SEBI Suggested New Mechanisms For the Closing Price of a Stock

The Securities and Exchange Board of India (SEBI) has proposed a shift in the method used to determine the closing price of a stock. Currently, the volume-weighted average price (VWAP) is employed, but SEBI is considering replacing this with a Close-Auction Session (CAS), a practice commonly used in international markets. The shift comes in response to concerns that passive investors, who rely on index tracking, may face higher tracking errors, particularly during volatile event days.

Concerns over the Current VWAP System

SEBI’s proposal comes amid increasing concerns about the current VWAP-based system, which determines the closing price by averaging the prices during the last 30 minutes of trading, weighted by the volume at each price point. With the growing trend of passive investing, particularly in index funds, the regulator is worried that any large price movements during volatile events—such as index rebalancing or derivative expiry—could create significant price disparities. These disparities may harm passive fund performance, as large orders may not be completed, leading to increased tracking errors.

Details of the Close-Auction Session (CAS)

Under the proposed CAS model, a separate 15-minute auction period would be introduced between 15:30 and 15:45 to determine the closing price of a stock. During this call auction session, buyers and sellers submit their bid and ask prices, which are then used to calculate an equilibrium price, becoming the official closing price for the stock. This method aims to reduce volatility and prevent the issues caused by large orders that go unexecuted in the current system.

International Practices and Their Relevance

SEBI’s proposal is influenced by international best practices, where call auctions are commonly used to determine closing prices. Such mechanisms are considered more efficient in ensuring price stability during periods of high volatility. With passive investing becoming more prevalent, adopting this mechanism is seen as a way to minimise potential disruptions caused by significant market events.

Phased Implementation of CAS

The regulator has suggested that CAS be implemented in a phased manner, initially targeting stocks that have derivatives available. This would help ensure that the system is first applied to stocks with sufficient liquidity, minimizing risks associated with less liquid stocks. This gradual implementation will allow for careful monitoring and adjustments if necessary.

Proposed Four-Stage Implementation Process

The consultation paper outlines a four-stage process for implementing CAS:

1. Reference Price Determination Period: A phase to establish a reference price for the auction.
2. Order Input Period: Investors will submit their buy and sell orders during this phase.
3. No Cancellation Period: Once orders are submitted, no cancellations will be allowed to prevent market manipulation or instability.
4. Trade Confirmation and Order Matching: The final stage will involve confirming the trade and matching orders to set the closing price.

Conclusion

SEBI’s proposal to shift from the VWAP system to a Close-Auction Session for determining the closing prices of stocks represents a step towards improving market efficiency and reducing volatility, especially on event days. The phased implementation plan aims to test the system on highly liquid stocks, ensuring that the transition is smooth and well-monitored.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.