The Securities and Exchange Board of India (SEBI) is set to introduce a new Closing Auction Session (CAS) for certain equity cash segment stocks. This move comes in response to feedback from global passive funds and other market participants regarding the significantly higher end-of-day price volatility observed in Indian equities compared to other major markets.
Addressing End-of-Day Volatility
Currently, the closing price for stocks in India's equity cash segment is determined by the Volume Weighted Average Price (VWAP) of trades executed during the last thirty minutes of the Continuous Trading Session (CTS). This method has been criticized for being susceptible to large institutional trades near the close, which can disproportionately skew prices. High volatility during index rebalancing and derivative expiry days creates distortions, particularly impacting passive funds and arbitrage strategies.
SEBI's research, combined with a study of global practices, indicates that a Closing Auction Session provides a more stable and less volatile closing price. Major global markets in the US, Europe, and Asia already employ CAS for price determination.
Key Features of the Closing Auction Session
The new CAS mechanism is designed to aggregate market interest into a single pool of liquidity, facilitating a fair and transparent closing price that reflects collective market consensus. This is crucial as closing prices serve as a reference for derivative settlements, index computation, and mutual fund Net Asset Value (NAV) determination.
Applicability and Phased Approach
- Phase 1: Initially, CAS will apply only to stocks in the cash segment that also have derivative contracts available.
- SEBI plans a phased approach, potentially expanding CAS to more securities or even all securities in the equity cash segment after the success of the initial phase.
Session Timings and Reference Price
- The Continuous Trading Session for non-CAS securities will run from 9:15 am to 3:30 pm.
- The Equity Derivatives Segment will have revised timings from 9:15 am to 3:40 pm.
- The reference price for a stock in CAS will be the VWAP of trades executed between 3:00 p.m. and 3:15 p.m.
Price Band and Order Types
- A price band of +/- 3% from the reference price will be applicable during CAS to curb excessive price movements.
- Only limit orders and market orders will be permitted. Stop-loss orders and iceberg orders are not allowed.
Order Execution Priority and Equilibrium Price
Orders will be executed based on a defined priority, with market orders taking precedence. The equilibrium price, which will be the determined closing price, will be based on demand-supply mechanisms, aiming for the price at which the maximum volume is executable with minimum order imbalance. If multiple prices meet these criteria, the price closest to the reference price will be chosen.
Impact on Passive Funds and Derivatives
The introduction of CAS is particularly beneficial for passive funds, such as ETFs and index funds, which are mandated to trade at the closing price to minimize tracking errors. Under the previous VWAP system, these funds often had to 'chase' prices. With CAS, they become core participants in the price discovery process, helping to form the equilibrium price.
For the F&O segment, a post-auction alignment window (typically 3:30 PM to 3:40 PM) ensures that the derivatives market can price in the auction-discovered cash price. This promotes price convergence and market stability, preventing chaotic price swings often seen when both markets close simultaneously.
Risk Management and Long-Term Outlook
SEBI has also outlined risk management protocols, including margin requirements for orders placed during CAS. While arbitrageurs may face short-term disruptions, the long-term impact of the Closing Auction Session is expected to be greater transparency, reduced manipulation, and better global alignment for India's capital markets. This evolution is considered necessary for the robustness and efficiency of the market ecosystem.