Over-the-counter trading (OTC) refers to securities trading not on the stock exchange, but directly between the buyer and the seller.
Over-the-counter trading has its unique characteristics in terms of the subject matter and mode of transaction.
The liquidity of over-the-counter transactions is poor and there is less public information available, which may lead to credit risk.
Learn about OTC transactions
Over-the-counter trading is conducted directly between the two parties without the supervision of the stock exchange. In over-the-counter transactions, the transaction price is not necessarily publicly disclosed. It stands in stark contrast to exchange trading with open prices and liquidity.
There are many kinds of securities traded over the counter. The stock exchange sets strict listing conditions for listed securities, and only accepts those securities that meet the strict listing conditions, so the number of securities that can be traded on the exchange is relatively small.
On the other hand, over-the-counter securities are usually unlisted securities, which do not need to meet the strict listing conditions issued by stock exchanges and government regulatory agencies, so their quantity is very large. Compared with listed securities, the variety of over-the-counter securities is more abundant and diverse. It is worth noting that unlisted securities are not all inferior securities. Some securities are not traded on the stock exchange simply because the issuer of the securities did not apply for listing.
In the United States, new shares issued by joint-stock companies can be transferred through over-the-counter transactions, and some federal government securities, local government bonds and corporate bonds are also traded over-the-counter.
Advantages and disadvantages of over-the-counter trading
The listing of securities must comply with the strict listing conditions prescribed by the stock exchange, and the issuer must perform strict disclosure obligations. At the same time, for issuers, applying for securities listing is a relatively high-cost financing activity, and issuers must bear all kinds of listing-related costs. This may not be what they expect for companies that raise capital on a smaller scale and those that want to keep their finances and business secrets. Therefore, over-the-counter trading and over-the-counter market are indispensable and have their positive significance. However, over-the-counter trading also has its disadvantages. Generally speaking, the trading institution in the over-the-counter market is only an intermediary, they do not provide settlement guarantee for investors, and the credit risk needs to be borne by investors themselves. The lack of regulation in some over-the-counter markets can lead to opaque quotations, making it difficult for investors to defend their rights in the event of disputes. Here are some specific advantages and disadvantages.
Over-the-counter trading provides securities that are not available on stock exchanges, such as delisted stocks, bonds and financial derivatives.
Over-the-counter deals provide an opportunity for companies that want to keep their finances and operations secret to raise large amounts of money.
Larger spreads and fewer regulations in over-the-counter trading make it possible for speculative investors to get higher returns.
Less regulated over-the-counter trading means that counterparties have a higher risk of default and are difficult to maintain their rights.
Over-the-counter stocks may face the risk of less disclosure of corporate information, which leads investors to misestimate future prices.
The lack of liquidity in some securities in the over-the-counter market may make it difficult to buy or sell.
American over-the-counter Group (OTC Markets Group)
Over-the-counter trading originated in the United States, and there used to be two main participants in the over-the-counter market, one is the pink bill (Pink Sheets), and the other is the over-the-counter trading board (OTCBB) operated by the Financial Regulatory Authority (FINRA). However, the US Financial Regulatory Authority formally suspended the operation of OTCBB on November 8, 2021.
At present, the main participant in the OTC market is the American over-the-counter Group (OTC Markets Group), which is a financial platform that provides price and circulation information for more than 10, 000 over-the-counter securities. American over-the-counter trading groups provide services in three core areas: trading services, market data and corporate services. Note that it is not a stock exchange.
Over-the-counter securities are listed on three levels of the market, namely, the QTCQX market with the most stringent listing requirements, the OTCQB risk market with certain listing requirements, and the pink public market that allows companies in financial distress or bankruptcy to enter the market. Of the three markets, the pink sheet public market is the largest in terms of the number of companies and trading volume.