Close out
Settling an undelivered sale in cash instead of shares: the defaulting seller is charged at a penal close-out price, used when an auction finds no sellers or is not held at all.
In plain language
When a seller fails to deliver shares, the clearing corporation first tries to buy them in an auction. Sometimes that is impossible - there may be no sellers in the auction, or the rules may not allow an auction for that trade at all.
In those cases the obligation is closed out. The buyer receives money instead of shares, and the defaulting seller is charged at a deliberately high price: the highest price seen in the market over the relevant period, or a fixed mark-up over the closing price, whichever is higher.
The price is designed so that failing to deliver is always more expensive than delivering. A seller should never be able to profit from defaulting.
How it works
The workbook (sections 6.3.4 and 6.5.2) sets out several close-out prices. Each is a "whichever is higher" test:
| Situation | Close-out price |
|---|---|
| Normal shortage, no sellers in the auction | Highest price across the exchange from trade day to auction day, or 20% above the official closing price (settlement price) on auction day |
| Corporate action: auction pay-out cannot happen on or before record date / book closure minus 1 business day | Highest price across exchanges from trade day to auction day, or 10% above settlement price on auction day |
| Block deal window and trade-for-trade (TFT) shortages - closed out directly on settlement | Highest price across exchanges on T day (till settlement minus one day), or 20% above settlement price on T day |
| Optional T+0 shortages - no auction held | 10% above the highest price of the day across all exchanges |
| Auction seller fails to deliver on auction pay-in day | Highest price from original trade day till auction day, or 20% over the official closing price on close-out day - charged to the auction seller |
For corporate actions, short deliveries of shares traded cum-benefit are closed out directly unless the auction pay-out can happen on or before record date minus 1 business day.
Close-out is also a funds remedy: if a funds defaulter never brings in the money, the clearing corporation may close out securities in the normal or auction market. Surplus proceeds of an auction or close-out go to the Core SGF, not to the defaulter.
A worked example
Illustrative prices; the rule is the workbook's.
A seller fails to deliver 1,000 shares sold on Monday at Rs 200. The auction on Tuesday attracts no sellers.
- Highest price across the exchange from Monday to auction day: Rs 214
- Official closing price on auction day: Rs 190, so 20% above = Rs 190 x 1.20 = Rs 228
Close-out price = higher of Rs 214 and Rs 228 = Rs 228.
The seller is charged 1,000 x Rs 228 = Rs 2,28,000, against a sale worth 1,000 x Rs 200 = Rs 2,00,000 - a Rs 28,000 cost of defaulting, before any penalty.
Now change one fact: the shares were in the T+0 cycle and the day's highest price was Rs 214. There is no auction; the close-out price is Rs 214 x 1.10 = Rs 235.40, and the charge is Rs 2,35,400.
Why NISM asks about it
Chapter 6 (Settlement Process, sections 6.3.4 and 6.5.2) is the source, with the T+0 rule repeated in Chapter 5 (section 5.7 on optional T+0 settlement). Questions typically give a set of prices and ask for the close-out price, or ask which situations are closed out directly without an auction (T+0, block window, trade-for-trade, certain corporate-action cases).
Common exam traps
- Always "whichever is higher", never "lower" and never an average.
- 20% or 10%? 20% above the closing/settlement price for a normal no-seller auction, for block window/TFT and for a defaulting auction seller; 10% for the corporate-action case and for T+0 (where it is 10% above the highest price, not the settlement price).
- T+0 has no auction at all - shortages go directly to close-out.
- Close-out follows a failed auction; it does not replace the auction for ordinary rolling-settlement shortages.
- Surplus goes to Core SGF, not the defaulting member.
Check yourself
1.The penal interest that the Exchange or Clearing Corporation may levy on a member's funds pay-in shortage is:
- a)Not less than 0.07 percent per day
- b)Not less than 0.7 percent per day
- c)A flat 15 percent per annum
- d)Not less than 1 percent per month
Show the answer
Answer: (a) Not less than 0.07 percent per day
The Exchange/Clearing Corporation may levy a penal interest of not less than 0.07 percent per day on the pay-in shortage of the member.
On an annualised basis that is roughly 25%, which is why it is set as a daily rate — the point is to make even a one-day shortfall expensive.
Beyond the interest, the consequences escalate: members failing to fulfil their funds obligations (including STT/Stamp duty obligation and Capital Cushion requirement) by the scheduled date and time to Clearing Corporation shall render him liable for withdrawal of trading facility or such other actions including disciplinary actions.
In case of pay-in shortfall, the trading facility of the trading member shall be withdrawn, and the securities pay-out would be withheld if the shortfall is in excess of the amount specified by SEBI or the Clearing Corporation from time to time, or there are recurring fund shortages by the member within a certain period and for a certain amount.
And ultimately: if the funds are not brought in at any time by the funds defaulting member, the Clearing Corporation, at its discretion, will proceed to close out securities in the normal/auction market.
2.If on the auction day there are no sellers for a short delivery, the defaulting seller is charged:
- a)The settlement price on the auction day
- b)The highest price from the day of trading till the auction day, or 20% above the settlement price on the auction day, whichever is higher
- c)The highest price from the day of trading till the auction day only
- d)10% above the settlement price on the auction day
Show the answer
Answer: (b) The highest price from the day of trading till the auction day, or 20% above the settlement price on the auction day, whichever is higher
If on the auction day, there are no sellers for a particular short delivery, the Clearing Corporation/Clearing House will then carry out a process called "Close out". In this process, the seller will be charged with the highest price prevailing across the stock exchange from the day of trading till the auction day or 20% above the official closing price (settlement price) on the auction day, whichever is higher.
The "whichever is higher" is the design feature — it guarantees that failing to deliver is never cheaper than delivering, in either a rising or a falling market.
Option D describes a different case: where a company announces any corporate action and auction pay-out cannot be done on or before Record Date/Book closure minus 1 business day, shortages shall be directly closed out at the highest price prevailing across the Exchanges from the day of trading till the day of auction or 10% above the settlement price on the auction day, whichever is higher.
Two further variants: for block window and TFT segment, the position will be directly closed-out on settlement at the highest price prevailing across the Exchanges on the T day (till settlement minus one day) or 20% above the settlement price on the T day, whichever is higher. And for optional T+0, security shortages shall be directly closed out at 10% above the highest price of the day across all exchanges.
3.A funds-defaulting member never brings in the amount in default. What will the Clearing Corporation do?
- a)Recover the amount from the investors whose trades created the obligation
- b)Cancel the member's trades for that settlement
- c)At its discretion, close out securities in the normal/auction market
- d)Pay the buying members from the Investor Protection Fund
Show the answer
Answer: (c) At its discretion, close out securities in the normal/auction market
The workbook: “The funds defaulting member will be allowed such time as may be permitted by the relevant authority, depending upon the facts of the case, to bring in the amount in default. If the funds are not brought in at any time by the funds defaulting member, the Clearing Corporation, at its discretion, will proceed to close out securities in the normal / auction market.”
Why the others are wrong:
- Recover from investors — the clearing corporation deals with its clearing members; novation makes it the counterparty to the member, not to investors.
- Cancel trades — trades are not cancelled; the settlement is guaranteed and the CC closes out.
- Investor Protection Fund — the IPF compensates investors against a defaulter broker; it is not the tool to complete a settlement.
Where this is taught
Free preparation for NISM Series VIIRelated terms
- Record dateThe date on which a company looks at its register and decides who gets the bonus, dividend, rights or split — you must be holding the shares in your demat account at the end of that day.
- Buy-in auctionThe auction a clearing corporation runs through the exchange system on settlement day to buy shares a selling member failed to deliver, so the buying member still receives them.
- Pay-inThe leg of settlement in which clearing members hand over what they owe: funds into the clearing corporation through the clearing bank, and securities into its pool account through the depository.
- Valuation debitThe amount a member is debited when it fails to deliver securities on pay-in day, equal to the shortfall quantity valued at a valuation price fixed by the clearing corporation.
- Settlement Guarantee FundA fund held by the clearing corporation, built from contributions by the exchange, the clearing corporation and clearing members plus a share of settlement penalties, used to complete settlement if a member defaults.
- Ex-dateThe first day a security trades without a corporate action benefit, and the cut-off that decides whether a short-delivery auction near that action proceeds normally or is closed out directly instead.
- Internal shortageA shortage that arises inside a single member's book when a selling client fails to deliver shares that were netted off against a buying client's purchase, so no obligation reached the clearing corporation.
- Bad deliverySecurities that are delivered for settlement but rejected by the depository for technical reasons such as incorrect signatures, names or details — treated like a short delivery and closed out through auction.
- Short deliveryA member's failure to pay in securities, fully or partly, on the settlement day — closed out at the shares' last closing price and made good by the clearing corporation through an auction.