SEBI Proposes Major Overhaul of ETF Pricing Rules: Dynamic Price Bands and Call Auction Introduced

SEBI Proposes Major Overhaul of ETF Pricing Rules: Dynamic Price Bands and Call Auction Introduced​

Regulator Aims to Align ETF Trading Prices with Underlying Asset Values​

The Securities and Exchange Board (SEBI) has unveiled a significant proposal aimed at reforming the pricing mechanism for Exchange Traded Funds (ETFs). This move intends to narrow the persistent gap often observed between the actual trading price of an ETF and the value of the assets it tracks. The regulatory overhaul targets enhanced transparency and tighter alignment across the market.

New Framework for Determining Base Price​

A core element of the SEBI proposal involves redefining how the base price for ETF trading limits will be calculated. Under the new framework, the base price will be determined using the volume-weighted average closing price observed during the final 30 minutes of the previous trading session. This measure seeks to provide a more stable and representative reference point for market participants.

In situations where an ETF experiences no trading activity during that specific period, the proposal mandates that the base price defaults to its last traded price from the preceding session. If zero trading activity is recorded throughout an entire trading day, the latest available Net Asset Value (NAV) must be utilized as the operational base price.

Dynamic Price Bands for Equity and Debt ETFs​

SEBI has also introduced the concept of dynamic price bands specifically for equity and debt ETFs. The initial trading limit under this system will be set at a range of plus or minus 10 per cent. Following a designated cooling-off period, this permissible band can be expanded up to plus or minus 20 per cent.

This proposal builds upon suggestions previously put forth in February, which recommended substituting fixed price limits with dynamic bands based on the previous trading day's indicative NAV. These changes are designed to introduce market flexibility while maintaining necessary controls over volatility.

Introducing Call Auctions for Commodity-Linked ETFs​

For gold and silver ETFs, given that these commodities are traded continuously in global markets, SEBI proposes implementing a call auction mechanism before the start of trading. The purpose of this pre-market auction is specifically to help discover an equilibrium price for these commodity instruments.

Previously, the regulator had suggested removing fixed price bands entirely for these precious metals ETFs. It also suggested aligning their trading limits with the daily price limits currently applicable to related derivatives contracts. This multifaceted approach aims to stabilize and rationalize the pricing of commodity-linked funds.