By Vineet Kumar 
SEBI’s Proposal: How It Could Revolutionize the Way Indian Stocks Get Their Closing Prices
For decades, the closing price of a stock has been a vital reference point for investors, especially for passive funds. But now, the Securities and Exchange Board of India (SEBI) is proposing a game-changing shift in how Indian stocks get their closing prices. This move could transform the dynamics of stock trading, reducing tracking errors for passive funds and enhancing transparency in the market.
Let’s dive into the details.
How Are Closing Prices Determined in India?
If you think stock prices are solely determined by demand and supply, you’re not entirely wrong. The daily buying and selling activity dictates whether a stock moves up or down. However, the closing price in India isn’t directly based on these movements.
Currently, SEBI uses the Volume Weighted Average Price (VWAP) method to determine closing prices. Here’s how it works:
1. SEBI looks at the stock’s price movements during the last 30 minutes of the trading day.
2. It factors in the number of shares traded at each price point.
This means if most trades happen at ₹100, that price carries more weight than a few trades at ₹110. While VWAP works like an average, it isn’t perfect—especially for passive funds like index funds and ETFs, which replicate the performance of stock indices like NIFTY 50 or BSE SENSEX.
Why Is VWAP a Problem for Passive Funds?
Passive funds depend on the closing price to adjust their portfolios. If there’s even a small distortion in this price, it can lead to something called a tracking error, where the fund’s returns deviate from the index it tracks.
For instance, imagine a stock—let’s call it Hello Ltd.—mostly trades around ₹100 during the day. But just before the market closes, someone executes a massive trade at ₹110, pulling the VWAP-based closing price to ₹105. While the index considers Hello Ltd. at ₹110, the passive fund buys it at ₹105. This mismatch creates a gap in returns, frustrating investors.
This issue has become more pressing as passive funds in India now manage ₹11 lakh crores—a sixfold increase since 2020. Moreover, the growing weight of Indian stocks in global indices means last-minute distortions can ripple across international markets, amplifying tracking errors.
The Volatility Factor
VWAP-based calculations also struggle with market volatility, especially during:
1. Index rebalancing days: When indices add or remove stocks, trading activity surges in the last 30 minutes. For example, during an MSCI index update earlier this year, SEBI noticed that the volatility in NIFTY 50 stocks during the final 30 minutes was three times higher than the rest of the day.
2. Derivatives expiry days: Since derivatives derive their value from underlying stocks, unusual price movements can distort their value.
SEBI’s Proposed Solution: The Closing Auction Session (CAS)
SEBI wants to replace VWAP with a Closing Auction Session (CAS), a system already in use in markets like the US, UK, Japan, and South Korea.
Under CAS, once the regular trading session ends, an auction begins:
Buyers and sellers submit their price and quantity preferences.
The closing price is determined at the level where the maximum number of trades can occur—where demand matches supply.
This approach minimizes distortions, aligns prices with market sentiment, and reduces tracking errors for passive funds.
How CAS Works: An Example
Let’s revisit Hello Ltd.:
During a CAS, 300 buyers and sellers agree to trade Hello Ltd. at ₹101. That becomes the stock’s closing price—transparent, fair, and less prone to manipulation.
The Global Experience with CAS
While CAS offers many benefits, it’s not foolproof. Hong Kong introduced CAS in 2008 but suspended it within 10 months due to manipulation. For instance, a massive trade on HSBC stock caused its price to plummet 10% right before the market closed, only to rebound the next day.
When Hong Kong reintroduced CAS in 2016, they implemented safeguards, such as:
Limiting CAS to major index stocks.
Capping price movements at ±5% from the last traded price.
Rolling out the system in phases.
SEBI’s Rollout Plan
SEBI is likely to follow a phased approach, starting with stocks that have derivatives and high liquidity. This ensures the system applies only to actively traded stocks, making it more effective.
Challenges of CAS
Despite its advantages, CAS isn’t without challenges:
1. Complexity for Investors: VWAP is straightforward, while CAS requires investors to understand the auction mechanism.
2. Technological Demands: CAS requires robust systems to match orders quickly and accurately.
3. Extended Trading Hours: The additional auction session could increase operational costs for brokers and exchanges, a significant consideration for developing markets like India.
What’s Next?
SEBI’s proposal aims to enhance fairness, reduce tracking errors, and align India’s markets with global best practices. However, the success of CAS will depend on its implementation and whether investors and market participants embrace the change.
As the market evolves, one thing is certain—change is inevitable. And with SEBI at the helm, the Indian stock market is taking a step toward greater transparency and efficiency.
Stay tuned for more updates on this transformative move.
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