Over-The-Counter Market Vs. The Exchange Market In Canada

Posted on Thursday, December 22nd, 2016 at 11:34 am

What is the Canadian Securities Exchange?

Would it be easier to answer if I provided the name of its U.S. counterpart?

It’s the Canadian version of the New York Stock Exchange – an exchange market providing a place for Canadians to trade bonds, equities, stocks, derivatives and currencies (financial securities). The exchange market is one of two ways of organizing the financial market, which is a complex system that stabilizes the market while influencing the prices of financial securities.

The second way to establish the financial market is with an Over-the-Counter (OTC) market. However, comparing the OTC to the exchange is difficult because their transformation to the digital world distorted their distinct characteristics. So, let’s go through each and reveal what exactly is different.

The Exchange Market

In the ‘70s when trading started to gain popularity, it was easy to define the benefits of the exchange market because it used the “open outcry” method, which enabled investors to meet in person on the trading floor. They would “cry out” the prices of their securities and hopefully find a buyer that was willing to spend that amount. Now, trading floors are being replaced with electronic trading because it reduces costs and speeds up the execution of trades. But the ability to exchange digitally didn’t permit the loss of its benefits because institutional rules that govern the way investors swapped securities and information still stand in the online platforms and it is a centralized digital location.

Because it’s centralized, the exchange market eliminates counterparty risk and stabilizes prices of securities. For example, let’s say a seller is selling stocks to another investor, they are counterparties to each other, and each side holds the risk of the other party not fulfilling their end of the contract. However, the exchange market stands as a “clearing house,” that sits between the seller and the buyer as a centralized party, to ensure that each party fulfills their agreed action of the transaction. Thus, reducing counterparty risk and forcing all parties to be transparent and prices to be listed publicly and consistent.

Over-the-Counter Market

The OTC is a decentralized market with no particular location. In this less formal and non-transparent system, dealers are the market makers and create the prices of securities, and they use multiple ways of communication: phone, email, social media and written letters. However, unlike the exchange, prices of securities are unlisted, enabling dealers to quote different prices to their customers without other clientele or dealers finding out. That might sound bad, but this market gives both sides of the party the ability to negotiate prices and acquire or sell securities at their desired amount.

Although the OTC has the potential of having lower transaction costs, it is prone to counterparty risk because the other party can opt out of their end of the contract. However, after the 2008 recession, Canada, along with all G20 countries, made it mandatory that dealers and customers make their OTC transactions online or through exchanges to reduce this risk and increase transparency. Unfortunately, this regulation did not eliminate all the risks found in this market.

Both types of financial markets have their pros and cons. If you want to purchase less risky securities, consider the exchange market because all your counterparties are forced to be transparent and sell at a certain price. But if you are looking for a deal, try the OTC market. You can shop from dealer to dealer to find your desired price. Just beware of the risks involved. If you’re not sure which one to choose, then visiting a stockbroker is the best thing for you. They will help you sell or buy securities and are knowledgeable at avoiding risks!



M. Policicchio

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