SEBI has decoupled derivative settlements from the closing auction session, effective December 7, to improve price discovery. While this change helps stabilize the cash market, market experts suggest that further reforms, such as introducing imbalance-only orders and reviewing transaction taxes, are necessary to support the rapidly growing passive investment sector.
The Securities and Exchange Board of India (SEBI) has introduced a significant structural change to the closing auction session, effectively separating it from derivative settlements. Starting December 7, expiring index and stock derivatives will settle using the Volume Weighted Average Price (VWAP) calculated over the last 30 minutes of trading. This move is designed to ensure the closing auction can focus entirely on its primary goal: establishing a stable and reliable closing price for cash-market stocks.
The update comes at a time when passive investing in India is expanding rapidly. Data shows that assets under management for passive funds, such as index funds and exchange-traded funds (ETFs), have grown from 9.8% in 2021 to 18.6% of the total industry. Because these funds must track indices closely, they often rebalance their portfolios during the final minutes of the trading day. Previously, when these large orders hit the market alongside derivative settlements, it created liquidity imbalances that led to unnecessary price volatility.
To further stabilize these closing trades, experts have proposed three key improvements. First, the introduction of imbalance-only orders is suggested. This mechanism would allow market makers to see the difference between buy and sell orders before the market closes and step in to provide the necessary liquidity. This system is already used on international exchanges to reduce price swings.
Second, there is a call for a more open Securities Lending and Borrowing (SLB) mechanism. By allowing more institutional participants to lend their stocks, the market can ensure that enough shares are available for arbitrageurs—traders who profit from small price differences—to step in and bridge the gap between supply and demand.
Finally, the Securities Transaction Tax (STT) has become a point of contention. Currently set at 0.1% on each side of a trade, this tax can often be higher than the thin profit margins earned by liquidity providers. Critics note that since the original reason for this tax in 2004 was to replace long-term capital gains, the current dual structure feels redundant, especially when investors are already paying capital gains taxes. Removing this tax for closing auction trades could lower costs and encourage more participants to provide liquidity, making the market more efficient for everyone.
Moving forward, the primary area to monitor will be whether SEBI adopts these additional measures. While the decoupling of derivative settlements is a positive step, the long-term goal of building a deep capital market by 2047 will likely depend on how effectively regulators can lower friction costs and improve market depth for domestic long-term savers.