India’s equity-derivatives market is set for a potential recovery following a significant regulatory shift announced late Thursday. The Securities and Exchange Board of India (SEBI) stated that it would revert to its previous mechanism for settling derivative prices on expiration days. Under this reinstated system, settlements will be determined using the volume-weighted average prices (VWAP) of underlying stocks recorded during the final 30 minutes of continuous trading.
This policy reversal effectively undoes a key feature of the closing auction session that was implemented on August 3. The earlier system had been linked to significant fluctuations in reference prices, leading to periods of market instability. Market participants and analysts noted that the confusion surrounding the auction process had weighed heavily on trading activity, causing a noticeable decline in volumes across the National Stock Exchange of India Ltd. and the BSE Ltd.
Reflecting on the change, Dhiraj Relli, managing director of HDFC Securities Ltd., indicated that the return to the older methodology will provide market participants with greater clarity and predictability regarding expiry settlement prices. According to Relli, this should help restore trader confidence, reduce uncertainty-driven changes in behavior, and potentially encourage derivatives volumes to return to levels seen before the introduction of the closing auction system.
The market had been navigating a challenging period, as the auction system coincided with broader regulatory efforts to curb speculative trading. Data indicated that in the month the auction system was introduced, average daily turnover in equity derivatives dropped to an 18-month low on the National Stock Exchange, while declining by one-third on the BSE. Although there was a slight rebound in September, brokers and traders remained cautious due to the volatility observed during the previous transition.
Industry analysts at Jefferies Financial Group Inc. suggested that the latest move should reduce expiration-day volatility, which is expected to benefit brokers. Improved settlement predictability is likely to help proprietary trading desks manage expiry risks more effectively, while also aiding arbitrageurs who rely on precise execution for strategies involving cash equities and derivatives. Furthermore, the change is expected to lower the influence of smaller book sizes on closing prices, particularly within thinly traded instruments.
Eshaan Lazarus, founder and chief executive officer of 021 Trade, noted that the previous system, while aimed at regulation, created liquidity issues that allowed participants with smaller holdings to influence closing prices disproportionately. By reverting to the VWAP system, the regulator aims to reduce the scope for such price swings. This shift is expected to draw back traders who had previously stepped away from the market due to concerns regarding the fairness and predictability of settlement prices.
While SEBI remains committed to its broader mandate of reining in market excesses, the reversal of this specific settlement rule is seen as a pragmatic adjustment. Market watchers anticipate that as confidence stabilizes, the transition will foster a more predictable environment for both retail and institutional investors. As trading activity normalizes, brokerages and exchanges may see a corresponding recovery in transaction revenues, marking a return to more standard operational conditions within the Indian financial markets.
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