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Akanksha Sharan & Sarah Xaxa are students of Hidayatullah National Law University.
Introduction
On 5th December 2024, the Securities and Exchange Board of India (“SEBI”) proposed the Closing Auction Session (“CAS”) mechanism, which would determine the pricing of commodity by isolating market function for a limited period. The stock market would be allowed to function normally throughout the day, however in the final fifteen minutes slot of market day, participation would be halted to determine the price of a stock commodity. This new method would be replacing the Volume Weighed Average Price (“VWAP”), which calculated the price in consultation with the average of volume of commodity traded within the time slot of thirty minutes.
This transition within adopting different pricing mechanisms implies substantial change in market behaviour, price volatility and a long term shift in trading strategies. It also poses challenges and opportunities for India’s financial landscape. Consequently, the SEBI consultation paper warrants thorough analysis to unpack the potential ramifications of this paradigm shift.
The CAS mechanism, however, proposes Time Weighted Average Pricing (“TWAP”) as a remedy. By considering multiple time slots, TWAP aims to neutralize trade tension and mitigate undue influence during capital periods of market activity.
Through this article, the authors would be critically analysing the contraption of the two price determination mechanisms, the VWAP and the CAS, with an aim to decode potential implications of the policy along-with probable shortcomings in the proposal. We would also assess the various factors regarding market forces, price determination, stock indices, marketability and liquidity of commodity and the future notion of SEBI’s policy.
Cracking the Code: Understanding VWAP and the Current Closing Price Mechanism
To contextualise the discussion, VWAP is calculated by evaluating the total price of each commodity (stock) traded, multiplying it with the volume of commodity traded then finally dividing it by the total volume of commodities traded in a market day. While VWAP focuses on a limited degree of variables which promote the market utility of passive funds. The process of calculating VWAP is followed in a closed-loop thirty minute slot. On the basis of the price and volume of stocks traded in the day, price would be accordingly determined.
The use of cumulative algorithm and specific time slot invites multiple intricacies. As final price is determined in the specific time slot, any behaviour in final hour, whether direct or indirect, would ultimately affect the final price. It becomes convenient to induce market volatility and price manipulation by deviant factors to gain unfair dues. Price is also influenced by the volume of stocks trade, any variation in this would directly impact price determination.
Rethinking Closing Price Determination: Addressing SEBI’s Proposal with Market Innovations
The SEBI now recommends fundamental changes to closing price mechanisms because they want to tackle price manipulation and excessive volatility along with existing framework weaknesses. The existing VWAP mechanism operating in the final 30 minutes of trading faces extensive criticism because it enables manipulative practices particularly in stocks with low trading float. The changes introduced by SEBI through TWAP methodology together with extended auction time horizons are designed to create an efficient and trustworthy price discovery system.
The proposed restructuring of closing auctions by SEBI includes the implementation of a CAS to improve the mechanism. An isolated closing auction session at market conclusion determines prices by keeping high-frequency trades and speculative market behavior away from the decision process. SEBI intends to achieve fair market condition-based closing prices through TWAP because this method suppresses unpredictable price movements.
The proposed CAS framework will modify different legal regulations and capital market governance rules that operate in India. Modifications to the SEBI (Stock Exchanges and Clearing Corporations) Regulations, 2018 need to be made because they outline how stock exchanges operate and their duty to protect fair trade practices. The SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 will enhance its surveillance systems to track price irregularities that occur in the closing auction period.
The main aspect of SEBI’s modernisation includes distinct auction methods for different stock types. Large-cap stocks will use a continuous auction system with algorithmic approval yet stocks with reduced liquidity might require a two-phase auction process to protect market prices. The auction model matches international standards observed at the Hong Kong Stock Exchange and the Tokyo Stock Exchange through their successful implementation of custom auction sessions for market distortion control.
To implement the new price discovery mechanisms SEBI needs to review and modify the SEBI (Market Infrastructure Institutions) Regulations, 2021 so clearing corporations can adapt to the changes. The revised methodology for price discovery requires institutional investors together with mutual funds and alternative investment funds to adjust their Net Asset Value (“NAV”) calculation methods which affects SEBI (Mutual Funds) Regulations 1996 and SEBI (Alternative Investment Funds) Regulations 2012.
SEBI plans to strengthen its surveillance system by implementing real-time monitoring capabilities for tracking trading activities within the auction period. Recent market surveillance methods replicate NASDAQ’s SMARTS Surveillance System that observes behavioral abnormalities across markets for regulatory compliance purposes. The implementation of advanced surveillance systems brings two main benefits by making markets more secure and keeping retail investors together with institutions protected from illegal operations.
SEBI works to improve market stability while increasing market price transparency through regulatory adjustments that will harmonize Indian securities markets with international standards. These reforms advance India’s financial structure by protecting investor trust and boosting confidence while defending the closing price process against market manipulation and speculation.
Lessons from Global Exchanges: What India Can Learn
Understanding the implications of India’s proposed auctioning mechanism requires a comparative analysis of its application in other countries.
The Hong Kong Stock Exchange (“HKSE”) introduced the CAS in 2008, but it was discontinued within ten months due to concerns highlighted by the research committee, including extreme price fluctuations and market manipulation. A decade later, in 2018, the HKSE cautiously reintroduced CAS with additional safeguards to address these issues. The revamped mechanism included a nine-minute auction period, which ended at a random minute to mitigate market volatility. There were also petitions to include a lower price bar, to effectively prevent any possibility of external manipulation. By anticipating potential risks, the HKSE aimed to fortify its economy against market failures.
The New York Stock Exchange (“NYSE”), on the other hand, had adopted the CAS in later 1990’s prioritizing global competitiveness and technological integration. Unlike HKSE’s risk-averse approach, NYSE took a revolutionary stance by implementing an automated version of CAS. Overtime, the NYSE introduced innovations features like the Closing Imbalance Data, which provides insights into stock behavior over the last three months. This data-driven approach has facilitated more informed decision-making and plans for extended auction periods to further refine price determination.
Both NYSE and HKSE demonstrate distinct strategies in adopting CAS. While NYSE embraces a forward-thinking, technology-driven model, the HKSE adopts a more cautious, risk-mitigating approach. Despite their differences, both exchanges have meticulously structured their auction periods to prevent significant economic losses. However, even with these safeguards, global markets remain vulnerable to systemic shocks – a minor ‘sniffle’ by the trade giants can potentially result in the global economies ‘catching a cold’.
Question arises on how can one efficiently bring about SEBI’s proposal. By evaluating the NYSE and HKES, we are handed with two possible models which can be applied in the Indian markets. To undertake this objective, we can take into consideration the nature of economic history and practices in both example markets and employ the model which holds a substantial degree of similarity of circumstance.
In experience, both economies hold different economic ideals, America follows a capitalist centric market, while China focuses on a socialist market structure. As India features a mixed economy with an emphasis on public welfare, it becomes imperative that the market dynamics in India would be somewhat identical to the Hong Kong model. Both share demographic as well as socio-cultural similarities which also indicate an interchangeable attitude towards performances in the stock exchange.
Can CAS Solve Market Volatility? Navigating Risks and Rewards
Firstly, the destabilized market issue poses a significant challenge. While CAS effectively curbs all active trading during its designed time slot, this period leaves the market highly vulnerable to value loss and instability. Such predictability can result in mass economic failures and destabilized economies.
Instead of relying solely on end-of-day calculations, a more comprehensive method involving multiple time slots to evaluate investment cycles based on aggregate volume could provide a balanced solution. A hybrid approach that incorporates both VWAP and CAS principles would lay a stronger foundation for this mechanism.
Secondly, market imbalance remains a critical concern. By providing a limited time slot at the end of the trading day, CAS leaves ample room for price fluctuations. Investors, understanding that prices are determined within this specific window, can strategically influence outcomes by inducing or withholding investments. Such manipulative practices undermine confidence and create unrest in the market.
To address this, India could adopt the Auction Imbalance Analysis Mechanism used by the NYSE, which enables investors to elevate imbalance data and make more informed decision based on opportunity costs.
Thirdly, the change in investment behaviour induced by CAS necessitates attention. India’s market traditionally leans toward active fund investments, but SEBI’s proposal suggests a shift towards passive funds. While such a change could stabilize the market in some respects, it may also exacerbate imbalances if not carefully managed. Policymakers must endure that this transition necessarily align with India’s unique market dynamics to avoid unintended consequences.
Lastly, the lack of Infrastructure presents a significant hurdle for CAS implementation in India. The success of CAS is the U.S. relied on advanced and automated commercial infrastructure, a standard India has yet to achieve. Adequate investments in technology, infrastructure, and regulatory frameworks are essential for India to replicate this model effectively. Bridging these gaps will be instrumental in ensuring robust oversight and the successful rollout of CAS.
Concluding Remarks: India’s Step Towards Transparency
SEBI’s proposed CAS marks a major advancement in the way India’s stock market calculates closing prices. SEBI has initiated a shift from VWAP to TWAP pricing because this new approach aims to stop price manipulation and reduce market volatility while ensuring stability.
SEBI advances India’s financial market modernization through implementing advanced technologies which include AI-driven price discovery and blockchain-based transparency and hybrid auction models. Through real-time data analysis AI generates accurate price predictions but blockchain technology ensures both risk reduction through data protection and data transparency. Hybrid auction systems which adapt to stock category behaviors offer a modern approach toward correcting market unbalance conditions.
The implemented reforms establish India as a global market regulation leader through adoption of international standards. The implemented reforms combine existing market efficiency improvements with fair practices and sustainable operations alongside investors trust strengthening. Real-time surveillance combined with ESG-focused liquidity adjustments will allow SEBI to build a robust transparent sustainable market environment.
SEBI’s ongoing initiatives create opportunities for India’s securities market to establish global leadership benchmarks while enhancing its financial standing and ensuring its ability to face future challenges through innovative resilience.
