Sebi mulls new framework to help passive funds reduce tracking error

Separate call auction session proposed to mitigate final hour volatility

The Securities and Exchange Board of India (Sebi) on Thursday proposed introducing a separate call auction session (CAS) after the market hours to determine the closing price of stocks in the equity cash market, akin to the mechanism followed globally.

 

In a consultation paper, Sebi proposed introducing a call-auction mechanism for determining the closing price of each stock through a separate 15-minute session between 3:30 pm and 3:45 pm. The proposed mechanism would initially be available only for stocks in the derivatives segment and later extended to others in a phased manner.

 

The new mechanism will replace the current practice of determining the closing price through the last half an hour’s volume weighted average price (VWAP).

 

Currently, the closing price of the stocks is calculated by weighing the prices of a scrip during the last 30 minutes of trading by the volume executed at each price.

 

However, several international passive fund houses have suggested that India should adopt a call auction session, as the current mechanism for determining the closing price results in significant price volatility and carries a high risk of large orders not being completed.

 

Fund houses said this adds to the tracking difference of a passive fund — a key metric used to analyse the performance of an index-tracking fund. The tracking difference is seen to be more affected during derivative expiry days and index rebalancing days, when Indian stocks are added to or deleted from major global indices.

 

The market regulator has sought public comments on the proposed functioning and framework of the CAS on aspects such as price limits, order execution, and calculation of the settlement price, among others.

 

In its analysis, Sebi stated that foreign portfolio investors and mutual funds might prefer executing their trades at the close price discovered through the CAS.

 

The market regulator observed that the tracking difference on index rebalancing days for certain international passive funds in their orders for Indian stocks averaged at -3.39 basis points (bps)—substantially higher than the average of -0.19 bps across all other days.

 

Sebi observed that on days of stock additions or deletions in MSCI Global Standard Indexes, volatility during the last half hour was 3.3 times and 2.9 times higher than the volatility observed from the opening to 2:30 pm.

 

With the introduction of CAS, the current post-closing session at exchanges will be discontinued.