How does SEBI’s new closing auction system work, and how did two firms manipulate it?

Breaking it down necessitates an understanding of how the new mechanism works.

How does Closing Auction Session work?

Normal trading for stocks covered under the CAS system halts at 3:15 PM, and a reference price for these stocks is calculated in the next five minutes. The CAS begins after that, and continues till 3:30 PM, subject to random closure by the exchanges between 3:28 PM and 3:30 PM to avoid any last-moment manipulation.

Currently, only stocks with futures and options (F&O) contracts available go through the CAS, while the rest continue to trade until 3:30 PM, with closing prices calculated using the traditional volume-weighted average price (VWAP) mechanism.

VWAP is a mechanism where the closing price of a stock or index is calculated based on both the volume and the price of the entity in the final 30 minutes of the trading session.

Suspicious spike in prices

The incident came to light when SEBI’s surveillance system flagged that the indicative price — that show the price a stock will close the CAS session at — of the Sensex index spiked sharply in three separate windows cumulatively lasting 42 seconds during the CAS session on August 13.

This also happened to be Sensex’s weekly expiry day, when the weekly derivatives contracts of the index expire, and traders scramble to either hedge or square off their bets on where the price of an entity would end on the expiry day. Such days are prone to more manipulation due to the large amount of money involved, with traders aiming to profit or limit their losses.

On examining the overall order book for the session, the regulator found that Copthall was responsible for a substantial portion of aggressive buy orders during the sharp upward movements, accounting for 85-99% of the buy order value during the three periods which had seen a spike.

Large orders placed, most cancelled

These orders were all placed at or around the 3% upper limit above the reference price across nearly all Sensex constituents. A large portion of these orders were then cancelled after the price of Sensex had spiked, benefiting Copthall, who bet on the index ending higher.

Meanwhile, the regulator found that Mansi had placed aggressive sell orders of Rs 145.65 crore over five minutes across a few of the Sensex stocks and cancelled these orders within three seconds. “This cancellation created an immediate surge in SENSEX IEP by 232.96. By using inverse logic, it can be inferred that the sell orders of Mansi were causing an artificial suppression of IEP by at least 232.96 points in Sensex,” the regulator noted.

These orders were placed 1.5-3% below the reference price of these stocks, which is near SEBI’s limits. The regulator noted that Mansi’s derivatives positions on the day implied the firm would benefit from a lower close of the Sensex.

“If you are placing such high-volume orders just to cancel it moments later, it clearly reflects some ulterior motive. It shows that you want to influence the price by the sudden high volumes at extremely high or low prices, thus dictating the market. That sort of market manipulation is what SEBI has warned against,” a trader at a domestic broking firm said.

The regulator calculated wrongful gains made by Copthall at Rs 2.96 crore and Rs 71.64 lakh for Mansi. However, it did not allege that both the entities had acted in concert.

In his order, SEBI Whole-Time Member Kamlesh Chandra Varshney reiterated the regulator’s stern stance on such manipulation. “Any manipulation or unfair practices employed to disturb the fair discovery of prices in CAS has to be dealt with sternly by the regulator. Such conduct, if permitted to continue or replicated by other participants in the securities markets, has the potential to undermine the integrity of the CAS mechanism, affect the fair discovery of price through such mechanism and moreover, completely disrupt the orderly functioning of the securities markets,” he noted.