Over-the-counter (OTC) or off-exchange trading is done directly between two parties, without the supervision of an exchange. It is contrasted with exchange trading, which occurs via exchanges. A stock exchange has the benefit of facilitating liquidity and providing transparency by centralizing the bid and ask orders and making the order book visible for all participants.
Many equity securities, corporate bonds, government securities, and certain derivative products are traded in the OTC market.
OTC Markets Group
The OTC Markets Group is an American financial service, that operates an alternative trading system (ATS) by providing price and liquidity information for almost 10,000 over-the-counter securities.
The group has its headquarters in New York City. OTC-traded securities are organized into three markets to inform investors of opportunities and risks:
- OTCQX: This market consists of American growth companies and American Depository Receipts (ADRs) of foreign multinational companies that trade on foreign stock exchanges.
- OTCQB: This market has lesser disclosure requirements and is suited for smaller venture stock.
- Pink Sheets: This is an open market for stocks and has no required financial disclosures or standards. Companies whose stocks trade as Pink Sheets are not required to be registered with the SEC.
- Grey Market: Securities that trade in the Grey Market are stocks outside of the OTCQX, OTCQB or Pink markets that broker-dealers are not willing or able to publicly quote OTC securities because of a lack of investor interest, company information availability or regulatory compliance.
Forwards contracts are contracts for the future delivery of an underlying asset. Forward markets are generally informal over the counter markets. Standardized forward contracts are called futures contracts. Futures are traded on exchanges.
Most bonds do not trade on exchanges but over the counter. Investors engage in one-off deals with each other often through informal networks of bond dealers. This means that bids to buy and sell a particular bond are not centralized and therefore not seen by all market participants.
Are OTC markets regulated?
In the United States, the Financial Industry Regulatory Authority (FINRA) regulates broker-dealers that operate in the over-the-counter market.
The role of Broker-Dealers
In financial services, a broker-dealer is a natural person, company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and derivatives trading process.