Non-deliverable forwards (NDFs) have not always gone hand in hand with algorithmic trading, but in light of recent market developments, this could be about to change. The instruments have been pegged by the buy-side as the next frontier when it comes to algorithmic trading efforts in the foreign exchange (FX) markets.
Speaking to The TRADE at the TradeTech FX European conference in September, heads of trading said they intended to focus their attention on understanding how to best develop and adopt algorithmic offerings tailored to these instruments.
It is therefore unsurprising that the electronification of NDFs is being discussed on the main stage at this year’s TradeTech FX US conference in Miami. Key questions around market depth, liquidity and initiatives launched by institutions and vendors to innovate in this space in light of new demand are set to be explored.
NDFs are cash settled short term forwards – the notional amount is never exchanged – earning itself the title of non-delivered. The instruments can require significant documentation and mediation from both parties involved and historically, they have been more of a side-line market in the wider foreign exchange sphere, making them less liquid and less transparent, and also making it far easier to move markets.
It is these workflow factors combined that have meant NDFs have been slower to automate and algorithmically trade when compared against other FX instruments. There is a limited number of participants eager to trade in size algorithmically when comparing NDFs to the spot markets for example. Instead, many institutions still opt to trade by voice.
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“The limited number of market participants that have significant transaction sizes hinders the widespread use of NDF algorithms,” APG Asset Management’s senior trader Sunil Patil tells The TRADE. “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.”
NDFs have, until recently, represented a relatively small segment of the FX markets. The buy-side has subsequently chosen to opt for reliable counterparty relationships to maintain presence and research in different regions and has resulted in a muted desire for electronification, until recently. However, in the advent of market developments, such as Mifid II research unbundling rules in Europe, a greater number of non-bank participants have begun entering this landscape.
“Recent trends highlight an increasing demand from asset managers, fast money, and quant funds, expediting the transition toward electronification in NDF markets,” says Patil. “As liquidity improves, standardisation increases, and more market participants express interest, the eventual mainstream adoption of algo usage in NDFs becomes increasingly likely.”
Circumstances over the last few years have incentivised increased interest in NDFs trading across the buy-side. And while algorithmic adoption is by no means mainstream, the pace of growth in this market has been steady and slow.
Where there are volumes, automation will surely follow. Throughout the course of 2022, several regulatory deadlines came into play – namely the final phase of Uncleared Margin Rules (UMR) and the Standardised Approach for Counterparty Credit Risk (SA-CCR) – which have pushed participants into the arms of NDF clearing in order to optimise balance sheets.
This shifting backdrop, paired with a general push for automation where possible – particularly to cut costs and boost performance on smaller orders – from the street has encouraged a wave of development across the sell-side as firms look to cater to new demand for NDF algo offerings.
In research published at the end of 2022, Worldwide Business Research (WBR) found that while only 8% of FX trading desks had already adopted NDF algo execution, an additional 27% said they were planning to implement them in the following six months. Nearly half of the respondents were also evaluating NDF algos with their counterparties, but said they had no immediate plans to adopt them, indicating potential for future growth.
Read more – CME Group to establish unified global NDF trading venue
Progress was slowed over the last few years due to market conditions. The volatility and rates backdrop seen throughout 2023 somewhat stunted the formerly projected growth in NDFs algos, MEAG’s senior trader Nicholas Nellis tells The TRADE. While firms such as MEAG use NDF algos already, and despite the number of institutions like them growing, banks have not yet seen the uptake of their new NDF algorithmic offerings that they had previously expected.
“For a while, a lot of people were trading NDFs to try and pick up carries, especially in the low rates environment,” says Nellis. “In this environment now, with more volatility and the ability to get decent returns elsewhere, people that are traditionally in those markets have probably stepped back. People are a lot more comfortable still trading voice on the NDF side.”
A key hurdle for the mainstream adoption of algorithms in NDF trading has historically been the lack of opportunity for traders to interact with liquidity on an order book – hindering market depth and transparency. Previously, there were few platforms dedicated to the trading of NDFs. But in recent months, market headlines have been littered with a string of announcements as platform providers and venues announce new ventures, which Nellis confirms has improved algo performance.
“There isn’t that much liquidity so trying to trade it electronically over a platform is not as easy. You can move markets quite quickly. In that space, spreads tend to be a lot wider when you trade electronically for some of these markets,” he explains. “But we’ve seen more players come into the electronic/ECN market. They’re trying to provide more liquidity. There’s been a change in algo performance at least with these additional venues in place. It just takes time.”
CME Group was the latest firm to make such an announcement, confirming in December last year that it had established a global unified NDF trading network. The trading venue is set to combine its two non-deliverable forward (NDF) liquidity pools on the EBS Market platform onto a single trading venue in October, subject to regulatory approval.
The move will bring market participants across regulatory jurisdictions into a unified global trading environment, which CME Group claims will enhance market efficiency and improve EBS’ role as a source of centralised liquidity and price discovery in NDFs.
“Amid continued fragmentation and rising complexity within the global FX market, the need for a unified, globally accessible primary trading venue in NDFs is greater than ever,” said Paul Houston, global head of FX products at CME Group, at the time of the announcement.
“Combining our two leading NDF trading platforms will improve access for participants around the world while expanding liquidity, improving price discovery and providing operational efficiencies for the marketplace.”
Earlier in 2023, Trading Technologies confirmed it was also due to set up a new foreign exchange unit in early 2024, with plans to extend its offering to include liquidity from major banks, alongside the expansion of the product set to include forwards, NDFs and swaps.
Asia focus
Central to the recent growth and evolution seen in the NDF markets is Asia. Many of the new initiatives announced of late have a link to the Asian markets – home to a huge chunk of the world’s global foreign exchange activity. The Asia NDF markets trade throughout the day, making them a useful way to access these markets outside of market hours in other regions, while an overlap with European trading hours makes them appealing to institutions attempting to facilitate transactions across time zones.
Asian markets were early adopters of electronic trading platforms for NDFs in comparison with other markets and the continent now contains some of the most traded NDF currencies in the world, namely in Korea, Taiwan, Singapore, India, and Indonesia, making it a popular destination for those looking to set up new ventures.
Singapore in particular has made a huge push into positioning itself as trading hub across several asset classes – in particular global FX – by creating a favourable regulatory environment for new platforms coming to market. The Singapore Exchange (SGX) acquired a 20% stake in institutional FX trading platform BidFX in 2019, going on to acquire the remaining 80% stake in the company from TradingScreen for $128 million in 2020.
Many of the recent new launches have subsequently been centred in the region. Among the recent initiatives is a new NDF matching platform based in Singapore, launched by the London Stock Exchange Group (LSEG) in November 2023. Based in Singapore, and with the backing of the Monetary Authority of Singapore (MAS), the platform is the first phase of LSEG’s plans to implement NDF, spot matching and streaming relationship venues in Asia.
“NDFs are a growing part of the FX market, with limited customer options when it comes to execution on an order book,” LSEG’s head of foreign exchange, Neill Penny, told The TRADE.
“As such, there has been clear interest from customers for us to support NDFs as part of matching. There is also a lot of interest from customers in the cleared execution part of the venue which should result in improved liquidity, more efficient use of credit, and reduced administrative overheads.”
In the same month, LMAX Group subsidiary, LMAX Exchange Singapore, was granted regulatory approval by the Monetary Authority of Singapore (MAS) to offer NDF trading in both Singapore and London. LMAX said the launch would allow its clients to hedge their FX exposure against non-convertible currencies on a central limit order book (CLOB) and that it would leave to more transparent price discovery, deeper liquidity and efficient market structure in NDFs trading.
With new players entering the market and new platforms launching each quarter, greater liquidity in the NDFs sphere is almost certainly set to spark greater algorithmic trading capabilities for those looking to execute more efficiently. Gaps still exist, namely around broken dates and how to aggregate NDF liquidity into one system, and as FX algo providers look to attract further adoption of their NDF strategies, they will need to offer increasingly sophisticated data analytics, algo execution and liquidity management tools to mitigate this.
“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,” says Patil.
“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 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.”
With infrastructure building out globally to accommodate new interest in NDFs, greater appetite for more automation must surely follow. A lack of transparency historically has hindered NDF algorithmic progress, but with the prospect of order book trading on multiple new competing venues on the horizon, that could all be about to change.
“What you will also see – and you can see this with NDFs – is that less liquid products are going to become more transparent, and the more transparent they are the more trading you get. The more trading you have, the more automation you can drive into it,” says LSEG’s head of FX sell-side trading, Bart Joris.