Seeing red over blue-chip swap in Argentina’s NDF fiasco  

Emta protocol salve aside, peso settlement rate snafu is a warning for emerging market FX derivatives

  • Under pro-markets president Macri, Argentine peso bonds resurged and dealers hedged their FX risk with NDFs.
  • As his presidency gave way to nationalist successor Fernandez, Macri introduced currency controls and FX markets seized up.
  • Argentina’s rival settlement rates – the benchmark MAE (Mercado Abierto Electrónico) and the so-called blue-chip swap – began to diverge significantly, prompting a battle over which one should be use to settle NDFs.
  • As the spread – or brecha – between the two rates grew, market participants triggered a stalling mechanism in industry-standard Emta documentation to prevent having to settle at a range of different rates.
  • Now Emta has incorporated a longer-term amendment to its contracts to prevent the same outcome from happening in volatile conditions.
  • While the solution hasn’t pleased everyone, it could well be applied in other emerging markets that document on a similar basis, notably Brazil.

In markets as in politics, it’s not always the simple majority that carries the day – leaving at least a sizeable minority feeling aggrieved. Such was the outcome of a settlement issue for non-deliverable forwards (NDFs) in the Argentine peso last October. The market-wide dispute over NDF settlement rates, resolved by the New York-based Emerging Markets Traders Association (Emta), may yet give way to fresh challenges. And it should serve as a warning for foreign exchange derivatives dealers in other emerging markets.

When the pro-markets Mauricio Macri took office as president of Argentina in 2015, foreign investors returned to the local peso bond market for the first time in years. They also hedged their FX risk with NDFs – going short pesos, long US dollars and locking in healthy yields.

But market conditions – like political ones – are rarely truly settled in Argentina. For investors, things took a turn for the worse in August last year, when it became apparent that Macri was likely to lose power to his nationalist rival, Alberto Fernandez. By September, the country had imposed capital controls.

Throttled by the restrictions, the official exchange rate used to settle NDFs diverged significantly from onshore prices and triggered a battle over which rate should be used to settle contracts. In response, a handful of market participants – including Goldman Sachs and Pimco – submitted notices triggering contractual clauses that could have meant an array of rates would be used to settle the same contracts, resulting in valuation chaos.

“The NDF market was effectively broken following implementation of the capital controls,” says Rick Harrell, an analyst at Aperture Investors. “It is slowly coming back to life now, but the focus remains on the parallel exchange rate – the blue-chip swap – [which] will likely prevail as long as exchange controls remain in place.”

The blue-chip swap (BCS) rate is at the centre of the issue. It is implied by comparing the onshore and offshore value of peso-denominated securities – or the dollar amount that could be gained by buying a bond in Argentina for pesos and then selling it in the US.

The NDF market was effectively broken following implementation of the capital controls
Rick Harrell, Aperture Investors

It rivals the benchmark rate, produced by Argentina’s Mercado Abierto Electrónico market, which is widely used to settle NDFs – local currency contracts that are settled in dollars.

As the two rates started to diverge under currency controls, some participants argued that inability to transact in significant size at the MAE rate meant participants should use the BCS rate instead.

“The argument of those who [were] challenging was that the MAE [was] not a representative rate anymore because I cannot go there and freely trade my pesos for dollars – because the government is not letting me do it,” says the head of Latin American FX trading at one large dealer.

“There was a big tug of war between people who were sending these letters to Emta and people who were basically saying: ‘You’re out of your mind. That’s wrong,’” he adds.

By late September, the MAE rate was around 57 pesos to the dollar; the BCS was roughly 68 pesos, giving significant incentives for some to argue against the MAE as the settlement rate. Meanwhile, banks that had hedged with MAE-linked products were reluctant to diverge.

There was a big tug of war between people who were sending these letters to Emta and people who were basically saying: ‘You’re out of your mind. That’s wrong’
Latin America FX trading head at a large dealer

It took only five market participants to trigger a clause in Emta’s industry-standard contract to pause settlement of contracts for 30 days to see whether rates converged. If they did not, the final settlement price would be decided by the calculation agent appointed by each set of counterparties – according to the documentation fallbacks – potentially creating major disruption for market-makers.

Emta then proposed a voluntary amendment that would strip out the ability for market participants to trigger the 30-day pause, solidifying the MAE as the main rate for Argentine NDFs – and leading to a fierce battle between parties.

The change was accepted and Emta is now seeking to apply similar changes to other currency contracts. But the debate continues over what rate should be used.

Taking notice

When foreign investors returned to the local bond market in the early years of Macri’s tenure, nearly $200 million a day was said to be a typical session in resulting FX hedging activity – roughly 10 times the average amount before he came to power.

But when Macri was close to departing, his three-month currency control on the peso required institutions to obtain central bank authorisation to buy more than $1,000 in the official MAE-linked market. The only way for foreign investors to get their pesos out of the country was to buy locally denominated bonds and sell them for dollars at a discount on a foreign market – usually in the US – driving the switch to use of the BCS.

“There was more and more activity in the BCS market, as foreign investors … subject to the same capital market controls and restrictions … resorted to the blue-chip swap to take their profits in pesos and convert to dollars through a market that has seen daily turnover increase from $50 million to close to about $100 million a day,” says Patrick Esteruelas, head of research at Emso Asset Management.

There was more and more activity in the BCS market, as foreign investors … subject to the same capital market controls and restrictions … resorted to the blue-chip swap to take their profits in pesos and convert to dollars
Patrick Esteruelas, Emso Asset Management

As investors shorted pesos, the spread between the BCS and the MAE – the brecha, as it is known in Spanish – widened from almost zero to 35–40% at times, with foreign investors unable to trade against the MAE.

Participants started to examine their documentation more closely. Emta’s governing language for Latin American NDFs includes fallback provisions that are triggered if a price source is not available. But Argentina and Brazil contracts included an extra event that would trigger fallbacks.

If five unaffiliated Emta members submitted notices to the association that the MAE had, for three consecutive days, failed to reflect “the current prevailing Argentine peso bid and offer rates for a standard size peso/US dollar financial transaction”, a so-called exchange-rate divergence could be triggered.

Contracts set to be valued that day would be postponed for 30 days, unless rates converged beforehand, in which case the MAE would be used. If the 30-day period expired, a calculation agent would determine the final settlement price.

On September 5, five days after capital controls were imposed, Emta issued a notice to its members, highlighting the exchange rate divergence rules. Minutes from the New York Federal Reserve’s standing group of markets lawyers that day recorded that participants expected this eventuality.

On September 23, notices started showing up at Emta. Amia Capital, Cargill, Goldman Sachs, King Street Capital Management and Pimco all informed the trade body they no longer believed the MAE was representative. All five declined to comment to

A note from Pimco’s Ismael Orenstein, a portfolio manager, included redacted screenshots of Bloomberg chat quotes, showing divergences of more than 20%. Input from an emerging markets sales desk claimed the basis could rise to 50% or more.

Capital controls make the NDF contracts invalid. If you’re using NDFs to hedge, you’re suddenly unhedged
Paul McNamara, GAM Investments

Julio Badi, co-head of Americas FX trading at Goldman Sachs, said in his notice that the firm, as a non-resident of Argentina, had been having trouble finding quotes for a $2 million contract at the MAE rate since the capital controls were imposed. However, he said it was able to find quotes for that size at the BCS from local broker-dealers, again showing a divergence of more than 20%.

Some outside this group of five maintain that asset managers had other reasons for preferring the BCS. If an investor had hedged a peso bond with an NDF, the conversion of the bond into dollars could only be done via the BCS market, creating a mismatch if the NDF remained at the MAE.

“Capital controls make the NDF contracts invalid,” says Paul McNamara, investment director at GAM Investments. “If you’re using NDFs to hedge, you’re suddenly unhedged.”

And for investors whose NDFs were short peso, long dollar, the higher BCS rate gave the contract greater value.

Polls apart?

“From the point [they] declared this price source disruption the whole market that was transacting based on Emta clauses became unable to settle their outstanding NDF stock,” says Luis Martins, global head of FX and G10 rates at BBVA. “We, just like many other banks, had maturing NDFs. We couldn’t settle our OTC contracts as expected.”

More problematic was that after 30 days, calculation agents would need to decide the final rate. For market-makers, this meant a contract would not net against a counterparty’s existing Argentine NDF if it did not settle at the MAE rate. 

Given that each counterparty relationship can appoint their own calculation agent, a market-maker with what appeared to be offsetting positions between two counterparties could end up settling at two different rates.

“If you had trades with 10 counterparties, you could have had a situation where, potentially, you could have a determination of up to 10 different criteria,” says BBVA’s Martins.

Market-makers hedged with locally listed MAE-linked futures faced the same problem: “Can you imagine if then they [had] to sell literally billions of notional at 20–30% higher rates? The banks [would] have a very large mismatch,” says the Latin America FX trading head.

From the point [they] declared this price source disruption the whole market that was transacting based on Emta clauses became unable to settle their outstanding NDF stock
Luis Martins, BBVA

Emta needed to act fast. On October 9, at the request of members, it published a voluntary protocol that would allow market participants to amend their existing bilateral trades en masse.

The amendment deleted exchange-rate divergence as a trigger for the fallbacks, effectively locking in the MAE as the applicable rate and solving the netting and close-out issues. It also shortened the valuation postponement period from 30 days to 14.

Members had nine days to decide. Unsure of his counterparties’ plans, the FX trading head began calling other dealers to see whether they were going to adhere to the protocol.

“What if some of the banks that I have deals with adhered and others didn’t? Then I wasn’t sure [what was] the best outcome for me, not necessarily in terms of making money, but to protect myself from losses,” he says. understands most market participants did adhere to the protocol. As the trading head put it: “If we [didn’t] do anything before the 30 days lapsed, this market [was] going to [be] totally broken and we [were] never going to be able to settle any of these things. It [would] be like a Lehman collapse.”

Counterparties that didn’t sign had to be dealt with separately and banks found themselves dedicating large numbers of hours engaging counterparties – and their lawyers.

But the outstanding trades were settled at the MAE rate, and the worst outcome was avoided.


Having grasped the weakness of its exchange rate divergence mechanism, Emta adopted the protocol changes into its main Argentina contract. The outcome is that a small minority can no longer trigger the fallback. Market participants can be confident that the NDFs will use the MAE as the fixing unless the rate stops being published, and then a fallback trigger event would be decided only by an independent calculation agent.

“The price source disruption is no longer based on [the] criteria of participants, but it’s rather a more objective observation of whether the spot reference stops being published or stops being available,” says BBVA’s Martins.

Leslie Payton Jacobs, senior legal counsel at Emta, says the divergence mechanism was controversial because it allowed a minority of the market to make an overly subjective determination that would apply not only to their contracts, but to the market as a whole.

“For new contracts, the newly recommended documentation replaced this mechanism with a more standard price source disruption provision,” she says.

So you’re saying: ‘Oh, the MAE is not representative but I want to use a rate which is way more volatile, way less liquid and way less transparent to determine all the other contracts to be valued at’?
Latin America FX trading head at a major dealer

Similar changes are being considered for the US dollar/Brazilian real contract, where seven members can trigger an exchange rate divergence notice.

Jacobs acknowledges the trade group is aware that a small minority of the market would have preferred the NDFs settled at the BCS. But she says: “The market consensus is that the BCS rate is only an implied rate and that, as a practical matter, the MAE rate is the only rate at which Argentine peso/US dollar exchanges can actually be transacted, and that therefore the MAE rate is the only appropriate rate for the settlement of peso NDFs.”

This view is backed up by market participants who are baffled that large firms would consider using an unofficial rate to conduct business: “So you’re saying, ‘Oh, the MAE is not representative but I want to use a rate which is way more volatile, way less liquid and way less transparent to determine all the other contracts to be valued at’?” says the FX trading head.

He points out that the BCS existed as far back as 2010, and no-one previously suggested it should be the main rate. Others note that around 10 or 12 local broker-dealers can quote the BCS. Quotes are normally for minimal sizes because of these brokers’ relatively small balance sheets compared to larger dealers.

“They’re saying they want to trade at a rate which is clearly 30–50% higher. But [it] was determined on the corners of Buenos Aires, based on $1 million transactions,” says the FX trading head. “Try to settle trades worth $50 million and $100 million [with it].”

Still, others argue that not only can they not use the MAE, but also foreign investors looking to sell dollars to buy new peso bonds would in practice avoid it.

“The MAE market is basically dead because nobody wants to sell dollars and get 60.5 pesos for it when they can get 80-odd in the blue-chip market, and possibly even more in the proper black market,” says GAM’s McNamara.

Sources say spot currency volumes transacted against the MAE have fallen from around $400 million a day to about $200 million. For NDFs, where previously banks would trade out to two-year tenors, now they will only go to six months at most, according to market participants.

Volumes in the derivatives market have also collapsed from a daily level of $150 million–200 million prior to the imposition of controls to around $20 million–30 million, market participants estimate. Some, however, suggest this could be down to a general lack of interest in peso bonds since the imposition of capital controls.

Emso’s Esteruelas agrees that the official MAE rate has effectively become an obsolete measure.

“It is a gauge that is purely for domestic consumption and political reinforcement messaging purposes,” he says. “The BCS has become the new tradeable FX vehicle for any non-resident that was invested in pesos prior to the capital controls and has been looking to trade the confusion over how the government would approach local currency and hard currency bonds.”

But BBVA’s Martins says there is now confidence that the MAE-linked NDF market can function properly.

“As long as that price continues to be the tradeable spot reference in onshore Argentine markets, the NDF has all the framework [necessary] to behave without any disruption,” he says.

This confidence – for both peso trading and other emerging market currency derivatives – will no doubt be tested by the current revival in global FX volatility.

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