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In an NDF, two parties agree on a future date, an exchange rate, and a notional amount in a specified currency. When the contract matures, the difference between the agreed-upon rate and the prevailing market rate is settled in cash. This cash settlement removes the need for physical delivery of the non deliverable underlying currencies, making NDFs particularly useful in emerging markets or countries with restricted currency flows.
- NDFs are mainly executed over-the-counter (OTC), with durations typically extending from one month to one year.
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- An NDF essentially provides the same protection as a forward trade without a full exchange of currencies taking place.
- Instead, the only monetary transaction involves the difference between the prevailing spot rate and the rate initially agreed upon in the NDF contract.
- NDF/NDSs are primarily used to hedge non-convertible currencies or currencies with trading restrictions.
- Most contracts like this involve cash flows based on a notional principal amount related to a loan or bond.
Understanding Non-Deliverable Swaps (NDSs)
The launch of NDF Matching brings together https://www.xcritical.com/ the benefits of an NDF central limit order book and clearing to offer a unique solution for the global foreign exchange market. Benefit from counterparty diversity and reduced complexity as you execute your NDF foreign exchange requirements. 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.
Related NDF Templates and Documentation
If we go back to our example of a company receiving funds in a foreign currency, this will be the amount that they are expecting to be paid in the foreign currency. A non-deliverable forward (NDF) is a two-party currency derivatives contract to exchange cash flows between the NDF and prevailing spot rates. One party will pay the other the difference resulting from this exchange. This is what currency risk management is all about and the result of a non-deliverable forward trade is effectively the same as with a normal forward trade. While the company has to sacrifice the possibility of gaining from a favourable change to the exchange rate, they are protected against an unfavourable change to the exchange rate.
Release Milestones and Documentation
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. 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. A key point to note here is that because this is a non-deliverable swap, settlements between the counterparties are made in U.S. dollars, and not in Argentine pesos.
In a Deliverable Forward, the underlying currencies are physically exchanged upon the contract’s maturity. This means both parties must deliver and receive the actual currencies at the agreed-upon rate and date. On the other hand, an NDF does not involve the physical exchange of currencies. Instead, the difference between the agreed NDF rate and the prevailing spot rate at maturity is settled in cash, typically in a major currency like the USD.
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. The profit or loss is calculated on the notional amount of the agreement by taking the difference between the agreed-upon rate and the spot rate at the time of settlement. It is used in various markets such as foreign exchange and commodities. NDFs are also known as forward contracts for differences (FCD).[1] NDFs are prevalent in some countries where forward FX trading has been banned by the government (usually as a means to prevent exchange rate volatility).
For normal corporate client for non-trade related, client can use CNH offshore spot contract for RMB FX exchange. ISDA fosters safe and efficient derivatives markets to facilitate effective risk management for all users of derivative products. ISDA fosters safe and efficient derivatives markets to facilitate effective risk management for all users of derivative products. A non-deliverable swap (NDS) is an exchange of different currencies, between a major currency and a minor currency, which is restricted. FXall is the flexible electronic trading platform that delivers choice, agility, efficiency and confidence that traders want, across liquidity access to straight-through processing.
The contract is settled in a widely traded currency, such as the US dollar, rather than the original currency. NDFs are primarily used for hedging or speculating in currencies with trade restrictions, such as China’s yuan or India’s rupee. A non-deliverable swap (NDS) is a variation on a currency swap between major and minor currencies that are restricted or not convertible. This means there is no physical delivery of the two currencies involved, unlike a typical currency swap where there is an exchange of currency flows. Periodic settlement of an NDS is done on a cash basis, generally in U.S. dollars. The settlement value is based on the difference between the exchange rate specified in the swap contract and the spot rate, with one party paying the other the difference.
The borrower acquires the loan in dollars, and while the repayment amount is determined in dollars, the actual payment is made in euros based on the prevailing exchange rate during repayment. Concurrently, the lender, aiming to disburse and receive repayments in dollars, enters into an NDF agreement with a counterparty, such as one in the Chicago market. This agreement aligns with the cash flows from the foreign currency repayments. As a result, the borrower effectively possesses a synthetic euro loan, the lender holds a synthetic dollar loan, and the counterparty maintains an NDF contract with the lender. As said, an NDF is a forward contract wherein two parties agree on a currency rate for a set future date, culminating in a cash settlement. The settlement amount differs between the agreed-upon forward rate and the prevailing spot rate on the contract’s maturity date.
For example, the borrower wants dollars but wants to make repayments in euros. So, the borrower receives a dollar sum and repayments will still be calculated in dollars, but payment will be made in euros, using the current exchange rate at time of repayment. CNH FX Swap is a simultaneous purchase and sale, of identical amounts of one currency for another with two different value dates (normally spot to forward). The two parties agree a currency exchange on one day and simultaneously agree to reverse that deal on a date in the future.. That is, the two parties have the right to use the exchanged currency at a specific time. NDFs, by their very nature, are the most valuable to markets where traditional currency trading is restricted or impractical.
In the past 12 months, HSBC has added multiple additional sources of liquidity for NDF currencies. HSBC provides deep NDF liquidity by size and tenor, including a broad offering of many more esoteric NDF currencies such as EGP and NGN. NDFs are mainly executed over-the-counter (OTC), with durations typically extending from one month to one year. Dollars are the most prevalent currency used to resolve these instruments. For further information, please refer to the ABS and SFEMC press release, ABS details , SFEMC details, and related materials.
Non-deliverable forward trades can be thought of as an alternative to a normal currency forward trade. Whereas with a normal currency forward trade an amount of currency on which the deal is based is actually exchanged, this amount is not actually exchanged in an NDF. The rate is calculated using the spot rate and a forward point adjustment for the tenor of the contract. The largest NDF markets are in the Chinese yuan, Indian rupee, South Korean won, New Taiwan dollar, Brazilian real, and Russian ruble. The largest segment of NDF trading takes place in London, with active markets also in New York, Singapore, and Hong Kong.
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. 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.
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. NDFs are typically quoted with the USD as the reference currency, and the settlement amount is also in USD. There are two kind of RMB for spot trading – CNY (Onshore RMB) and CNH (Offshore RMB). If corporate client would like to exchange RMB for cross-border merchandise trade related with providing relevant supporting documents, client can select CNY onshore spot contract as cross-border FX exchange.
While there is a premium to be paid for taking out an option trade, the benefits provided by their optional nature are significant. On the other hand, if the exchange rate has moved favourably, meaning that at the spot rate they receive more than expected, the company will have to pay the excess that they receive to the provider of the NDF. 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. Also known as an outright forward contract, a normal forward trade is used to lock the exchange rate for a future date. 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.
In certain situations, the rates derived from synthetic foreign currency loans via NDFs might be more favourable than directly borrowing in foreign currency. While this mechanism mirrors a secondary currency loan settled in dollars, it introduces basis risk for the borrower. This risk stems from potential discrepancies between the swap market’s exchange rate and the home market’s rate. While borrowers could theoretically engage directly in NDF contracts and borrow dollars separately, NDF counterparties often opt to transact with specific entities, typically those maintaining a particular credit rating. A non-deliverable forward is a foreign exchange derivatives contract whereby two parties agree to exchange cash at a given spot rate on a future date.
This creates a niche yet significant demand, allowing brokers to capitalise on the spread between the NDF and the prevailing spot market rate. With the right risk management strategies, brokers can optimise their profit margins in this segment. In the swap, the contract comes with a fixed rate that’s been taken directly from the spot rate. The U.S.-based company is set to pay $150,000; the South Korean company is set to pay $90,000 won.