OTC Markets

8 Key excerpts on "OTC Markets"

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  eBook - PDF

  Transparency and Fragmentation

  Financial Market Regulation in a Dynamic Environment

  • J. Board, C. Sutcliffe, S. Wells(Authors)
  • 2002(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  9 Over the Counter (OTC) Markets OTC Markets are part of the total market for a security, and so have been considered in the Chapters dealing with transparency and fragmentation. OTC trading tends to be a hidden aspect of financial markets whose importance is large and growing, but where regulation and disclosure are small. For these reasons, this chapter brings together the material on OTC Markets from elsewhere in this book to highlight the importance of these markets to regulators. It will be argued in this chapter that OTe trading is as much a part of the market in a financial security as is trading on an exchange,l and so should be included within the ambit of 'orderly markets'. Second, the consequences of OTC trading for exchanges will be examined. Third, the case for trade reporting and pre- and post-trade transparency in OTe markets will be considered. Finally, some possible policies for increased trade reporting and transparency in OTC Markets are presented. 9.1 Background on OTe markets 2 OTC Markets grew up to meet some specialised needs that exchanges could not meet, or where the circumstances of the market (e.g. type of user) was such as to render an exchange unnecessary. The following factors have encouraged their growth: • The transaction is in a customised contract - e.g. for a different dur- ation to the standard exchange contract • There is no organised exchange for the asset - e.g. swaps or forex • OTC trading is cheaper than exchange trading because there are no exchange fees, though these are small, larger savings are made from the avoidance of brokerage fees 240 Over the Counter (OTC) Markets 241 • The trade is too large for the exchange. In some markets these large trades are brought on-exchange through block trade facilities • aTe trades avoid the transparency or other regulations applying to exchange-traded products.

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  Understanding Investments

  Theories and Strategies

  • Nikiforos T. Laopodis(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  NYSE-National is a fully electronic market that combines the high performance of NYSE technology with a “taker/maker” fee schedule. With the highest exchange rebates available for removing liquidity, NYSE-National is an attractive trading venue for investors using fee-sensitive strategies to take liquidity or for passive traders seeking to minimize their time-to-fill. NYSE-Chicago is an ideal venue for hedge funds, options market makers, quantitative traders, professional traders, and active individual traders that require immediate and automated execution, in addition to serving the needs of traditional broker-dealer clients and the individual investors they represent.

  Finally, there are some regional exchanges such as the Philadelphia Stock Exchange, the Boston Stock Exchange, and the Pacific Stock Exchange. Such exchanges list smaller companies with a local (regional) geographic interest. Another function of regional exchanges is dual-listing or the listing of securities that are also listed on the NYSE and the AMEX.

  4.3.2 US Over-the-counter securities markets

  Opposite to organized exchanges, there is another securities market, the over-the-counter (OTC) market, which operates through a network of dealers scattered nationally and worldwide and communicating with each other via computer networks. A dealer is a trader who trades in securities (stocks) with investors and with each other. In general, OTC Markets are typically less transparent than exchanges and are also subject to fewer regulations. Because of this, liquidity in the OTC market may come at a premium. OTC Markets are primarily used to trade bonds, equities, currencies, derivatives, and structured products such as mortgage-backed securities. OTC Markets are regulated by the Financial Industry Regulatory Authority (FINRA). See the Market Flash box for OTC news.

  What are some issues with OTC Markets? First, sometimes the securities being traded lack buyers and sellers. As a result, the value of a security may vary widely depending on which market makers trade the stock. Also, it makes it potentially dangerous if a buyer acquires a significant position in a stock that trades OTC should they decide to sell it at some point in the future. Second, when trading over-the-counter, counter parties do not know each other, and thus one party may default prior to the completion of the trade and/or not make the current and future payments required of them by the contract. Such lack of transparency can also cause a vicious cycle to develop during times of financial stress, as was the case during the 2007–8 global credit crisis.

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  The Forbes / CFA Institute Investment Course

  Timeless Principles for Building Wealth

  • Vahan Janjigian, Stephen M. Horan, Charles Trzcinka(Authors)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  regional stock exchanges. These include the Philadelphia Stock Exchange, the Boston Stock Exchange, the Pacific Stock Exchange, the Chicago Stock Exchange, the National Stock Exchange, and the CBOE Stock Exchange. The NASDAQ, which we discuss later in this chapter, acquired the Philadelphia and Boston exchanges in 2007. The NYSE acquired the Pacific exchange in 2006.

  In addition, there are exchanges in major financial centers around the world, including London, Frankfurt, Montreal, Toronto, Hong Kong, and Tokyo. Over-the-Counter Markets

  Stocks that are not listed on an exchange trade in the over-the-counter (OTC) markets. The OTC Markets have no specific location, but consist of hundreds of individual brokers and dealers located throughout the country and linked by a computer network. The members are registered with the Securities and Exchange Commission (SEC) and belong to the Financial Industry Regulatory Authority (FINRA), which succeeded the National Association of Securities Dealers (NASD).

  FINRA sets minimum capital requirements for its members and also has the right to discipline, fine, and expel members that violate FINRA regulations. The SEC assists FINRA in regulating the activities of the OTC Markets.

  There are several competitors for the business of making a market in OTC stocks. The most important are the NASDAQ, Instinet, and NYSE Arca. Each operates in a different way. NASDAQ

  The most widely recognized OTC market is the NASDAQ, originally an acronym for the National Association of Securities Dealers Automated Quotation system. This computer network provides brokers with competing prices on stocks quoted in the system. The NASDAQ also displays the names of the competing market makers, enabling brokers and customers to expedite trades.

  Investment Insight Investors often compare their portfolio or security performance to a benchmark. The following are among the more common equity indexes.

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  The Making of Finance

  Perspectives from the Social Sciences

  • Isabelle Chambost, Marc Lenglet, Yamina Tadjeddine, Isabelle Chambost, Marc Lenglet, Yamina Tadjeddine(Authors)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  Report on trading of OTC derivatives, February 2011 Information, texts, industry publications and discourses from: International Swaps and Derivatives Association (ISDA) website (e.g. ISDA paper, MIFID/MIFIR and transparency for OTC derivatives, February 15, 2012) Tabbgroup and Tabbgroup’s TabbFORUM Understand the context of the OTC market context Confirm the main events Provide first textual accounts of debates and discussions MiFID consultation 8 December 2001–2 February 2011 Completed by interviews Text of MiFID 2 279 publicly available responses were analysed Interviews with an ISDA member and an MEP’s assistant Understand the motives of the proposed regulation Analyse the justifications and the arguments of the industry opposing the new regulation Triangulate facts and analysis, enhance validity of insights and understand respective views of progress in the MiFID legislative process Press articles Factiva (2008–11): 150 articles analysed for key words: ‘OTC Markets’ and ‘regulation’ Retrace main events (see Appendix 3) Contextualise the analysis in terms of the evolution of the financial industry Notes 1 Over-the-counter (OTC) markets are financial markets organised around OTC trading. OTC trading is sometimes called off-exchange trading as it occurs directly between two parties, without any intervention of an exchange. OTC trading is significant in some asset classes, such as interest rate, foreign exchange, equities and commodities, but can occur with any financial instruments. OTC trading allows for considerable freedom in the design of financial contracts and the main characteristics of OTC transactions are to be bespoke and bilateral. In OTC Markets, prices are normally not made public information. 2 Bank for International Settlements Statistics, 2011. 3 Founded in 2003, TABB Group is a financial market research and strategic advisory firm focused on capital markets

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  Financial Reforms in Modern China

  A Frontbencher's Perspective

  • Sun Guofeng(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  In Germany, whose treasury bond market ranks third in the world, the OTC market embraces 85–91 percent of the treasury bond trading volume. In developed countries, bond market usually means OTC bond market, while exchange-based bond market is a supplement to OTC bond market and generally has a very small scale. In a sense, the exchange-based bond market may even be omitted. In Eastern Europe and other transitional economies, most of the bond trad- ing are conducted over the counter, inter alia, 90 percent of Czech’s bond trading is dealt by the OTC market, and the trading of Hungarian OTC electronic system accounts for 75 percent of the government bond market. In Poland, bond trading is conducted in the Warsaw Stock Exchange with relatively poor liquidity. Almost every market participant reached a com- mon understanding that government bond trading by institutional investors shall not be conducted in stock exchanges and requires a new trading system (Earl and Kurz, 1997). The practices of bond markets in developed countries and transition economies prove that, for both institutional and individual 64 ● Financial Reforms in Modern China investors, OTC bond market features measurable risk control, simplicity in trading, and readiness in conclusion of transactions. Therefore, OTC bond market shall also be an inevitable choice for China’s bond market. However, China’s bond market has gone through twists and turns in this respect. (I) China’s Bond Market before 1997 China resumed the issuance of treasury bonds in 1981. In 1988, the Ministry of Finance carried out pilot projects for treasury bond circulation and transfer in 61 cities all over China and opened trading over the bank counters, which marked that China’s secondary treasury bond market took shape. In 1994, Shanghai Stock Exchange (SZSE) and Shenzhen Stock Exchange opened treasury bond trading, which led to the coexistence of OTC trading and exchange-based trading patterns.

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  Financial Institutions

  Markets and Money

  • David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard W. Sias(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  Investors use brokers to locate the most favorable dealer because they are usually unfamiliar with the identities of the dealers making markets in specific issues and because brokers can contact dealers at lower cost. More generally, brokers capitalize on economies of scale in search. Broker‐dealers who operate in the OTC market are regulated by the Financial Industry Regulatory Authority (FINRA), a private (i.e., not governmental) self‐regulatory organiza- tion. There are three major electronic quotation systems inside the OTC market—the OTCQX, OTC QB, and OTC Pink Markets, Inc. These systems allow members to see real‐time quotes, last‐sale prices, and volume for many OTC stocks. The OTC market in aggregate claimed to have quotes for 9,981 securities in 2015. The market subdivision OTCQB rules require that companies must file current financial reports with the Securities and Exchange Commission (SEC) or file on the OTC site itself to be quoted on their system. Stocks that trade on the OTCPink do not file reports or audited financial statements with the SE although most make some information publicly available. The name Pink in OTCPink indicates this market has evolved from the aforementioned pink sheet stocks. Many microcap stocks (very small companies) or penny stocks (prices less than $5) trade through the OTCQB or OTCPink. The lack of public information, listing standards, and the high risk imply that investors should be especially diligent when investing in these securities. The SEC notes, for example, that although many microcap stocks are legitimate businesses, fraud can be a problem. For example, a common “pump‐and‐dump” trick is for EXHIBIT 10.3 The U.S. Equity Markets: The NYSE Versus NASDAQ Number of Listed Companies Exchange Domestic Foreign Total Percentage of Total Market Value (%) NASDAQ 2,430 352 2,782 26.5 NYSE 1,939 527 2,466 73.5 Source: World Federation of Exchanges (www.world‐exchanges.org), December 2014.

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  Finance

  The Basics

  • Erik Banks(Author)
  • 2023(Publication Date)
  • Routledge

    (Publisher)

  OTC derivatives, as the name suggests, are arranged between two parties on an off-exchange basis. Each contract represents a customised negotiation of terms and conditions, with the parties agreeing to specifics related to the characteristics noted above. Since each contract is tailor-made, resaleability is very limited compared to markets where standardisation is mandatory (i.e., the exchange-traded market that we consider below). Lack of liquidity adds to total costs, as expressed through the bid (buy) and offer (sell) spread. In fact, some OTC contracts feature relatively wide spreads, which can impact the economics of a hedge or speculative trade. However, certain other contracts, such as standard, on-market interest rate, currency, and equity derivatives on major references, feature reasonably good liquidity.

  Dealing occurs off-exchange (either telephonically or via electronic platforms) rather than through formalised exchanges; there is no ‘central forum’ for OTC dealing, as activity is arranged and transacted by major financial institutions and their clients. Since OTC derivatives are arranged between two parties with no intermediate clearing house (or neutral clearing party), credit risk can arise unless collateral is posted as security; this risk occurs when the contract creates a receivable for one party and the opposing party defaults – leading to a financial loss on the receivable.

  Let us consider the essential instruments of the OTC derivatives market.

  Forward

  A forward contract is a single-period contract that allows one party, known as the seller, to sell a reference asset at a forward price for settlement at a future date, and a second party, the buyer, to purchase the reference asset at the forward price on the named date. A forward is considered a bilateral contract since either party may be obliged to make a payment at maturity. Market terminology indicates that the party that has sold the position is ‘short’ and the one that has bought the position is ‘long’; this is true of all other derivative (and financial asset) positions, so we’ll use the terms throughout this chapter. A notional amount is used as a reference to compute the amount payable/receivable at maturity; in fact, the two parties exchange no initial or intervening cash flows. Settlement of the contract at maturity (which in practice can range from one month to several years) may be set in physical or financial terms. If the market price at maturity is greater than the contracted forward price set at trade date, the buyer makes a profit and the seller a loss, and vice versa. These relationships hold true for all price-based forwards, including those involving equities, bonds, indexes, currencies, and commodities. The profit positions of generic long and short forwards are summarised below, and the flows are illustrated in Figure 7.4

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  Energy Price Risk

  Trading and Price Risk Management

  • T. James(Author)
  • 2002(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  CHAPTER 4 OTC Energy and Related Derivative Markets OTC ENERGY DERIVATIVE MARKETS Nearly all the key terms of an OTC derivatives deal are negotiable, which means that the pricing reference, the payment terms and the volume can all be adjusted to suit the counterparts to the deal. This is a benefit if an organisation has a very specialised or unique price risk which requires a one-off hedging tool. Basically, anything is possible in the OTC energy markets, although, of course, the price of the derivative instrument quoted to suit a customer’s precise and perhaps esoteric needs, may not always be attractive. Fortunately, for risk management purposes, the core energy markets, like the larger oil, gas and electricity (power) markets have some active and fairly standardised OTC contracts. They are stan- dard both in their floating price reference, and in the sort of minimum contract volume that would normally be traded. Indeed, the increasing standardisation in the plain vanilla OTC Markets has led to the develop- ment of a number of electronic trading platforms. People often ask why regulated futures exchanges seem to be unable to launch new petroleum futures contracts. The answer is that the needs of the market are already being met by the now well-established and liquid OTC derivatives market. Another supporting factor of this observation is that futures exchanges have been successful in launching futures contracts in both the natural gas and power markets. The reason for this is that the regulated futures markets were launched soon after deregulation prior to or at the same time as an OTC market was establishing itself. The effectiveness of the OTC market can also be seen in Asia, which overtook Europe as the second largest oil consuming region in the world several years ago. Today, Asia includes the world’s second, third, seventh, eighth and ninth largest importers of oil: Japan, Korea, India, China and Taiwan.

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