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What is Auction And What Is The Process Of That

15 May 2024

Why are shares auctioned? 

In the equity segment, share auctions occur primarily due to two reasons. Firstly, if you have sold shares but failed to fulfil the pay-in obligation on the delivery date. This can happen due to various factors, such as a discrepancy in the delivery slip or if the shares were pledged as collateral or for margin requirements. Secondly, if you are a trader who does not have an active Securities Lending and Borrowing (SLB) account and you have taken a short position on a stock but failed to close the position within the same trading day, this is known as the short delivery of shares. In both cases, the exchange initiates the auction process to ensure the completion of the transaction.

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How do stock exchanges conduct the share auction process?

The auction is carried out by the exchange on the T+2 day. The time for the auction is between 2 p.m. and 2:45 p.m. The lowest bidder wins the auction. The exchange puts a cap at the bids with an upper and lower limit. Stocks cannot be sold for lower or higher than 20% of the T+1 day's closing price. After the auction is concluded, the delivery of the shares is made to the buyer on the T+3 day. 

Let's take an example to understand the concept better: 

Let's say Mr A sold 100 shares of Tata Capital @Rs 100 to Mr B. On T+1 day when the seller is required to deliver the shares to the exchange, Mr A defaults. In such a case, even though Mr A could not provide the promised shares, Mr B, who has paid for them, is entitled to the shares. Therefore, it is the responsibility of the exchange to fulfil that obligation through an auction. 

The exchange will now notify the member brokers about the auctions through its website or any other media of communication between the exchange and the member brokers. All the interested brokers can opt to participate in the auction and the bid, which seems the most favourable, is awarded the purchase. The exchange now purchases the shares from the bidder and hands them over to the buyer (here, Mr B). 

There are two scenarios that can play out:- 

Case 1: Share price went up

Assume that the closing price of the shares on T+1 day went up and hence the bid concluded at a price higher than the original sale price. In such a case, the seller will bear the expenses. In this case, if the exchange concludes, the bid for 100 shares of Tata Capital @Rs. 105. Since the auction price is higher than the original sale price, the difference will have to be paid by the defaulting seller.  

Case 2: Share price went down

Assume that the closing price of the shares on T+1 day went down and hence the bid concluded at a price lower than the valuation price. In such a case, the surplus will go to the Investor Protection Fund and not to the seller. In this case, if the exchange concludes, the bid for 100 shares of Tata Capital @Rs. 95. Since the auction price is lower than the original sale price, the difference will go to the Investor Protection Fund. 

However, if for some reason the auction cannot be undertaken, the exchange then settles the trade at the close-out price or the close-out rate. The close-out price of shares varies from script to script. The ideal pricing is the highest price that the stock hit between the trading day and the auction day, or 20% above the closing price on the auction day.

Who can participate in the auction? 

Clients of the brokerage firm involved in the default are not eligible to participate in the auction of the same security. All other member brokers of the exchange can participate in the auction. To participate in an auction, any individual investor can contact his/her broker to get the details on the upcoming auctions and place bids through the member broker. 

What are the different methods through which the auction takes place

There are 3 types of auction that can take place, depending on the nature of the purchase those are: 

Live Auction: Live Auction requires the physical presence of the bidder, which can be at any exchange-specified location where all the bidders meet and auction for the sale of said securities and the best bid wins the auction.

Online Auction: In an online auction, the exchange carries out the auction on an online platform like eAuction India, where the bidder can register itself and participate in the auction.

Sealed Bid Auction: In the third type, sealed bid auction, the bidders are required to submit one closed bid to the exchange and then the exchange evaluates the best bid and extends the offer to the winning bidder.

Conclusion

Share auctions play a crucial role in the Indian stock markets by ensuring the completion of transactions in cases of default or short delivery. These auctions are regulated by the exchanges, such as the NSE and BSE, and follow a specific procedure. The auction process involves notifying member brokers, who can participate in the auction. Understanding the auction procedure is essential for both buyers and sellers, as it ensures the completion of transactions and maintains the integrity of the market. By following the regulations set by the exchanges, investors can navigate share auctions and make informed decisions in their trading activities.

Related Articles: Share Auctions Unveiled Understanding the Process and ImplicationsHow Auction Affects My Portfolio and Profit And Loss

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