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The Securities and Exchange Board of Indias (SEBI) proposed changes to the settlement of futures and options (F&O) contracts could address a key concern over the reliance on the Closing Auction Session (CAS) to determine expiry prices, but deeper cash-market participation will be needed to make the auction mechanism more robust, according to a report by Kotak Institutional Equities.
SEBI has proposed changes to the way settlement prices of expiring index and stock derivatives are calculated. At present, the settlement price is linked to CAS, a short auction held towards the end of the trading session to determine closing prices. Kotak said the proposed revision could reduce the dependence of derivatives settlement on the closing auction. The report noted that the current mechanism has raised concerns because a short and relatively shallow cash auction currently determines expiry payoffs in the much larger derivatives market. Under one of SEBIs proposed options, the settlement price would be based on trades executed during the last 30 minutes of the Continuous Trading Session (CTS) and the 10-minute CAS. The two periods would be weighted according to their actual traded value, with no fixed weight assigned to CAS. Explaining the proposal, the report said, Instead of letting the relatively short CAS determine 100% of derivatives settlement, SEBI proposes using a broader 40-minute pool of actual trades. Under the second option, SEBI has proposed temporarily returning to the earlier system, under which expiring derivatives would be settled using the volume-weighted average price (VWAP) during the last 30 minutes of normal trading. SEBI could subsequently move to the blended methodology after at least one year, subject to sufficient liquidity, participation and familiarity with CAS, the report said. Kotak said the proposals appear to be part of wider efforts by the regulator to deepen participation in the cash market and strengthen the link between the cash and derivatives markets. The report said SEBIs future steps are aimed at deepening cash-market participation, improving securities borrowing and lending, and facilitating hedging and arbitrage, with the broader objective of improving liquidity, price discovery and linkages between the cash and derivatives markets. Kotak noted that deeper reforms would still be needed to make CAS more robust. It said successful closing auctions globally tend to develop alongside deep securities lending markets, while Indias cash-market volumes and turnover velocity remain lower than several major markets. The report also noted some improvement in trading activity after weakness in August. While second-quarter volumes remain lower sequentially, activity levels have shown signs of recovery from August lows. (ANI)
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