Auction rate penalties are charges imposed on sellers who fail to meet their obligation to transfer shares to the exchange on the designated settlement date, resulting in a share auction. These penalties serve as a deterrent to prevent defaults and ensure accountability in share transactions. This article explores the calculation methods for auction rate penalties and their significance in the financial market.
Auction rate penalties are enforced to hold defaulting sellers accountable for their failure to deliver shares on time. By imposing penalties, exchanges and regulators discourage sellers from defaulting on their pay in obligations, which can disrupt the settlement process and cause inconvenience to buyers. The penalties act as a financial consequence for non-compliance and help maintain the integrity and efficiency of the market.
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The penalty is imposed when the seller fails to transfer shares to the exchange by the T+1 settlement day, leading to a delay in share transfer to the buyer on the T+2 day. To address this, an auction is conducted on the T+2 day, usually between 2 p.m. and 2:45 p.m., to determine the appropriate penalty for the defaulting seller. The penalty amount is calculated based on specific methods, depending on the nature of the transaction and the parties involved.
There are different calculation methods for auction penalties, depending on the type of scrip and the involvement of the buyer and seller:
If both the buyer and seller are clients or members of Motilal Oswal, and the auctioned stock is a futures and options (F&O) scrip, the penalty is calculated as the higher of the highest price between T day and T+2 day or the closing price of the share on T+2 day plus 3%.
In the case of non-F&O scrips and when both the buyer and seller are clients or members of Motilal Oswal, the penalty is determined as the higher of the highest price between T day and T+2 day or the closing price of the share on T+2 day plus 7%.
If the buyer is not associated with Motilal Oswal, the penalty is calculated at 0.10% of the Market Auction Value. The Market Auction Value is determined by multiplying the share price on the auction day by the number of shares.
Apart from the above methods, there are additional penalty scenarios:
When internal and external methods cannot be executed, and both the buyer and seller have an account with Motilal Oswal, the penalty is calculated as the closing price on T+2 day plus 20%, or the highest price between T day and T+1 day, whichever is higher.
In trade-for-trade transactions, where share delivery is mandatory, the penalty is determined as the higher of the highest price between T day and T+1 day or the closing price of T+1 day plus 20%.
If the bidder fails to deliver shares to the exchange following the auction, the penalty is calculated as the higher of the highest price between T day and the close-out day or the closing price of T+1 day plus 20%.
For block deals (BL) and inter-lender (IL) transactions, the penalties follow the same calculation methods mentioned earlier.
Auction penalties charged by Indian exchanges act as a deterrent against defaults and ensure fair and transparent share transactions. These penalties impose financial consequences on defaulting sellers, promoting accountability and maintaining market integrity. By understanding the calculation methods and implications of auction penalties, market participants can better navigate the consequences of default and actively participate in a secure and efficient financial ecosystem.