Closing auction session: Key features, how it may address higher end-of-day volatility

Currently, the closing price of stocks in the equity cash segment of the Stock Exchanges is determined based on the Volume Weighted Average Price (VWAP) of trades executed during the last thirty minutes of the Continuous Trading Session (CTS). Large institutional trades near the end can disproportionately skew prices. Volatility spikes during index rebalancing days and derivative expiry creates distortions for passive funds and arbitrage strategies.

SEBI received feedback from global passive funds that trade Indian Equities typically experienced significantly higher end of day price volatility than investors trading most other markets. Feedback was received that this can negatively impact the performance of mutual funds, passive funds and ETFs, as well as the investment returns and the experience of trading for retail investors. Since the Indian securities market ecosystem does not currently support execution at a single closing price, there was feedback that there is scope for index tracking differences amongst passive funds.

Research conducted by the regulator and a study of global practices in other major jurisdictions indicated that a Closing Auction session (CAS) provides a more stable and less volatile closing price compared to the volatility often observed under a Volume Weighted Average Price (VWAP) based closing price methodology, considering the following: • The closing price of stocks is determined through CAS in major global markets like US, Europe, Asia etc. 

• All categories of market participants, investors and traders get an equal opportunity to participate in the price discovery process in the closing auction.

• CAS aggregates market interest into a single pool of liquidity, thereby providing a fair and transparent closing price and improving the efficiency of execution for large orders

• The significance of a fair and transparent closing price, especially since it is used as the reference for settlement in derivatives, index computation, mutual fund net asset value (NAV) determination, etc.

• It ensures that the discovered closing price reflects the collective market consensus at the close of trading hours

• Facilitates passive funds to transact at the closing price of the stocks thereby reducing the tracking error.

Applicability  

Phase 1: Applicable only to stocks in the cash segment on which derivative contracts are available. It is envisaged that the regulator will take a phased approach and add more names in CAS in due course after the success of phase one. It is expected that more securities may be made eligible for CAS, or CAS might be made applicable to all securities in equity cash segment in future.

Continuous Trading for Non-CAS Securities: Session timings are 9:15 am to 3:30 pm.       Equity Derivatives Segment: Revised session timings will be 9:15 am to 3:40 pm.

Key Features

Reference Price: The reference price of a stock in CAS in the cash segment shall be determined based on the VWAP of the trades executed in the stock during the period 3:00 p.m. to 3:15 p.m.

Price Band: Price band applicable during CAS is +/- 3% from the reference price of the stock.  (Price band of ±3% around reference price is designed to curb excessive price movements during CAS, increasing stability of price formation at the end of the trading day.)

Order Types: Only limit orders and market orders are allowed. Stop loss orders and iceberg orders are not allowed in CAS.

Order Execution Priority

Priority 1: Market orders with Market orders (time priority)

Priority 2: Residual market orders with Limit orders (price time priority)

Priority 3: Remaining Limit orders with Limit orders (price time priority)

Determination of Equilibrium Price     1. The equilibrium price shall be determined based on the principle of demand supply mechanism.     2. The equilibrium price shall be the price at which the maximum volume is executable.     3. In case there is more than one price at which the maximum volume is executable, the equilibrium price shall be the price at which there is minimum order imbalance quantity (unmatched order quantity). The absolute value of the minimum order imbalance quantity is taken into consideration.     4. In case there is more than one price at which the maximum volume is executable, and they have same minimum order imbalance quantities, the equilibrium price shall be the price closest to the reference price.     5. In case there is more than one price at which the maximum volume is executable, same minimum order imbalance quantities and the reference price is the mid-value of pair of prices which are closest to it, then the reference price itself shall be taken as the equilibrium price.     6. Both limit and market orders shall be reckoned for the computation of equilibrium price.

Usage of Closing Prices Many ETFs, Index Funds, Mutual Funds, etc. use the closing prices to benchmark their portfolios and calculate Net Asset Values (NAVs). Hence it is an important price point for several institutional market participants. Perceived Role of Passive Funds

ETFs and Index Funds are structurally mandated to trade at the "closing price" to minimize tracking error, they create a predictable and massive pool of liquidity at the end of the day.

    • From “Price Chasers” to “Price Makers”: Under the old VWAP system, passive funds were forced to "chase" prices for 30 minutes. In the CAS, they become the core participants of the auction, helping to form the equilibrium price.

    • Systemic Importance: With Indian stocks gaining higher weights in global indices (MSCI, FTSE), it recognizes that a robust closing auction is essential to handle the multi-billion dollar "rebalancing flows" that occur on specific dates. How will CAS discovered close price align with F&O settlement, given equity derivatives will trade till 3:40 pm while CAS runs from 3:15 pm to 3:35 pm?

The implementation of the Closing Auction Session (CAS) creates a more robust and transparent settlement framework for the F&O segment. The primary benefit lies in the post-auction alignment window (typically 3:30 PM to 3:40 PM), which serves critical functions:

    • Price Convergence and Discovery: Once the CAS discovers the equilibrium price for the underlying cash stock at 3:30 PM, the subsequent 10 minutes of F&O trading allow the derivatives market to "price in" this information. This ensures that the basis (the difference between the spot and future price) converges towards zero as the contract nears expiry.

    • Market Stability: This structured sequence prevents the chaotic price swings during last minute often seen when both markets close simultaneously. It ensures that the final F&O settlement is based on a transparent, auction-derived cash price rather than 30 min VWAP.

All unexecuted limit orders of the CTS will be carried forward to CAS, except the following:     • Stop loss orders     • Iceberg orders     • Orders having prices beyond the price bands applicable in CAS.

Risk Management     1. Orders in CAS shall be subject to applicable margin requirement at order level, except for the limit orders carried forward from CTS to CAS.     2. Orders carried forward from CTS to CAS shall not be validated for margin sufficiency at order level. However, if such carried forward orders are modified during CAS, such modified orders shall be treated as orders received during CAS and shall be validated for margin sufficiency at order level.     3. All orders received in CAS (including carried forward CTS orders that are modified during CAS) shall be validated at the applicable margins for sufficiency of available capital prior to acceptance of the orders. If the available capital of a member is insufficient to cover the margin requirement of the order placed, the same shall not be accepted for CAS.

SEBI’s CAS framework attempts to address the anomaly of higher end-of-day volatility under VWAP. Due to CAS the arbitrageurs may face short-term disruptions but the long-term impact is greater transparency, reduction of manipulation, and global alignment—an absolutely  necessary evolution for India’s capital markets.

The author is an accomplished professional with 41 years of distinguished experience in the capital markets.