OTC Trading of Corporate Bonds

Over-the-counter (OTC) trading of corporate bonds refers to the buying and selling of corporate debt securities through bilateral transactions negotiated directly between participants rather than through a centralised exchange order book. In India, OTC trading has historically been the dominant mode of trading in the corporate bond market and continues to play a significant role in banking, finance, and the broader economy. It reflects the structure, maturity profile, and investor composition of the Indian debt market, where large institutional participants engage in negotiated trades.
The OTC corporate bond market is critical for channelising long-term funds to the corporate sector and supporting investment-led growth, particularly in infrastructure, manufacturing, and services.

Concept and nature of OTC corporate bond trading

In an OTC market, trades are executed through direct negotiations between buyers and sellers, often facilitated by brokers or trading platforms, but without anonymous order matching. Prices, quantities, and settlement terms are agreed bilaterally, allowing flexibility in structuring transactions.
OTC trading is especially suited to corporate bonds because such instruments are often heterogeneous in terms of maturity, coupon structure, credit quality, and issue size. This makes continuous exchange-based trading less efficient for many bonds, particularly those with limited outstanding volumes.

Structure of the Indian corporate bond market

The Indian corporate bond market is largely institutional in nature. Participants include banks, insurance companies, mutual funds, pension funds, and other large investors. Retail participation remains limited, which reinforces the dominance of OTC trading.
Most corporate bonds are held to maturity by institutional investors, resulting in relatively low secondary market turnover. OTC trading enables these investors to adjust portfolios or manage liquidity needs without relying on continuous market liquidity.

Regulatory framework and oversight

OTC trading of corporate bonds in India operates within a regulated framework overseen by the Reserve Bank of India and the securities market regulator. While trading is negotiated bilaterally, reporting and settlement are subject to regulatory requirements to ensure transparency and market integrity.
Trades executed in the OTC market are required to be reported to authorised reporting platforms within prescribed timelines. This post-trade transparency allows regulators and market participants to observe price trends, volumes, and market activity, even though execution is not exchange-based.

Role of banks and financial institutions

Banks play a central role in the OTC corporate bond market as investors, arrangers, and intermediaries. They invest in corporate bonds as part of their treasury and liquidity management operations and also facilitate issuance and distribution for corporate borrowers.
Financial institutions rely on OTC trading to manage interest rate risk, credit exposure, and portfolio duration. The negotiated nature of OTC trades allows large-value transactions to be executed with minimal market impact, which is particularly important for institutional balance sheet management.

Advantages of OTC trading in corporate bonds

OTC trading offers several advantages in the Indian context. It provides flexibility in pricing and execution, accommodates customised bond structures, and supports large block trades. This is especially beneficial in a market where liquidity is concentrated in a limited number of issuers and maturities.
The OTC market also enables efficient price discovery for less frequently traded bonds through negotiated transactions, rather than forcing such instruments into thinly traded exchange order books.

Limitations and challenges

Despite its utility, OTC trading of corporate bonds faces certain challenges. Limited pre-trade transparency can make price discovery less efficient, particularly for smaller participants. The market can also be fragmented, with liquidity dispersed across numerous issuers and issues.
Lower retail participation and concentration of trading among institutional investors can restrict market depth. Additionally, reliance on negotiated trades may reduce immediacy during periods of market stress, when counterparties become risk-averse.

Impact on the Indian economy

The OTC corporate bond market plays a vital role in financing India’s corporate sector by providing an alternative to bank credit. It supports long-term funding needs and reduces pressure on the banking system, contributing to a more balanced financial structure.
Efficient OTC trading enhances investor confidence and encourages greater participation in corporate debt, which is essential for meeting the financing requirements of a growing economy. A deeper and more transparent corporate bond market can also improve monetary policy transmission by strengthening interest rate benchmarks.