NDF Market Continues Evolution

Shanny Basar

An increasing number of dealers are streaming prices for non-deliverable forwards leading to a rise in the use of algorithms, as the market is also shifting to central clearing.

NDFs are derivatives that are used to hedge or speculate against currencies where exchange controls make it difficult for overseas investors to make a physical cash settlement, for example, the Chinese renminbi.

Curtis Pfeiffer, Pragma Securities

Curtis Pfeiffer, chief business officer at Pragma Securities, a multi-asset quantitative trading technology provider, told Markets Media: “An increasing number of dealers are streaming NDFs prices, and streaming prices are a prerequisite for algorithmic trading, so clients asked us to develop algos as we have done in the spot market.”

In May last year the firm expanded its algorithmic trading platform, Pragma360, to include NDFs.

David Mechner, chief executive of Pragma Securities, said in a statement: “The ability for traders to have the same high level control and transparency that they enjoy with a G10 [currency], brings significant benefits when trading an NDF.”

Pragma has offered transaction cost analysis for more than 10 years and started in foreign exchange approximately five years ago when the firm launched its FX algos. The firm has also developed TradeRecap, which gives a one-page snapshot of performance for a recently completed trade as regulators focus on best execution.

Pfeiffer continued that as volumes of NDFs rise, algos provide the benefit of breaking orders into smaller pieces and trading more efficiently, thereby potentially improving execution quality.

Pragma clients can use several algos to trade the three most actively-traded NDFs – the Brazilian real, Korean kon and Indian rupee, which the firm said account for almost half of global NDF turnover – in addition to a suite of other currencies.

“When currencies are less liquid, the timing of orders and whether to cross the spread becomes an even more important decision,” said Pfeiffer. “We have developed a sophisticated microtrader that understands these market dynamics.”

He continued that in volatile markets traders may want to move aggressively and the algo can source liquidity quickly.

“Streaming of NDF volumes will likely continue to increase provided the geopolitical environment doesn’t change significantly and the use of algos for NDFs is a natural evolution of electronically streamed prices,”added Pfeiffer.

Traders may also have been encouraged by the increase in transparency in the NDF market as cleared volumes have risen. Clearing has been boosted since the final phase of the initial margin rules came into force in September last year requiring all financial counterparties to post collateral for initial margin against over-the-counter derivatives contracts that are not cleared.

In addition, the need to post collateral for variation margin for uncleared derivatives also came into force after a six-month grace period given by regulators to allow the necessary contracts to be put in place across the industry. As the need to post collateral has increased the cost of capital of uncleared derivatives, there has been a shift of certain products to clearing, particularly for non-deliverable forwards.

This month the Bank for International Settlements published its latest over-the-counter derivatives statistics which refer to the end of December 2017. For OTC foreign exchange derivatives, BIS noted that only 2% of notional amounts were centrally cleared at the end of last year.

“While the BIS does not collect a decomposition of FX derivatives into FX swaps and forwards, the cleared amounts were probably concentrated in non-deliverable forwards because they are one of the few FX instruments that CCPs offer for clearing,” added the report.

However, the London Stock Exchange Group’s ForexClear unit had a record first quarter this year for both NDF trades processed and notional cleared following the introduction of the uncleared margin.

Paddy Boyle, global head of ForexClear, LCH, said in a statement: “ForexClear has built on its strong start to 2018 with record levels clearing throughout the quarter as the risk, margin, capital and operational efficiencies of central clearing continue to attract users.”

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