The stock market in India is set to undergo a huge structural transformation in the near future as the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) launch the Closing Auction Session for futures and options-weighted stocks. Set to launch on Monday, August 3, it will help to improve the accuracy, reliability and fairness of closing prices. But Zerodha co-founder and chief executive officer Nithin Kamath has cautioned that the regulatory transition could be a challenge to market participants, investors and retail brokerages.
In his view from digital platforms, Kamath suggested that the new market structure is likely to have little financial impact on brokerage firms in the industry and Zerodha will see revenue growth of just one to five percent, which he believed. Retail investors may also be confused about the new trading hours and execution mechanics and will have to be worried about customer support questions because of this, he said, which could be a big shock with the new approach since the market will become a bit different.
The Closing Auction session is a window of auctioning after trading ends for securities with active derivative contracts. Instead of a single closing price being calculated in the open market, the new system pools all the buy and sell orders in the auction period and matches them for the same price. Kamath observed that this is a well-established process internationally and noted that major global institutions like the New York Stock Exchange and London Stock Exchange already employ similar auction models to calculate closing prices.
In India’s current system, the closing price for an equity is always based on the volume weighted average price of all trades performed in the last half hour of a regular trading session. In the new Closing Auction Session model, exchanges will aggregate orders first and perform them simultaneously at a mutually agreed price. Exchanges are introducing this reform due to two important market dynamics. First, passive investment funds tracking large benchmark indices tend to make large transactions close to market close to prevent tracking error and to artificially drive the price in the auction. Second, big institutional orders in the closing minutes can affect the stock and index market very heavily. By grouping and matching all orders at one equilibrium price, the auction design reduces the ability of any one player to manipulate or disproportionately influence closing prices.
Staggered market timings and investor confusion. Although Kamath recognized the long-term governance and pricing benefits of the reform, he warned that the new trading schedule would cause confusion among the retail market participants. Under this new schedule, stocks with options and futures trading will stop trading at 3:15 p.m. and will join the Closing Auction session. Non-F&O equities will continue normal trading until 3:30 p.m., and derivative contracts for stocks and indices will go on until 3:40 p.m.
This staggered closing situation diverges from the market closure that Indian investors experienced. Managing customer communication and understanding why different segments of the market appear to close at different times will become the most immediate operational dilemma for brokerages in the transition to the new market landscape, Kamath said.
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