Auction Process in Share Market

Most stock market trades settle smoothly, but there are times when shares are not delivered as expected. When this happens, the exchange steps in to protect investors and ensure the settlement cycle remains intact. This is where the auction process comes into the picture. For investors using platforms like Groww, understanding how auctions work can help avoid confusion, settlement delays, and unexpected outcomes.

What Is an Auction and Why Does It Happen

An auction in the share market is a mechanism used by stock exchanges when a seller fails to deliver the shares they sold. This situation is referred to as short delivery. Since the buyer has already paid for the shares, the exchange arranges an auction to source those shares from the market.

Auctions commonly occur due to:

• Insufficient shares in the seller’s demat account.
• Shares sold while under pledge or lock-in.
• Operational or technical settlement errors.
• Intraday positions were unintentionally converted into delivery.

The primary objective is to ensure that buyers are not disadvantaged due to seller default.

How Does the Auction Process Work

Once a short delivery is identified on the settlement day, the exchange automatically initiates the auction process on the next trading day.

The process typically follows these steps:

• The exchange announces the auction for the affected stock
• Sellers holding the stock place sell orders during the auction session
• The exchange purchases the required quantity.
• Shares are delivered to the original buyer.

If the shares are bought at a price higher than the original trade price, the difference is recovered from the defaulting seller.

Auction Timing and Participation Rules

Auction sessions take place during a specific time window defined by the exchange, usually in the afternoon trading hours.

Key points to know:

• Any eligible seller holding the stock can participate
• Buyers are not required to place any orders.
• Retail investors and brokers can both participate as sellers.
• Orders must comply with exchange-defined price and quantity rules.

Affected buyers are automatically included in the process without any manual action.

Auction Price Determination

Auction prices are discovered through market participation rather than being fixed in advance.

The exchange:

• Defines a permissible price range based on recent market prices
• Allows sellers to quote prices within that range
• Matches orders based on availability and competitive pricing

If the auction price exceeds the original selling price, the defaulting seller bears the additional cost.

Auction Due to Short Delivery

Short delivery is the most common reason for auctions in the share market. It occurs when shares sold are not delivered to the exchange on the scheduled settlement day.

This may happen because:

• The seller’s demat balance is insufficient
• Shares are pledged and not released in time
• Corporate action-related restrictions apply
• Settlement instructions are not processed correctly

Once confirmed, the buyer’s delivery is temporarily withheld until the auction is completed.

Close-Out Settlement (If Auction Fails)

In some cases, auctions fail due to a lack of sellers or insufficient quantity. When this happens, the exchange proceeds with a close-out settlement.

In a close-out settlement:

• The buyer receives cash instead of shares
• The payout is calculated using recent market prices or a predefined premium
• The defaulting seller bears the financial impact

While this ensures compensation, buyers may miss out on the opportunity to hold the stock.

Impact of Auction on Buyers and Sellers

The auction process affects buyers and sellers differently. For buyers, the scenarios may be the following: 

• Guaranteed Delivery - This happens in most cases, with buyers largely protected. They will receive their shares on T+2 or T+3 days, as per the schedule, or within these timeframes. This will be ensured by the exchange's intervention.
• Cash-Based Compensation - There may be a rare situation where the auction fails to source shares properly. In this case, the buyer will receive cash-based compensation at a higher price (often penalty-based) to cover any potential losses. 
• Negligible Disruptions - The entire process ensures that buyers' transactions are completed efficiently, without disrupting trading. 

Sellers may be affected in the following ways: 

• Penalties - Defaulting sellers face significant financial consequences. They have to cover the difference if the auction price exceeds the original sale price. Also, an additional penalty fee is payable by them to the exchange. 
• Zero Price Drop Benefits - If the auction price is lower than the original sale price, the defaulting seller will not profit from the difference. In these scenarios, the surplus is directed to the Investor Protection Fund. 
• Impact on Account & Reputation - Repeated short deliveries may result in the investor's trading account being blocked. The brokerage firm may also be barred from participating in the auction for that security. 
• Deterrence Against Short-Selling - Penalties serve as a major deterrent against short-selling without possessing the necessary shares or failing to meet delivery obligations. Hence, these stringent mechanisms help maintain market integrity and stability.  This makes it important for sellers to avoid actions that may lead to short delivery.

Examples to Understand the Auction Process

Consider an investor who buys 100 shares on Monday, with settlement scheduled for Wednesday. The seller fails to deliver the shares.

What follows:

• The exchange conducts an auction on Thursday
• Shares are sourced from another seller at the market price
• The buyer receives the shares after settlement
• The original seller pays any price difference

If no sellers are available, the buyer receives a cash close-out instead.

How to Avoid Auction Situations

Most auction cases can be avoided by following basic trading discipline.

Useful practices include:

• Confirming demat holdings before selling
• Unpledging shares well before settlement
• Avoiding sales of shares under lock-in
• Regularly tracking delivery and settlement status

Being proactive can significantly reduce auction-related risks.

Key Exchange Rules Related to Auctions

Stock exchanges follow a structured framework for auctions to ensure fairness and transparency.

These rules define:

• Auction timelines and sessions
• Price discovery limits
• Penalties for defaulting sellers
• Close-out settlement calculations

The framework is designed to protect investors and maintain market integrity. Some of the key exchange rules include the following: 

• Daily Occurrence - The auctions are a daily feature to ensure short-delivery resolution. 
• Defaulting Broker Exclusion - Fairness will be ensured by barring brokers linked to defaulting clients from bidding. 
• Price Discovery - The +20% band provides a controlled mechanism for price discovery in accordance with the exchange's rules. 
• Penalties - Exchange rules impose penalties and financial consequences on sellers who fail to deliver, to safeguard buyers. 
• Settlement - Auction purchases will settle under the T+3 mechanism, enabling timely deliveries to buyers without any hassles. 

Conclusion

The auction process is an essential safeguard in the share market that ensures settlements are completed even when delivery issues arise. Although auctions may appear complex, they are designed to protect buyers and uphold market discipline. By understanding how auctions work, tracking settlement updates on Groww, and following basic precautions while trading, investors can minimise risks and handle auction-related situations with greater confidence.