The Securities and Exchange Board of India’s (Sebi’s) proposal to overhaul the closing auction session (CAS) has drawn a mixed response from market participants, with experts divided over the proposed methodology for settling derivative contracts even as they welcomed measures aimed at curbing potentially manipulative order cancellations.
In a consultation paper released on Saturday, Sebi proposed two alternatives for determining settlement prices of index and single-stock derivative contracts on expiry days. The first is a blended volume-weighted average price (VWAP), combining prices during the final 30 minutes of continuous trading with those discovered during the 10-minute CAS, with weights based on the traded value in the respective periods.
The second is to continue using the VWAP of the final 30 minutes of continuous trading as an interim measure. Sebi has proposed retaining this method for at least a year before reviewing liquidity in CAS and market participants’ familiarity with the mechanism, potentially paving the way for a transition to the blended methodology.
Experts, however, differ over whether the transition period is necessary and whether the blended methodology is the right approach.
Venkatachalam Shunmugam, former head of research and administration at MCX, said the proposals indicate that Sebi does not want derivative settlement prices to remain linked to continuous-trading VWAP over the long term. However, he said derivatives traders are likely to prefer continuous-trading prices as they allow them to manage risks better than CAS, where orders are aggregated.
While a shift towards CAS may eventually be necessary, a one-year transition may not be sufficient unless Sebi takes steps to deepen liquidity in the auction session, he said. This would require greater participation from arbitrage funds and foreign portfolio investors (FPIs), including through the stock lending and borrowing mechanism (SLBM), as well as market-structure changes to manage order imbalances.
“Sebi will have to take substantial measures to strengthen liquidity and enhance supervision during CAS to increase participation,” Shunmugam said.
Chandan Taparia, head of derivatives and technicals at Motilal Oswal Financial Services, however, favoured moving directly to the blended VWAP methodology. He said the consultation paper makes it clear that Sebi intends to persist with CAS, and delaying the blended methodology by a year may therefore serve little purpose.
According to Taparia, combining continuous-trading and CAS prices could help reduce sharp swings in indices on expiry days while encouraging greater participation in the auction session.
Experts were more aligned on Sebi’s proposals to curb disruptive order behaviour during CAS.
The regulator has proposed discontinuing dissemination of the indicative index value (IIV), noting that investors may mistake it for an actual level reached by the index rather than an evolving indication based on the indicative equilibrium prices of constituent stocks.
Sebi has also proposed allowing cancellation of limit orders placed within 1% of the reference price, while barring cancellation of orders placed in the 1-3% range.
Shunmugam said the restriction could help curb spoofing — the practice of placing large buy or sell orders and subsequently cancelling them to influence prices — and reduce sudden changes in the apparent demand and supply of securities.
Taparia said the measure could similarly discourage participants from placing and cancelling orders significantly away from the reference price, helping reduce volatility during CAS.
Among other changes, Sebi has proposed allowing unexecuted iceberg orders to transition into CAS, with their entire remaining quantity disclosed to the market.
The regulator has also proposed two possible CAS schedules — 3:15 pm to 3:25 pm or 3:30 pm to 3:40 pm — along with a one-minute transition period and another five minutes after CAS before derivatives trading closes.
The proposals indicate that Sebi intends to retain CAS while addressing concerns around liquidity, price discovery and derivative settlements. Whether auction-discovered prices can assume a larger role in derivative settlements, experts said, will ultimately depend on how quickly liquidity in CAS deepens.