Non-Deliverable Swap NDS: Overview and Examples21/07/2023

Non-Deliverable Swap NDS: Overview and Examples

A Non-Deliverable Forward (NDF) is a financial derivative used in forex markets. It is a contract to pay the difference between an agreed-upon currency exchange rate and non deliverable forwards the real rate on a future date, using money rather than exchanging physical currencies. 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.

How NDFs Contribute to Global Currency Markets

Spot trading rose by more than that of NDFs over a five-day period in the case of the real, according to the Central Bank of Brazil. 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. 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 https://www.xcritical.com/ six months.

AU Small Finance Bank Fundamental Analysis

• The renminbi, with its idiosyncratic internationalisation, is not travelling either path.
• 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.
• A swap is a financial contract involving two parties who exchange the cash flows or liabilities from two different financial instruments.
• The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader.
• 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.
• Periodic settlement of an NDS is done on a cash basis, generally in U.S. dollars.
• NDF markets may become more transparent and liquid as trading moves to authorised multilateral trading and centralised clearing in accord with the current wave of regulatory reforms.

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)). An NDF is a contract to exchange cash flows between two parties based on the predicted future exchange rates of a particular currency pair. It differs from typical forward contracts as no physical delivery of the underlying currencies occurs at maturity. A non-deliverable forward (NDF) is a cash-settled, and usually short-term, forward contract. The notional amount is never exchanged, hence the name “non-deliverable.” Two parties agree to take opposite sides of a transaction for a set amount of money—at a contracted rate, in the case of a currency NDF. This means that counterparties settle the difference between contracted NDF price and the prevailing spot price.

Providing Liquidity and Price Discovery

However, how do they differ from their counterpart deliverable forward contracts? This binding contract locks in an exchange rate for the sale of the purchase of a specific currency on a predetermined future date. In other words, it is a customizable currency-hedging tool without upfront margin payment. The domestically traded and domestic currency-settled NDF market disappeared four years after liberalisation in 1983 (Debelle et al (2006)).

How Are NDFs (Non-Deliverable Forwards) Priced?

HSBC (2013, p 121) notes, “A large portion of [forward market] liquidity is still offshore due to credit constrain[t]s among local banks.” At the same time, continuing restrictions do not preclude considerable market development, as seen with the Korean won. NDF markets may become more transparent and liquid as trading moves to authorised multilateral trading and centralised clearing in accord with the current wave of regulatory reforms.

Is THB a non deliverable currency?

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). Reform allows us to assess NDF turnover spillovers from surprises like the adjustment in the renminbi exchange rate regime in August 2015. With this combination of sources, we find that, ironically, liberalisation of the renminbi is boosting other Asian NDFs even as it strangles the CNY NDF. The main difference between forward and NDF is that in a standard forward contract, there is actual delivery of the underlying currencies on the settlement date. In contrast, an NDF involves cash settlement of the difference between the agreed and prevailing market rates, without any physical exchange of currencies.

Synthetic foreign currency loans

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)). Still, the rouble NDF has lingered for 10 years and even enjoyed a modest revival recently.

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

Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Effectively, the borrower has a synthetic euro loan; the lender has a synthetic dollar loan; and the counterparty has an NDF contract with the lender. The base currency is usually the more liquid and more frequently traded currency (for example, US Dollar or Euros). Suppose a US-based company, DEF Corporation, has a business transaction with a Chinese company. One cannot convert Chinese Yuan to dollars, so it makes it difficult for American businesses to settle the transaction.

Corporations use them to hedge currency risk in markets with currency restrictions, while investors and traders use NDFs to speculate on currency movements in emerging markets where full currency convertibility is not available. NDFs provide liquidity and price discovery for currencies with limited or no spot market activity. 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.

It also helps businesses to conduct trade with emerging markets in the absence of convertible and transferable currency and manage the exchange rate volatility. The settlement of NDFs mostly takes place in cash as per the agreement made between the two parties. Most non-deliverable forward uses the dollar in the largest NDF markets like the Chinese Yuan, Brazilian Real, South Korean Won, and New Taiwan Dollar. A non-deliverable forward (NDF) is a two-party currency derivatives contract to exchange cash flows between the NDF and prevailing spot rates.

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. 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 this section, after documenting the deviations, we test which market, onshore or offshore, provides leading prices. For investors or traders seeking access to restricted, thinly traded emerging market currencies, NDFs provide a way to gain synthetic exposure without being subject to onshore capital controls. Since NDFs only involve a cash payment in a convertible currency at maturity, they avoid any restrictions. 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.

5 Which together reported trades of about $6 billion per day to the DTCC in January 2014. All in all, despite the huge amounts of data now available, it is difficult to reach a firm conclusion on the trend of NDF turnover since the Triennial Survey. Some of the growth to April 2013 may have reflected the cyclical search for yield. NDFs can be used to create a foreign currency loan in a currency, which may not be of interest to the lender.

Working with reputable banks and monitoring credit standing is key to risk management. Settlement of NDF contracts is subject to timing mismatches or errors, creating risk around execution of payments. Investors like hedge funds also use NDFs to speculate on emerging market currency movements. The one-way nature of NDF contracts make them a flexible tool for arbitrage as well.