The Securities and Exchange Board of India (SEBI) plays a crucial role in maintaining the transparency, integrity, and efficiency of the Indian stock market. Recently, SEBI has proposed changes to the methodology for determining the closing price of stocks. This move aims to address issues related to price manipulation, enhance market fairness, and ensure accurate reflection of a stock's value at the end of trading sessions.

Understanding the Current Closing Price Mechanism

Currently, Indian stock markets calculate the closing price based on the weighted average price during the final 30 minutes of trading. While this method is straightforward, it has significant drawbacks:

Example:

If Stock A trades at ₹500, ₹505, and ₹510 in the last 30 minutes with respective volumes of 100, 200, and 300 shares, the VWAP would calculate the closing price as:

While this mechanism generally works well, SEBI has identified loopholes that traders exploit to artificially inflate or deflate stock prices in low-liquidity scenarios or during volatile market conditions.

1. Volatility Spikes: A large proportion of trading activity is concentrated in the last half hour, particularly during index rebalancing days. SEBI's analysis shows that trading volumes often peak sharply during this time, with volatility rising to 3.3 times the average for stocks in indices like MSCI Global Standards.

2. Impact on Passive Funds: For index-tracking funds and ETFs, closing price volatility directly translates into tracking errors. SEBI observed that on rebalancing days, tracking differences for funds following indices like NIFTY 50 and NIFTY Midcap 150 spiked significantly. This leads to inefficiencies for funds that must buy or sell stocks at closing prices to match index weightings.

3. Global Lag: Unlike markets in Hong Kong, South Korea, and Europe, India lacks a closing auction mechanism. These international markets use CAS to aggregate orders and stabilize closing prices, reducing the impact of speculative trading.

Why SEBI Proposes Changes

1. Curb Price Manipulation

Manipulating closing prices allows certain players to influence benchmarks, derivatives settlement, or mutual fund NAVs. SEBI wants to minimize the risk of such practices.

Example: In thinly traded stocks, a trader might execute large orders at inflated prices in the last 30 minutes to push the closing price upward.

2. Enhance Price Discovery

SEBI aims to improve the alignment of closing prices with the true market sentiment by reducing the weight of trades that disproportionately skew the VWAP calculation.

3. Align with Global Standards

Globally, stock exchanges like NYSE and LSE use closing auctions that aggregate buy and sell orders into a single price for better market efficiency. SEBI’s proposed changes might include a similar system to increase transparency.

Proposed Changes by SEBI

While SEBI has not finalized the exact changes, key suggestions include:

- Introducing closing auctions where trades are matched in a single clearing window.

- Revising the time frame for calculating VWAP to minimize manipulation opportunities.

- Enhancing surveillance of end-of-day trades in illiquid stocks.

Impact on Stakeholders

#1. Retail Investors

Benefit: Retail investors will gain from more accurate closing prices, reducing the risk of being misled by manipulated data.

Challenge: Sudden changes in methodology might initially confuse retail investors.

#2. Institutional Investors

Benefit: Mutual funds, pension funds, and other large players will see better alignment of NAVs with actual market conditions.

Example: In cases where closing price manipulation inflates a stock's value, mutual fund NAVs can inaccurately reflect returns, misleading investors.

#3. Traders and Speculators

Challenge: Traders relying on last-minute price fluctuations for intraday or derivative strategies might face reduced opportunities.

#4. Listed Companies

Benefit: Improved price discovery reduces unwarranted volatility and builds investor trust.

#5. Stock Exchanges

Benefit: Adoption of globally accepted mechanisms like closing auctions enhances their credibility and aligns them with international peers.

Global Context and Lessons

Global markets like the London Stock Exchange and the New York Stock Exchange use a closing auction system, where a single closing price is determined by matching orders at the end of the day. SEBI’s move to adopt such practices can position Indian markets as more robust and transparent.

SEBI's benchmarking studies reveal the advantages of CAS in markets like Hong Kong and South Korea:

- Volatility Control: On rebalancing days, markets with CAS reported no significant spikes in volatility, unlike India.

- Liquidity Preservation: The continuous trading session preceding CAS continued to see robust turnover, with CAS itself attracting large volumes on event days.

- Investor Confidence: A transparent and systematic closing price mechanism enhances trust in market operations.

Conclusion

SEBI’s initiative to reform the stock closing price rules is a step towards enhancing market transparency and protecting stakeholder interests. By curbing price manipulation and aligning with global practices, these changes can instill greater investor confidence in the Indian stock market. However, effective implementation and investor education will be key to ensuring a smooth transition.

As SEBI continues its consultation with market participants, the Indian market is poised to adopt practices that will make it more resilient and competitive on a global scale.