SEBI said to ease arbitrage fund rules to aid closing auctions

India’s market regulator has given arbitrage mutual funds more flexibility in managing their positions, according to people familiar with the matter, seeking to draw a key source of liquidity into the struggling closing auction for stocks.

The Securities and Exchange Board of India has allowed these funds to temporarily carry unhedged positions of as much as 1% of their plans, said the people, who asked not to be identified because the details aren’t public. Arbitrage funds held a combined 3 trillion rupees ($31 billion) in assets at the end of August.

The relaxation is aimed at bringing liquidity into an auction that has struggled to attract enough players since its launch on Aug. 3. Arbitrage funds profit from price differences between the cash equities and futures markets, but requirements that they remain fully hedged have made it difficult for them to participate in the auction process.


Under the previous system, price swings in the final 30 minutes could create temporary gaps between cash shares and futures, giving arbitrage desks time to step in and close them.

The auction has shortened that window and increased the risk of a temporary mismatch. A fund may sell futures expecting to buy an equal amount of shares in the auction, only to find too few sellers in the cash market. The new 1% allowance lets funds carry that mismatch instead of staying fully hedged at all times.

The move adds to regulators’ efforts to tackle one of the auction’s biggest challenges: a lack of liquidity. Several institutional investors have largely stayed away, citing thin volumes that aggravate price moves and make it harder to set stable end-of-day prices. SEBI on Saturday also proposed sweeping changes to the closing auction framework, including a possible return to the previous method for settling derivatives on expiry days, after concerns emerged over sharp price swings.

Representatives for SEBI and the Association of Mutual Funds in India, an industry trade body, didn’t respond to emails seeking comment.

AMFI communicated the relaxation to asset management companies earlier this month, the people said. Funds seeking to use the allowance may need to communicate the change to unitholders, they said.