A gray market is an unofficial market for financial securities. Gray (or “grey”) market trading generally occurs when a stock that has been suspended trades off the market, or when new securities are bought and sold before official trading begins. The gray market enables the issuer and underwriters to gauge demand for a new offering because it is a “when issued” market (i.e., it trades securities that will be offered in the very near future). While the gray market is unofficial, it is not illegal.
The term “gray market” also refers to the import and sale of goods by unauthorized dealers; in this context, such activity is unofficial but not illegal.
Key Takeaways
- The gray market for financial securities refers to unofficial, over-the-counter (OTC) transactions in a security.
- Unlike typical OTC trading where securities never trade on an exchange, the gray market trades in securities that have been suspended from official trading, or those which haven’t yet begun official trading on an exchange.
- The gray market also refers to products, often imports, sold through alternative retail channels.
- While not illegal, the unofficial status of the gray market increases its riskiness.
Demystifying the Gray Market
In gray market trading, though the trade is binding, it cannot be settled until official trading begins. This could cause an unscrupulous party to renege on the trade. Due to this risk, some institutional investors, like pension funds and mutual funds, may refrain from gray market trading.
The gray market for goods thrives when there is a significant price discrepancy for a popular product in different nations. Popular consumer devices and electronics, luxury cars, high-end apparel, handbags and shoes, cigarettes, pharmaceuticals, and cosmetics are examples of items that flourish in the gray market. Unauthorized dealers may import such items in bulk and, despite adding a healthy markup, sell them at prices still considerably below the local cost.
Customers who buy such products for the discount price may face future problems and should ensure they meet local safety and certification standards. Post-sale service and support is another key issue, as authorized dealers may be unwilling to service goods bought in the gray market.
Consumers may also occasionally unwittingly buy a gray market product. Some indications include a significantly lower price than what’s offered by other local retailers, user manuals in a different language, and photocopied manuals or duplicated software CDs.
Adverse Impact on Businesses
Some gray markets are substantial, presenting challenges for the manufacturers of the goods. Aside from the loss of sales that a company can book directly, the gray market produces a risk to brand equity and damages relationships in the formal sales channel. This includes wholesalers, distributors, and retailers whose exclusivity for sought-after goods is weakened.
Related Terms: OTC Trading, Unauthorized Dealers, Brand Equity.
