The market regulator has proposed the introduction of a Close Auction Session (CAS) in India as a call-auction mechanism for determining closing price of each stock in equity cash segment, replacing the Volume Weighted Average Price (VWAP) mechanism used today. To begin with, CAS will be applicable to stocks on which derivatives are available.
Some of the major passive funds tracking international indices have suggested the need to introduce this mechanism to reduce tracking error. Globally, major jurisdictions around the world have a closing auction mechanism.
Currently, the closing price of stocks in India is determined through VWAP which weighs the prices of a security during the last thirty minutes of the trading day, by the volume executed at each price. While this facilitates determination of a fair market closing price based on trading interest in stocks spread through the last half an hour of the trading day, it does not enable the interested buyers and sellers to trade exactly at the close price of the day.
Price volatility
“The current closing price mechanism can result in significant price volatility across a range of stocks, as well as high risk of large orders not being completed, which in turn adds to the tracking difference of a passive fund. The said issue is particularly significant during large event days, such as, on index rebalancing days and derivative expiry days,” the consultation paper said.
For instance, the tracking error of an international passive fund, tracking difference on index rebalancing days, in respect of orders for Indian stocks aggregated across major global indices, averaged at -3.29 bps. This was substantially higher than the average value of -0.19 bps across all other days in the said period.
The AUM of domestic passive funds in India has grown to about ₹11 lakh crore. The weightage of Indian stocks in major international indices has grown too.
Implementation
CAS may be implemented as a separate session of 15 minutes from 15:30 - 15:45 pm. Limit orders and Market orders shall be allowed during CAS. Both shall be reckoned for computation of equilibrium price.
After the discovery of closing price in CAS, order matching would start. At the time of order execution, limit orders shall be given priority over market orders.
Pointers
Call-auction mechanism to replace volume weighted average price method used today
This will help reduce tracking error of passive funds
Such errors can magnify during index rebalancing and derivative expiry days
AUM of domestic passive funds has grown to ₹11 lakh crore.