Offshore NDFs’ Dubious Deliverables
After calculating non-deliverable forwards, where non-resident investors can take synthetic positions in controlled currencies, as a “tiny fraction” of foreign exchange trading, the BIS in a new paper sets likely future direction for these derivatives where they combine with onshore and deliverable markets involving actual transfer short of outright liberalization as their hedging and speculative role “fades away.” The 2013 Triennial Survey put daily volume at $125 billion with London accounting for one-third but Asian centers conduits for the Chinese renimbi and Korean won with comparable offshore size over 15 billion. The Brazilian real and Indian rupee show similar activity, while the Russian ruble features in one-quarter of the other popular units for these contracts settled in dollars for the difference between an agreed upon rate in advance and the spot reading at maturity. During last year’s Federal Reserve tapering scare NDFs were an “adjustment valve” for offloading bond risk, the analysis comments. Smaller exposures in markets like the Chilean peso and Peruvian sol were slashed as global regulators led by the US and Europe demanded “high-frequency and granular” reporting, and the New York-based DTCC now tracks $50 billion through its accounts each day. Regressions suggest that the NDF quote influences domestic values more during volatile periods as measured by the VIX. As to evolution, restrictions on forward buying and selling tend to disappear gradually and even with convertibility as with the ruble almost a decade ago the segment remains active. Korea has lifted curbs “cautiously” and banks arbitrage the onshore and external NDF markets and deal in a range of related swaps and options. Forwards are divided but non-deliverable consolidation in a central transparent platform should boost liquidity. Yuan internationalization is “idiosyncratic” as offshore deliverables and non-deliverables compete as the former went to $7 billion daily since 2010 introduction. Official investors favor this Hong Kong route and hedge funds have jumped in as for technical reasons it better tracks the onshore rate.
Until the recent downward move which may have been engineered by authorities to hurt these players, the one-way appreciation bet since dollar band loosening was immensely profitable and spawned a bevy of associated structured products. The managed exchange rate regime will not change in the near term according to the latest financial reform announcements and analyst consensus is for strengthening below 6/dollar by year-end. However the sudden blip underscored confusion about the new leadership’s monetary policy as it tries to squeeze property and shadow banking channels at the same time the 7.5 percent GDP growth target was reaffirmed through maintaining state bank industrial and infrastructure lines. These institutions are also large issuers and buyers in the $1 trillion corporate bond market where the first domestic default by a solar firm was a minor watershed as it also owes trusts which too may feel an initial sting, although the broader message of credit due diligence has yet to be delivered.
