Legal Definitions - over-the-counter market

Over-the-Counter Market (OTC Market)

The term Over-the-Counter Market, often abbreviated as OTC market, refers to a decentralized financial market where participants trade financial instruments directly with each other, rather than through a formal, centralized stock exchange like the New York Stock Exchange or the London Stock Exchange. In an OTC market, transactions occur through a network of dealers using electronic communication systems, telephones, or other direct negotiation methods. This direct trading mechanism allows for flexibility in pricing and terms for a wide variety of securities and other financial products that might not meet the listing requirements of traditional exchanges.

• Example 1: Trading shares of a small startup company.

  Imagine a promising new biotechnology startup that is too small and new to qualify for listing on a major stock exchange. Instead of going public on an exchange, investors interested in this company's growth might purchase its shares directly from the company itself or through a specialized broker-dealer network. These transactions happen "over-the-counter" because there's no central exchange facilitating the buy and sell orders; instead, buyers and sellers (or their brokers) negotiate and execute trades directly with each other.

• Example 2: Institutional trading of corporate bonds.

  When a large corporation issues bonds to raise capital, these bonds are often bought and sold primarily by institutional investors, such as pension funds, insurance companies, and investment banks. These institutions typically trade bonds directly with each other or through a network of bond dealers, rather than on a stock exchange. For instance, a pension fund might contact a bond dealer to purchase a large block of bonds from another institution. This direct negotiation and transaction between parties, outside of a formal exchange, is characteristic of the OTC market.

• Example 3: The global foreign exchange market.

  Consider a multinational corporation that needs to exchange a significant amount of Japanese Yen for U.S. Dollars to complete an international acquisition. This company would typically contact its bank, which then trades currencies directly with other banks or financial institutions through electronic networks. The vast majority of currency trading worldwide occurs in this manner, without a central exchange. This direct, interconnected network of banks and financial institutions facilitating currency trades exemplifies the OTC market on a massive scale.