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Mumbai: Indian mutual funds are increasing their participation in the stock market's new closing auction — but mostly in trades too small to matter, several fund managers told Mint, wary of the sharp price swings that can occur within the 15-minute window. Introduced on 3 August, the Closing Auction Session (CAS) has struggled to attract sustained participation despite a gradual increase in trading activity. Mutual funds are limiting the trades they route through the auction, preferring transactions where an adverse execution price would have a limited impact on a scheme's net asset value (NAV). The concern for mutual funds isn't whether the closing auction attracts enough activity — it's whether it can deliver a predictable price for large orders. A sharp swing during the 15-minute window could leave a fund buying or selling well off the prevailing market price, denting a scheme's NAV and leaving the fund manager to explain the trade to trustees. And the new system has already seen several instances of sharp price swings in the closing minutes. "Mutual funds are avoiding CAS for trades that are substantial in value and volume, and hence important to the fund house. Trades that are not very important and do not impact P&L are being sent to CAS. This is largely because of the unexpected price swings and uncertainty during CAS," said a mutual fund executive, requesting anonymity. The system's early months have shown how volatile that price can be: on the very first day, the Nifty jumped nearly 200 points in the closing minutes while the Sensex barely moved. On 3 September, the Sensex plunged about 2,100 points within minutes during the auction on a weekly expiry day, before recovering most of the fall to close 417 points lower. Under the new framework, the regulator has shifted the determination of the closing price from the earlier volume-weighted average price (VWAP) mechanism to an auction-based system. CAS covers 213 stocks available for derivatives trading. Continuous trading in these stocks ends at 3:15pm, followed by the auction, during which a single equilibrium price is set by matching the maximum number of buy and sell orders. Caution Persists The caution persists despite efforts by the Securities and Exchange Board of India (Sebi) to increase participation in the segment. The market regulator has asked mutual funds to put through more trades in CAS, three executives said. As a result, mutual fund participation in CAS had risen to nearly 25% of total volumes by mid-August, from about 5% when the framework was introduced, Sebi chairman Tuhin Kanta Pandey said on 12 August. Mint reported on 16 September that Sebi had also allowed arbitrage funds to maintain 1% of their assets under management (AUM) as unhedged positions, with the aim of improving their participation in CAS. Arbitrage funds seek to profit from price differences in the same security across the cash and futures markets. Overall activity, however, has been uneven. NSE data shows that between 3 August and 15 September, closing-auction trading volumes increased 21.6% to 31.5 million trades, while transaction value rose 37.2% to ₹1,751.46 crore. Participation remained weak through most of August. Trading volumes during the closing session fell 24.3%, from 25.8 million on 3 August to 19.6 million on 28 August. Transaction value declined 26%, from ₹1,276.4 crore to ₹944.94 crore. Participation recovered towards the end of the month following the MSCI index rebalancing on 31 August. Dhirendra Kumar, founder of Value Research, said the reluctance was understandable from a fund manager’s perspective. “Picture the dealer. Work an order through the day and he can point to VWAP. Put the same size into a 15-minute window and he has no cover. A print 3% off the market is his to explain to the trustees. Nothing rewards him for using the auction. So, he stays out. That is not timidity. That is sense.” For mutual funds, uncertainty around the final price remains a key concern because they trade on behalf of investors and must account for the impact of transactions on a scheme’s NAV. “Mutual funds are unlikely to participate until there is depth in the auction session. As of now, mutual funds are only putting through trades in CAS that would not materially impact the NAV if the trades make losses,” said another mutual fund executive. Changes needed Kumar said changes to the structure could make the auction more usable for institutional investors. “Recognise the closing price as an execution benchmark, so a dealer is not exposed for choosing it. Set price bands stock by stock, not a flat 3%. Publish the indicative price early enough for someone to answer it. Finish securities lending reform, because you cannot sell what you cannot borrow. Spread a big rebalance over more than one close.” “Today’s caution makes sense. Funds will show up when it is useful to them,” Kumar added. On 12 September, Sebi proposed several measures to change the settlement methodology for derivative contracts following concerns that the closing auction was contributing to abrupt price swings on expiry days. However, the measures are unlikely to spur participation immediately. “We are looking at the closing auction constructively. The changes are positive, but it would still take time for mutual funds to fully trust the auction. This cannot happen until there is visibility into closing prices every day,” a third fund executive said.
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