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Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with exchange trading, which occurs via facilities constructed for the purpose of trading (i.e., exchanges), such as futures exchanges or stock exchanges.


OTC-traded stocks

In the U.S., over-the-counter trading in stock is carried out by market makers that make markets in OTCBB and Pink Sheets securities using inter-dealer quotation services such as Pink Quote (operated by Pink OTC Markets) and the OTC Bulletin Board (OTCBB). OTC stocks are not usually listed or traded on any stock exchange, though exchange listed stocks can be traded OTC on the third market.

Although stocks quoted on the OTCBB must comply with SEC reporting requirements, other OTC stocks, such as those stocks categorized as Pink Sheets securities, have no reporting requirements, while those stocks categorized as OTCQX have met alternative disclosure guidelines through Pink OTC Markets.

OTC market statistics

Data provided by Pink Sheets:

  • Securities quoted exclusively on Pink Sheets - 5,019
  • Securities dually quoted on Pink Sheets and OTCBB - 3,445
  • Securities quoted exclusively on OTCBB - 130

Total OTC securities - 5,149 (December, 2008)

OTC contracts

An over-the-counter contract is a bilateral contract in which two parties agree on how a particular trade or agreement is to be settled in the future. It is usually from an investment bank to its clients directly. Forwards and swaps are prime examples of such contracts. It is mostly done via the computer or the telephone. For derivatives, these agreements are usually governed by an International Swaps and Derivatives Association agreement.

This segment of the OTC market is occasionally referred to as the "Fourth Market."

The NYMEX has created a clearing mechanism for a slate of commonly traded OTC energy derivatives which allows counterparties of many bilateral OTC transactions to mutually agree to transfer the trade to ClearPort, the exchange's clearing house, thus eliminating credit and performance risk of the initial OTC transaction counterparts.

South Korea will require new product approval for OTC derivatives

Original posted on International Financial Law Review by Tim Young:

South Korea’s New Product Approval (NPA) bill that will force banks to seek approval before selling new types of over-the-counter (OTC) derivatives has passed through the legislation and judiciary committee.

The bill received initial approval on February 16. It is expected to be passed on February 26 in the assembly plenary session.

If passed, the law will have a dramatic effect on institutions selling derivatives in the country. Any new credit derivatives will have to be reviewed by the newly established Korea Financial Investment Association (Kofia), regardless of the counterparty. And any new derivatives sold to general investors will also have to be approved, regardless of the underlying.

The NPA will affect all licensed investment brokers or dealers. These include a number of foreign banks, which have been fiercely contesting the licences and the right to trade derivatives in the country for years.

Despite political pressure to pass the bill, opposition remains. “It will seriously restrict the derivatives market,” said an in-house counsel at a Korean bank.

The counsel believes the pre-approval committee – made up of professors, accountants and private practice lawyers – won’t be knowledgeable or confident enough to approve many of the products.

“These so-called experts will be conservative in their approvals. Many are still aware of the litigation surrounding last year’s currency options and won’t want to be seen approving a product that could lead to further litigation,” he added.

The proposals are unique. “We have conducted a wide range of research into OTC regulation and have found nothing like this anywhere in the world,” said Hyun Joo Oh, derivatives partner at Lee & Ko in Seoul.

In December 2009, when the law was first proposed, The International Swaps and Derivatives Association (Isda) also publically criticised the plans.

Banks will have time to adjust though: the bill contains a grace period of three months, which is expected to remain in the final law if it is passed.

Some fear the law slowing down new products. “In OTC, timing is very important. If it takes two or three months for the banks to obtain approval it will be incredibly hard to launch products,” said Hyun Joo.

In informal conversations with the regulator, Hyun Joo was told that that the approvals will take between one and two weeks. “They have promised to expedite the process, but we’ll have to see.”

She does think that products will still be approved though. “Rather than a straight ‘no’, it’s more likely Kofia will ask to add some risk disclosure to the counterparty,” she added.

See also:

To hear a presentation by Isda outlining the problems with the bill, click here


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