Sun, 20 Dec 2009

How broken are the OTC markets?

The SEC has filed a complaint against the world’s largest inter dealer broker ICAP which dominates trading in US government securities and many other OTC markets. ICAP has settled the charges for $25 million and an undertaking to implement remedial action to be suggested by an independent consultant.

The charges are very serious:

• ICAP displayed thousands of fictitious trades designed to mislead other traders about the true state of the market; and
• ICAP brokers executed thousands of trades to liquidate ICAP’s positions against customer orders in violation of the stated workup protocol.

It is depressing that charges of such seriousness are settled without an admission of guilt. The alleged actions shake the very foundations of market integrity and make one wonder whether OTC markets can be trusted at all.

Around the same time that I was reading this complaint, Rortybomb alerted me to a Bloomberg story of a few months ago about an investigation against Markit. The charges here are of a very different nature but they are disturbing in their own way. It is alleged that Markit agreed to provide price information to a clearinghouse only if the latter agreed to clear only trades that involved a dealer.

The question in my mind now is how badly broken are the OTC markets. Whenever, people describe the stock exchanges as casinos, my response is that even if many of the participants are only gambling, the stock exchange still performs the socially useful purpose of price discovery. OTC markets that do not provide transparent price discovery do not perform this function and are much closer to pure casinos. Those that distort the price discovery are worse than casinos.

Posted at 17:20 on Sun, 20 Dec 2009     2 comments     permanent link

Comments...

Siddharth wrote on Mon, 21 Dec 2009 13:06

Re: How broken are the OTC markets?

Dear Sir,

Something unrelated to this post: Request you to write a post on the current change in trading hours on BSE and NSE? Do more hours of overlap with other Asian markets really mean anything to investors / traders?

The very little time given to switch over seems like a sad way of treating stakeholders.

Thanks.

• Vishal wrote on Mon, 21 Dec 2009 16:11

  Re: Re: How broken are the OTC markets?
  

  Adding to the point/request made by Siddharth,

  Woudl request you to please elaborate on following aspects of increasing trading hours :

  How would increasing the trading hours practically reduce the volatility of stock market movements (this is one of the pros gievn in favour of this proposition ) ?

  Why would the turnover increase on both bourses ? (another pros given for this proposition)

  My viewpoint : Both the volatility and turnover wont be affected as such . Theoretically speaking, yes volatility should reduce as we add more time value ,investors have more time to react and hence it reduces sudden price movements - but does it make sense ?

  Is it that investors are currently facing the crunch of time and are unable to invest in the allotted hours ? - I dont think so ..