SEBI has also restored continuous trading in the cash market until 3:30 p.m., shortened the closing-auction window from 20 minutes to 10 minutes and retained the auction for determining official closing prices of stocks in the derivatives segment.
The changes represent a significant adjustment to the framework introduced in August, after its initial implementation highlighted challenges in ensuring adequate liquidity and stable price discovery. SEBI had begun reviewing the derivatives settlement methodology in September.
What changes has SEBI introduced?
From December 7, settlement prices for expiring index and single-stock derivatives will be calculated using the VWAP of trades executed during the last 30 minutes of the continuous trading session.
This reverses the linkage between derivatives settlement and the closing-auction price. Consequently, price fluctuations during the auction will no longer directly determine the settlement value of expiring futures and options contracts.
The regulator has also restored the earlier cash-market trading schedule, under which continuous trading runs until 3:30 pm. The closing auction will subsequently operate for 10 minutes, ending at 3:40 pm, while stock derivatives trading will continue until 3:45 pm, including on expiry days.
What is a closing-auction system?
A closing auction is a mechanism through which an exchange determines a stock’s official closing price by collecting buy and sell orders and identifying a price at which the maximum possible trading volume can be executed.
Closing prices serve as important benchmarks across financial markets. They influence index calculations, exchange-traded fund valuations, mutual fund portfolios, derivatives settlements and the measurement of investment performance.
Before August 3, stocks traded continuously on Indian exchanges from 9:15 a.m. to 3:30 p.m. The official closing price was calculated using the VWAP of trades executed during the final 30 minutes of the session.
Under the revised framework introduced in August, eligible stocks in the derivatives segment moved to a closing auction after continuous trading ended. During this period, exchanges collected buy and sell orders before determining an equilibrium price based on the maximum executable volume. This price became the stock’s official closing price.
Stocks outside the derivatives segment continued to follow the earlier closing-price calculation methodology.
What are the revised trading timings?
The latest changes restore continuous cash-market trading until 3:30 pm while retaining the closing auction for determining official closing prices of stocks in the derivatives segment.
The revised schedule is as follows:
- Cash-market continuous trading: 9:15 a.m. to 3:30 p.m.
- Closing auction: 3:30 p.m. to 3:40 p.m.
- Stock derivatives trading: Until 3:45 p.m.
The closing-auction window has been reduced from 20 minutes to 10 minutes. However, the auction will continue to determine the official closing prices of eligible stocks.
Why is SEBI revising the closing-auction framework?
The initial rollout exposed concerns over inadequate liquidity and sharp price movements during the auction window.
Except on days involving major index rebalancing, trading volumes in the auction have remained substantially lower than those typically recorded towards the end of the continuous trading session.
Thin liquidity can amplify price movements when relatively large orders enter the market. It can also make it more difficult for arbitrageurs to maintain alignment between cash-market prices and derivatives prices.
By separating derivatives settlement from the auction, SEBI aims to limit the impact of such price fluctuations on expiring futures and options contracts. Under the revised framework, a sharp movement in the closing auction will no longer directly determine the settlement price of these contracts.
The changes are intended to reduce the risks associated with the initial implementation without abandoning the closing auction altogether.
Why did SEBI introduce closing auctions in the first place?
The closing-auction mechanism was designed to improve end-of-day price discovery by bringing buy and sell orders together at a single point in time.
Unlike continuous trading, where prices can be influenced by individual transactions, an auction aggregates orders to establish a single equilibrium price. This can help exchanges determine more representative closing prices, particularly when institutional investors execute large trades.
The mechanism is widely used by major international exchanges and can help passive investment funds, including index-tracking funds and exchange-traded funds, minimise tracking errors when adjusting their portfolios to benchmark closing prices.
SEBI first proposed the mechanism in 2024 after passive investment funds highlighted the potential benefits of closing auctions in reducing tracking errors and improving the efficiency of end-of-day price discovery.
Why has the new framework faced challenges?
India’s closing-auction mechanism has encountered a liquidity problem that could take time to resolve.
Institutional investors may be reluctant to place large orders in the auction because limited participation can lead to sharp price fluctuations. However, their reluctance to participate also prevents the auction from building the depth needed for more stable price discovery.
Trading on the National Stock Exchange’s closing auction has averaged around ?29 billion since its introduction, remaining below 1% of the market’s total daily turnover on all but three days associated with index rebalancing.
Market participants have also pointed to structural constraints that could limit the auction’s effectiveness.
One such constraint is the relatively shallow securities-lending market. Limited access to securities for short-selling can restrict arbitrageurs’ ability to respond when cash-market prices diverge from related instruments during the auction.
Liquidity is also split between the separate closing auctions conducted by the National Stock Exchange and the BSE. This fragmentation may make it more difficult for either exchange to build the depth required for efficient price discovery.
As a result, adopting a mechanism used by developed markets has not automatically delivered similar outcomes in India, where market structure and liquidity conditions differ.
Will the latest changes resolve the problems?
The revised framework should address some of the immediate risks, although it is unlikely to resolve the underlying liquidity constraints on its own.
Restoring the 30-minute VWAP methodology for derivatives settlement removes the direct influence of closing-auction price movements on the settlement of expiring futures and options. This should reduce the risk of thinly traded auctions triggering disproportionate changes in derivatives settlement values.
Restoring continuous cash-market trading until 3:30 p.m. also brings the cash-market schedule back to its earlier structure. Meanwhile, cutting the auction window to 10 minutes shortens the period during which the official closing price is determined through a separate mechanism.
However, the long-term success of the closing auction will depend on whether institutional investors, arbitrageurs and other liquidity providers become more comfortable participating in the process.
Without a meaningful increase in trading volumes and market depth, the auction could continue to face challenges in delivering stable and representative closing prices.
Have other markets experienced similar issues?
Closing auctions are widely used across developed equity markets and often account for a significant share of daily trading activity. However, they are not immune to volatility, particularly during periods of heightened uncertainty or when large portfolio adjustments take place.
Markets such as Australia have also experienced sharp price movements around closing auctions.
Despite these challenges, closing auctions have become an important source of liquidity in major global equity markets. Norges Bank Investment Management noted in a 2020 paper that well-designed auctions can attract natural liquidity and support efficient end-of-day price discovery.
The share of trading conducted through closing auctions has also increased substantially in major European and US markets.
For India, the challenge is to develop the liquidity, participation and supporting market infrastructure needed to make the mechanism work effectively. SEBI’s latest changes seek to address immediate concerns while retaining the broader objective of improving closing-price discovery.
Disclaimer: Business Today provides stock market news for informational purposes only and should not be construed as investment advice. Readers are encouraged to consult with a qualified financial advisor before making any investment decisions.