The sell-side market appetite for NDFs continues on a growth trajectory and shows no signs of slowing. This growth is partly driven by demand from the buy-side community, and partly by the hunt for spread capture. As Spot FX spreads have narrowed to nearly wafer-thin, NDFs are increasingly seen as one of few remaining refuges for electronic market makers.
The NDF market has been historically dominated by large Tier 1 banks with established local relationships in Asia and Latin America, yet in the last year more volume has moved through a growing pool of Tier 2-3 banks. With the NDF market’s increasing maturity comes further electronification to the point where most LPs are expected to stream two-way prices.
The pattern is well known from other similar asset classes: client demand grows, the market becomes more liquid, volumes increase, leading to electronification, democratization, and ultimately to spread compression. Early in the cycle, there is typically a battle for market share among liquidity providers, and in the NDF world, multi-bank disclosed liquidity providers, such as FX Spotstream, have begun announcing plans to support electronic NDFs. Similarly, plans are underway to launch NDF specific anonymous matching engines and ECNs, such as 24 Exchange, the brainchild of FX industry veterans Demitri Galanov and Jason Woerz.
The technology evolution has taken some time to gain traction. That is partly due to demand and liquidity provision. Over the years. there has been a pattern where liquidity consumers aggregate bank liquidity on an RFQ (Request For Quote) basis. As this has now progressed to an ESP (Electronic Streaming Prices) basis, which includes both standard tenors and broken dates, growth will likely accelerate exponentially. For buy-side consumers interacting with the market, this is a boon, as they now have the flexibility to choose the NDF settlement dates and request liquid streams that price continuously until ready to trade.
NDF ESP algorithms
The validation of this market segment’s maturity has been the application of Spot FX algorithms to NDFs. In particular, Tradepoint’s Spot FX algorithm suite has now been applied in its entirety to streaming NDFs. With LPs showing greater wiliness to stream the entire curve, strategies originally conceived as applicable only to deliverable currency pairs now deliver the goals of best execution, liquidity relationship protection, and minimal market impact with comparable efficacy for pairs built around non-deliverable currencies. Smart Order Router (SOR) logic utilized by aggregation and algorithm strategies can likewise rank streaming providers of NDFs by fill rates, as they have historically ranked liquidity providers of Spot FX.
“There are a number of key considerations to rolling out NDF ESP algorithms, non-more crucial than choosing liquidity providers,” reports Noor Mohammed, Head of Business Development at Tradepoint. “While the market is less fragmented than Spot, liquidity is primarily provisioned by banks on a bilateral basis. Outside the banks, only one venue offers significant market share: at EBS, the 1-month tenor remains liquid and competitive.”
To that end, Mohammed notes that Tradepoint has certified over a dozen banks to offer streaming liquidity for NDFs, not merely for standard tenors but all one-off dates as well, “so our customers have a rich set of choices among providers, and so providers can avoid the challenges associated with competitively pricing other banks in the overlapping Tier 2 space.”
Some of the dependency on banks can be cushioned by utilizing non-disclosed liquidity. While it offers less liquidity, the standard dates that do stream allow customers to hide their intentions when trading the key tenors, and then to automatically roll to the desired dates via their swaps desk. As the market matures, standards evolve.
Tradepoint CTO Joey Horowitz reports that some standards are still emerging: “We have not seen a standard methodology for handling fixing dates across banks. When subscribing on behalf of clients, some banks allow us to choose the fixing date in the market data subscription. Only some include the fixing date in the ESP market data streamed back to us, and some LPs won’t even accept a fixing date in the order, and report their own date back to the buyer.”
Though these variable date standards create nuance and complications, technology can help bridge the gap. Intelligent algorithms can work with variable vendor rules, while still aggregating and allowing for electronic strategies.
Further, the general mood in the marketplace during the transition to electronic trading is understanding, Tradepoint’s Horowitz reports. “Makers and takers have been sympathetic clients have been sympathetic and irregularities between systems are often dealt with, rather gently, out of band.”