Buy-in auction

The clearing corporation has promised the buyer's broker that shares will arrive. When the seller's broker does not deliver, the clearing corporation still has to keep that promise.

A buy-in auction is how it does so. The clearing corporation announces which securities are short and how many, invites members to offer those shares in a special auction session on the exchange, buys them, and delivers them to the buying broker.

The defaulting seller does not escape. It is debited a valuation debit for the shares it failed to deliver, and it is penalised. If nobody offers the shares in the auction, the matter moves to close-out.

Why shortages happen. The workbook lists a short seller failing to square up, a seller failing to deliver on time, or a seller delivering bad or wrong shares.

Valuation debit. Once shortages are identified, the member is debited an amount equal to the undelivered securities valued at a valuation price. Where no shortage confirmation is received from the clearing bank, that valuation amount is treated as a funds shortage.

The auction. An auction tender notice tells members the scrips short, the quantity for auction, and the date and time of the session. The auction is held on settlement day after pay-out: 2:00 p.m. to 2:45 p.m. on BSE and from 2:30 p.m. on NSE.

• It is not held more than once unless approved by a special resolution of the clearing corporation's governing board.
• It is never held beyond one week from the pay-in day of the settlement concerned.
• Successful sellers in the auction deliver on auction pay-in day, Auction + 1 (T+2 in the T+1 schedule), and auction pay-out of shares and funds is also on Auction + 1.

No auction; direct close-out instead for trade-for-trade securities, securities under corporate action (in certain cases), block-deal window trades, and all shortages in the optional T+0 cycle.

Internal shortages - where one client of a broker fails to deliver to another client of the same broker - can be submitted by the member on pay-in day for a self-auction, clubbed with normal shortages. The clearing corporation may charge a fee and may not guarantee such auctions.

Illustrative figures. Broker P's client sold 500 shares on Monday and did not deliver. On Tuesday (T+1), P's securities pay-in is short by 500 shares.

1. Valuation debit. At a valuation price of Rs 420, P is debited 500 x Rs 420 = Rs 2,10,000.
2. Auction notice. The exchange lists the scrip and 500 shares for auction.
3. Auction session. Tuesday afternoon after pay-out (from 2:30 p.m. on NSE, or 2:00-2:45 p.m. on BSE). Broker Q offers 500 shares and its offer is accepted.
4. Auction settlement. Q delivers 500 shares on Wednesday (Auction + 1); the buying side receives them in the auction pay-out the same day.

Broker P also faces a penalty for the securities shortage. If no one had offered the shares at step 3, the shortage would be closed out instead, at a price set by the close-out rule.

One more rule to remember: any amount left over from auction or close-out proceeds after settling the aggrieved party's claim is credited to the Core SGF, not returned to the defaulting party.

Chapter 6 (Settlement Process, section 6.5) covers auction of securities, internal shortages and close-out, and the activity schedule in section 6.1 places the auction on T+1 with auction settlement on T+2. Chapter 3's T+1 table (section 3.4.3) repeats the same days. A Chapter 6 sample question asks "What is the action taken when there is a failure on part of the broker to deliver the securities?" - the answer is auction, not sale or trade cancellation.

• A delivery failure leads to an auction, not cancellation of the trade. That is the sample question.
• Auction is on settlement day (T+1); auction pay-in and pay-out are on Auction + 1 (T+2).
• Not more than once, and not beyond one week from pay-in - both limits are examinable.
• BSE 2:00-2:45 p.m.; NSE from 2:30 p.m. Do not mix them up.
• No auction in T+0. Shortages there go straight to close-out at 10% above the highest price of the day across exchanges.
• Surplus proceeds go to Core SGF, never back to the defaulter.
• Internal shortages arise from netting between the broker's own clients; they are handled by self-auction, and the broker may not charge the client more than the clearing corporation's charges.