An over-the-counter (OTC) market is a market where securities are traded directly between two parties, without the intervention of a central exchange. This means that there is no central counterparty to guarantee the trades, and the parties involved are responsible for their own risk.
OTC markets are often used for securitisation because they allow originators to sell their securitised products directly to investors. This can be more efficient than listing the securitised products on a central exchange, as it can reduce the costs and time involved in the transaction.
Here are some of the applications of OTC markets in securitisation:
- Selling securitised products: OTC markets can be used to sell securitised products directly to investors. This can be more efficient than listing the securitised products on a central exchange, as it can reduce the costs and time involved in the transaction.
- Pricing securitised products: OTC markets can be used to price securitised products. This is because the prices of securitised products are often determined by the market, and OTC markets can provide a platform for buyers and sellers to interact and negotiate prices.
- Hedging risk: OTC markets can be used to hedge risk. This is because investors can use OTC markets to buy and sell derivatives, which are financial instruments that can be used to protect against changes in the price of an asset.
Overall, OTC markets can be a useful tool for securitisation. However, it is important to note that OTC markets are not regulated in the same way as central exchanges, and this can increase the risk involved in transactions.
Here are some of the risks associated with OTC markets in securitisation:
- Counterparty risk: There is no central counterparty to guarantee the trades in OTC markets, so the parties involved are responsible for their own risk. This means that if one party defaults on the trade, the other party may lose money.
- Lack of transparency: OTC markets are not as transparent as central exchanges, so it can be difficult to get accurate information about the prices of securitised products. This can make it difficult to price securitised products and to hedge risk.
- Compliance risk: OTC markets are not as regulated as central exchanges, so there is a risk that the parties involved in a transaction may not comply with the relevant regulations. This can lead to fines or other penalties.