Non-Deliverable Forward

An NDF — non-deliverable forward — is a forward contract on a currency pair that is settled in cash rather than through physical exchange of the two currencies. A company with exposure to Chinese renminbi (CNH) or Indian rupee (INR) — currencies that are not freely convertible or are restricted to certain counterparties — uses NDFs to hedge without needing to actually take possession of the currency.

Why NDFs exist

Some currencies are not freely convertible. The Chinese renminbi (CNY), the official currency, is restricted; residents and businesses cannot freely convert it to dollars. The offshore renminbi (CNH, traded in Hong Kong) is more flexible but still subject to capital controls.

A US company with a subsidiary in China that earns renminbi and needs to send profits home faces a dilemma: they cannot simply buy a forward contract because taking physical delivery of renminbi is difficult or impossible (or would require special government permission). Instead, they use an NDF.

An NDF lets them lock in an exchange rate today for cash settlement in the future. On the settlement date, they do not receive actual renminbi; instead, the bank pays them the difference between the contracted NDF rate and the actual spot rate at settlement, in dollars.

Example: A US exporter selling $1 million of goods to a Chinese buyer will be paid in renminbi in 90 days. They buy an NDF: 90-day NDF at 7.2000 CNH/USD. On settlement day:

• Actual spot rate: 7.3000 CNH/USD
• NDF rate: 7.2000 CNH/USD
• The buyer pays the seller: (7.3000 − 7.2000) × 1,000,000 = $137,000 paid to the seller in dollars

The seller has hedged the currency risk, even though no renminbi ever changed hands.

How NDF rates are determined

NDF rates follow the same logic as forward rates: they are based on the spot rate plus an adjustment for the interest-rate parity. If CNH interest rates are 3% and dollar rates are 5%, the forward NDF will trade at a discount to spot (fewer renminbi per dollar in the forward).

In practice, NDF rates can diverge from the theoretical forward rate because of supply and demand. There are many exporters wanting to sell renminbi forwards; fewer companies want to buy renminbi forwards. This imbalance pushes NDF rates away from the theoretical level, sometimes by 1–3% (significant on an annual basis).

OTC market and institutional-only size

NDFs are not exchange-traded and do not trade in standardized lot sizes. They are bespoke over-the-counter (OTC) contracts negotiated between the company and a bank. The minimum size is usually $1 million or more. A small company cannot access NDFs; they must work with a large multinational bank that has a dealing desk.

Pricing is negotiated bank-to-bank or bank-to-client. Spreads are wide — easily 50–100 pips or more — because the market is thin and the credit risk is high (you must trust the bank to pay you the difference on settlement day).

Varieties of NDFs

Fixing NDFs — the most common. The settlement rate is the official daily fix rate published by the relevant central bank or a consortium of banks (e.g., the CNH fixing published by the Hong Kong Monetary Authority).

Non-fixing NDFs — less common. The settlement rate is the actual mid-market spot rate at settlement, agreed between the two parties.

The choice matters: fixing rates can diverge from market rates, giving one counterparty an advantage. This is often negotiated and reflected in the NDF price.

Regulatory and liquidity considerations

NDFs are less regulated than currency futures because they are not exchange-traded. Some jurisdictions restrict use of NDFs by non-residents or prohibit them entirely. A company should check local law before entering an NDF.

NDFs can be unwound before maturity by taking an offsetting position with a bank, but the liquidity and pricing for unwinds can be poor. Once you are in an NDF, you are somewhat locked in.

See also