Asian currencies remain tightly controlled



The Central Bank of Uzbekistan’s August decision to allow its currency to float was bold – its previous attempt to free the som in 2017 saw it fall 48% against the dollar in a single day.

Fortunately for the job security of President of the Central Bank of Uzbekistan, Mamarizo Nurmuratov, this time around, the decision was more nuanced, with the som only falling 3.4% against the greenback. on its first day of free trade.

Nurmuratov’s decision was not only bold, it also marks the landlocked country as an outlier among Asian economies. Unlike floating currencies such as the British Pound or the Australian and Canadian dollars, which operate on a float, a large number of Asian central banks either opt for outright non-convertibility or a form of managed float.

Two types of currency control

The first group, subject to strict exchange controls, includes India, Bangladesh, Sri Lanka and Vietnam. Semi-Restricted Markets, where local currencies are not transferable but can be converted into foreign currencies, include the Philippine Peso, Thai Baht, South Korean Won, Indonesian Rupiah, and Malaysian Ringgit.

The most prominent member of this latest cohort is China, which only allows the yuan to trade within a 1% range on a daily basis.

Some of these restrictions have been in place for some time. The Bank of Thailand introduced a managed float regime after the Asian financial crisis of 1997/98, which saw the baht fall more than 50% against the dollar in just six months.

Others are more recent. In February of this year, Taiwan’s central bank excluded a number of major international banks from its monetary system, accusing them of helping commodity traders engage in currency speculation (FX) on behalf of the merchant trade.

These currency controls create a dilemma for companies looking to hedge their exposure to Asian currencies that are not freely traded, which is why many are turning to undeliverable futures or NDFs.

Khast Imam Mosque, headquarters of the Central Bank of Uzbekistan – Photo: Shutterstock

What is an NDF?

An NDF is similar to a traditional foreign exchange forward contract, except that at maturity it does not require physical delivery of currencies. A forward exchange contract is an obligation to buy or sell a specific currency on a future date (the settlement date) for a fixed price set on the contract date (the trade date). When the NDF expires, settlement is made in US dollars, the other currency of course being “undeliverable”.

Since many large companies in countries that limit the convertibility of the capital account operate offshore, and the transfer of funds to and from their home country is an inefficient process, the domestic currency exchange market in offshore locations has grown rapidly.

It is not easy to follow up-to-date NDF volume data as it is primarily an over-the-counter market – in other words, it is traded bilaterally rather than through exchanges.

KRW dominates the NDF market

The Bank for International Settlements’ 2019 triennial survey found that the KRW accounted for 22% of all NDF transactions, with an additional 19% in Indian rupees and 12% in New Taiwan Dollar. When the Chinese yuan is added, Asian currencies represent 60% of the total NDF trade volume.

According to Jason Woerz, president of 24 Exchange, heightened expectations of rising interest rates in the United States have led to demand for hedging and risk rebalancing and, as a result, higher NDF trading volumes recently.

Although Asian currencies are by far the most commonly traded, only 28% of these exchanges are carried out in the main regional financial centers of Singapore and Hong Kong compared to 46% in London where trading hours overlap with those in Singapore and Hong Kong. Kong.

Offshore currency trading dominates

An IMF document released in September 2020 suggested that NDF markets in many Asian emerging market currencies are overtaking onshore markets in trading volume. For currencies such as KRW, INR and TWD, NDF volumes exceed revenue from other foreign exchange products, including spot transactions, says Henry Wilkes, head of foreign exchange at Currency Solutions Services.

In the early years of NDFs, there was significant volatility between the onshore and offshore markets, but with the development of price discovery, these spreads became less common.

NDF markets tend to forecast significant depreciation during episodes of market stress, although sharp swings in emerging Asian market currencies are becoming less and less common according to Mahesh Sethuraman, head of sales at Saxo Markets Singapore.

Yeouido Park in South Korea's main financial districtYeouido Park in the main financial district of Yeouido in South Korea – alamy

Greater efficiency in NDF pricing

“The increase in NDF volumes is more (of) a sign of greater efficiency in the pricing of NDF pairs and therefore of a reduction in spreads and spreads (arbitrage opportunities) between the onshore and offshore, ”he said.

NDFs are spot derivatives and are linked to onshore markets, so they generally track volatility in those markets. Global currency market volatility has been near all-time lows due to central bank responses to the pandemic and widespread interest rates close to zero in many economies.

“However, we have seen emerging market currency pairs – and in particular Asian NDF pairs – continue to perform well over the past two years as they are tied to the natural interest flows between banks and their institutional clients. “said Jeff Ward, global head of EBS, a US currency brokerage firm.

NDFs help price discovery

Paul Millward, Product Manager at 24 Exchange dismisses the suggestion that Asian NDF markets are more volatile than onshore markets, suggesting that when differences between the spot price and the futures price arise, they are quickly arbitrated by traders. who can access both onshore and NDF markets.

“The most significant volatility of NDF versus onshore occurs when new, unexpected capital controls are introduced,” he adds.

This view is shared by Mahesh, who claims that the difference in volatility between onshore and NDF markets has steadily diminished in recent years.

“It is true that NDF markets will be more volatile during times of extreme market stress – like a US presidential election or the promise of a Fed tapering – because a market that is open all day and has less. government or central bank intervention is likely to be better for price discovery than onshore markets, ”he explains.

Longer trading hours for NDFs

“But on normal trading days, the volatility gap between onshore and offshore markets narrows,” he adds.

During national trading hours, NDFs generally trade in accordance with local markets, said Trent Beacroft, CEO of Euronext Markets Singapore and APAC sales manager for Euronext FX.

“However, volatility can occur after hours during non-national time zones when onshore currencies are closed and market liquidity becomes more sporadic,” he adds.

Wilkes also refers to increased volatility due to the fact that NDFs are a 24-hour global market, subject to less scrutiny from local regulators and central banks. By their very nature, local onshore markets are highly regulated and supervised – although there are significant differences in local regulations across Asia, he says.

“NDFs appear to exert a significant influence on onshore markets, because the ability of policymakers to regulate trade in this market is extremely limited and also because the market is able to incorporate new information when onshore markets are closed. . “

Electronic NDF

The NDF market is in the early stages of electronic development, although a number of banks have introduced algorithmic products.

“We are seeing domestic financial markets growing in both size and sophistication, which puts their currencies at the forefront,” Beacroft said. “With the continued growth of the electronization of financial markets, the volume and interest in these products will continue to grow. “

For non-standard tenors (for example, beyond three months) and larger banknotes, the market continues to rely on the telephone transaction model, as the risk of carrying out these transactions electronically outweighs the benefits to the transaction institution, Mahesh explains.

However, most observers agree that the increase in NDF electronic trading has boosted price discovery and provided access to lower cost hedging with tighter spreads for standard duration contracts ( up to three months) and notes under $ 10 million, improving the quality of execution.

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The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade a CFD.
You can still benefit if the market moves in your favor, or suffer a loss if it moves against you. However, with traditional trading, you enter into a contract to exchange legal ownership of individual stocks or commodities for cash, and you own it until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the total value of the CFD trade to open a position. But with traditional trading, you buy the assets for the full amount. In the UK there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs come with overnight costs to hold trades (unless you use 1 to 1 leverage), which makes them more suitable for short-term trading opportunities. Stocks and commodities are more normally bought and held longer. You could also pay a commission or brokerage fees when buying and selling assets directly and you would need a place to store them safely.

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