Fourth Market

The fourth market is a market that trades securities between institutions on a private, over-the-counter computer network, rather than over a recognized exchange such as the New York Stock Exchange (NYSE) or Nasdaq. Institutions can trade various types of securities and options.

The fourth market is utilized by institutions only and can be compared to the primary market, secondary market, third market and dark pools. While primary, secondary and third markets have similar trading mechanisms and utilize similar technology as the fourth market, these markets are exchanges of publicly offered shares for all investors including retail and institutional.

Market exchanges are a significant aspect of the financial industry’s infrastructure globally. In the U.S., primary, secondary and third markets are all viable parts of the financial system. Primary markets include the first issuance of a security and its initial public offering (IPO). Secondary markets are markets such as the New York Stock Exchange and Nasdaq which trade actively throughout the day, five days a week. Third markets also trade actively with a five-day week and are known as the over-the-counter markets. All of these markets provide access for all types of investors to publicly traded securities that must be registered with the Securities and Exchange Commission for public sale.

Fourth markets are generally more closely comparable to dark pools, with the two phrases often used interchangeably. These markets are private exchanges that trade between institutional investors. A wide range of securities and structured products can trade on the fourth market with little transparency to the broad public market.

Fourth market trades are transacted between institutions. These trades are typically placed directly from each institution with low transaction costs. The fourth market can encompass a broad array of securities including publicly offered securities traded privately as well as derivatives and structured products tailored to the needs of corporate institutions.

These trading platforms can be set up by independent companies or they may be formed by institutions themselves. Liquidity and trading volume can vary extensively with this type of trading.

Often the fourth market is used for trading securities that involve a company’s risk management strategy. For example, swap options are one type of derivative that can be traded through the fourth market. Swap options allow institutions to manage interest rate risk. With a put swaption, an institution can enter a contract to pay a fixed rate of interest and receive a floating rate of interest pertaining to credit debt on its balance sheet.

In other cases, companies may choose to exchange securities privately. This could occur if a mutual fund and a pension fund enter into a large block trade with each other. The two companies could transact over an electronic communication network. By executing the transaction this way, both parties avoid brokerage and exchange transaction fees. They also avoid the possibility of distorting the market price or the volume traded on an exchange.