(Bloomberg) — India’s equity-market close is about to align with major global peers. For arbitrage funds, that could come at a cost.
The traditional way of calculating the closing price of Indian stocks — based on the trading in the last half hour of the session — had given rise to arbitrage strategies that profited from growing price dislocations toward the close. A new auction system could change that.
Starting Monday, Indian exchanges will begin holding a closing auction session for stocks that have derivatives tied to them. The practice, common in markets from Europe to the US, is meant to reduce volatility in the busy final minutes of trading. But it could shave returns for arbitrage funds by 10 to 15 basis points, according to Eshaan Lazarus, co-founder and chief executive officer of broker 021 Trade.
“Some of the payoff for arbitrage funds could disappear,” Lazarus said, adding that the actual impact will become clear only after the changes are implemented. “The last stretch of the market is typically where the maximum opportunities lie.”
The change adds pressure to an industry that’s already been hit recently by a higher securities transaction tax on derivatives. Returns at arbitrage funds have dropped to 5.8% in the past 12 months, below their annualized three-year average of 6.7%, according to Value Research.
India’s roughly $36 billion arbitrage fund industry has attracted investors seeking relatively stable, debt-like returns while benefiting from the lower tax rates of equity funds. The funds primarily make money by buying shares in the cash market and simultaneously selling futures trading at a premium. Spreads are usually wider at the market open and just before the close, when prices tend to swing more wildly.
The closing auction will make large orders easier to execute and provide a fair price to be used as a reference for everything from derivatives settlements to index levels, India’s securities regulator said.
The auction will last 20 minutes, starting at 3:15 p.m. Mumbai time, shortening the trading day by 15 minutes for those seeking to adjust or hedge cash positions. In the last five minutes of the process, buy and sell orders will be matched to calculate a closing price within 3% of the 3:15 p.m. reference price, effectively putting a cap on the wild swings seen on index rebalancing days or expiries.
For now, stocks with no derivatives tied to them, as well as options and futures, won’t go through the auction process, keeping their closing times at 3:30 p.m. and 3:40 p.m., respectively.
The move should make India’s market structure more appealing to institutional investors, according to Kruti Shah, a quantitative analyst at Equirus Securities.
“Global investors are already familiar with closing auctions because that’s how most major exchanges determine benchmark prices,” Shah said. “As liquidity migrates into the auction, execution quality should improve and price discovery at the close is likely to become more efficient.”
Lazarus expects the biggest impact to be felt on days when indexes rebalance their components and when derivatives expire: Up until now, arbitrageurs positioned ahead of those predictable events, earning a premium by providing liquidity or by trading around the temporary price dislocations when investors unwind or roll futures near the close. Now such strategies are likely to become less profitable, Lazarus said.
Brokerages could also feel the pinch, according to Nithin Kamath, founder of broker Zerodha.
“The honest bit: This will probably knock off some revenue, perhaps around 1-5% of brokerage income,” he said in a post on X.
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