India’s closing auction needs funds to show up

On August 3, India introduced the closing auction session (CAS) mechanism, a market structure reform aligned with global standards. For stocks with derivatives, the final daily price is no longer calculated using a 30-min volume-weighted average. Instead, all orders placed between 3.20 pm and 3.30 pm are pooled, and a single closing price is established based on the point where the highest volume clears.

Closing auctions lower trading costs, sharpen price discovery, and make raising capital cheaper for companies. Key to making the mechanism effective, however, is broad participation, which is voluntary.

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A 2003 study, 'A Closing Call's Impact on Market Quality at Euronext Paris', found that execution costs decreased and price discovery improved following the introduction of a closing call in 1996 and 1998, primarily for mechanical reasons. In continuous trading, large orders cross the spread and walk the book, incurring progressively higher costs with each share. Conversely, during an auction, all orders clear at a single price.

But a 2005 study, 'Opening and Closing the Market: Evidence from the London Stock Exchange', found that after a closing call was introduced to its Stock Exchange Electronic Trading Service (SETS) order book in May 2000, even as auction improved price discovery relative to the dealer system, it struggled to clear smaller, less-liquid stocks. The study attributed this to the externality of a 'thick' market - an auction works only if participants expect others to be present. In 'thin' markets, traders avoid participating, fearing a lack of counterparties. The fault lies not in design but in lack of attendance.

India's data indicates that on MSCI rebalancing days, 73-83% of trading in impacted stocks takes place during the last half-hour. Volatility during these periods is 2x-over 3x than during rest of the day, and the difference between reference price and the close ranges from 61 to 404 bps. FPIs account for 56-60% of traded value, proprietary desks roughly 17%, retail investors around 11%, and domestic MFs 8-9%. Meanwhile, the industry most dependent on an accurate closing value appears to be acting as a bystander.

So, what specific actions can each type of fund perform within its legal framework?

Hedged funds - For starters, there are hedged categories, which held about ₹11.4 lakh cr as of June. An arbitrage fund is required to keep its equity exposure fully hedged. It must be long on stock in cash and short on the same stock in futures. This requirement enables it to sell into buy-heavy auctions. It owns the shares, and unwinding the hedge is its primary activity. This allows it to provide the sell side without shorting any stocks.

Now that the derivative window extends to 3.40 pm, and stock derivatives settle based on auction price, both legs of the transaction settle at a single price. Equity savings funds follow the same hedged approach.

Balanced advantage funds - These funds can adjust their equity exposure within a broad range on any given day. This flexibility allows them to respond to supply shortfalls in the auction by buying during a sell-heavy close and selling during a buy-heavy close, framing these actions as normal asset allocation, rather than opportunistic trading strategies.

Active equity funds - These funds don't require additional regulatory approvals for such moves. For example, a flexi- or multi-cap fund planning to reduce a position can place that order at market close instead of executing it gradually throughout the day. A cash-holding fund can do the same. Value, contrarian and dividend-yield funds have the strongest case for this approach, since buying what index funds are selling directly aligns with their core mandates.

The ceiling is equally real and serves as a firm regulatory limit. No domestic fund engages in naked short selling. During a cash auction, a fund can sell only what it can deliver, with capacity strictly capped by its own assets.

Specialised investment funds - As the only structures permitted to intentionally short, these funds are capped at 25% of their portfolio and were valued at around ₹17,858 cr in mid-2026. Stock lending remains limited, with only about 176 of the roughly 2,600 listed stocks eligible.

Passive funds - These funds typically hold almost no cash to facilitate purchases. However, Sebi has proposed allowing them to borrow overnight against auction positions.

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For funds, benefits are clear: executing large trades at transparent prices with minimal market disruption, the primary reason regulators favour auctions over block deals. This supports accurate evening net asset values (NAVs), while Sebi's push to expand auctions beyond derivative stocks will reward agile funds with broader liquidity.

Adopting global standards is meaningless without active participation. By mid-2025, passive capital reached ₹20.5 lakh cr for foreign investors (29% of their Indian equity holdings), and ₹9.18 lakh cr for domestic funds. Because passive money trades against closing prices, an efficient auction allows global allocators to size up India without penalising it for execution risk. We know what happens when an auction lacks turnout. Domestic funds can ensure that someone actually shows up.

Baid is dean, National Institute of Securities Markets, and Shunmugam is partner, MCQube