The Structure of OTC Derivatives Markets

The purpose of this primer is to clarify some of the key characteristics of the over-the-counter (OTC) derivatives markets. A clearer picture of these markets will help legislators and regulators write better legislation and rules for the prudential regulation of OTC derivatives markets. (Note that this Primer is followed by a short list of key definitions used to describe OTC derivatives markets.) Derivatives are financial contracts whose value is linked to the price of an underlying commodity, asset, rate, index or the occurrence or magnitude of an event. The term derivative comes from how the price of these contracts is derived from the price of some underlying commodity, security or index or the magnitude of some event. The term derivative is used to refer to the set of financial instruments that includes futures, forwards, options and swaps. The combination of a derivative with a security or loan is called a hybrid instrument or alternatively a structured security and structured financing. Derivatives are traded in two kinds of markets: exchanges and OTC markets. Exchanges have traditionally been defined by “pit” trading through open outcry, but exchanges have recently adopted electronic trading platforms that automatically match the bids and offers from market participants to execute trades in a multilateral environment. The trading of derivatives (traditionally futures and options) on exchanges is conducted through brokers and not dealers. The Commodity Exchange Act describes this arrangement as a trading facility and in particular as an organized exchange (see definitions in Section V). The OTC markets are organized along several different The Structure of OTC Derivatives Markets