Non-Deliverable Forward (NDF)

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Non-Deliverable Forward (NDF)

What is an NDF?

A non-deliverable forward (NDF) is an over-the-counter (OTC) foreign-exchange derivative used to hedge or speculate on currencies that are restricted, illiquid, or not freely convertible. Instead of exchanging the underlying currencies at maturity, parties settle the contract in cash—usually in a freely traded currency such as the U.S. dollar—based on the difference between the agreed forward rate and the prevailing spot rate at the fixing date.

Key takeaways

  • NDFs are cash-settled forward contracts for currencies with capital controls or limited offshore liquidity.
  • Settlement is in a convertible currency (commonly USD) and is based on the difference between the contract rate and the reference spot rate.
  • Major NDF markets include the Chinese yuan, Indian rupee, Brazilian real, South Korean won, New Taiwan dollar, and Russian ruble.
  • Typical users: multinational corporations, banks, hedge funds, and sometimes central banks.
  • Main risks: market risk, counterparty risk, and liquidity risk.

How NDFs work

  • Parties agree on: currency pair (restricted currency vs. convertible currency), notional amount, NDF rate (forward rate), fixing date, and settlement date.
  • On the fixing date the reference spot rate is observed (as defined in the contract).
  • Settlement amount = (NDF rate − Reference spot rate) × Notional amount
  • If the formula is quoted as restricted-currency units per USD and positive, the party short the restricted currency pays the difference; contract terms determine payer/receiver.
  • Only the net cash difference is exchanged in a convertible currency on the settlement date—no physical delivery of the restricted currency.

Example

Party A and Party B agree an NDF on 1,000,000 USD at an NDF rate implying 6.41 units of restricted currency per USD; fixing is in one month.
If the reference spot in one month is 6.30, the restricted currency has strengthened (favors the party that bought it) and the counterparty pays the net difference in USD. If the spot is 6.50, the restricted currency has weakened and the other party is paid.

Key contract features

  • Notional amount — the principal used to calculate settlement.
  • NDF (forward) rate — the agreed rate used in the settlement calculation.
  • Fixing date — date the reference rate is observed.
  • Settlement date — date the net cash payment is made.
  • Settlement currency — usually USD, sometimes EUR, JPY or other convertible currencies.

Common currencies and trading hubs

  • Frequently traded NDF currencies: Chinese yuan (CNY), Indian rupee (INR), Brazilian real (BRL), Argentine peso (ARS), South Korean won (KRW), New Taiwan dollar (TWD), Russian ruble (RUB).
  • Major trading centers: London, New York, Singapore, Hong Kong.
  • USD is the dominant settlement currency; EUR and JPY are also used.

Market participants

  • Multinational corporations — hedge cash flows and operating exposure in restricted markets.
  • Banks and dealers — provide liquidity and act as counterparties.
  • Hedge funds and trading firms — take speculative positions on currency moves.
  • Central banks/governments — occasionally use NDFs for reserve management or to influence perceived exchange rates.

Risks

  • Market risk — adverse movements in the reference exchange rate can create losses.
  • Counterparty risk — OTC nature means exposure if a counterparty defaults.
  • Liquidity risk — certain NDF markets can be thin, widening bid-ask spreads and making it hard to enter/exit positions.
  • Operational/settlement risk — ambiguity in reference rate definitions or timing can affect payouts.

NDFs vs. currency swaps

  • NDF: single cash-settlement at maturity based on the difference between forward and spot rates; commonly used for short-term hedging and for currencies that cannot be delivered offshore.
  • Currency swap: involves exchanging principal and periodic interest payments in two currencies (often with principals exchanged back at maturity); suited for long-term financing and managing interest-rate/FX exposure.
  • Complexity and cash flows: NDFs are simpler with one net settlement; swaps have multiple cash flows and a principal exchange.

When to use an NDF

  • To hedge FX exposure in a currency that cannot be freely traded or held offshore.
  • To gain exposure to or speculate on movements in restricted or emerging-market currencies without physical delivery.
  • As a short- to medium-term risk management tool when access to onshore markets is restricted.

Conclusion

NDFs provide a practical way to manage FX risk in markets with capital controls or limited convertibility by settling exposure in a freely traded currency. They offer flexibility and simplicity for hedging and speculation but carry distinct market, counterparty, and liquidity risks that participants should manage through careful counterparty selection, contract specification, and risk controls.