South Korea moves to limit NDF trading by onshore banks

The South Korean Ministry of Finance and Economics (Mofe) has introduced new regulations aimed at limiting activity in the non-deliverable forwards (NDF) market by onshore banks. The move is aimed at reducing the volatility in the Korean won exchange rates with other currencies witnessed in the past few months.

The first new regulation was introduced last Friday. This restricts onshore banks from increasing long positions through NDFs by more than 110% of their outstanding position as of Thursday January 15. Yesterday, Mofe announced that short positions through NDFs could not drop below 90% of short positions held as of Friday January 16. “In other words, short position holders cannot take purchase over 10% above their holdings of their positions,” said an MOFE official.

“The dollar selling of offshore players through NDFs was increasing,” added the official. “The speculative dollar selling was actually increasing the volatility in the Korean forex market, which may have harmful effects to the real economy. So that was why we had to introduce the regulation.”

Foreign exchange strategists were relatively unimpressed by Mofe's efforts to stem the build-up of downward momentum in the dollar/Korean won market. "I don’t think what they’re doing is particularly effective," said James Malcolm, forex strategist at JP Morgan Chase in Singapore. "On a short-term basis, it really doesn’t have very much impact because there’s no impetus to square positions - liquidity’s kind of gone but it’s not like you get penalised from carrying your existing positions." Malcolm said that in the longer term, the Korean market might develop in a similar manner to Taiwan, which he believes still remains a very liquid market. “I think it’s more just about wanting to retain a little bit more control, wanting to separate things a little bit more," said Malcolm. Putting in place control mechanisms might help stablise the South Korean currency should China decide to revalue the renminbi against the US dollar in the next few months.

The dollar/won exchange rate closed at 1,180 won on Thursday. After Friday’s announcements, the exchange rate spiked at 1,192 won but traded back to 1,186 by the end of the day. Yesterday, the US dollar/won closed at 1,185 won.