Ruble turmoil prompts calls to fix NDF contracts

Some market participants want to see offshore fixings as an option in all standard documentation

The sanctions on Russia, and the resulting volatility in the value of the ruble, have led to renewed calls for all non-deliverable forwards – and not only those related to Russia’s currency – to be able to use offshore fixing rates.

As NDFs most often deal with currencies that are difficult to trade physically outside the territories in which they are legal tender, onshore exchange rates have proved the most reliable for fixing. However, if they diverge from the offshore rates on London-based primary spot markets, such as EBS, this can cause problems for foreign market participants.

Following Russia’s invasion of Ukraine on February 24, the Moscow Exchange rate for the ruble began to diverge significantly from offshore prices. On March 11, the difference between the Moex rate and the prevailing offshore dollar/ruble rate was 19.6 rubles according to Bloomberg, though it had gone down to -1.5 rubles by 6 May.

The Moex rate, published daily by the Moscow Exchange at 12.30pm local time, is typically used to calculate the settlement of dollar/ruble and euro/ruble NDF trades. It normally tracks the FX rate in the offshore international spot market.

“Most of the time, the difference between the onshore and offshore foreign exchange market is small,” says the global head of FX trading at one large US asset manager. “It really took the Russia situation to get people’s attention and make them realise that differences between the two markets can be a really big deal. The ruble situation has really shone a light on the plumbing of the NDF ecosystem.”

Because dealers tend to hedge NDFs in the offshore spot market, a dislocation can lead to risk management problems. Asset managers also have their FX exposures linked to benchmarks, such as the London-based WM Reuters 4pm fixing, that are based on offshore trading. if the NDF hedges are linked to a rate that diverges, that also creates basis problems.

The global head of FX trading says recent events have shown that the current NDF documents are inadequate for situations in which a fixing is still being printed onshore but diverges significantly from the offshore rate: “Although the fixing rate for the ruble was available, it just wasn’t investable or a true reflection of what the currency value actually was.”

The head of trading says the Emerging Markets Trade Association, which oversees NDFs, should be broadening the language used in contracts to take account of such scenarios. EMTA has released alternative documents that allow traders in ruble NDFs to use the WM Reuters fixing, with Moex as a fallback. A growing number of traders hope the organisation will extend this approach to all NDF contracts.

NDFs for the Ukrainian currency have also been affected, though they are traded less frequently than those for the ruble. Ukraine’s central bank has continued to publish the dollar/hryvnia fixing that is used for the contracts. However, the fixing has actually been unchanged since February 24, despite movement in the offshore market. This created concerns among ruble NDF traders about hedging, regulatory reporting and the valuation of collateral agreements known as credit support annexes.

“This is a serious issue for us and other banks with a large participation in the Russian market,” says Alexander Tsorilinis, head of market risk management at Raiffeisen Bank International. “There are big concerns as to which fixing rate we should be using for valuing financial instruments, given our attachment to the onshore ruble rate for things such as credit support annexes’ collateral valuation and clearing.”

Ruble and hryvnia NDFs are by no means the only ones traded with onshore fixings. Most non-G10 NDFs use rates set by institutions within their respective countries. If any of these onshore rates were to become dislocated from their offshore counterparts, then it could precipitate the same hedging and valuation issues that ruble NDF trades are facing today.

Diego Alejandro Rojas Mateus, an emerging markets rates and FX director at BBVA, says that if the Brazilian real, the Peruvian sol or the Colombian or Chilean peso were to experience market stress similar to the kind faced by the ruble, dislocations between these currencies’ onshore and offshore markets would not be out of the question.

He says Brazil is the country in Latin America with the greatest potential exposure to fixing issues. This is because its onshore rate is derived from a market survey, which can become more subjective during periods of stress. Chile and Colombia each use a volume-weighted average of the whole spot trading session to derive their respective onshore fixing rates, which Rojas says offers a more objective approach.

Others are concerned that a wave of strikes by employees of Brazil’s central bank could also affect its ability to continue producing the fixing.

Forward thinking

Although NDFs’ documents include provisions for when onshore fixings are not available, there has never been a real solution for situations where the onshore rate is still printed but has diverged significantly from the London-based offshore market spot rate.

Although discussions have taken place intermittently over the years to resolve the issue, it has never been enough of a priority. “It’s never really been the right time for that conversation, because there’s always been something in the market going on,” says one legal source with knowledge of industry discussions on the issue. “And if you have a specific instance in flow, it’s almost impossible to have a general discussion.”

In the case of the ruble, the head of FX had to bilaterally amend NDF contracts with counterparties to switch from Moex to alternative offshore rates, such as the WM Reuters fix: “But even though we were able to solve this issue bilaterally, that’s not a scalable solution for the industry as a whole. The contract language around situations like this really should be strengthened.”

Raiffeisen’s Tsorilinis believes that clearer and stronger language in NDF contracts would benefit the market. “In general, concrete backups within derivatives contracts as to what happens when the onshore fixing rate faces issues would be extremely helpful, and I think will come in time,” he says. “That then sets the standard for the market and avoids what happened in the first few days of the war in terms of big disputes over valuation and margining.”

However, Amanda Breslin, head of the corporate advisory team at Chatham Financial, warns that there is no one-size-fits-all solution when it comes to dislocations between the onshore and offshore NDF markets: “There are meaningful differences across a lot of emerging market currencies – which is part of the challenge in solving the problem, as each currency faces this onshore/offshore dislocation problem to a different extent.”

BBVA’s Rojas believes the current approach of using onshore fixings works 90% of the time, and that issues only arise during times of market stress. He believes any issues arising with onshore fixing rates should be dealt with on a case-by-case basis, and that there is no need for the whole onshore NDF market to be completely rethought.

“Given what’s happened with the ruble, should we consider changing the source of all onshore fixings?” he asks. “Is there a better way to fix our NDF contracts in Latin America? I don’t think so.”

Rojas believes the onshore market is the most relevant source of liquidity, and that the central banks that manage these fixings are generally reliable and independent: “They’ve purposely designed their methodologies to capture the liquid market venues and make sure that trading based on these fixings is practical and can be scalable. Yes, that approach faces difficulties during times of stress, but I can’t envision a better solution.

“We shouldn’t be changing the system purely for the times in which we’re in a worst-case scenario – especially as we can’t foresee what the next market stress will be and whether the new approach would actually be any better. We have no idea what the next crisis will look like, and each crisis creates different stresses on how to work out the real fair value of any given currency.”

Update, May 17, 2022: This story has been updated to include additional commentary by Chatham Financial.

Editing by Daniel Blackburn