A complete guide to non-deliverable forwards (NDFs) in foreign exchange—what they are, how they work, when to use them, how to evaluate them, and the risks you need to manage.
Nd forex most commonly refers to non-deliverable forwards (NDFs), a type of foreign exchange derivative used primarily for currencies that are not freely convertible or that have limited offshore markets. Unlike a standard deliverable forward, an NDF is cash-settled in a major currency (usually U.S. dollars) based on the difference between a contracted forward rate and a reference fixing rate at maturity. There is no physical exchange of the underlying non-convertible currency.
NDFs are essential tools for participants who need to hedge or gain exposure to emerging market currencies such as the Chinese renminbi (CNY), Indian rupee (INR), South Korean won (KRW), Brazilian real (BRL), Chilean peso, Colombian peso, and Indonesian rupiah. These currencies often have capital controls, restrictions on convertibility, or limited offshore liquidity, making deliverable forwards impractical or impossible.
According to the Bank for International Settlements (BIS), trading in NDFs and other emerging market FX derivatives has grown significantly over the past decade, reflecting increased global trade and investment in emerging economies. The BIS Triennial Survey provides detailed data on NDF turnover, which is concentrated in major financial centres such as London, New York, Singapore, and Hong Kong.
NDFs are over-the-counter (OTC) instruments, meaning they are traded directly between counterparties rather than on an exchange. This allows for flexibility in terms, but also introduces counterparty credit risk and less transparency than exchange-traded products. The market is dominated by large international banks and specialized brokers, with corporate and institutional clients as the primary end-users.
An NDF is a contract with three key elements: the notional amount, the contracted forward rate, and the fixing rate at maturity. At contract inception, the two parties agree on a notional amount of the non-convertible currency and a forward exchange rate. No money changes hands at this point.
At the maturity date, the fixing rate (often an average of spot rates from a panel of banks at a specified fixing time) is compared to the contracted forward rate. The difference is multiplied by the notional amount. If the fixing rate is higher than the contracted rate, one party pays the other; if it is lower, the payment goes in the opposite direction. The settlement is made in a freely convertible currency, typically U.S. dollars.
NDFs have standardised fixing dates (e.g., two business days before maturity for most currencies) and are often traded with maturities from one month to one year, though longer tenors are available. The fixing rate is usually set by an independent source such as Reuters or a central bank reference rate. The contract documentation (often using the ISDA Master Agreement) specifies the fixing source, the fixing time, and the settlement currency.
NDFs are used in a variety of real-world scenarios, particularly when dealing with emerging market currencies. Here are three common use cases.
A U.S. manufacturing company has a large contract to supply machinery to a Brazilian customer. The contract is denominated in Brazilian reais (BRL), which is subject to capital controls and has limited liquidity offshore. The company uses an NDF to hedge the BRL exposure, locking in the USD/BRL rate and protecting its margin from adverse moves.
An asset manager holds a portfolio of Indian equities and is concerned about a potential depreciation of the rupee. The manager enters an NDF on the USD/INR pair to hedge the currency risk of the portfolio without having to sell the underlying equities or deal with onshore convertibility restrictions.
A trading company imports goods from China and pays in renminbi (CNY). Since the CNY is not fully convertible offshore, the company uses an NDF to lock in the USD/CNY rate for a future payment, ensuring cost certainty and avoiding the volatility of the offshore CNH market.
A U.S. technology company has won a contract to provide software and services to a Brazilian bank. The contract is worth R$50 million, payable in six months. The current USD/BRL spot rate is 5.00, meaning the contract is worth approximately $10 million today. The company is concerned that the BRL might weaken (USD/BRL rises) over the next six months, reducing its dollar revenue.
The company enters a six-month NDF on USD/BRL with a contracted forward rate of 5.20. At maturity, the fixing rate is published as an average of spot rates. If the fixing rate is 5.40 (BRL weakened more than expected), the company receives a cash settlement in USD equal to the difference (5.40 − 5.20) multiplied by the notional amount. This compensates for the loss in revenue. If the fixing rate is 4.90 (BRL strengthened), the company pays the counterparty, but it benefits from a higher dollar value of the underlying contract.
Note: This is an illustrative example. Actual NDF rates, spreads, and availability vary by provider and market conditions. Always verify current pricing and terms with your FX counterparty.
When considering an NDF, evaluation should cover several dimensions: pricing and transparency, counterparty risk, liquidity, and regulatory standing.
NDF pricing is derived from the underlying spot market (where available) and interest rate differentials between the two currencies. However, since the underlying currency may have limited offshore liquidity, NDF prices can be volatile and less transparent than major currency forwards. Providers typically quote a bid-ask spread, and clients should request quotes from multiple counterparties to ensure competitiveness.
Because NDFs are OTC contracts, the creditworthiness of the counterparty is paramount. Participants should only transact with well-capitalised, regulated financial institutions. Credit support annexes (CSAs) and collateral agreements are often used to mitigate counterparty risk, especially for larger or longer-dated transactions.
Liquidity in NDFs varies significantly by currency. The most liquid NDF markets are for CNY, KRW, INR, and BRL. Less liquid currencies may have wider spreads and less reliable pricing. Participants should assess whether the NDF market for their desired currency is deep enough to support their hedging or trading needs without excessive cost.
| Feature | NDF | Deliverable Forward | FX Option |
|---|---|---|---|
| Settlement | Cash-settled (USD or major currency) | Physical delivery of both currencies | Cash-settled or physical (depending on terms) |
| Currency Type | Non-convertible / restricted | Freely convertible | Both, but NDF options available for restricted currencies |
| Obligation | Obligation to settle the difference | Obligation to deliver | Right (not obligation) to exercise |
| Cost Structure | Spread only (no upfront premium) | Spread only | Premium + spread |
| Counterparty Risk | Yes (OTC) | Yes (OTC) | Yes (OTC) |
| Regulatory Treatment | CFTC-regulated as swaps in U.S. | CFTC-regulated as forwards in U.S. | CFTC-regulated as swaps in U.S. |
Before entering an NDF, consider the following practical checklist.
NDFs are complex OTC derivatives that carry significant risks. The CFTC has issued investor warnings regarding the risks of off-exchange foreign currency transactions, including NDFs. These products can involve leverage, illiquidity, and counterparty default risks. Prices can be volatile, and losses may be substantial.
The NFA BASIC database provides information on registered entities and their disciplinary history, which is a useful starting point for evaluating counterparties. However, registration does not eliminate market risk. This guide does not provide personal financial, legal, or tax advice. Consult a qualified professional for advice tailored to your circumstances.