Otc Market Is an Important Part of Multi-Layered Capital Markets

OTC market is an important part of multi-layered capital markets, and reflects investment and financing needs of the general concerns of SME. In addition to the main board, OTC market provides more diversification, more flexible transaction methods, and more complicated and customized securitization product. Mostly, the enterprises listed in OTC market are SMEs in the early growth stage, with underperformed corporate governance, management and unpredictable profitability. As a result, the risk of OTC securities, particularly the market risk turns out to be relatively high. With the expansion of GEM and the growth of regional OTC markets, transaction explodes in volume. Therefore, it has become an important issue for the domestic and abroad securities legislation research and practice how to ensure the OTC market sustainable development and protect the investors’ interest. In recent years, although Chinese scholars had conducted in-depth research on the OTC market's regulatory system and learned a lot from foreign market about OTC market construction, there are still problems to further clarify. On our securities practitioners opinion, we comprehensively use the knowledge ranged from civil law, economics sociology to practical experience, study and analysis the OTC market regulation.

We will discuss the problem through six thorough sections. The first part analyzes the fundamentals of OTC market establishment, and we particularly contemplate the OTC legislate characteristics.

Firstly, we analyze the characteristics of OTC markets, and compare the concept of OTC market, capital market, property ownership market with over-the counter market, in order to clearly define the OTC market. We believe that the OTC market is independent of the exchange transaction system, and is essential to the stock market. OTC market has various investment portfolios, multiple market participants, less regulation and lower entry requirement. Meanwhile, OTC market functions benefit both private and public. In the public sectors, OTC market plays a positive role as improving the multi-layer capital market and promoting regional economy growth. In the private sectors, OTC market provides enterprises with financing and enforces the company improve corporate governance practice. We believe it is the core value of OTC market that the capital trade functions provide to the private sector and connect the capital demand and supply.

Compared OTC with exchange markets, we distinguish the character differences in the legal system, transaction features and supervision mode, and come up with the idea that the legislation of OTC market subject to private law. We believe that OTC markets thrive on autonomy of the will. Rather than administration instruction, the social contract within the market participants leads OTC construction progress. The participants ‘ common interests emerge in the markets functions and values, trading rules and other legal system design and arrangement. The participants follow the honesty, equality, mutual benefit and other basic principle of civil law, in less regard of the legal norms of public law. Autonomy of the will and other basic principle of civil law play an core role in OTC markets. It is the innovation in this essay that we define OTC legal system subject to private law, and we deduct following conclusions just from this origin.

In the second part, we discuss how to regulate the OTC market maker. We define a market maker or liquidity provider is a company, or an individual, that quotes both a buy and a sell price in a financial instrument or commodity held in inventory, hoping to make a profit on the bid-offer spread. Thanks to the difference in mechanism, counterparty and information of market maker trading and auction trading, it is obviously that the regulation should make a change.

Secondly, we explain the main reason that OTC market should choose market maker system is market liquidity and stability. For investors, market maker provides a more reasonable price and ensures the price- discovery process. For regulation, market maker helps increase efficiency and lower regulation cost.

Also, we explain how the market makers quote bid and ask price, how they activate the liquidity, the risk they undertake and information asymmetry. We analyze the necessity of establishing legal regulation in market making system.

Then, we suggest the indicators of choosing market makers, including instant transaction capacity, valuation ability and integrity. A good market maker should be able to balance and fulfill these requirements.

Finally, we propose the information disclosure rules as the fundamental to improve OTC market maker systems.