Over-the-Counter (OTC) Market
The Over-the-Counter (OTC) market is a decentralised marketplace where financial instruments are traded directly between two parties through dealer networks or electronic platforms rather than on a formal exchange with a centralised order book.
The term 'over-the-counter' comes from an era when stock certificates were literally handed over a bank counter in exchange for cash. Today it refers to any trading that takes place outside the order-driven, centralised matching engines of formal stock exchanges like NSE or BSE.
The OTC market is actually larger in aggregate value than exchange-traded markets globally. India's government securities market (G-Sec), the interbank forex market, and a large portion of corporate bond trading all happen OTC. In the G-Sec OTC market, banks and primary dealers negotiate and execute transactions bilaterally, typically in large ticket sizes (Rs 5 crore minimum), and report them on the RBI's NDS-OM platform or the Clearcorp Dealing Systems.
OTC markets have both advantages and disadvantages compared to exchange markets. The key advantage is flexibility — terms can be customised to suit specific needs. An interest rate swap, for instance, can be structured with any notional amount, tenure, fixed rate, and payment dates agreed between the two parties. Exchange-traded derivatives, by contrast, have standardised contract sizes and expiry dates. This flexibility makes OTC markets the preferred venue for hedging highly specific risks.
The key disadvantage of OTC markets is counterparty risk — the risk that the other party defaults before the contract is settled. On exchanges, the clearing corporation serves as a central counterparty, guaranteeing trades. In OTC markets, each party bears the credit risk of the other. Post the 2008 global financial crisis, regulators globally pushed for central clearing of OTC derivatives to reduce this systemic risk. SEBI and RBI have progressively required more OTC derivatives to be centrally cleared in India as well.
For retail investors in India, the most relevant OTC markets are those for unlisted shares (companies not listed on exchanges), where there is no regulated marketplace and prices are often opaque and spreads are wide. The sovereign gold bond secondary market also partly operates OTC between investors for small-ticket transactions, though it is also listed on exchanges.
Regulatory oversight of OTC markets in India is shared: SEBI oversees OTC equity and corporate bond markets, RBI oversees the government securities OTC market and forex market, and SEBI-RBI jointly regulate OTC derivatives through their respective regulatory frameworks.