The OTC market (Over-the-Counter-Market) is a bilateral market where deals are done directly between two traders. This is the main difference to trading on an exchange which is anonymous, which means the trading parties don’t get to know each other.
Trading on an OTC market
Due to the bilateral trading relationship between the two parties only they know about the exact terms and conditions of the trading deal. For example the price is not published and cannot be seen by other market participants. On an OTC market products are traded with similar delivery times to products traded on an exchange with the exception that on the spot market mainly daily or weekly products for base or peak load are traded. Hourly products are traded rarely. In contrary to an exchange you don’t need to fulfill specific criteria to be allowed to trade. If you want to trade on an OTC market, then there are two different ways of getting in. Either you fulfil the criteria of the OTC platforms in order to trade directly with the OTC partners or you trade through a broker company which trades on behalf of their customers.
In order to take part in an OTC spot market a company must fulfil the following criteria:
First a balancing group contract has to be concluded with the transmission system operator because transactions have to be settled physically. For trading a qualified person is necessary and the company must fulfil certain technical requirements. This could be for example the internet connection to a special internet platform because OTC trading is normally done over the phone or via the internet.
For direct OCT trading an additional trading partner has to be found. In a special trading agreement fundamental trading terms and conditions are specified and agreed on. It is decided upon which maximum volume within a certain timeframe can be traded, how much capital is necessary and which type and to what extend financial-safeguards are necessary. This is why creating such a business relationship between two business partners often costs a fair amount of time and money.
An alternative to entering the market directly is using the help of a broker. These brokers are specialist companies which trade on behalf of a third party and earn their money with commission payments. Services offered by a broker start at the matchmaking of business partners all the way to doing the business transactions and clearing them.
Even though the OTC trades are bilateral they are still organised through central trading platforms. These platforms are run by brokers whose job it is to run the market place and are then not the same as brokers who help companies to enter the OTC market.
Trading on an electricity exchange
The special thing about trading on an exchange is that in general, as well as for electricity exchanges, the products are standardised and the parties stay anonymous so that they don’t know who they have been trading with. The exchange brings buyers and sellers together and the trades are conducted through the exchange.
The market participants send their orders directly to the exchange which then tries to match the orders. Market participants send their orders at a price which they would like to buy or sell a product. If two orders can be matched a ‘trade’ happens which is a business transaction similar to signing a contract.
By doing this both trading partners have an obligation towards each other which has to be fulfilled: the buyer has to buy the electricity at terms and conditions of the contract and then pay for it; the seller underlies the obligation to deliver the electricity. Due to the fact that the trade is anonymous the entire transaction is done through the exchange, only the exchange knows who bought and sold to whom. This procedure is also known as clearing.
A difference to the OTC trades is that all the prices of the trades which have been concluded are made public. The trading partners who have traded with each other though stay anonymous. Due to the fact that the whole procedure is anonymous no consideration about relationships between customers and suppliers has to be taken into account and business strategies don’t have to be revealed.
The comparison between an OTC and an exchange
Trading on an OTC
In comparison to trading on an exchange trades are done outside of the order book of an exchange, which is why only the parties trading who traded with each other know details about the price and volume they traded. Due to the fact that the prices on the exchange are a reference for the OTC market, this means the OTC market is influenced by the price transparency on an exchange. If there are differences in prices between the products sold on the OTC market and the exchange then these differences normally disappear very quickly due to the fact that traders sell at a low price in the one market and sell at a higher price in the other one.
Standardised contract frameworks have reduced costs in OTC trading significantly and have made the process a lot easier. Often the transaction costs and fees are lower than those of an exchange. The standardised OTC contracts offered at EEX make it possible to settle trades through the ECC which is easier and minimizes the counterparty risk.
Trading on an exchange
The exchange is an institutionalised marketplace. The products are standardised, that means the contracts are uniform in regard to their structure and form. Due date, place of delivery, the time in which the deliveries will take place, load type and the conditions for clearing and settlement are standardised. The set of rules such as the conditions to be admitted to trade on the exchange are made public and are the same for every market participant. Prices and revenues are also made public. The participation is of your own free will and non-discriminatory. Trading partners don’t have to be found and the counterparty risk is minimalised. Since the trading process is anonymous market participants can keep their strategy a secret.