Non-deliverable forwards (NDFs) are a unique type of foreign currency derivatives used primarily in the forex market. As the name suggests, NDFs are forward contracts where the payments are settled in a convertible currency, usually USD, rather than in the currencies specified in the contract.

What are Non-Deliverable Forwards?

A non-deliverable forward is a short-term forward contract in which counterparties enter into an agreement to pay or receive the difference between the contracted NDF price or rate and the prevailing spot price or rate on an agreed notional amount. The key aspect of NDFs is that at no point are the underlying currencies exchanged.

How NDFs Work

Here is a step-by-step overview of how non-deliverable forwards work:

  1. Two parties, usually a corporation and a bank, enter into an NDF contract to buy or sell a specific currency at a specified exchange rate on a future maturity date.
  2. On the maturity date, there is no physical exchange of the currencies. Rather, there is a cash settlement made in a convertible currency like USD or EUR, based on the difference between the agreed upon NDF rate and the prevailing spot exchange rate.
  3. The party in an NDF contract with a profit due to favorable exchange rate movements receives a payment from the counterparty. The party with a loss makes a payment to the counterparty.
  4. Once cash settlement occurs, the NDF contract expires. There is no delivery of the underlying currencies.

For example, a U.S. importer enters into a 3-month NDF contract to buy 100 million Indian rupees at an NDF rate of INR 75 per dollar. If on the maturity date, the INR/USD spot rate is INR 70, the importer has a profit of INR 5 per dollar. The bank counterparty must make a payment of 100 million x (INR 75 – INR 70) = USD 500,000 to settle the NDF.

Key Features of NDFs

There are several unique features that distinguish NDFs from regular currency forwards:

  • Cash settlement – As described above, NDFs involve no physical delivery of currencies upon maturity. Settlement is done in a designated convertible currency.
  • Short-term – Most NDF contracts have terms under one year, often 3, 6 or 12 months. The short tenors enable hedging against currency moves in the near future.
  • Developing currencies – NDFs are commonly used for currencies which are not easily convertible or are subject to capital controls. Examples include the Chinese yuan, Indian rupee, Korean won, etc.
  • Tailored terms – NDFs can be customized to a corporation’s specific needs in terms of size, tenor, and settlement dates.
  • OTC instruments – NDFs are traded over-the-counter between the counterparties, unlike futures which are exchange traded.

Why Are NDFs Used?

Non-deliverable forwards serve multiple purposes providing benefits to corporations, investors, and traders operating across borders:

Hedging Currency Risk

NDFs are primarily used to hedge against currency risk in the near term for corporations that have exposure to developing market currencies which are often subject to high volatility. 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.

Access to Restricted Currencies

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.

Speculation and Arbitrage

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.

Lower Trading Costs

In some cases, NDFs may have lower costs compared to forward contracts on restricted currencies since they do not incur the expenses related to physical delivery of the currencies. The lower barriers to access make them preferred by investors with smaller capital.

Tailored Exposure

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.

Where are NDFs Traded?

NDFs are primarily traded in over-the-counter markets between authorized financial institutions and large corporations. They are usually not traded on exchanges due to the non-standard nature of the contracts and the need for credit relationships between the counterparties.

Major NDF Trading Centers

The main global hubs for NDF trading include:

  • Singapore – Most NDF trading volumes for Asian currencies are booked here due to the city-state’s advanced banking infrastructure and currency forward markets.
  • Hong Kong – Major center for trading Chinese yuan NDFs due to its proximity to mainland China.
  • London – Leading NDF center for trading currencies in the Middle East and Africa region.
  • New York – Key hub for trading Latin American currencies.

Market Participants

The most common participants in NDF markets globally are:

  • Banks – Large global banks are the major dealers and market-makers in NDF markets across currency pairs.
  • Corporations – Multinational companies are the primary users of NDF markets for hedging emerging market currency exposures.
  • Institutional investors – Hedge funds, asset managers engage in NDF trading for speculation and arbitrage strategies.
  • Brokers – Inter-dealer brokers facilitate transactions between banks for certain currency pairs and regions.

Why Trade NDFs? Pros and Cons

Here are the key advantages and disadvantages of trading non-deliverable forwards:

Advantages of NDFs

  • Gain exposure to exotic currencies – NDFs allow access to restricted currencies like the Korean won.
  • Lower trading costs – Savings on transactions costs and commissions compared to forward markets.
  • Customizable – NDFs can be tailored by corporates for their specific hedging needs.
  • Credit risk only – Only counterparty credit risk since no principal is exchanged.
  • Speculation – Purely a directional instrument allowing trades on currency volatility.

Disadvantages of NDFs

  • Counterparty risk – Reliant on creditworthiness of counterparty for cash settlement.
  • Less liquidity – Thinner trading volumes make entering and exiting positions more challenging.
  • Quotation nuances – NDF quotes can differ across providers for the same currencies.
  • Operate offshore – Many NDFs are booked offshore so taxes and regulations may apply.
  • Less transparency – OTC trading means quotes and pricing are not as visible as exchange trading.

Valuation and Pricing of NDFs

NDF prices are primarily based on the interest rate differential between the currencies involved and the expected spot rate on the value date. Here are the key factors:

Interest Rate Differentials

The difference in interest rates between the currencies in an NDF drive its pricing to a large extent. The currency with the higher interest rate will trade at a forward premium to the currency with a lower interest rate.

Current and Expected Spot Rates

The current spot exchange rate and market forecasts of where the spot rate will be on the maturity date impact NDF levels. The expected spot rate is a crucial pricing factor.

Days to Maturity

NDFs for longer tenors will have wider differentials between the contract rate and spot rate compared to short-term NDFs.


More uncertain and volatile FX markets command a higher risk premium, leading to wider differentials in NDFs compared to stable currency pairs.

Supply and Demand

Competitive quoting from multiple NDF dealers leads to narrower pricing, while low liquidity results in wider bid-ask spreads.

In addition to market-driven factors, the counterparty credit risk is also factored into NDF pricing by dealers. High risk clients face wider quotes.

Key Risks of Trading NDFs

While non-deliverable forwards can be useful instruments, participants need to be aware of the following key risks:

Counterparty Credit Risk

Since there is no principal exchanged, the holder of an NDF contract is reliant on the credit quality and financial standing of the counterparty bank or dealer to fulfill their payment obligations. A default can lead to losses.

Settlement Risk

Settlement of NDF contracts is subject to timing mismatches or errors, creating risk around execution of payments. Confirming cash flows in advance is crucial.

Liquidity Risk

The opaque OTC nature of NDF markets makes entering and exiting large positions more challenging. Sudden drying up of liquidity can make unwinding positions difficult.

NDFs traded offshore may not be subjected to the same regulations as onshore currency trading. Regulatory gaps pose risks for clients.

Operational Risks

Delayed confirmations, increased cancellations and amendments raise the likelihood of operational issues in OTC NDF markets compared to exchange trading.

Non-Deliverable Forwards Case Study

Let’s walk through an example of how a European multinational firm can utilize non-deliverable forwards to hedge Mexican peso exposure:

Business Scenario

BASF, a German chemical company, operates a manufacturing facility in Mexico. It expects to receive 300 million Mexican pesos in 90 days from customer sales in Mexico. BASF wants to hedge this incoming MXN exposure to EUR, its home currency.

Hedging with NDF

BASF enters a 90-day MXN/EUR NDF contract with Deutsche Bank to sell 300 million MXN at an NDF rate of 21 MXN per EUR.

Settlement at Maturity

If the actual MXN/EUR spot rate in 90 days is 22.50, BASF nets a profit of:

300 million x (21 – 22.50) = EUR 3 million

Deutsche Bank will pay BASF this settlement amount in EUR based on the NDF-spot differential.


The NDF effectively locked in BASF’s targeted MXN/EUR rate, eliminating the uncertainty of currency moves over the 90 day period. Settlement was seamless in a convertible currency without executing FX trades or transfers.

Final Thoughts

Non-deliverable forwards enable corporations, investors, and traders to efficiently hedge or gain exposures to exotic emerging market currencies. By providing synthetic access without physical delivery, NDFs circumvent issues like capital controls and illiquid local markets.

However, the opaque OTC structure also poses risks around counterparty credit, liquidity constraints, and operational issues. Understanding contract specifications and nuances across NDF providers is vital. Working with reputable banks and monitoring credit standing is key to risk management.

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.