Offshore Currency Markets: Non-Deliverable Forwards NDFs in Asia

They also use NDSs to hedge the risk of abrupt devaluation or depreciation in a restricted currency with little https://www.xcritical.com/ liquidity, and to avoid the prohibitive cost of exchanging currencies in the local market. Financial institutions in nations with exchange restrictions use NDSs to hedge their foreign currency loan exposure. Some nations choose to protect their currency by disallowing trading on the international foreign exchange market, typically to prevent exchange rate volatility.

Non-Deliverable Forward (NDF) Meaning, Structure, and Currencies

With a background in higher education and a personal interest in crypto investing, she specializes in breaking down complex concepts into easy-to-understand information for new crypto investors. Tamta’s writing is both professional and relatable, ensuring her readers gain valuable insight and knowledge. Foreign exchange options can carry a high degree of risk and are not suitable for everyone as they can have a negative impact on your capital. If you are in doubt as to the suitability of any foreign exchange product, SCOL strongly encourages you to seek independent advice from suitable financial advisers. BNP Paribas recently introduced its first NDF algo for Asian currencies, adapting its existing algos non deliverable forward to manage the nuances of the NDF market and giving clients the ability to automatically trade large NDF contracts. The bank has seen over $17bn of NDFs executed via algo since launching its NDF suite.

Offshore Currency Markets: Non-Deliverable Forwards (NDFs) in Asia

For instance, a company importing goods from a country with currency restrictions could use NDFs to lock in a favourable exchange rate, mitigating potential foreign exchange risk. The article will highlight the key characteristics of a Non-Deliverable Forward (NDF) and discuss its advantages as an investment vehicle. In normal practice, one can trade NDFs without any physical exchange of currency in a decentralized market. OTC market provides certain advantages to traders like negotiation and customization of terms contained in NDF contracts like settlement method, notional amount, currency pair, and maturity date. NDF specifies a fixed exchange rate on the maturity date, which is normally two working days before settlement, to reflect the spot value. Generally, the fixed spot rate is based on a reference page on Reuters or Telerate, determined by four leading dealers in the market for a quote.

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• An agreement that allows you to lock in a rate of exchange for a pre-agreed period of time, similar to a Forward or the far leg of a Swap Contract.
• This allows clients to automatically trade NDF contracts, to capture spread and reduce operational risk.
• The expansion allows clients to use effective hedging tools for trading OTC derivatives contracts and leverage products in line with regulations in respective countries.
• Long with quantity, even the quality of the client base expands and improves.
• It is mostly useful as a hedging tool in an emerging market where there is no facility for free trading or where conversion of underlying currency can take place only in terms of freely traded currency.
• For those seeking liquidity in NDFs, it’s essential to turn to specialised financial service providers and platforms that fit this niche market.

Meanwhile, the company is prevented from being negatively affected by an unfavourable change to the exchange rate because they can rely on the minimum rate set in the option trade. What non-deliverable forwards provide is the opportunity to protect a business (or an investor or individual if needs be) that is exposed to currency risk in a currency for which a normal forward trade is not possible. Usually, the forward trade provider will act as a third party in the exchange, handling the transfer of money between the business and the counterparty which is making the payment to them. Also known as an outright forward contract, a normal forward trade is used to lock the exchange rate for a future date. The integration of clearing into NDF Matching enables easier access to the full book of liquidity in the venue for all participants and better transparency of the market. Cleared settlement brings innovation to the FX market, including simplified credit management, lower costs, and easier adoption by non-bank participants.

Foreign Exchange Non-Deliverable Forwards Course Overview

Unlike other types of swaps, there is no physical exchange of the currencies. Because of the complicated nature of these types of contracts, novice investors usually shouldn’t take on NDSs. A swap is a financial contract involving two parties who exchange the cash flows or liabilities from two different financial instruments. Most contracts like this involve cash flows based on a notional principal amount related to a loan or bond. In the intricate landscape of financial instruments, NDFs emerge as a potent tool, offering distinct advantages for investors. They safeguard against currency volatility in markets with non-convertible or restricted currencies and present a streamlined cash-settlement process.

AN OVERVIEW OF THE NON-DELIVERABLE FORWARD (NDF) MARKET

This will determine whether the contract has resulted in a profit or loss, and it serves as a hedge against the spot rate on that future date. In the Covid-19 pandemic, implied interest rates and hence depreciation pressures spiked in the NDFs of several emerging markets, including India, Indonesia, Malaysia and Philippines. In order to avoid the restrictions imposed by the foreign currency in question, NDF is settled in an alternative currency. UK-based company Acme Ltd is expanding into South America and needs to make a purchase of 2,000,000 Brazilian Real in 6 months. Acme Ltd would like to have protection against adverse movement and secure an exchange rate, however, BRL is a non-convertible currency. Tamta is a content writer based in Georgia with five years of experience covering global financial and crypto markets for news outlets, blockchain companies, and crypto businesses.

Why Should A Broker Offer NDF Trading?

The risk that this company faces is that in the time between them agreeing to the sale and actually receiving payment, exchange rates could change adversely causing them to lose money. Non-deliverable forwards are most useful and most essential where currency risk is posed by a non-convertible currency or a currency with low liquidity. 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. NDFs, by their very nature, are the most valuable to markets where traditional currency trading is restricted or impractical. This creates a niche yet significant demand, allowing brokers to capitalise on the spread between the NDF and the prevailing spot market rate.

NDFs allow investors to settle the difference in the value of a currency between the agreed-upon exchange rate and the actual rate at the contract’s maturity. 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. Once the company has its forward trade it can then wait until it receives payment which it can convert back into its domestic currency through the forward trade provider under the agreement they have made.

The Non-Deliverable Forward Market

Non-deliverable forwards (NDF) are gaining interest in Asia and the market will likely grow further as most Asian emerging market currencies are only partially convertible. The People’s Bank of China controls the level of Renminbi (RMB) and offshore access. Following on from this, a date is set as a ‘fixing date’ and this is the date on which the settlement amount is calculated.

Due to currency restrictions, a Non-Deliverable Forward is used to lock-in an exchange rate. Depth and quality of the liquidity pools is an essential component of execution algorithms. The algo must be able to source good quality liquidity in order to provide optimal execution. BNP Paribas’ NDF algos take advantage of fragmented external liquidity sources, but also tap into the bank’s local market franchise and internalise the flow by utilising pools of internal liquidity sources. However, as electronic trading in NDF markets grows, they have become increasingly more complex and fragmented. Banks, however, have overcome this challenge with the deployment of NDF algos helping to automate execution and optimise costs.

Swaps are commonly traded by more experienced investors—notably, institutional investors. They are commonly used to manage different types of risks like currency, interest rate, and price risk. Any investment products are intended for experienced investors and you should be aware that the value of your investment may go down as well as up. HSBC Innovation Bank Limited does not provide Investment, Legal, Financial, Tax or any other kind of advice. Before entering into any foreign exchange transaction, you should seek advice from an independent Advisor, and only make investment decisions on the basis of your objectives, experience and resources.

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. Lastly, we will outline several ways to negate or cancel an existing forward position that is no longer needed. On the settlement date, the currency will not be delivered and instead, the difference between the NDF/NDS rate and the fixing rate is cash settled. The fixing rate is determined by the exchange rate displayed on an agreed rate source, on the fixing date, at an agreed time.

If one party agrees to buy Chinese yuan (sell dollars), and the other agrees to buy U.S. dollars (sell yuan), then there is potential for a non-deliverable forward between the two parties. Schmittman and Teng said that spill-overs from NDFs to onshore markets are a policymaker concern, as exchange rate management could be less effective and the ability to conduct an independent monetary policy is crippled. The NDF markets in many Asian emerging market currencies are large, rapidly growing, and often exceed onshore markets in transaction volume, an International Monetary Fund working paper published in September last year showed.

Similar to algos seen in the FX spot market, NDF algos are able to source liquidity across multiple venues and execute trades on behalf of clients, automatically, while securing optimal pricing. Due to NDF being a relatively illiquid market, with greater spreads than the most traded, or ‘G10’, currencies, these algos are well positioned to capture wider spreads providing favourable pricing for clients. Usually, the foreign currency is sent to the forward trade provider who converts it into the original company’s domestic currency and transfers it to them. 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.

In our example, the fixing date will be the date on which the company receives payment. FXall is the flexible electronic trading platform that delivers choice, agility, efficiency and confidence that traders want, across liquidity access to straight-through processing. An agreement that allows you to lock in a rate of exchange for a pre-agreed period of time, similar to a Forward or the far leg of a Swap Contract. That said, non-deliverable forwards are not limited to illiquid markets or currencies. They can be used by parties looking to hedge or expose themselves to a particular asset, but who are not interested in delivering or receiving the underlying product. As clients become confident using these algos, demand for BRL contracts has steadily increased.

Our trade matching will enable you to access firm pricing, achieve high certainty of execution and trade efficiently. FX Aggregator is reliable and cost-efficient, giving you seamless execution to the deepest market liquidity pools. This course is designed for those who desire to work in or already work with FX trading, specifically in exotic markets where capital controls exist and it is not possible to construct a deliverable forward curve. In an industry where differentiation can be challenging, offering NDF trading can set a brokerage apart. It showcases the firm’s commitment to providing comprehensive financial solutions and its capability to navigate complex trading environments.