Former SEBI Chairman UK Sinha Says Market Regulator Needed Better Preparation for Closing Auction Mechanism

Former Securities and Exchange Board of India (SEBI) Chairman UK Sinha has stated that the market regulator could have been better prepared before implementing the closing auction session (CAS). The new market mechanism has recently faced scrutiny from market participants regarding liquidity issues and sharp price swings.

Speaking on the rollout, Sinha noted that additional preparation, consultation, and beta testing were necessary, though he expressed confidence that the system will eventually stabilise. The closing auction mechanism was introduced on August 3 for stocks in the futures and options (F&O) segment, altering how official closing prices are determined. Under this framework, continuous trading for these stocks ends at 3.15 pm, followed by an auction process to arrive at the final closing price.

Ahead of the framework's finalisation in January, the regulator issued two consultation papers. However, stock exchanges conducted a CAS-specific mock trading session on August 1, just two days prior to the mechanism going live. Since its implementation, the CAS has drawn attention due to large intra-session moves during the auction period, including unusual movements during last Thursday's monthly derivatives expiry on the Sensex.

Market participants have expressed concerns over liquidity and submitted suggestions to the regulator, with some calling for a rollback of the framework. According to experts, similar vulnerabilities existed under the earlier volume-weighted average price methodology, although the auction mechanism reportedly makes potential manipulation attempts easier to identify.

Sinha mentioned that while wider preparation could have helped, the chances of catching those attempting manipulation are now significantly higher. He added that an active securities lending and borrowing mechanism would have smoothed the transition. Last week, SEBI took action against entities for alleged cash market manipulation involving large orders placed during the auction to benefit derivatives expiry positions.

This implementation has highlighted a wider disconnect between the size of the derivatives market and the underlying cash market, where large derivatives positions are settled based on prices discovered in a cash market with smaller trading volumes. Over the past two years, SEBI has implemented measures to curb excessive speculation in the derivatives space, including altering contract sizes and creating incentives to deepen cash market volumes. Sinha supported the regulator's approach, noting that F&O trading carries inherent risks for individuals trading with leverage.

Stating that retail participants whose main profession is outside finance should avoid direct investment in leveraged products, Sinha suggested that investor suitability checks could help mitigate these risks.

"The implementation of the closing auction session highlights the operational challenges regulators face when balancing market structure reforms with liquidity management. As former Chairman UK Sinha noted, comprehensive beta testing and preparation are critical when introducing structural changes to derivatives and cash segments. For businesses and market participants, regulatory shifts require careful operational alignment, especially when dealing with leveraged instruments and evolving compliance standards." — Dr. Shishir Gupta, Founder & CEO, StartupLanes