NDF — the cash-settled forward for emerging-market currencies

Picture a company that has won a contract in Brazil and will be paid in Brazilian reais six months from now. The trouble is that the real cannot be hedged as simply as the euro or the dollar — Brazil restricts the free flow of capital, and banks abroad cannot freely buy and sell the currency. The answer is an NDF (non-deliverable forward): a forward contract settled purely in cash, in US dollars, with no physical delivery of the underlying currency. It is an institutional tool for currencies that simply cannot be moved across borders. Below I explain how an NDF works, which currencies it was built for, and whether a retail trader will ever actually run into one.

What a non-deliverable forward actually is

An NDF is a variant of an ordinary forward contract — an agreement in which two parties fix today the exchange rate for a specific date in the future. There is one difference, but it is fundamental. In a classic forward, delivery actually takes place on the settlement date: one side hands over euros, the other dollars. In a non-deliverable forward there is no delivery at all. The parties compare the rate agreed in advance with a reference rate on the settlement date and pay each other only the difference, always in US dollars (USD). Hence the name: a contract with no delivery.

Why does such a structure exist in the first place? Because some of the world's currencies are non-convertible or subject to capital controls. China, India, Brazil, South Korea and Taiwan restrict how much of their currency may leave the country and who may trade it abroad. A foreign investor or exporter cannot simply buy these currencies forward the way they buy the British pound (GBP). An NDF sidesteps the problem: nobody moves a single yuan or real across the border — only the dollar difference changes hands. The currency exposure is there; the physical transfer is not.

For the record, it is worth saying what an NDF is not. It is not a retail product like a CFD on a currency pair. It is a wholesale market built on master agreements (the ISDA standard and EMTA documentation templates), with minimum sizes measured in hundreds of thousands and millions of dollars. The counterparties are banks, funds and large corporations, not an individual trader with a few thousand in the account.

How settlement works, step by step

The mechanics of an NDF rest on three elements: the agreed contract rate, the reference rate on the fixing date, and a notional amount expressed in dollars. Let us trace it through the exporter from the opening paragraph, who wants to hedge a payment in Brazilian reais (BRL) three months ahead.

1. Today the parties enter into a USD/BRL NDF with the contract rate set at 5.00 and a notional of one million dollars, settling in three months.
2. On the settlement date the official reference rate is checked — for the real, the rate published by Brazil's central bank (PTAX). Suppose it comes in at 5.30, meaning the real has weakened against the dollar.
3. The difference between the fixing rate and the contract rate is 0.30. Applied to the notional, this produces a settlement of several tens of thousands of dollars, which one side pays the other.
4. Nobody receives or delivers any reais. The whole transaction ends with a single dollar transfer — that is the essence of cash settlement.

The fixing is the crucial part, because it decides who pays whom. Every currency has its own official reference rate: for the Indian rupee (INR) it is the fixing published by the Reserve Bank of India, for the Korean won (KRW) it is the rate from the Seoul banks' association, for the Singapore dollar (SGD) it is the fixing published by the local central bank. Typical NDF maturities run from one to twelve months, with the one-month and three-month contracts being the most liquid.

Which currencies the NDF was built for

The NDF is the domain of emerging markets. According to the Bank for International Settlements (BIS) survey of April 2022, global turnover on the foreign-exchange market reached 7.5 trillion dollars a day, of which forward contracts accounted for roughly 15 percent. Non-deliverable forwards are part of that segment — and, crucially, their importance in emerging markets keeps growing. The BIS notes that five currencies — the Chinese yuan (CNY), the Indian rupee (INR), the Korean won (KRW), the Brazilian real (BRL) and the Taiwan dollar (TWD) — account for about 55 percent of global NDF turnover.

To this group you can add further cash-settled currencies, among them the Indonesian rupiah (IDR) and the Philippine peso. The common denominator is always the same: restrictions on the free trading of the currency outside the country's borders. Where those restrictions do not exist — the euro (EUR), the pound, the Japanese yen (JPY), the Swiss franc (CHF) — the NDF is redundant, because an ordinary deliverable forward does the job.

Offshore yuan (CNH) versus onshore yuan (CNY)

The most common confusion concerns the Chinese yuan, because it exists in two versions. That distinction is the clearest illustration of why the NDF exists at all and when it stops being needed.

The onshore yuan (denoted CNY) is the domestic currency, available only on the Chinese market, subject to capital controls and steered by the local central bank. For a foreign investor, direct deliverable forward trading in CNY is impossible — and this is precisely where the NDF historically stepped in. The offshore yuan (denoted CNH) is the same currency, but traded outside mainland China, primarily in Hong Kong. CNH is convertible and can genuinely be delivered, which is why it even appears in the offering of some retail brokers.

Importantly, the two rates can drift apart — in periods of market stress the gap between CNH and CNY can reach several percent, because the offshore rate moves freely while the onshore one is managed. The growth of the offshore market in Hong Kong has in fact made the yuan an exception to the rule: the BIS points out that for the Chinese currency, ordinary deliverable forwards (CNH) are gradually displacing the NDF, while for the Indian rupee, the won and the Taiwan dollar the non-deliverable market is still expanding. In other words, the NDF is a solution for as long as a currency cannot be moved freely — once that becomes possible, the deliverable contract takes over.

"The dollar dominated internationally in the second half of the twentieth century for the same reasons and in the same way that the United States dominated the global economy." — Barry Eichengreen, Exorbitant Privilege: The Rise and Fall of the Dollar, Oxford University Press, 2011.

That observation explains nicely why NDF settlement happens in dollars of all currencies. Emerging-market currencies may be non-convertible, but the dollar is the common denominator of global finance — and it is in dollars that the rate difference is paid out, even when the contract is about reais or rupees.

How a retail investor can use it

Here I have to be honest: directly, almost never. The NDF is a wholesale product with large notionals and master agreements struck between institutions. From my own vantage point — I have followed the forex market as an analyst since 2007 and have run MyBank.pl since 2004 — in all those years I have not met an individual retail investor settling a genuine NDF on a retail account. It simply is not a segment for retail.

What is more, the Polish zloty (PLN) is a fully convertible currency and does not need this construction. Someone wanting to hedge euro or dollar exposure uses the ordinary instruments available at a broker or a bank. The NDF only enters the picture with exotic emerging-market currencies under capital controls.

If you are after emerging-market exposure as a retail investor, the practical tools are different from the NDF. The simplest are exchange-traded funds (ETFs) on emerging markets, available for a few hundred and covered by regulation. And if you want to understand the wider context — how banks and companies hedge currency risk on a forward basis — the articles on the mechanics of FX swaps and on currency options will help, because the NDF is simply another instrument from the same family. It is also worth knowing that exposure to a currency does not always require physically owning it — a point covered well in the ForexMechanics section on forex basics.

Common misconceptions and risks

We have already covered the first misconception: confusing CNH with CNY. The second concerns risk. The NDF is sometimes presented as a convenient way around capital controls, but it carries dangers that an ordinary forward does not.

• Counterparty risk. Since settlement comes down to a single transfer of the rate difference, everything hinges on the solvency of the other side on the settlement date — that risk is higher than in a deliverable trade.
• Liquidity risk. Emerging-market currency markets can dry up during a crisis, and closing an NDF position then becomes difficult and costly.
• Divergence from the spot market. The NDF rate can detach from the current spot rate of the currency, especially when capital is fleeing the country and the central bank is defending an official rate.
• Regulatory risk. Capital controls and fixing rules can change overnight by central-bank decision, which directly affects how the contract settles.

The third misconception is the belief that the NDF is an exotic curiosity of no importance. The opposite is true — it is one of the pillars of emerging-market currency trading, and its role is growing. It is just happening at a level the average retail investor never sees, because it plays out between banks and large companies.

What to do tomorrow

1. Check whether the currency you are interested in is convertible at all. Go to your broker's website and look for the currency pair you want to trade. If you find the Singapore dollar or the Indian rupee only as a pair against the dollar, with a note about cash settlement, that is a signal you are dealing with NDF mechanics rather than an ordinary forward.
2. Tell CNH apart from CNY in your broker's offering. If your broker offers the Chinese yuan, check the instrument specification to see whether it is the offshore version (CNH) or the onshore one (CNY). That is the first difference worth remembering — practically only CNH is tradeable for retail.
3. If you want emerging-market exposure, compare ETFs. Open a fund comparison tool and find two or three emerging-market exchange-traded funds. Check their annual costs and listing currency — for a retail investor this is a far simpler and cheaper route than any currency contract on those markets.
4. Get the basics of forward instruments straight. Read the articles on the mechanics of FX swaps and on currency options before you dig into NDFs — without understanding an ordinary forward, a non-deliverable contract will stay an abstraction.