What is Third Market?

Key Highlights

• In the third market, exchange-listed securities are traded by investors outside centralized exchanges, using a network of broker-dealers and institutional investors.

• Institutional investors, including investment firms and pension plans, are commonly involved in the third market, as are traders in over-the-counter markets.

• Over-the-counter markets facilitate the trading of securities that don't meet the criteria for listing on conventional exchanges through a network of broker-dealers.

• Securities in the third market can often be acquired at reduced prices since there are no broker fees involved.

Third Market Meaning

The third market is a platform where stocks of publicly listed companies, which are typically traded on formal stock exchanges, are instead traded over-the-counter (OTC). When investors engage in transactions through the third market, they effectively circumvent the entire secondary market, including intermediaries like brokerage firms and the official stock exchange. This approach enables investors to reduce expenses related to brokerage fees, turnover fees, taxes, and other associated costs. Consequently, it grants the purchasing party the advantage of acquiring shares at prices lower than those quoted on traditional stock exchanges. After understanding the third market definition, let us get into how third market works

How Does the Third Market Work?

The Third Market operates outside of traditional exchanges and involves institutional investors, broker-dealers, and alternative trading platforms. However, the third market provides a distinct space for brokers and institutional investors, like fund managers, to engage in the trading of exchange-listed securities without relying on traditional secondary market platforms.

To execute a third market transaction with exchange-listed securities for non-members, a member firm must fulfill all limit orders on the specialist's book at an equal or higher price. Institutional investors, such as investment firms and pension plans, frequently partake in the third market. This market brings together significant investors who are ready to buy and sell securities for immediate cash delivery. One notable advantage of the third market is the potential to acquire securities at lower prices due to the absence of broker commissions.

Third-party trading systems play a crucial role in this setup by bypassing conventional brokers and facilitating substantial orders from various institutions to "cross" with each other. Anonymity rules ensure that the identities of the parties involved remain undisclosed, preserving the confidentiality and discretion of these transactions. While certain rules and logic within flow management interfaces are undisclosed to the public, they contribute to the overall anonymity of third market transactions.

Who Participates in the Third Market?

There is a diverse range of participants engaged in various transactions. While traditionally dominated by large institutional investors,investors including hedge funds, pension funds, and investment banks, the landscape has evolved to include other players as well. Retail investors and individuals with a substantial net worth now also find themselves venturing into the third market.

By venturing into the third market, retail investors and high-net-worth individuals can gain exposure to a wider range of investment opportunities and potentially benefit from the advantages it offers, such as lower costs and increased liquidity. This expanding participation has contributed to the evolving landscape of the third market, making it a more inclusive space for various types of investors.

Overall, while large institutional investors have historically been the primary participants in the third market, the involvement of retail investors and high-net-worth individuals has expanded its reach and potential, transforming it into a market that caters to a broader spectrum of investors.

Why Do Institutional Investors Prefer The Third Market?

Institutional investors prefer the third Market for its benefits in terms of liquidity, cost savings, and flexibility. Trading outside of traditional exchanges can enhance liquidity by providing additional avenues for executing large orders without significant market impact. This allows institutional investors to efficiently trade securities while minimizing transaction costs.

The third market also offers flexibility in trading strategies, allowing institutional investors to implement customized approaches tailored to their specific investment objectives. Access to alternative trading platforms, dark pools, and direct negotiations with other market participants enables them to explore unique investment opportunities not available on traditional exchanges. Additionally, the use of advanced trading technology and algorithms in the third market ensures efficient execution, optimizing trade processes and outcomes for institutional investors. These advantages make the third market a preferred choice for institutional investors seeking enhanced liquidity, cost-effectiveness, and flexibility in their trading activities.

Example of Third Market Trade

Suppose an investment firm intends to purchase 100,000 shares of Ashok Leyland Limited, an exchange-listed company, at a price of Rs. 100 per share. If they were to execute this trade through the secondary market, they would incur various fees and costs associated with trading on the exchange. Assuming these costs amount to 4% of the total turnover of the trade, the firm would need to allocate around Rs. 400,000 towards these expenses ((100,000 shares x Rs. 100 per share) x 4%). As a result, the cost of ownership per share would increase from Rs. 100 to approximately Rs. 104 ((Rs. 100,000,000 + Rs. 400,000) ÷ 100,000 shares). However, by conducting the trade in the third market, these additional costs can be completely avoided.

Another significant advantage that the third market offers institutional investors is the aspect of anonymity. Not all institutional investors desire their investment activities to be publicly disclosed. The third market allows them to maintain anonymity while making substantial investments or divesting their holdings. In fact, the level of anonymity in the third market is so high that neither the buyer nor the seller can ascertain each other's identity. This ensures a high level of confidentiality and discretion, making the third market an attractive choice for institutional investors seeking privacy in their transactions.

Overall, the cost savings and anonymity provided by the third market make it a preferred choice for institutional investors when conducting bulk trades. By minimizing expenses and maintaining confidentiality, institutional investors can optimiseoptimize their investment strategies and protect sensitive information.

Conclusion

The existence of third markets plays a vital role in the trading and investment landscape. These markets enable the seamless buying and selling of large blocks of company shares, facilitating efficient transactions for institutional investors. Without the presence of third markets, executing substantial trades in the secondary market could lead to increased volatility and potential disruptions in stock prices.

The availability of a separate market for bulk deals helps alleviate the strain on the secondary markets, ensuring a smoother flow of trades and maintaining market stability. By providing a dedicated platform for significant transactions, third markets contribute to the overall functioning and efficiency of the broader stock market ecosystem.