Closing auction gets off to a rocky start, but India’s markets will adapt

As elsewhere, passive funds are becoming more predominant in India. Over 20% of domestic MF assets under management (AUM) and 30% of FPI AUM are estimated to now be contributed by passives (index and ETFs). In the US, they are already at 55%, and their share is growing.

For passive investors who benchmark themselves to the official closing price, the absence of a closing auction resulted in tracking error and execution challenges. Closing auction session (CAS) is an important parameter in most benchmarks, and almost every major market has one. So, questions on the transition to CAS are not a question of ‘if’ but ‘how’.

The initial days since its implementation on August 3 have been disruptive. Auction prices cleared 0.5-1% away from the continuous market. Participation rates and volumes around the closing have dropped, with only 50,000 client codes participating in CAS on the first day compared with a 1.2 mn daily average. CAS volumes were only 2% of daily turnover compared with around 10% in the final 30 mins under the volume-weighted average price (VWAP), and 10-15% under CAS in mature markets. Volumes and participation have since seen a pick-up.


Last week, Sebi stated that it had ‘not observed any manipulation’. It attributed the divergence between the Sensex and Nifty to early-day circumspection. In this thin environment, a single ‘market-on-close’ (MOC) order from a passive fund can move the needle disproportionately because the ‘other side’ — arbitrageurs, proprietary desks and active MFs — has not fully shown up yet. This is not a failure of the auction. It’s an invitation for arbitrage that hasn’t been accepted yet.

If buyers are willing to pay a premium at the close to avoid tracking error, sellers should naturally emerge to capture that spread. That this hasn’t happened yet suggests that the plumbing — specifically broker interfaces and the visibility of ‘indicative equilibrium prices’ as well as order imbalances — needs urgent attention. Arbitrageurs will not be willing to take on basis risk in the dark.

Sebi’s December 2024 consultation paper received sharply divergent responses and led to multiple rounds of meetings of various stakeholders with the regulator. This was followed by a second consultation paper in August 2025 incorporating the feedback. The exchanges also held mock trading before implementation.

But any market reform has a learning curve and calls for a change in trading behaviour. In any new market mechanism, participants (especially retail traders and smaller brokers) take time to adapt. Even institutional players need time to recalibrate.

The existing market structure naturally created trading and business opportunities for arbitrage funds and traders around the closing VWAP. The new market design presents changed opportunities that they can leverage instead. Algorithmswill eventually be rewritten, and the ‘MOC’ culture will seep into domestic funds. Areas that need to be addressed are the low auction participation levels we have seen initially. This is something everyone should work to improve, because liquidity is fundamental to the success of any auction.

The auction window of 3.15-3.30 pm only partially overlaps with derivatives trading, which runs until 3.40 pm, and for a period the derivatives market is blind to cash market prices. This creates basis gaps between cash and futures markets, which are keeping some players away. The timing gap created by derivatives trading being open till 3.40 pm needs to be critically examined.

Sebi needs to facilitate the participation of domestic arbitrage funds in the derivatives market during CAS timings by ensuring adequate disclosure of order imbalances and reference prices. Brokers have, since the first day, improved disclosure of order imbalances to their clients.

Persistent price differences should also not exist between the continuous market and CAS. Cash and derivatives are economically linked, and calls to exclude derivatives settlement from the CAS closing price are unwarranted. If derivatives settle using the cash closing price, then that settlement price should itself be as robust and transparent as possible, particularly given the fact that open interest in options on expiry day is several times that of the cash market.

Even under VWAP, the system was vulnerable to manipulation via ‘bang-the-close’ tactics, where large players could distort prices in the final minutes to benefit derivatives positions or MF NAVs. There had been some discomfort among market participants with market activity at the close (even with VWAP) on certain expiry days and on some rebalancing days. There have been murmurs that some closings were either unnaturally less volatile or too volatile.

Even as Sebi followed a consultative process, in hindsight, implementation could have had a phased rollout, starting with Nifty 50 rather than all 200+ F&O stocks. This would have prevented the ‘index aberration’ that saw the Nifty and Sensex trade as if they were in different markets.

Any new system takes time to settle. Changes often alter existing business models and initially create uncertainty. History, however, also shows that more efficient, transparent and trusted markets ultimately attract more participants, deepen liquidity and expand the overall market.