The Closing Auction Needs Attendance, Not a Rethink

A well-attended closing auction benefits investors by lowering trading costs, providing a closing price closer to fair value, and making capital raising cheaper for traded companies. India has recently established this mechanism. However, it now requires participants, and the industry best equipped to supply them is now attempting to understand it at present.

Since August 3, all Indian stocks with listed derivatives now close an auction from 3:20 to 3:30 pm, collecting orders with a random stop. During this period, orders are pooled, and the price that clears the highest volume is set as the close, replacing the previous volume-weighted average of the last half hour. Until recently, India was the only major market that closed based on an average rather than an auction.

The evidence behind that switch is worth stating plainly, because research of this kind rarely reaches the people who trade. In 2003, Pagano and Schwartz studied Euronext Paris after its introduction of a closing call in 1996 and 1998. They found that execution costs decreased and price discovery improved, primarily due to mechanical reasons. In continuous trading, large orders cross the spread and walk the book, incurring higher costs with each share. Conversely, during an auction, all orders clear at a single price. Similarly, Kandel, Rindi, and Bosetti in 2012 examined Borsa Italiana following its 2001 closing call, discovering increased efficiency because orders can be revised during auctions without execution, allowing participants to reveal true intentions rather than quoting defensively. Additionally, Butler, Grullon, and Weston in 2005 analysed 2,387 U.S. share sales from 1993 to 2000, finding that banks charged firms with more liquid stocks approximately 101 basis points less in fees—about one-fifth of the average—since the risk to underwriters decreases when the market is capable of absorbing the shares.

A study warns that we should pay close attention. Ellul, Shin, and Tonks (2005) analysed the London Stock Exchange following the introduction of a closing call to its SETS order book in May 2000. While the auction improved price discovery compared to the dealer system, it consistently struggled to clear smaller, less-liquid stocks. They 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, which confirms their fears. The fault isn’t in the design but in the lack of attendance.

India’s situation is revealing: data indicates that during MSCI rebalancing days, 73 to 83 percent of trading in impacted stocks takes place in the last half hour. Volatility during these times is two to over three times higher than the rest of the day, and the difference between the reference price and the close ranges from 61 to 404 basis points. Foreign portfolio investors account for 56 to 60 percent of the traded value, proprietary desks about 17 percent, retail roughly 11 percent, and domestic mutual funds only 8 to 9 percent. Meanwhile, the industry most dependent on an accurate closing value appears to be a bystander.

So, what specific actions can each type of fund perform within their current legal framework? Let’s begin with the hedged categories, which had approximately ₹11.4 lakh crore as of June 2026. An arbitrage fund is required to keep its equity exposure fully hedged—meaning it must be long the stock in cash and short 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 actually shorting any stocks. Now that the derivative window extends to 3:40 pm and stock derivatives settle based on the auction price, both legs of the transaction settle at a single price. Equity savings funds carry the same hedged approach.

Balanced advantage funds can adjust their equity exposure within a broad range on any day. This flexibility allows them to respond to shortfalls in the auction by buying during sell-heavy close and selling during buy-heavy close, framing these actions as normal asset allocation rather than trading strategies. Active equity funds do not need additional approval for such moves. For example, a flexicap or multicap fund that plans to reduce a position can place that order at market close instead of gradually throughout the day, and a cash-holding fund can do the same. Value, contrarian, and dividend-yield funds have the clearest case for this approach, since buying what the index is selling aligns with their mandates.

The ceiling is equally real and serves as a regulatory limit. No fund engages in naked short selling, and during a cash auction, a fund can only sell what it can deliver, making capacity limited to its owned assets. Specialised Investment Funds, the only structure allowed to intentionally short, are capped at 25% of the portfolio and were valued at around ₹17,858 crore in mid-2026. Stock lending is limited, with only about 176 of the roughly 2,600 listed stocks eligible. Passive funds typically hold almost no cash to facilitate purchases, but SEBI has proposed allowing them to borrow overnight against auction positions.

There are substantial advantages for funds. They can execute large transactions at transparent prices with minimal market disruption, which is why regulators promote the auction as an alternative to the block-deal window. This leads to a higher net asset value each evening. Furthermore, as SEBI broadens the auction to include stocks beyond derivatives, funds that adapt quickly will gain access to a much larger pool of resources.

Aligning with global standards isn’t only about having a global closing mechanism but also about making it robust through active participation for mutual benefit. By mid-2025, foreign investors’ passive money amounted to around ₹20.5 lakh crore, representing nearly 29% of their Indian equity investments, while domestic passive funds held about ₹9.18 lakh crore. This money moves based on tracking error, which is determined at market close. A close that behaves like London’s allows global allocators to size India without factoring in discounts for execution risk. Ellul and his co-authors showed what happens when nobody turns up. The funds can make sure somebody does.

Authors: Rachana Baid (Dean, NISM), V Shunmugam (Partner, MCQube)