SEBI Unveils Strategic Plan: New Closing Auction Session for Liquid Derivative Stocks

In a significant move poised to reshape India's equity markets, the Securities and Exchange Board of India (SEBI) has unveiled a groundbreaking proposal: a dedicated 30-minute closing auction session for a select group of highly liquid stocks that also have derivative contracts. This forward-thinking framework, detailed in a comprehensive consultation paper, aims to significantly enhance price discovery, curb market volatility, and align Indian trading practices with leading global financial centers.

The proposed auction session, slated to run from 3:30 PM to 4:00 PM (or 4:00 PM to 4:30 PM for derivative-linked securities, pending the extension of the derivatives trading window), represents a strategic effort to ensure more robust and representative closing prices.

SEBI plans to kickstart this initiative with an initial roster of 25 scrips that exhibit both high liquidity and active derivative contracts, before potentially expanding its scope based on initial success and market feedback.

Under this new regime, market participants will be able to place both limit orders and market orders.

Importantly, all market orders will automatically be converted into limit orders at a predetermined reference price, ensuring orderly execution. To maintain market integrity and prevent undue price fluctuations, SEBI has introduced a two-tiered price collar mechanism: a dynamic ±5% band and a tighter fixed ±1% band around the calculated reference price.

This reference price will typically be the Volume Weighted Average Price (VWAP) of trades executed in the preceding 30 minutes, or a weighted average of the last few trades if trade volume is sparse.

The ultimate goal of this auction is to determine a fair and transparent settlement price. This will be achieved by calculating the VWAP of all trades executed during the 30-minute closing auction session, provided there's sufficient liquidity.

Should liquidity be inadequate, the reference price will serve as the settlement price, offering a fallback mechanism to ensure a consistent closing valuation.

SEBI's rationale behind this proposal is multi-faceted. Firstly, it seeks to improve the price discovery mechanism, particularly during the critical closing hours when significant trading volumes often occur.

By creating a structured auction environment, the regulator anticipates more accurate and less susceptible-to-manipulation closing prices. Secondly, it is expected to significantly reduce price volatility at market close, providing greater stability and predictability for investors. Thirdly, the framework is designed to facilitate the execution of larger orders, which often struggle to find immediate liquidity in a regular continuous trading session, especially as trading winds down.

This move is also a conscious step towards global harmonization.

Many developed markets already employ similar closing auction mechanisms, recognized for their efficacy in fostering efficient and transparent price formation. While India currently has closing sessions, they primarily cater to illiquid stocks, focusing on a different segment of the market. This new proposal for liquid derivative stocks mirrors the success of existing pre-open sessions, which have proven instrumental in setting fair opening prices based on aggregated demand and supply.

SEBI has invited public comments on this pivotal proposal until July 1, 2024.

This consultation period offers all stakeholders – including exchanges, brokers, institutional investors, and retail traders – an opportunity to provide valuable feedback, ensuring a well-rounded and effective implementation that benefits the entire Indian securities market.