OTC is a transaction of purchase and sale of securities, concluded not through a financial exchange, but through the organizer of this sale or directly. The buyer is looking for a seller (or vice versa) using communication networks.
What is the difference
The main advantage and distinguishing feature of a stock exchange from an OTC transaction is its independence from the conditions that are put forward by the exchange trading platform. Relations between the seller and the buyer are regulated only by agreement, and it can even be verbal. Of course, in the implementation of such transactions, the parties feel more freely. However, there is a drawback - the risk of non-compliance with the terms of the contract by one or another party. But in this case, the party that suffered may prove to be right if it provides a recording of the conversation over the phone as an argument (it must be recorded).
Is it still possible to trade on the exchange
Registration of OTC transactions on the exchange is regulated at the legislative level in accordance with the regulation on the registration by the commodity exchange of such transactions with exchange commodities, including long-term supply contracts, as well as maintaining a register of these transactions and providing information from the register in accordance with paragraph 3 of Article 6 of the Federal Law “ About commodity exchanges and exchange trading ”
Features of the conclusion
There are only two types of relationships between parties to an OTC transaction:
- the dealer purchases securities from the owner;
- the dealer buys securities from another dealer for the purpose of their further resale.
Thus, here you can not do without a dealer. He can be either a single trader or a legal entity, that is, a dealer company, but still plays the role of an intermediary, making wholesale purchases at a cheap price and then selling them in smaller batches, but more expensive.
How the price is formed by the dealer
It is the dealer who puts forward the purchase price of a bond or stock, which consists of:
- selling price - the very value that is calculated by him for the sale of a security in the future;
- markups, that is, added value, designed to bring profit to the dealer and cover the costs incurred; it has a relative value, an average of five to ten percent of the value of the security, can increase when the dealer purchases shares from a not-so-well-known company, if there is any doubt about its high liquidity.
Distinctive Features of the OTC Market
The main difference from the exchange market is the way in which OTC transactions are registered. The market in the latter case has no localization, that is, they can be concluded anywhere and at any time, the main thing is the availability of access to communications. Another distinguishing feature is the distribution of responsibility. Even if the transaction is carried out through the sales organizer, the intermediary is not responsible for the fulfillment by the parties of their duties, while in exchange trading the organizer is the exchange, and it is also responsible. In order not to doubt the correctness of an OTC transaction with securities, it is necessary to conclude a sales contract at least in the simplest universal form (you can use the standard form of the agreement).
Differences are also in the form of calculation. So, the reservation of funds during exchange trading is made before the auction, due to which the risk of non-payment is minimized, and the type of agreement considered involves a deferred payment.In the latter case, we can talk about OTC derivatives transaction.
What the OTC Market consists of
OTC Market Structure:
1) Street. Here they trade bonds and stocks that did not hit the stock market. Setting prices is carried out only by sellers and buyers, bidding is held in the form of an auction. Upon receipt of a certain number of applications, it opens. The broker and dealer conclude an agreement by telephone.
2) Tertiary. This type of market involves trading in securities that are on the list of shares. Its existence is determined by the reasons why trading on the main exchange becomes unprofitable for traders, including:
- a fixed commission, since in such a trade the situation can really be like a farce if the trader’s commission costs are higher than his expenses for conducting a trading operation;
- a fixed time when transactions on the exchange are made only at strictly set hours, in connection with which traders in certain parts of the world have to trade at night; there is no such restriction on over-the-counter transactions.
3) Fourth - this market makes it possible to trade stocks and even portfolios of securities without the participation of the exchange and brokers, that is, without actually spending anything on the implementation of a trading operation. This type of market is traded through the Instinet electronic system (in the United States of America).
Types of transactions
There are three types of transactions in the OTC market:
- Forward contract. In such an agreement, the time for transferring the securities to the buyer and payment for the purchase by him is set in advance. It is very important that the fixing of the exchange rate is carried out immediately at the time of the conclusion of this transaction. According to its terms, the buyer must accept the purchase and pay for it at a future date without the right to break the agreement. It is the impossibility of cancellation is the main disadvantage of this type of OTC transaction.
- There are the following types of forward contracts: settlement (or NDF) and delivery (DF). The difference between the two is that delivery transactions require immediate settlement of the buyer with the seller (or within one to two days), and the transaction is then completed. His special case is a spot deal. With an estimated forward, the delivery of goods is in principle not supposed. Such an OTC transaction involves paying the price difference between the value of the asset and the purchase price of the losing party at a predetermined time (this difference is called the variation margin). In Russia, a settlement forward is almost never used, since it is impossible to monitor the fulfillment of obligations by the party that lost.
- OTC option. This form of transaction implies that one of the parties has the right to acquire the asset, but it is not obliged to buy it (which distinguishes it from the forward contract).
OTC REPO Transactions
A repo transaction means the sale of a securities company with a buyback obligation. Such a transaction is alternative to lending, as the client receives funds through the sale of his securities. At the same time, the client himself, thanks to this, has the following advantage: the ability to easily receive money. The solvency of the client is not checked by the buyer, which means that the seller will not have to prepare a huge package of documentation. The buyer’s advantage is also that, after the acquisition, he does not act as a pledge holder, but as a full owner of the Central Bank. If the seller refuses to buy them back, he has the right to sell the securities on his own.
It is very important that the Central Bank repurchases within this type at a predetermined price, and not at their market value, which was established at the time the OTC transaction was completed.
REPO has the following conditions:
- the minimum amount is four hundred thousand rubles;
- the validity period of this transaction is from seven to one hundred and five days;
- interest rate on a short-term transaction - thirteen (up to thirty-five days), on a long-term transaction - fifteen.
Currently, Sberbank offers this service to its customers, but there is a certain restriction for them: the seller must have a connection to the MICEX trading platform.
Most Popular OTC Markets
The most popular OTC sites are:
- RTS. Leader in the Russian Federation. Created in 1995. Then, in 2011, the RTS merged with the MICEX, but even after this event, its heir, the nonprofit partnership, continued to exist independently.
The key principle of trading here is the right to freely choose an asset and time for trading. No preliminary deposit is made, so you can trade securities of a large number of companies. It is worth noting that the RTS index (like the MICEX index) is one of the main indicators of the Russian stock market.
- Pink Sheets (translated as "pink sheets"). OTC America. All information is printed on sheets of pink since its discovery, that is, since 1913. The main feature is the absence of financial reporting requirements and audit results from trading companies.
- OTC Marketplace Bulletin Board, or OTCBB. The specificity of trade is that between the buyer and seller there is a direct connection by telephone or through social networks and the Internet. Here open access to the Central Bank of more than three thousand companies, but only registered brokers or dealers are able to enter into transactions. Unlike the previous platform, OTC transactions reports are regular here, which makes it more authoritative among investors.