Curatia Analysis for Wed, Apr 17, 2024

OTC Markets: As International Stock Trading Booms, Firms Find a Wealth of Advantages in Trading European Stocks in the US

Jason Dibble Co-Founder, Editor in Chief

The popularity of international stock trading has exploded in recent years — a phenomenon for which retail investors have garnered much of the attention.

But diverse benefits accruing to firms trading European stocks in US markets including access to elusive alpha, market-making opportunities in volatile after-hours trading, and the chance to trade on market-moving information outside normal trading hours highlight the value of trading across regions, suggesting the trend may just be getting going.

Breakneck Growth

When the dawn of commission-free trading unleashed an unprecedented retail-investing boom in 2020, few experts foresaw the breakneck growth in international and off-hours stock trading that would follow as retail investors sought access to foreign markets and securities.

The trend has become a high-profile pillar of retail investing’s rise. Since launching 24/5 trading last May, retail brokerage Robinhood has logged as much as a quarter of total trading volume on its platform outside standard market hours on its busiest days.

Less heralded, though, has been the parallel growth of international stock trading among professional traders, who often prefer to keep their strategies close to the vest. At OTC Markets Group, where 84% of dollar volume traded in 2023 was in international securities, shares traded in companies based outside the US have more than tripled since 2016.

The trend is particularly telling because OTC Markets has become the go-to destination for large-cap companies already listed on exchanges abroad that seek to gain exposure to US markets with minimal friction in terms of expense, complexity, and reporting requirements.

At the same time, OTC Markets offers a robust, three-pronged framework to protect and inform investors. It includes regulatory oversight by FINRA and the SEC, a three-tiered market structure that buckets companies trading on its platform according to disclosure and governance standards, and risk profile data available via the market operator’s data offerings.

The resulting fusion of access to US investors and convenience for corporations has helped OTC Markets attract many of the world’s most iconic brands. Nearly a third of dollar volume traded in international securities on its platform in 2023 was concentrated in ten stocks: Tencent, Roche, Luckin Coffee, Nestle, LVMH-Moet, DiDi Global, Bayer, Siemens, Nintendo, and L'Oreal.

On the whole, 83% of OTC Markets dollar volume in 2023 was in companies with market caps exceeding $1B — a figure that may surprise even many professional traders more familiar with OTC markets’ historical association with penny stocks than its contemporary identity as a global trading hub.

In that sense, OTC Markets Group’s metamorphosis reflects broad-based growth in international stock trading by retail and professional traders alike.

While stock exchanges the world over have weathered a two-decade secular decline in the tally of listed companies, the number of international securities trading on OTC Markets’ platform has tripled to nearly 10,000, sparking a 92% surge in annual dollar volume over the past decade.

“Our market is very complementary for international issuers as it provides simple, convenient access to US investors, institutional and retail, during US trading hours – in most cases driving an increase in US and local market liquidity,” OTC Markets EVP of Market Data Matthew Fuchs said.

Favorable Dynamics

Behind that growth story lie dynamics of international and off-hours trading broadly favorable to market participants. Trading internationally yields additional profit opportunities through diversification and price arbitrage across markets.

Additionally, market-making firms have followed retail traders into the international sphere to interact with retail flows, which can be more lucrative than trading against institutional flows.

The off-hours trading whereby traders often access international markets is also generally less liquid and more volatile than trading during regular hours, yielding wider spreads and bigger moves that enhance market-maker profits.

Traders gain a four-and-a-half-hour window in which to trade European stocks through OTC Markets between the closure of European markets at 11:30 am Eastern time and US markets’ 4:00 pm closure. (The gap grows to five-and-a-half hours for three weeks in March and shrinks to three-and-a-half hours in the first week of November due to regional differences in implementing daylight saving time.)

The added trading window helps traders in Europe and the US limit information asymmetry that naturally develops around European stocks when markets are closed. During that interlude, stale asset prices can diverge from actual company valuations as news breaks, yielding profit opportunities for traders.

The phenomenon has resulted in a whopping 34% of trades in the US and Europe occurring in the trading day’s first hour, according to a July FOREX.com survey spanning equities, bonds, commodities, and FX.

The same dynamic has boosted European stock-trading activity on OTC Markets after European markets close. That’s especially true when traders can transact in real time around market-moving news such as earnings releases occurring outside normal trading hours.

“In Q1 2024, we observed 68% of dollar volume in cross-traded European securities on our market between European close and US close,” Mr. Fuchs said. “Nearly a quarter of that activity occurs in the first hour alone, when a sizable share of European companies announces earnings after their domestic markets close.”

In fact, the desire to transact in international stocks outside regular trading hours has been so strong among trading firms as to stoke the growth of an emergent finance hub in Dubai, where marquee hedge funds including Millennium, Brevan Howard, ExodusPoint, and Eisler Capital have set up outposts to capitalize on the region’s time-zone access to both European and Asian markets.

European Opportunities

The trend underscores a wider push into international trading by firms keen to escape crowding in US markets as proliferating hedge funds deploy similar approaches — a tendency the industry’s unfolding AI transformation could exacerbate by spawning convergent trading strategies.

To sidestep that pitfall and capitalize on European trading dislocations, numerous hedge funds have expanded their European footprint. Firms with commodity-trading operations in Europe, for instance, have reaped substantial profits from volatility caused by Russia’s invasion of Ukraine and the consequent acceleration of Europe’s push to decouple from Russian fossil fuels and pivot to clean energy.

Even so, establishing a physical presence in Europe can prove onerous for trading firms navigating linguistic, cultural, and capital barriers — not to mention regulatory restrictions.

Dark-trading caps, high capital requirements, and spiraling compliance costs have prompted nearly half of proprietary-trading firms, who collectively represent 50% of daily European market liquidity, to weigh moving operations out of European markets, a recent Acuiti study found.

A 2023 EU vote to ban payment-for-order-flow arrangements likewise complicates market makers’ mission to interact with potentially lucrative retail flows.

The developments bolster the case for trading firms to transact in European stocks on ex-European venues like OTC Markets, where they can avoid stricter regulatory requirements that have pressured their ability to compete in Europe.

Not all European regulatory developments have been hostile to trading firms, however. The creation of a European consolidated tape for equities figures to provide additional data that trading firms operating either inside or outside of Europe can use to enhance profit-making opportunities.

That’s just one example of how a post-Brexit regulatory rivalry between the UK and Europe could foster improved trading conditions in equities markets as the two jurisdictions loosen rules in a competition for flow.

Those developments, together with favorable trading dynamics and retail traders’ burgeoning interest in international stocks, promise to propel growth in European stock trading for years to come.