There is a clear directional interpretation of the lagged independent variable coefficients in the sense of Granger causality. A rejection of the null hypothesis of no Granger causality in either direction between onshore quotes and NDF suggests two-way spillovers between onshore and offshore currency markets. A rejection of the null hypothesis in one direction implies a one-way spillover.

In our example, this could be the forward rate on a date in the future when the company will receive payment. This exchange rate can then be used to calculate the amount that the company will receive on that date at this rate. NDFs are traded over-the-counter (OTC) and commonly quoted for time periods from one month up to one year. They are most frequently quoted and settled in U.S. dollars and have become a popular instrument since the 1990’s for corporations seeking to hedge exposure to illiquid currencies. Unlike in an NDF contract in which the difference between the NDF rate and the fixing rate gets settled in cash, a deliverable forward currency involves the delivery of the settlement currency when the contract matures.

V. Price Linkages Between Onshore and Offshore Currency Markets

Non-deliverable forwards (NDFs) are contracts for the difference between an exchange rate agreed months before and the actual spot rate at maturity. The spot rate at maturity is taken as the officially announced domestic rate or a market-determined rate. Thus NDFs yield payoffs related to a currency’s performance without providing and requiring funding in the underlying currencies as do deliverable forwards. The IDR rate in the DNDF market is fixed by BI using the Jakarta Interbank Spot Dollar Rate daily and has typically been below that in the NDF market. The spread was the widest when the IDR came under depreciation pressure in mid-May and early August 2019 amid the escalation in US-China trade tensions. During the COVID-19 market turbulence the DNDF – NDF spread reached record levels with the NDF market pricing more depreciation (Figure 17).

• They are also distinct from deliverable onshore forwards for which the entire notional amount is exchanged on the due date and not just the profit or loss (net settlement).
• If the exchange rate has moved unfavourably, meaning that the company receives less than expected at the spot rate, the provider of the NDF contract will reimburse them by the appropriate amount.
• We estimate that outstanding DNDFs auctioned by BI were in the range of USD1 to 4 bn prior to COVID-19.
• Investors thereby circumvent limits on home market (“onshore”) trading and on delivery of the home currency offshore.
• One interpretation of the revival is that credit and legal concerns since 2014 have prolonged the life of the rouble NDF.

For MYR, the coefficients on the error correction term in the regressions with NDFs as dependent variable are statistically indistinguishable from zero. Similarly, for INR the error correction term coefficients for NDFs are also statistically insignificant in some cases. Figures 10 through 15 present the difference in onshore and NDF implied interest rates over time. During the taper tantrum in 2013, large dislocations between onshore and offshore pricing occurred for IDR and INR with the offshore markets pricing large depreciations. Besides IDR and INR, the taper tantrum affected TWD offshore/onshore pricing, but had relatively little effect on the onshore/offshore pricing differentials of other Asian currencies. 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.

Pricing and valuation

Prior to COVID-19, deliverable onshore forwards, NDFs, and DNDFs were priced close to each other. We estimate that outstanding DNDFs auctioned by BI were in the range of USD1 to 4 bn prior to COVID-19. Starting in February 2020 when Indonesia experienced large portfolio outflows and IDR depreciation pressures, BI increased sales of DNDFs to close Important Features Of Analytical Crm 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. Deviations in Korean won NDF and onshore forward implied interest rates have been limited.

In 1 month (maturity date or settlement date), I pay you USD 1 milion and receive from you EUR 1.2 million. Stack Exchange network consists of 183 Q&A communities including Stack Overflow, the largest, most trusted online community for developers to learn, share their knowledge, and build their careers. 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. Directional influence in this paper refers to an asset price significantly affecting another asset price in the sense of Granger (1969). London accounts for close to half of all trading (45%), followed by the US (16%), Singapore (16%), and Hong Kong SAR (12%) (Patel & Xia 2019). DNDFs tend to price in less depreciation than NDFs when the rupiah faces depreciation pressures.

How NDFs Contribute to Global Currency Markets

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 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. 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. This cash settlement feature makes NDFs practical in scenarios where physical delivery is challenging. A non-deliverable forward (NDF) is a straight futures or forward contract, where, much like a non-deliverable swap (NDS), the parties involved establish a settlement between the leading spot rate and the contracted NDF rate.

For example, corporates may have an actual USD demand in the future and therefore prefer currency delivery. 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).

Non-deliverable forwards: impact of currency internationalisation and derivatives reform

NDF trading in INR, TWD, and KRW experienced the fastest growth since 2016, rising 204%, 168%, and 100%, respectively. 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. With an option trade, a company that is exposed to exchange rate risk can rely on a similar agreement to a forward trade. In order to avoid the restrictions imposed by the foreign currency in question, NDF is settled in an alternative currency.

They can then pay each other the profits/losses in that freely traded currency. Thankfully, both parties involved in the non-deliverable contract can settle the contract by converting all losses or profits to a freely traded currency, such as U.S. dollars. So, they can pay one another the losses or gains in the freely traded currency. Unlike a deliverable forward contract which involves the exchange of assets or currency at an agreed rate and future date, a non-deliverable forward (NDF) requires cash flow, not tangible assets.

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. 9 Interviews with market participants in Hong Kong in late 2013 suggested that they perceived that the CNH had already eclipsed the NDF market in April. In the Triennial Survey, renminbi NDFs represented 71% of offshore forwards. Summing CNH forwards, CNH spot and renminbi NDFs, on the grounds that any one of them transforms currency exposure, NDFs were still 45% of such offshore trading. London data for October 2013 show that this share fell by 10 percentage points over the previous six months.

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. The NDF market has maintained its share globally in overall FX trading, despite shrinkage of CNY NDF turnover in recent years. This market’s resilience reflects hedging and position-taking demand for currencies subject to restrictions on non-resident use. Data made available through mandatory disclosure have made it possible to study NDF market dynamics at a high frequency.

Introduction to Non-Deliverable Forwards (NDFs)

They can also attempt to forbid facilitation of NDF transactions by foreigners through attestations of non-participation in the market as a precondition for domestic market access. IDR NDF turnover is the highest among South East Asian currencies with volumes exceeding onshore trading. The restrictions which prevent a business from completing a normal forward trade vary from currency to currency. However, the upshot is the same and that is they will not be able to deliver the amount to a forward trade provider in order to complete a forward trade. There are also active markets using the euro, the Japanese yen, and, to a lesser extent, the British pound, and the Swiss franc. Anna Yen, CFA is an investment writer with over two decades of professional finance and writing experience in roles within JPMorgan and UBS derivatives, asset management, crypto, and Family Money Map.

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. Different policy approaches reflect country specific circumstances and preferences.