▲ Foreign exchange rates are displayed at a currency exchange booth in Myeong-dong, Jung-gu, Seoul, on the 3rd.
The Bank of Korea (BOK) released an analysis showing that about one-third of the surge in the won-dollar exchange rate observed in March of this year was driven by non-deliverable forward (NDF) trading.
In a blog post published on the 4th titled "How Much Do NDFs Affect the Won-Dollar Exchange Rate?", the BOK stated that this was the finding of its analysis on the impact of NDF transactions on exchange rates.
An NDF is a type of forward contract in which parties agree to buy or sell foreign currency at a predetermined exchange rate on a specific future date, with only the net difference between the contracted rate and the spot rate settled at maturity.
Because NDFs can be traded offshore 24 hours a day without physical Korean won or US dollar cash, they are frequently utilized by foreign investors for hedging purposes, while some market participants also use them for speculative gains.
According to the BOK's analysis, the rise in the exchange rate attributed to net NDF purchases in March of this year was approximately 26 won, accounting for about 33 percent of the total monthly exchange rate increase of 79 won.
In May of this year, net NDF purchases also pushed up the exchange rate by about 7 won, accounting for roughly 26 percent of that month's total increase of 27 won.
Analyzing the period from 2024 onward, offshore net NDF purchases were estimated to have contributed an average of about 2 won per month to exchange rate gains (an increase of about 0.1 won per 100 million dollars in net purchases).
The BOK explained, "These analytical results show that NDF trading can serve as a channel that intensifies upward pressure on exchange rates during specific periods."
Previously, BOK Governor Shin Hyun-soo also pointed to NDF trading as a key factor behind the high volatility of the exchange rate in March of this year, diagnosing that "transactions through off-balance-sheet derivatives appear to have caused a phenomenon where the tail wags the dog."
The reason offshore NDF transactions affect the onshore spot exchange rate is that financial institutions that sell NDFs engage in hedging operations by purchasing dollars in the domestic market.
For instance, if an overseas investor anticipates a rise in the won-dollar exchange rate and heavily buys NDFs, the overseas financial institution that sold them will purchase NDFs from domestic foreign exchange banks to mitigate exchange rate risk.
Subsequently, the domestic foreign exchange banks will likewise purchase actual dollars in the local foreign exchange market to offset their exchange rate risk, which can create upward pressure on the exchange rate.
Looking at the impact by time of day, net NDF purchases had a greater influence on the exchange rate during nighttime hours than during the daytime when the Seoul market is open.
Examining the 10 months with the largest scale of net NDF purchases since 2024, the nighttime contribution of NDF trading to exchange rate increases was estimated at an average of 12 won per month, whereas the daytime contribution was limited to an average of 3 won per month.
The BOK explained, "During nighttime hours, the proportion of NDF trading is high and overall foreign exchange trading volume is relatively low, which can amplify the impact of NDF transactions."
Recently, as volatility in the won-dollar exchange rate has increased, foreign investors' net purchases of NDFs have also surged significantly.
In the first half of this year, the total volume of net NDF purchases by foreigners reached 53.9 billion dollars, marking an all-time high for a half-year period.
The BOK pointed out that alongside the 24-hour operation of the domestic foreign exchange market, if foreign investors' demand for NDF trading is absorbed into the domestic foreign exchange market through future measures such as the introduction of the BOK's won-denominated international settlement network, the impact of NDFs on the exchange rate could diminish.
The BOK stated, "Conditions have been established for global news to be reflected in our foreign exchange market in real time through 24-hour trading," adding, "We expect that as NDF trading is absorbed into the domestic foreign exchange market, its impact on the won-dollar exchange rate will decrease."
(Photo: Yonhap News)
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