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How Is OTC Markets Different From Exchanges?

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How Is OTC Markets Different From Exchanges?

The universe of public companies open to U.S. investors is a lot larger than most people realize. 

There are nearly 18,000 securities available in the U.S. Over 11,000 of these trade on OTC Markets, while the rest trade on national exchanges like NYSE and Nasdaq. 

For many retail investors, the experience of using their brokerage to trade an exchange-listed security may not be all that different than trading a security on OTC Markets but there are some key differences in how the markets function. 

The Structure Of OTC Markets

OTC Markets is divided into three main markets— OTCQX, OTCQB, and Pink—with each tier having different standards. The goal, according to OTC Markets Group, is to create more efficient markets by organizing securities “based on the quality and quantity of information companies disclose.”

OTCQX, the highest tier, is home to the largest companies like Meritage Hospitality Group, Inc. (OTCQX: MHGU). Many of these companies also have a primary market in another country (such as Roche Holdings (OTCQX: RHHBY) and Adidas (OTCQX: ADDYY)). It’s also where a lot of community banks trade, like Coastal Carolina Bancshares Inc (OTCQX: CCNB) and Lyons Bancorp, Inc. (OTCQX: LYBC). 

OTCQB, the middle tier, is where smaller, emerging companies trade, such as Nextech AR Solutions (OTCQB: NEXCF). 

The Pink Market is an “Open Market,” where any company, from large-caps like Nestle (Pink: NSRGY). to a reorganizing JC Penney (Pink: JCPNQ), can trade. 

Who Participates In The OTC Markets?

Securities on OTC Markets can be bought and sold by any investor, from large institutions to individual retail investors through a registered broker-dealer. Investors and broker-dealers are amongst a few key groups that are a part of the market.

COMPANIES

There are over 11,000 securities traded on the various tiers of OTC Markets. 

Many of these securities are ADRs for major international institutions like BNP Paribas (OTCQX: BNPQF) and AXA (OTCQX: AXAHY). These companies are primarily traded in their home countries, but have ADRs that trade on OTC Markets to give U.S. investors better access and diversify their shareholder base. 

Many companies with securities on OTC Markets fall into a number of common industries. This includes community banks like Bank of San Francisco (OTCQX: BSFO), and metals and mining companies like Standard Lithium (OTCQX: STLHF) and Impala Platinum (OTCQX: IMPUY). 

OTC Markets also serves as a home for many innovative industries that fall outside the established guidelines of a national exchange. This includes the cannabis industry which is well-represented. Because U.S. cannabis operators are unable to list on an exchange while cannabis is classified as a Schedule I drug, many have their securities traded on OTC Markets. Other innovative industries like crypto can be found as well. Grayscale’s portfolio of products, including the Grayscale Bitcoin Trust (OTCQX: GBTC) and Grayscale Ethereum Trust (OTCQX: ETHE) trade on the OTCQX Market. 

BROKER-DEALERS

Unlike exchanges, which match buyers and sellers through a number of centralized locations, OTC Markets consists of a network of over 90 broker-dealers who trade directly with one another. These are the same broker-dealers that also trade exchange listed securities.

Investors can place orders through these broker-dealers, who can either fill the order themselves or connect with other broker-dealers through an alternative trading system such as OTC Link. This system allows broker-dealers to communicate, negotiate trades on behalf of clients, and post quotes to the public. Orders can also be placed through OTC Link ECN, which combines the Broker-Dealer network model with the anonymity of traditional markets. 

The aggregate bids and asks posted by different broker-dealers for a given security are then consolidated to define the market for that security. 

REGULATORS

In addition to the qualifying standards placed by OTC Markets for the OTCQX and OTCQB markets, there is also federal regulation of OTC Market participants. 

All broker-dealers are regulated by FINRA. These regulations include rules that, among other things, require a broker-dealer to get the best possible price for a customer when executing an order and prohibit them from front-running customer orders. 

Some securities that trade on OTC Markets are also “SEC reporting” meaning they are registered with and regulated by the SEC. Both organizations also regulate the OTC Link trading system. 

When trading a security on OTC Markets, it’s important to understand how the market’s different players interact with each other. Each participant contributes to the liquidity and efficiency of the market and can affect how, when, or if your buy or sell order gets executed. 

Photo by M. B. M. on Unsplash

 

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