SEBI Reviews Closing Auction Session Amid Market Feedback on Derivative Settlement

The Securities and Exchange Board of India (SEBI) is preparing to review the recently implemented Closing Auction Session (CAS) following feedback from market participants regarding settlement volatility. Introduced on 3 August, the CAS mechanism has faced scrutiny for its impact on last-minute price swings during the settlement of stock and index derivatives. According to sources familiar with the discussions, the regulator is expected to issue a consultation paper within the coming week to evaluate potential revisions to the current framework.

While the daily CAS is slated to remain in place, the proposed review focuses on the settlement of weekly and monthly derivative contracts. SEBI is considering a return to the previous volume-weighted average price (VWAP) model, or potentially a hybrid approach that combines VWAP with the new auction-based pricing. The objective is to mitigate the gaps between Nifty and Sensex settlements that have emerged since the transition away from the traditional VWAP mechanism.

The shift to the Closing Auction Session was intended to refine the price discovery process, yet the transition has encountered teething troubles that have prompted regulatory reassessment. Market participants have raised concerns about the stability of settlement prices on expiry days, noting that the new mechanism has introduced unexpected volatility. By initiating a formal review, SEBI aims to balance the benefits of the auction-based system with the need for predictable settlement outcomes.

Industry observers note that the regulator’s willingness to issue a consultation paper underscores a responsive approach to market feedback. The proposed changes, if adopted, would represent a significant adjustment to the settlement architecture for Nifty and Sensex weekly options, as well as monthly stock futures and options. The upcoming consultation process will serve as a critical juncture for determining whether the market requires a return to volume-based pricing or a more nuanced hybrid model.

Beyond the immediate regulatory developments, the broader Indian equity market is showing signs of structural maturation, particularly within the small-cap segment. Samir Vartak, founder and chief investment officer of SageOne Investment Managers, highlights that small-cap stocks have become significantly more resilient to market corrections in the post-Covid era. Historically, these stocks were prone to declines of 40-45% during market pullbacks, but recent data suggests that average corrections have narrowed to approximately 25%.

This increased stability is attributed to cleaner balance sheets and improved profitability across the small-cap universe. Vartak notes that the median net debt-to-equity ratio for small-cap companies has dropped to near zero, with over 50% of these firms now operating debt-free. Furthermore, return on equity (ROE) for the sector has risen from 10-12% in pre-Covid years to roughly 15% today, reflecting a fundamental improvement in operational efficiency and cash-flow management.

Small-cap earnings growth has also decoupled from large-cap performance, now outpacing it by at least 5 to 8 percentage points. Unlike the Nifty index, which is heavily weighted toward financial services, IT, and FMCG, the small-cap space is dominated by manufacturing-oriented industries. Sectors such as building materials, power ancillaries, defence, and contract development and manufacturing organizations (CDMO) are currently driving the bulk of this growth.

Export-oriented opportunities, bolstered by recent free trade agreements with the UK and Europe, are further supporting this trajectory. Vartak emphasizes that the current environment favors bottom-up stock picking, particularly in textiles, garments, and specialty chemicals. As India positions itself as an export hub, companies involved in critical industries like defence are seeing demand surges, with some small-cap defence firms trading at more attractive valuations—around 20-25 times earnings—compared to their large-cap counterparts.

Despite the domestic growth narrative, the Indian market remains sensitive to global macroeconomic headwinds, particularly the rise in US interest rates. With the US 30-year yield reaching levels not seen since 2007-08, emerging markets are facing increased pressure as capital flows adjust to higher borrowing costs. This environment has made the so-called 'AI trade' less attractive, as the high capital intensity of such investments becomes more expensive to finance.

While Taiwan and South Korea have experienced meaningful foreign outflows, India has not seen a corresponding large-scale shift, largely because its market allocation is driven by growth differentials. Vartak points out that India currently lacks a significant growth advantage over the US, and with the rupee’s depreciation, dollar-denominated growth remains constrained. Investors continue to monitor these global yield trends closely, as they remain a primary risk factor for emerging market liquidity and valuation stability.

As SEBI moves toward its consultation on the CAS mechanism, market participants are awaiting clarity on the future of expiry-day settlements. The outcome of this review will likely influence trading strategies and risk management practices for institutional and retail investors alike. Simultaneously, the resilience of the small-cap sector, supported by improved fundamentals and manufacturing-led demand, continues to provide a distinct narrative for long-term investors navigating the current range-bound market environment.

Looking ahead, the interplay between domestic earnings growth and global interest rate cycles will remain the defining feature of the Indian equity landscape. Whether the regulator opts for a full return to VWAP or a hybrid settlement model, the goal remains the preservation of market integrity and the reduction of unnecessary volatility during critical settlement windows.