In finance, a non-deliverable forward (NDF) is an outright forward or futures contract in which counterparties settle the difference between the contracted NDF price or rate and the prevailing spot price or rate on an agreed notional amount. It is used in various markets such as foreign exchange and commodities. 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).

Market

The NDF market is an over-the-counter market. NDFs began to trade actively in the 1990s. NDF markets developed for emerging markets with capital controls, where the currencies could not be delivered offshore. Most NDFs are cash settled in US dollars.

The more active banks quote NDFs from between one month to one year, although some would quote up to two years upon request. Apart from the standard tenors (1, 2 and 3 months) 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.

Structure and features

An NDF is a short-term, cash-settled currency forward between two counterparties. On the contracted settlement date, the profit or loss is adjusted between the two counterparties based on the difference between the contracted NDF rate and the prevailing spot FX rates on an agreed notional amount.

The features of an NDF include:

* the notional amount: This is the "face value" of the NDF, which is agreed between the two counterparties. It should again be noted that there is never any intention to exchange the notional amounts in the two currencies

* the fixing date: This is the day and time whereby the comparison between the NDF rate and the prevailing spot rate is made.

* the settlement (or delivery) date: This is the day when the difference is paid or received. Depending on the currencies dealt, the fixing date is one or two good business days before the settlement date.

* the contracted NDF rate: This is the rate agreed between the two counterparties on the transaction date, and is essentially the outright forward rate of the currencies dealt.

* the prevailing spot rate: The fixing of spot rate on the fixing date is based on a reference page on Reuters or Telerate with a fallback of calling four leading dealers in the relevant market for a quote.


Because an NDF is a cash-settled instrument, the notional amount is never exchanged. The only exchange of cash flows is the difference between the NDF rate and the prevailing spot market rate that is exchanged on the settlement date.

Consequently, NDFs are "non-cash" products, which are off-the-balance-sheet and as the principal sums do not move, possess much lower counter-party risks. NDFs are committed short-term instruments; both counterparties are committed and are obliged to honor the deal. Nevertheless, either counterparty can cancel an existing contract by entering into another offsetting deal at the prevailing market rate.

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