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But customers cannot penetrate the market among dealers. Some OTC markets, and especially their interdealer market segments, have interdealer brokers that help market participants get a deeper view of the market. The dealers send quotes to the broker who, in effect, broadcasts the information by telephone. The bulletin boards show bid, ask, and, sometimes, execution prices. The broker screens are normally not available to end-customers, who, as a result, are usually not fully informed of changes in prices and the bid-ask spread in the interdealer market.
Dealers can sometimes trade through the screen or over the electronic system. Some interdealer trading platforms allow automated algorithmic rule-based trading like that of the electronic exchanges. Otherwise the screens are merely informative, and the dealer must trade through the broker or call other dealers directly to execute a trade. Advances in electronic trading platforms have changed the trading process in many OTC markets, and this has sometimes blurred the distinction between traditional OTC markets and exchanges.
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In some cases, an electronic brokering platform allows dealers and some nondealers to submit quotes directly to and execute trades directly through an electronic system. This replicates the multilateral trading that is the hallmark of an exchange—but only for direct participants. However dealers resist the participation of nondealers and accuse nondealers of taking liquidity without exposing themselves to the risks of providing liquidity.
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Others criticize dealers for trying to prevent competition that would compress bid-ask spreads in the market. Unlike an exchange, in which every participant has access, these electronic arrangements can treat participants differently based on, say, their size or credit rating. Moreover clearing and settlements of trades are still left to the buyer and seller, unlike in exchange transactions, where trades are matched up and guaranteed by the exchange. The architecture of OTC markets helps explain why structured securities which divide the risk of the underlying assets into several slices, each of which is sold separately faced problems during the recent financial crisis.
Credit derivatives, commercial paper, municipal bonds, and securitized student loans also faced problems.
All were traded on OTC markets, which were liquid and functioned pretty well during normal times. But they failed to demonstrate resilience to market disturbances and became illiquid and dysfunctional at critical times. The failure of the price discovery process aggravated the problems at banks and other financial firms during the recent crisis by making it more difficult to meet disclosure and reporting requirements on the value of their securities and derivatives positions.
Not only were there no efficient direct market prices, there were often no benchmark prices which are prices of assets similar to the one being valued. As a result, the assets and positions that were once valued at market prices were instead valued through models that sometimes were not adequately informed by benchmark prices.
These valuation problems further depressed prices of affected securities. The jump in volatility made it especially dangerous and expensive for dealers to continue to make markets. Without the dealers, there was no trading, especially in securities such as collateralized debt obligations, certain municipal securities, and credit derivatives.
Like much of the young crypto industry, the realm of OTC trading brokers can be opaque and difficult to navigate. If you end up stumbling into the virtual office of a disreputable OTC broker, you might discover that they could game you just as much as an actual exchange could , in ways that are even harder to spot unless you know where to look. Wayne Trench. Hong Kong, China. Key OTC features: Michael Moro.
Formerly Director at SecondMarket. Founding Partner: Shuoji Zhou. Beijing City, China.
Over-The-Counter - OTC
Kazuki Obata. Tokyo, Japan. George Melika, trading platform and payment system developer; Akbar Thobhani, formerly head of growth and business development at Airbnb.
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