Non-Deliverable Forwards
When dealing in emerging markets where exposure exists to the local currency, there are hedging instruments and methods that a corporate treasury can employ to mitigate this exposure.
A Non-Deliverable Forward (NDF) allows corporate treasurers to hedge their exposure to foreign currencies that are not traded, are only thinly traded internationally, or do not possess a forward market for non-domestic players. Examples of these currencies include Korean Won (KRW), Brazilian Real (BRL), Philippine Peso (PHP), Taiwan Dollars (TWD), Chinese Renminbi (CNY) and Indian Rupee (INR).
The NDF is appropriate for companies that have local currency payables (i.e., cannot deal in U.S. dollars), such as the costs for foreign plant operations or local loans denominated in the local currency.
An NDF is a committed forward FX “cash settlement” currency derivative instrument. It is essentially an outright (forward) FX contract whereby on the contracted settlement date, profit or loss is adjusted between the two counterparties based upon the difference between the contracted NDF rate and the prevailing spot FX rates on an agreed notional amount.
The notional amount is the face value of an NDF, which is agreed between the two counterparties. It should again be noted that there is never any intention to exchange the two currencies; the only exchange is the profit and loss between the contracted NDF rate and the prevailing spot market rate at expiry. This amount is settled on the settlement date.
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