Summary:
SEBI has temporarily allowed arbitrage funds to hold up to 1% unhedged positions to increase participation in the Closing Auction Session. The move aims to improve CAS liquidity, strengthen closing price discovery and encourage greater institutional participation in the mechanism.
The Securities and Exchange Board of India (SEBI) has temporarily permitted arbitrage funds to hold up to 1% unhedged position in their assets under management (AUM) to participate more in the closing auction session (CAS).
The regulator said the temporary relaxation would facilitate higher level of participation and enhance liquidity in the closing auction session.
Arbitrage funds can hold up to 1% unhedged exposure under AUM and participate in the closing auction mechanism, Sebi said.
The closing auction mechanism sets the final price of a stock or index on the basis of trading activity during a given time period. It plays a crucial role in deciding the prices of indices as well as stocks as large institutional players use closing prices for fund valuation and portfolio rebalancing purposes.
Why SEBI Introduced The Change
Prior to the introduction of the new closing price discovery mechanism, the closing price of a stock or index was determined on the basis of 30-minute volume-weighted average price (VWAP) of that scrip.
According to the new closing price discovery mechanism, the closing price of a stock or index is determined through a call auction process during the last 30 minutes of the trading session.
The auction process takes place between 3:00 pm and 3:30 pm with the equilibrium price being discovered between 3:00 pm and 3:15 pm. The trading resumes at 3:15 pm until 3:30 pm but the discovered price remains unchanged during this period.
The regulator had introduced the closing auction system (CAS) to discover a more realistic closing price of a stock or index through a more transparent auction process.
However, the response to the new system remained muted with lower level of participation from market players on its first day of implementation August 31.
Encouraging Higher Level Of Participation
The closing auction system witnessed consistent participation on day two of its launch (September 2) but the level of trading activity remained lower than normal.
The turnover through the closing auction system shot up 37.2% to ₹1,751.46 crore on September 2 from ₹1,271.06 crore on August 31 with about 2.1 lakh investors participating on the day.
However, the market activity through the new closing auction system witnessed a decline of 26% on September 1 (₹927.40 crore) after registering a turnover of ₹1,246.40 crore on August 31.
On the other hand, the number of trades executed through the new system declined 24.3% to 2.5 lakh on August 31 from 3.3 lakh on August 30.
The trading activity improved on September 2 with the number of trades rising 9.6% to 3.1 lakh from 2.8 lakh on September 1.
Impact On Market Participants
The relaxation announced by Sebi would give arbitrage funds higher flexibility to participate in the new closing auction system. Arbitrage funds usually take offsetting positions in different markets and this relaxation would enable them to take small unhedged positions.
Market participants feel the regulator has taken a right step by introducing the closing auction system and relaxing the 1% unhedged position norm for arbitrage funds. The revised trading mechanism would help improve liquidity and efficiency of the closing auction session.
What Investors Should Watch Ahead
The participation level from various market players including arbitrage funds will determine the future of the new closing auction mechanism. It is important for institutional players and arbitrage funds to participate more in the closing auction session to discover a fair closing price of a stock or index.
Sebi’s recent step shows its commitment to promoting a more realistic closing price discovery mechanism as well as efficient functioning of the stock market in general.
