India’s revamped stock-market closing auction is facing an unexpected challenge: some of the high-frequency and proprietary trading firms that provide significant liquidity are largely opting not to participate, according to a report by Bloomberg.
The firms say the country’s securities-lending framework makes it difficult to hedge or establish short positions efficiently during the new closing process, creating a mismatch with the rapid trading strategies typically employed by high-frequency traders.
The concerns are significant for India’s $5.2tn equity market. Proprietary trading firms, including high-frequency and market-making specialists, account for roughly one-third of turnover on the National Stock Exchange of India, according to exchange data.
Rajib Ranjan Borah, co-founder of high-frequency trading firm iRage Broking Services, said the limited development of India’s securities-lending market could discourage proprietary traders from participating in the auction, even though the new system offers potentially attractive technological infrastructure.
Under the new rules, introduced to improve price discovery and bring India closer to international market practices, investors submit buy and sell orders during a 20-minute closing auction. The exchange then establishes an equilibrium price, which becomes the official closing level.
The process replaces the previous system, under which the closing price was based on the volume-weighted average of trades during the final 30 minutes of continuous trading.
For fast-moving trading firms, however, the short-selling constraints are proving problematic. Traders seeking to profit from falling prices generally need to borrow shares, but India’s existing lending arrangements can expose them to positions lasting days or weeks. That can be difficult to reconcile with strategies designed to enter and exit trades within seconds or minutes.
India’s securities regulator, the Securities and Exchange Board of India, has established a panel to examine potential reforms to the country’s short-selling framework.
There are already signs that the change has affected liquidity around the close.
During the first two sessions under the new regime, the closing auction helped recover some of the Nifty 50’s losses, leaving the official closing level above where the index had stood when continuous trading ended at 3:15 p.m. local time.
The difference subsequently narrowed as additional participants entered the auction, following efforts by regulators to encourage greater liquidity.
Trading activity has nevertheless been markedly weaker. A trader familiar with the data said average turnover in Nifty 50 constituents during the final 15 minutes of trading on Monday and Tuesday fell below $100m, compared with roughly $700m during the preceding week under the previous closing mechanism.
The experience differs from Hong Kong, where closing auctions have attracted greater participation from high-frequency firms. A more developed securities-borrowing market allows those traders to take both long and short positions more efficiently, including placing substantial sell orders during the closing process.
For India, improving the ability of market participants to borrow securities and establish short positions could therefore be critical to the success of the new auction.
Nithin Kamath, co-founder of Zerodha Broking, has argued that policymakers should make securities lending and short selling easier, while reducing inconsistencies between different financial instruments and creating better conditions for genuine market makers.
Without those changes, the closing auction risks remaining relatively thin, potentially increasing price distortions rather than delivering the deeper liquidity and more robust price discovery that regulators intended.
