The Securities and Exchange Board (SEBI) of India has suggested a set of substantial structural changes to the settlement methodology for derivatives, overall timing restrictions, and operational rules of the closing auction session. The proposals arrive weeks after a new closing-price type was adopted.

These plans for regulatory changes are set out in a comprehensive consultation paper issued by the capital market regulator on Saturday. The principal goals of these proposed improvements are to clarify the process of price discovery, limit possible misunderstandings of the price, and enhance market efficiency. The regulator is asking for public feedback on each of these seven detailed proposals until October 3, 2026.

Proposed modifications and indicative movements

The current price discovery mechanism for equities listed for the closing is an equilibrium price discovery mechanism based on the accumulation of buy and sell orders. The process of price discovery for the underlying securities is ongoing while the derivatives continue to trade. This concentration results in more frequent changes in price and trade activity on the final trading day for the derivatives on those days in the final 30 minutes of the auction, when traders will focus on prices of the underlying securities whose terms are expiring.

To address these complexities, the regulator has presented two separate methodologies for the settlement price calculation on an expiry date for both index and single-stock derivatives. Option 1, the Blended VWAP approach, would be based on trades from the last 10 minutes of the closing auction session and the last 30 minutes of continuous trading before the settlement day, when calculating the expiry-day settlement price. 

In the case of index derivatives, the contribution of each period would depend on the actual trade values rather than the fixed weights. The price would also be calculated for stock derivatives, based on the volume-weighted average price over exchanges with value traded in both windows. 

Option 2, known as the CTS VWAP approach, would pause the calculation of the settlement price in this instance and use trades only from the final 30 minutes of continuous trading sessions rather than the closing auction session. The regulator said the CTS VWAP approach would be kept for a minimum of 1 year before determining whether to transition to the blended methodology through market conditions, liquidity, and participant familiarity.

The regulator pointed to issues with participant conduct during the final auction round. Participants in the auction frequently use indicative equilibrium prices in the first minutes of the auction session to form the indicative index value used to inform decisions about derivatives trading. An indicative equilibrium price is one of the parameters of the order book and does not necessarily correspond to the price of actual trades.

The regulator proposed to cease disseminating the indicative index value computed from indicative equilibrium prices and to continue with the dissemination of indicative equilibrium prices for individual securities. 

The final value of an index can only be determined at the end of the auction session when the final security prices are set. Traders can misunderstand movements in indices as movements in actual levels. 

This proposal follows international market practices, in which closing auctions typically do not recalculate disseminated index values continuously using unexecuted indicative prices for individual constituent securities.

Proposed regulations and structural operational changes

The regulator has proposed two structures for general market timings to facilitate the move from continuous trading to the closing auction session. Option A would maintain the current exchange trading until 3:30 pm. The closing auction of eligible stocks for all markets would be conducted between 3:31 pm and 3:40 pm, followed by a brief transition period of up to 1 minute, and derivatives trading would be allowed to continue thereafter until 3:45 pm. 

Option B would have the continuous trading process be terminated earlier at 3:15 pm for stocks of the closing auction session and 3:30 pm for non-auction stocks. Derivatives trading would also end at 3:30 pm, while the transition to the closing auction session would take place from 3:15 pm to 3:25 pm.

For both options, the volume-weighted average price of the final 15 minutes of the continuous trading session will continue to serve as the reference price for the closing auction session price band. 

To maintain the efficiency of the system, the regulator suggested a decrease in the timeframe between continuous trading and the closing auction session from five minutes to one minute. The post-auction derivatives trading window would also decrease from 10 minutes to 5 minutes.

With the market order flex unchanged at 3% plus or minus, the regulator suggested specific limitations on cancellations of orders during the closing auction session to prevent manipulation. If orders are placed within 1% of reference price, this may still be withdrawable. 

Orders altered by a deviation between the current order price and the reference price by 1% to 3% cannot be cancelled, but can be adjusted to the best of the order price. This measure serves to prevent a sudden withdrawal from trading interest located away from reference price.

The regulator suggested that unexecuted Iceberg orders placed during continuous trading be moved directly to the closing auction session. Any unexecuted quantity from an Iceberg order would become a standard limit order, and its quantity to be triggered would be completely visible in the auction order book. The measure guarantees that the closing price discovery process fairly reflects legitimate outstanding trading interest at the end of continuous trading.

Conclusion

The comprehensive proposals presented by the Securities and Exchange Board of India are proactive efforts to bring the domestic market operations in line with best international practices.

The regulator aims to reduce systemic friction and eliminate distortions in closing sessions through the settlement price calculation changes, the elimination of misleading indicative values, fixes in session timing and cancellations, and the addition of Iceberg orders. The regulatory regime governing equity and derivative securities liquidations is set to be finalized after stakeholders submit their comments by October 3, 2026.