Non-deliverable forwards: hedge restricted currencies without delivering the currency at maturity

A non-deliverable forward, or NDF, is an FX derivative where the parties agree a future exchange rate but settle only the cash difference between that contracted rate and a reference spot rate. The underlying currencies are not physically delivered, which makes NDFs useful for currencies with exchange controls or limited offshore deliverability.

NDFs settle the difference rather than exchanging both currencies

The Bank for International Settlements defines an NDF as a forward in which counterparties settle the difference between the contracted rate and the prevailing reference rate on an agreed notional amount. Settlement is commonly in a freely convertible currency such as US dollars.

The notional amount is used to calculate the gain or loss. It is not normally delivered in the restricted currency at maturity.

NDFs can hedge currencies that are difficult to deliver offshore

Businesses with revenue, costs or assets linked to restricted currencies can use an NDF to protect the sterling or dollar value without needing an offshore delivery of the underlying currency.

The commercial cash flow still exists locally. The NDF provides a separate settlement that offsets part of the exchange-rate movement.

The contract needs a reference fixing rate and date

The settlement uses an agreed reference rate observed on a fixing date, followed by cash settlement on the contractual date. Treasury should know the source and timing of that fixing.

Local market controls or unusual holidays can affect reference rates. Do not assume the final spot rate from a retail FX screen is the contractual fixing.

The hedge can have basis risk

The rate used in the NDF market can differ from the exchange economics of the local commercial transaction. Capital controls, liquidity and offshore demand can make NDF pricing diverge from onshore markets.

That means the hedge may reduce currency risk without producing a perfect offset. Model the basis and settlement currency.

NDFs are OTC derivatives with counterparty exposure

Use approved banks or regulated derivatives counterparties and understand master-agreement, collateral and closeout terms for material programmes.

Large corporates should apply counterparty limits because a profitable hedge still depends on the provider being able to settle.

Keep the hedge and local exposure connected

Document the notional, fixing source, maturity, settlement currency and underlying commercial exposure. Accounting and tax treatment follows applicable derivative and foreign-exchange rules.

Do not let a cancelled supplier order leave an open NDF unreviewed. Once the underlying exposure disappears, the derivative can become a standalone market position.

Worked example: a UK company expects a large receivable linked to Indian rupees but cannot use a normal offshore deliverable INR forward in the same way as sterling-dollar. An INR NDF can fix an economic exchange rate and settle the difference in dollars, while the local rupee receipt remains handled separately.

Compare NDF settlement timing with the commercial cash flow. If the receivable arrives two weeks late, the hedge can settle before the company receives the local currency and create a temporary liquidity need.

Report NDFs by currency and hedge purpose. A treasury team should be able to distinguish hedges of real commercial exposure from trading positions that have no underlying business cash flow.

Worked example: a UK company expects a BRL-linked payment worth about $3 million in six months. Instead of arranging physical delivery of Brazilian reais offshore, treasury enters an NDF that settles the difference between the contracted BRL-dollar rate and the agreed fixing rate in dollars. The local commercial receipt and offshore hedge remain separate cash flows.

Set hedge ratios conservatively where the underlying amount is forecast rather than contractually fixed. An NDF for the full expected sale can become oversized if customer volume falls before maturity.

Review fixing-source disruption. Restricted-currency markets can experience holidays, capital controls or reference-rate changes that affect settlement methodology. The contract should state fallback provisions rather than leave the parties negotiating after the fixing fails.

Keep NDF gains and losses separate from product revenue. The derivative is a treasury result that offsets currency exposure, not evidence that the underlying customer paid more or less for the goods.

Use approved valuation sources at month end. NDFs can move materially with exchange-rate expectations even before fixing, so treasury should reconcile counterparty marks and investigate large differences rather than wait until settlement.

Limit NDF dealing to authorised treasury users and approved counterparties. Restricted-currency products are specialised derivatives and should not be booked ad hoc by operating subsidiaries without central visibility.

Set maturity alerts several working days before fixing. Treasury needs time to confirm the underlying exposure, settlement account and any rollover decision before the reference rate is determined.