to the BIS survey. The INR, KRW, and TWD accounted for 55% of total daily global NDF turnover of USD258 bn as of April 2019 (Figure 1). Outside of Asia, the Brazilian real (14%) and the Russian ruble (2%) have sizeable NDF markets. NDF trading in INR, TWD, and KRW experienced the fastest growth since 2016, rising 204%, 168%, and 100%, respectively. NDFs are traded over-the-counter (OTC) and commonly quoted for time periods from one month up to one year.

non deliverable forward currency

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. As the name suggests, a deliverable forward contract involves the delivery of an agreed asset, such as currency. So, for example, in a forward contract involving a currency pair of USD/AUD, there would be a physical exchange of USD equivalent to AUD.

Understand NDFs to Navigate Forex

An NDF contract can thus give a trader exposure to the Chinese renminbi, Indian rupee, South Korean won, new Taiwan dollar, Brazilian real, and other nonconvertible currencies. Many South American countries function as nonconvertible currencies because of historic excess economic volatility, even if their currencies officially float freely on the global currency markets. The volume response was bigger Non-deliverable Forward Ndf 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.

non deliverable forward currency

Our dataset covers NDF, spot, and onshore deliverable forward prices for IDR, INR, KRW, MYR, PHP, and TWD extracted from Bloomberg using the BFIX function. For NDFs we use both New York end of trading day quotes in line with most other studies, as well as quotes that are exactly time-matched to onshore prices. Unlike traditional forward contracts, NDFs do not involve the physical delivery of currencies at maturity.

What is the difference between a currency and interest rate swap?

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. NDFs are customizable, offering leverage and flexibility to suit different needs and preferences.

non deliverable forward currency

Trading of NDFs has begun to shift to centralised platforms, and higher margin requirements for non-cleared derivatives trades implemented in September saw centralised clearing of NDFs jump. Disclosure of trades has become mandatory in a number of jurisdictions, and the resulting increased transparency can inform a better understanding of market dynamics. 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. 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.

NDF example

The Indonesian rupiah experienced extreme onshore-offshore price differentials during the taper tantrum and the COVID-19 pandemic. In Tokyo, an important regional hub for NDFs, KRW and INR are also the most traded currencies, followed by IDR and TWD. NDFs account for the largest share of trading by instrument for INR, KRW, and TWD. Daily NDF trading in three Asian currencies (INR, KRW, TWD) accounts for 55% of global NDF trading volume.

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)). The displacement of the renminbi NDF by deliverable CNY trades has progressed furthest in the offshore centres that have traded the renminbi the longest. Asian centres enjoyed an early lead in renminbi trading under the strategy of renminbi internationalisation.

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, 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. Apart from the renminbi, NDFs grew in line with turnover in EME currencies.

Much like a Forward Contract, a Non-Deliverable Forward lets you lock in an exchange rate for a period of time. However, instead of delivering the currency at the end of the contract, the difference between the NDF rate and the fixing rate is settled in cash between the two parties. Using DTCC and Triennial data, this box explores how renminbi market developments in August 2015 spilled over into emerging FX markets. This analysis using newly available turnover data sheds new light on international spillovers from China’s currency markets, heretofore identified through prices (Shu et al (2016)).

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