Why have NDFs been slower to be become electronified?
The electronification of non-deliverable forwards (NDFs) has been influenced by idiosyncratic factors. Historically, liquidity in this domain has been in the hands of traditional banks, be they regional or global entities. Regional banks, with their local presence, typically offer more robust liquidity and expertise in dealing with specific currencies.
Since NDFs represent a relatively small segment within the broader FX markets, this has resulted in a muted demand for electronification. Major asset managers, ourselves included, have traditionally favoured partnerships with banks known for their research and presence in a particular region. This preference shifted notably after the implementation of Mifid II research unbundling regulations, opening the door for non-bank participants to enter the market making and electronification landscape.
Recent trends highlight an increasing demand from asset managers, fast money, and quant funds, expediting the transition toward electronification in NDF markets. This evolution reflects changing dynamics, with technology and a broader range of market participants playing pivotal roles in reshaping the market landscape.
Why are the NDF markets in Asia so deep?
Asian non-deliverable forwards (NDFs) outshine their Latin American counterparts due to the sheer scale and dynamism of Asian markets. This prominence is fuelled by the substantial economic activity, considerable gains from globalisation, and a strengthened regulatory and risk management framework post the 1997 Asian financial crisis.
The early adoption of electronic trading platforms for Asian NDFs is another distinguishing factor. Multinational corporations, financial institutions, and hedge funds, aiming to hedge FX risks or engage in speculative trading, drove the early development of these platforms. Additionally, the prolonged overlap with European trading hours provides a strategic advantage, facilitating seamless transactions across different time zones.
What will it take to make NDF algo usage mainstream?
The primary approach for engaging with NDF algorithms currently involves initiating trades on a one-month or IMM date basis and subsequently rolling positions to align with preferred non-standard maturity dates. However, this method presents challenges in estimating the all-in price ex-ante, as opting for a more favourable spot rate may result in less favourable forward points, influenced by market makers’ positioning.
Moreover, the limited number of market participants that have significant transaction sizes hinders the widespread use of NDF algorithms. While algorithms can be effective for smaller sizes, the maximum benefits are typically realised with larger transaction volumes. Notably, this dynamic shifts for systematic-only funds, where considerations and advantages associated with NDF algorithms may differ. As liquidity improves, standardisation increases, and more market participants express interest, the eventual mainstream adoption of algo usage in NDFs becomes increasingly likely.
What is algo usage like for NDFs trading on the buy-side?
The limited adoption of algorithms in NDF markets can be attributed to their unique characteristics. We still opt for NDF algorithms in markets where liquidity supports larger trades. Currently for us, the overall percentage of NDF volume traded via algorithms still remains relatively low, given the decent OTC liquidity with sharper spreads, making it the preferred method for the majority of NDF trading. However, I anticipate a shift in this scenario as more participants enter the market, leading to the evolution of NDF trading practices.