Unleashing the potential of NDFs

Rocketing trading volumes in non-deliverable forwards are driving the market’s electronification, and that could be just the beginning

The non-deliverable forward market is booming. Daily volumes almost doubled to $258 billion in the three-year period to 2019, according to the Bank for International Settlements.

The question is whether the forces that have driven that growth will continue to do so.

One of these is the hunt for yield. In a world of low interest rates, some investors have embraced NDFs as a way to generate returns in emerging markets. Demand for these instruments is further boosted by local market participants’ hedging needs.

To meet buy-side demand, venues are introducing NDF trading in electronic form – Euronext was the latest to do so in September.

Banks have latched on to growing electronic volumes by streaming prices to clients via APIs and offering NDF-specific execution algorithms. Barclays, BNP Paribas, Goldman Sachs, HSBC and JP Morgan all offer NDF algos to clients, and the list is expected to expand in the coming months.

That’s how the virtuous circle of electronification works – or vicious circle, if you’re a voice desk that wants to hang on to its margins. Growing volumes produce calls for greater efficiency in execution, driving down trading costs and further boosting volumes.

But it’s not always a smooth journey, and e-trading in NDFs has some way to go before it can be considered mature. Industry practitioners lament that liquidity is often too thin and that information leakage is a regular problem – allowing market participants to spot trades in advance and move the market against them. 

Rob Hutchins, head of fixed income, currencies and commodity execution services for Asia at Goldman Sachs, acknowledges the risk and notes that “when considering a venue for inclusion into the NDF algo offering or the market-making book, there needs to be a critical mass of volume for it to make sense, given the risk of potential signalling.”

And while algo execution is on the up, the range of trading strategies available for NDFs is eclipsed by those in the spot space. Once again, the main obstacle being the fragile liquidity environment in which some NDFs operate. 

But as more and more banks expand their offering by borrowing trading solutions from other instruments, and client demand continues to rise, the NDF space is likely to become one to watch closely. 

As we explore in this month’s lead story, trades and strategies once thought inconceivable are now finding a home in the NDF market. And this is only the beginning. 

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