Non-Deliverable Forwards (NDFs)

A non deliverable forward (NDF) is a currency forward that is settled in cash, usually in US dollars, rather than by exchanging the two currencies. NDFs exist for currencies that cannot be freely traded offshore because of capital controls, such as the Indian rupee, Korean won, Taiwan dollar, Brazilian real and Chinese yuan in its onshore form. They let international investors and companies hedge or speculate on these currencies without moving money in or out of the restricted market.

How an NDF works#

1. Two parties agree on a notional amount, a forward rate and a fixing date.
2. On the fixing date, the official or benchmark spot rate is observed.
3. On the settlement date, usually two business days later, one party pays the other the difference in US dollars.

settlement (USD) = notional × (fixing rate - NDF rate) / fixing rate

for a contract where the notional is in US dollars and rates are quoted as local currency per dollar. The sign shows which party pays.

Main NDF currencies#

BIS data show NDFs are a significant share of trading in several emerging market currencies, with large volumes booked in financial centres such as London, Singapore and New York.

Fixing rates#

Each NDF currency has an agreed fixing source, often a central bank published rate or a benchmark from an industry body. Fixing disputes are rare but possible during market disruptions, and documentation specifies fallbacks. See FX Fixings: London and Tokyo.

Who uses NDFs#

• Foreign investors hedging stocks and bonds in restricted markets.
• Multinational companies hedging earnings from subsidiaries.
• Hedge funds speculating on emerging market currencies.
• Banks managing their exposures.

Onshore vs offshore#

NDF prices can differ from onshore forward prices because of capital controls. When offshore investors are pessimistic, the NDF can imply a weaker currency than the onshore market. Central banks sometimes intervene in NDF markets to influence sentiment, as the Reserve Bank of India has done. See Central Bank Intervention.

Risks#

• Market risk: emerging market currencies can move sharply in crises.
• Convertibility and policy risk: governments may change rules or fixing methods.
• Counterparty risk: NDFs are over the counter, though many are now centrally cleared after post 2008 reforms. See Market, Credit and Counterparty Risk.
• Basis between onshore and offshore markets.
• Liquidity in longer tenors.

NDFs vs deliverable forwards#

See FX Forwards and Forward Points.

Frequently asked questions#

What is a non deliverable forward?#

A cash settled currency forward in which only the difference between the agreed rate and a fixing rate is paid, usually in US dollars, with no exchange of the restricted currency.

Why do NDFs exist?#

Because some currencies have capital controls that prevent offshore investors from trading or delivering them directly.

Which currencies trade as NDFs?#

Common NDF currencies include the Indian rupee, Korean won, Taiwan dollar, Brazilian real and several other emerging market currencies.

Next, learn about currency swaps in FX Swaps and Currency Swaps.