The story so far: Market regulator, the Securities and Exchange Board of India (SEBI), has taken a well-calibrated step to introduce the Closing Auction Session (CAS) in the equity cash market, aiming for fair valuation, improved depth and statistical reliability of price discovery.

From an econometrics angle, it is an attempt to reduce price noise and improve the information efficiency of Indian equity markets, given that exchange-traded funds (ETFs) and index funds increasingly rely on accurate closing prices to replicate benchmarks.

CAS, introduced on August 3, is a transparent mechanism that relies more on closing auctions than on last traded prices or VWAP (Volume Weighted Average Price), implying that it converts closing price determination from passive averaging into a dynamic demand-supply discovery.

With this move by SEBI, both the National Stock Exchange and the Bombay Stock Exchange have joined major global bourses like NASDAQ, NYSE, London Stock Exchange, Euronext, Hong Kong Stock Exchange, Singapore Stock Exchange, Tokyo Stock Exchange and Australian Securities Exchange.

By making India’s market closing prices more realistic and aligned with international market practices, CAS can potentially improve inflows into Indian equities, especially from institutional investors, even as the impact depends on their chemistry — whether passive (ETFs/index funds) or active funds.

CAS — an official 20-minute auction (3:15 – 3:35 p.m.) that transparently locks in a single closing price — has been gaining popularity since its launch on August 3, initially starting with stocks having futures and options contracts. As SEBI chairman Ruhin Kanta Pandey said, mutual funds’ participation rate in CAS has drastically risen to 25% compared to 5-7% earlier.

In capital markets, the closing price of a security is not merely a number; rather, it is a reference for portfolio valuation, index computation, derivative settlement, mutual fund net asset value calculation and institutional investments; hence, it should reflect the expectations of both sellers and buyers.

The earlier system saw bourses determine the closing price largely through the VWAP of trades in the last 30 minutes of continuous trading, but a few large last-minute trades could disproportionately affect the final average price, creating possibilities of price distortion, especially during large events such as index rebalancing days and derivative expiry days.

It was observed that for NIFTY 50 stocks, the volatility during the last half-hour was higher than the observed volatility for the trading period from 09:15 to 14:30 by 1.8 times and 1.5 times, respectively, on MSCI and FTSE index rebalancing days in 2024.

So, instead of relying only on trades executed before market closure, the system collects buy and sell orders from market participants during the closing auction window. These orders are then matched at an equilibrium price — the price at which the maximum number of shares can be traded.

In contrast to continuous trading, where bids and offers can match instantly, an auction can only result in a trade after it is ended by the exchange. This difference allows more time for supply and demand to find a new equilibrium.

Closing auctions were initially put in place to achieve efficient price discovery, and now they have become increasingly popular as a liquidity event, with volume shares of closing auctions increasing across both Europe and America.

Key differentiator

A key differentiating indicator of CAS is order imbalance — the gap between cumulative buy and sell quantity at different price levels. If the imbalance is low, the discovered price is likely to represent a more stable consensus.

Perceived growth of sophisticated execution algorithms that analyse order imbalance, liquidity patterns and equilibrium prices can potentially make Indian markets evolve towards more institutional-quality trading practices.

Execution efficiency

The auction mechanism allows, especially large investors, to participate anonymously to execute deals at a commonly discovered price, which not only reduces information leakage and improves market confidence but could also reduce the price impact that usually comes with large orders close to market closing time.

Foreign investors managing billions of dollars often prefer markets with predictable closing mechanisms, which CAS can ensure.

Overarching concerns

CAS might face several practical challenges during implementation, especially given that cash market closing prices are determined through CAS, while derivative markets continue to operate separately, creating a temporary gap, particularly around expiry days.

Institutional traders and algorithmic firms may need to rethink strategies, based on traditional VWAP-based closing patterns. Trading models will need to factor in auction imbalances, indicative prices, and real-time order-flows.

Market participants had raised concerns over the sharp difference between index levels before the CAS and the levels recorded after the auction session on the first two trading days, even as SEBI ruled out any foul play.

For many retail investors, the closing price has traditionally meant the last traded price or a value calculated using VWAP. Since this is a new concept, some investors — especially intraday traders and derivatives market participants—may initially find it confusing.

Acknowledging that the industry requires time to grasp the structural reform; SEBI had said “our problem is that there is a lack of understanding because historically algos and other players have based their models on the old mechanism.”

The efficiency of CAS depends on the sufficient order participation. In less liquid securities, limited buy and sell orders may result in a closing price that does not fully represent broader market sentiment.

Equity derivatives continue trading beyond CAS window, temporarily leading to mismatches between spot and futures prices, potentially creating challenges for arbitrage traders.

Case for CAS

India’s passive funds, which have expanded from a relatively small base to multi-crore assets under management, driven by ETFs and index funds, are likely to be the biggest beneficiaries initially.

A well-functioning CAS can make closing price a stronger valuation benchmark by incorporating bid spread, order imbalance, liquidity and investor conviction.

A move towards smarter, transparent and market-driven valuation has already begun, the pace of which hinges on liquidity, participation and regulatory vigilance.

CAS should be evaluated not by short-term volatility but by measurable improvements in market quality — lower tracking errors, reduced closing-price variance, narrower spreads, improved liquidity and stronger price efficiency.