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Non-Deliverable Forwards & NDF Markets

It would also be consistent with the absence of policy intervention or faster price discovery. Similarly, a comparison of pricing between onshore and offshore markets is not normative, but useful to understand differences in market views and investor sets. Asia accounts for the most traded NDF currencies worldwide, with the largest volumes in the Korean won (KRW), Indian rupee (INR), and New Taiwan dollar (TWD).

Turning to the coefficients on the lagged independent variables, we first analyze the direction of influence between onshore prices at the local market closing time and NDFs at the New York close. Two-way influences between NDFs and onshore FX are present for INR (spot and forward), MYR (spot), and TWD (forward). The VECM approach sheds light on the long-run equilibrium relationship between NDF and onshore markets, the adjustment toward that equilibrium in case of perturbations, and the influence of changes in lags of one variable on the other. For the latter, there is a directional spillover interpretation in the sense of Granger causality. A variable X is said to Granger cause another variable Y if lagged values of X help in predicting Y beyond the information contained in the lagged value Y.

For example, an American firm with subsidiary in India that earns revenues in rupees but reports in USD can hedge the EUR/INR risk by using NDFs. To our knowledge, we are the first to move to higher frequency data than daily to analyze NDF and onshore market relationships. The requirement not to engage in the NDF market was longstanding but not strictly enforced. In November 2016, BNM required an attestation from banks to certify that they did not engage in the NDF market. In December 2016, BNM introduced a requirement for conversion of 75 percent of export proceeds into MYR and a measure limiting investment in FX assets by residents with domestic ringgit borrowing was extended to exporters. Market contacts pointed out the link between hedging costs and bond holdings.

The Force’s Defence Health Services provides medical services to service personnel, it operates sick bays at all bases and units as well the military hospitals. The more active banks quote NDFs from between one month to one year, although some would quote up to two years upon request. The most commonly traded NDF tenors are IMM dates, but banks also offer odd-dated NDFs.

The only cash that actually switches hands is the difference between the prevailing spot rate and the rate agreed upon in the NDF contract. Overall, non-deliverable forwards open up possibilities for clients and investors seeking opportunities in inaccessible currencies abroad. When used prudently, NDFs can be an effective tool for risk management as well as for speculative trading strategies. The current spot exchange rate and market forecasts of where the spot rate will be on the maturity date impact NDF levels.

NDF Structure

In this section we empirically examine price linkages between NDFs and onshore forward and spot markets using vector error correction models (VECM). In contrast with most existing studies, we time-match NDF and onshore price quotes to control for spillover effects due to differences in trading hours. This allows us to differentiate between time-zone induced and concurrent spillovers. We separately analyze the COVID-19 market stress episode using hourly data. Figures 10 through 15 present the difference in onshore and NDF implied interest rates over time.

As of February 2012, it was reported that a Chinese company paid US$499,950 into Shalli’s account in Zambia while he was the NDF chief.[22] Poly Technologies was supplying equipment to the NDF at the time. NDFs can be used to create a foreign currency loan in a currency, which may not be of interest to the lender. The base currency is usually the more liquid and more frequently traded currency (for example, US Dollar or Euros).

NDF Structure

In the COVID-19 pandemic, implied interest rates and hence depreciation pressures spiked in the IDR, INR, MYR, and PHP to high levels. Conversely, for the TWD NDF implied interest rates declined far below onshore rates suggesting appreciation pressures in the offshore market. Taiwan POC’s successful handling of the COVID-19 pandemic with limited cases and less restrictions than most countries could have contributed to this pattern. In addition, Taiwanese investors, in particular life insurers, have built large overseas portfolios in recent years and increased currency hedges in the NDF market during the crisis could have contributed to lower implied NDF interest rates. In India, the fast growth of the INR NDF market raised concerns around the forces determining the currency value and the authorities’ ability to ensure currency stability (Reserve Bank of India, 2019). The Reserve Bank of India commissioned a Task Force to study the offshore INR market.

Today, it numbers over 1100 personnel and deploys a small number of lightly armed patrol vessels. Martin Shalli and Charles ‘Ho Chi Minh’ Namoloh were involved in the negotiations that allowed the Kenyan infantry battalion to remain for that period. 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 Military ranks of Namibia are the military insignia used by the Namibian Defence Force.

This is unsurprising since a large share of trading in NDFs is without underlying asset positions which is not permissible in the Malaysian onshore market. Convertibility risk refers to the risk of loss arising from an inability to convert local currency into a fully convertible currency and/or to repatriate convertible currency back to a home country as a result of exchange controls. 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 to USD 8 bn (Figure 16).

Some market participants indicated a preference for NDFs at the time due to convenience. Restrictions on currency positions without underlying asset exposures in onshore markets were an additional concern. The volatility and pricing of NDFs relative to onshore FX markets provides insight in the behavior of both markets and the interactions between them. High volatility does not necessarily indicate a more speculative investor base or price overshooting.

NDF Structure

Corporations can fine tune their hedging needs via tailored NDF contracts, unlike standardized futures contracts. Banks also structure NDFs flexibly to meet client business requirements in terms of size, dates, and benchmarks. 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). MYR NDF activity dropped sharply after the authorities reinforced a ban on NDF trading.

  • Convertibility risk is a concern given that DNDFs are settled in domestic currency at maturity.
  • For example, to obtain the KRW interest rate implied in a KRW/USD NDF one would take the NDF price, the spot price, and the US interest rate as given and solve for the KRW interest rate using the standard CIP equation.
  • As a result, there will be a significant impact from the NDF on onshore FX prices simply because the same information is priced in at different times.
  • The Force’s Defence Health Services provides medical services to service personnel, it operates sick bays at all bases and units as well the military hospitals.

For these currencies, NDF volumes far exceed all other FX products including spot trading. This underscores the importance of NDF markets for price discovery and relevance from policymakers’ perspective. Turnover data for NDFs is mostly available from surveys, given the over-the-counter nature of NDF trading.

For the New Taiwan dollar there have been more deviations, often with NDF markets pricing more appreciation than onshore markets. The largest NDF markets are in the Chinese yuan, Indian rupee, South Korean won, new Taiwan dollar, and Brazilian real. The largest segment of NDF trading takes place in London, with active markets also in Singapore and New York. Some countries, including South Korea, have limited but restricted onshore forward markets in addition to an active NDF market. A non-deliverable forward (NDF) is usually executed offshore, meaning outside the home market of the illiquid or untraded currency.