Analysis: what is the OTC market, and what transactions are made there
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The exchange is far from the only place where investors can carry out operations with shares and other assets. In the event that two counterparties want to agree directly on special conditions, they can use the so-called OTC market (Over The Counter, OTC).
Today we’ll talk about how this market is organized, how the process of making transactions on it differs, and why a stock broker is needed here.
Note : the OTC market is a tool for experienced investors, who for some reason are not satisfied with the terms of transactions that they can receive on the exchange. To make transactions on the OTC market, you will need to open a brokerage account online .
What is Over The Counter
These are decentralized markets for transactions without intermediaries. Transactions on them take place directly between two counterparties. To do this, use a phone, email, or specialized software (for example, Bloomberg terminal).
In the OTC market, dealers act as market makers - participants announce the price at which they are ready to buy or sell a specific asset. The transaction takes place between two participants, while other market players cannot know at what price it was completed.
What is traded on the OTC market
On the OTC market, investors can perform transactions with assets of various types: from stocks to all kinds of bonds, derivatives and structural products. Often there is practically no information about specific financial instruments in open sources.
The agreement under which the transaction takes place differs from the standard purchase / sale agreement for financial instruments on the exchange. In it, the parties agree on such conditions as the purchase or sale price, type of instrument, as well as possible additions.
The risks
The design of OTC markets implies a significantly higher degree of risk. In particular, there are counterparty risks - that is, it is likely that one of the parties to the transaction will go bankrupt before it fulfills its part or is unable to do so in the future.
OTC market opacity also contributes to increased risk. For example, during the US mortgage crisis in 2007-2008, many CDO derivatives (Collateralized Debt Obligation - bonds secured by debt obligations) and CMO (Collateralized Mortgage Obligations - bonds secured by mortgage obligations) - were traded exclusively in the OTC market.
Banks issued CDOs on the basis of bad housing loans issued to people who could not pay them or made a minimum down payment. With the development of the crisis in the US real estate market, such financial instruments became toxic, and holders tried to get rid of them in large numbers. However, liquidity falling to near zero made the solution to this problem extremely difficult.
Why do you need a broker
To avoid such situations, investors need to carefully consider the possible risks or attract specialists who can do this. This is precisely the role of the exchange broker in conducting such transactions. Within the framework of the over-the-counter market, a company can be either a broker or a settlement center, helping to evaluate all risks.
For example, ITI Capital provides OTC transactions with stocks, Eurobonds, forward or option contracts, structured products, repos. We carry out transactions of any complexity with a large number of financial instruments.
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