Over-the-Counter Privileges

Definition

Over-the-Counter (OTC) Privileges refer to the rights and privileges of trading securities that are not conducted through formal stock exchanges. These transactions typically occur in over-the-counter markets, where parties can directly negotiate prices and terms without the restrictions imposed by exchanges. OTC privileges offer investors greater flexibility to trade securities not listed on exchanges, such as stocks of small companies, bonds, and derivatives. However, this trading method may also involve higher liquidity risks and information asymmetry risks.

Origin

The concept of over-the-counter trading originated in the early stages of the securities market development, where many securities were traded in informal settings. Over time, the OTC market gradually formed and significantly developed in the mid-20th century, especially in the U.S. and European markets. A key event was the establishment of the NASDAQ in 1971, marking the modernization of the OTC market.

Categories and Features

OTC privileges can be categorized into various types, including OTC trading of stocks, bonds, and derivatives. OTC stock trading often involves shares of small or startup companies that may not meet the requirements for listing on major exchanges. OTC bond trading is common for corporate and government bonds, offering greater trading flexibility. OTC derivatives trading allows investors to customize contracts according to specific needs. While OTC trading provides flexibility and customization advantages, it also has drawbacks such as insufficient liquidity and information asymmetry.

Case Studies

A typical case is the Pink Sheets in the U.S., an OTC market specifically for trading stocks of small companies not listed on exchanges. Many startups use the Pink Sheets for financing as they do not meet the stringent requirements of major exchanges. Another example is Credit Default Swaps (CDS), an OTC derivative used to hedge credit risk. During the 2008 financial crisis, the CDS market's risks highlighted potential issues of OTC trading, such as information asymmetry and liquidity risk.

Common Issues

Common issues investors might face when engaging in OTC trading include liquidity risk, which is the difficulty in finding a counterparty, and information asymmetry risk, which is the lack of sufficient information to make informed investment decisions. To mitigate these risks, investors should conduct thorough due diligence and consider seeking advice from professional advisors.