MSCI Rebalance To Test India’s New Closing Auction System

India’s new Closing Auction Session (CAS) is set for its biggest test yet on Monday, with around $4 billion of passive-fund trades expected to pass through the mechanism during MSCI’s quarterly index rebalancing.

The MSCI index changes could generate about $5 billion in trading turnover from global passive funds. Around $4 billion of that activity is expected to take place during the CAS, according to the information available.

The scale will be far larger than the auction’s usual activity. Daily turnover has so far averaged about $125 million. The sharp rise in trading activity comes as the new system faces scrutiny from market participants following volatile price moves since its launch earlier this month.

Sensex Flash Crash Raises Concerns

The BSE Sensex saw a flash crash during the auction last Thursday. The move added to concerns about liquidity and the possibility of price manipulation during the new trading window.

The Securities and Exchange Board of India (SEBI) introduced the auction to improve the way closing prices are determined and help passive funds reduce tracking errors.

SEBI Chairman Tuhin Kanta Pandey said last week that the mechanism would remain in place despite calls from some market participants for changes. Monday’s MSCI rebalance will therefore provide a much larger flow of institutional orders through the system.

Passive funds typically need to adjust their portfolios when index constituents or weightings change. They buy stocks that gain weight and sell those whose weight falls or which leave an index. These trades are often placed close to the official market close so that funds can keep their portfolios in line with their benchmarks.

Reliance Outflows In Focus

MSCI rebalancing will bring several changes to its standard indexes. Lenskart Solutions Ltd, Laurus Labs Ltd, Adani Energy Solutions Ltd, and Billionbrains Garage Ventures Ltd will be added. Balkrishna Industries Ltd, SBI Cards & Payment Services Ltd, and Astral Ltd will be removed.

Reliance Industries Ltd will also see a reduction in its index weight. The change is expected to result in around $500 million of passive-fund outflows. MSCI said it would monitor the practical effectiveness of India’s new closing auction system. The index provider said its assessment would take into account feedback from market participants, including clients and index users.

Liquidity Remains Key Challenge

Most passive funds are expected to use the auction for a large part of their trades because it allows them to transact close to the official closing price.

However, the size of Monday’s orders could test whether the auction has enough liquidity to absorb them without large price moves. Markets that have introduced similar systems have faced comparable issues. Australia, for instance, experienced sharp price swings during the early phase of its closing auction system.

Experts said the system faces a liquidity problem because institutions may wait for evidence that the auction is fair and resistant to manipulation before participating in larger numbers. They added that broader participation could improve liquidity once investors gain confidence in the mechanism.

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