Legal Definitions - OTC

OTC stands for Over-the-Counter.

In a legal and financial context, "Over-the-Counter" refers to a method of trading financial instruments, such as stocks, bonds, or derivatives, directly between two parties or through a dealer network, rather than on a centralized, formal exchange like the New York Stock Exchange (NYSE) or NASDAQ. These transactions are typically negotiated directly between participants, often facilitated by brokers or dealers who quote prices and execute trades.

• Example 1: Trading Shares of a Smaller Company

  Imagine a promising new biotechnology startup that is not yet large enough to meet the stringent listing requirements of a major stock exchange. Instead of being listed on the NYSE, its shares might be bought and sold directly between investors through a network of brokers and dealers. These transactions occur "over-the-counter," meaning they are not executed on a centralized exchange but rather through direct negotiation and electronic networks connecting market participants.

  This illustrates OTC trading as a mechanism for companies that may not qualify for or choose not to list on a major exchange to still have their securities traded among investors.

• Example 2: Corporate Bond Transactions

  A large manufacturing company decides to issue new corporate bonds to fund the construction of a new factory. Instead of listing these bonds on a public bond exchange, the company's investment bank arranges for them to be sold directly to a group of institutional investors, such as pension funds and insurance companies. The subsequent trading of these bonds between these large investors or other financial institutions often occurs directly between them or through a network of bond dealers, rather than on a centralized exchange.

  This demonstrates how many fixed-income securities, like corporate bonds, are predominantly traded OTC, allowing for direct negotiation of terms and prices between sophisticated buyers and sellers.

• Example 3: Foreign Currency Exchange

  A multinational corporation needs to convert a substantial amount of Japanese Yen into U.S. Dollars to pay its American suppliers. Instead of using a formal currency exchange, the corporation contacts its bank, which then executes the currency conversion directly with another financial institution or from its own inventory of currencies. The global foreign exchange (forex) market, where trillions of dollars are traded daily, operates almost entirely on an OTC basis.

  This example highlights how the vast majority of global currency transactions are OTC, occurring directly between banks, financial institutions, and large corporations without passing through a central exchange, facilitating international trade and investment.