SEBI wants tighter ETF ties

In today’s Finshots, we give you an oversimplified explanation of how ETFs are priced, and why SEBI has proposed some changes through a recent consultation paper.

But here’s a quick note before we begin. This week we offer a free 2-day Insurance Masterclass where we will guide you through simple rules to choose the right insurance plan and the common mistakes you should avoid.

📅 Friday, 20 Feb. ⏰at 18:30: Life insurance
How to protect your family, choose the right coverage amount and understand what really matters during a term claim.

📅 Saturday, 21 Feb. ⏰at 10am: Health insurance
How hospitals process claims, common deductibles, common mistakes buyers make, and how to choose a policy that won’t let you down when you need it most.

👉🏽 Click here to register while seats last.

Now, on to today’s story.

The Story

All the chatter around gold and silver lately has probably made one term very popular – ETF.

You probably know what it is. Some of you may even own one. But for anyone new to this, an ETF, or Exchange Traded Fund, is simply an investment fund that reflects something else. It can track an index like the NIFTY or SENSEX. Or it could follow gold, silver, other commodities, government bonds or safe debt instruments. There are more varieties out there, but these are the basics. And since ETFs are listed on stock exchanges, you can buy and sell them as easily as stocks.

This also means that an ETF’s price is shaped by two forces. First, there is the underlying asset that it mimics. This determines the NAV or net asset value, which is simply the total value of everything the ETF owns (net of expenses), divided by the number of units. Second, there is regular market supply and demand – all the buying and selling on the exchange, which determines the traded market price.

Now, in an ideal world, the two move almost together. That’s the ETF’s job.

But sometimes they drift apart. And when that happens, authorized participants, often called market makers, step in to close the gap.

For example, let’s think of an ETF that tracks apples. One unit is equal to 1 kg of apples costing ₹100 per kg. But if strong demand pushes the ETF’s market price up to ₹105, the ETF trades above its current value.

Here, market makers respond by buying apples directly from the farmers’ market at ₹100 per kg. They then deliver these apples to the fund house, which in return creates new ETF units (currently trading at ₹105 on the exchange) and gives them to the market maker. The market maker then sells these ETF units in large quantities. The increase in supply pushes the ETF’s price down, and soon enough it moves back closer to ₹100. They also profit from the ₹5 difference between the buying price and the selling price, hence this process is called arbitrage.

You’ll notice that we said “closer to ₹100” because NAV also includes small adjustments, such as accounting for fund expenses. Which means there will always be a small gap between an ETF’s NAV and market price. This is called a detection error.

But why are we explaining all this to you, you ask?

Well, market regulator, SEBI issues a consultation paper a few days ago said it was thinking about changing how ETF prices are determined and how extreme volatility is handled. And all that context we discussed was necessary to understand what SEBI is trying to fix now.

And now that you have that, let’s talk about what SEBI is proposing.

When we talked about ETF pricing, we explained how an ETF gets its value. But there is another layer to this, that is, which day’s value becomes the reference point for trading.

Let’s go back to the apple example. Apples were ₹100 per kg today, so the ETF’s NAV was ₹100. Simply. But in the real world, with stocks and commodities, you can’t use live prices to declare the official NAV. The fund house that manages the ETF only calculates and publishes the final NAV at the end of the day, usually around 11pm. In some cases, such as certain commodity ETFs, it can even be 9:00 a.m. the next morning. Exchanges and brokers then use that published NAV as a reference.

But because of these time constraints, ETFs currently use the T-2 day closing NAV as the base price for trading. Meaning, if today is T-day, the reference value is from two days ago.

This creates problems, especially if an ETF tracks a bunch of stocks. Because let’s assume a stock (company) within the ETF announces a dividend on T-1 day, the NAV should reflect this as cash is coming into the ETF because it owns that stock. That cash doesn’t go directly into your bank account, but is instead automatically reinvested in the fund, either by buying more of the same share or allocating it within the portfolio.

But because the base price is two days old, exchanges have to manually adjust it. And manual adjustments always carry the risk of error.

But the bigger problem emerges when you look at price movements.

Since ETFs trade like common stocks, they are also subject to price bands. A price band is simply a limit on how much a security can rise or fall in a day. For most stocks, it can rise up to 20% on either side, based on the previous day’s closing price or T-1 day. There are also market-wide circuit breakers if indices swing wildly.

For ETFs, exchanges currently apply a fixed ±20% band on the base price. And others like overnight ETFs – the low-risk ones that track assets like overnight debt instruments have a tighter ±5% band.

And that creates a problem because the shares within the ETF are governed by T-1-based limits. But the ETF itself uses a T-2 NAV as its base price. So they are not anchored to the same reference point.

Let’s give you another example to make it clearer. On Monday (T-2), the ETF’s NAV is ₹100. On Tuesday (T-1), markets jump and the actual NAV becomes ₹110. But Wednesday’s bond is still calculated at ₹100.

Hence, the ETF may trade between ₹80 and ₹120 (±20%) on Wednesday. Even if nothing dramatic happens, it can legitimately trade at ₹120, which is almost 9% above its current value. These are wrong prices right?

These are exactly the problems that SEBI wants to address. That’s why it’s essentially saying, “Hey, we need to revise the base price for ETFs by moving to a T-1-based NAV instead of a T-2 NAV. And we need to rethink the price bands as well, so that temporary mispricing doesn’t create unnecessary distortions in the market.”

SEBI’s ideas are actually quite simple.

First, on the base price. If we move to a T-1 reference instead of T-2, what exactly should we use? One option is the ETF’s closing price on T-1, defined as the weighted average traded price of the last 30 minutes.

Another is the average iNAV of the last 30 minutes on T-1. iNAV is simply a live, indicative value of what the ETF should be worth based on its underlying assets. Fund houses usually calculate this every 10-15 seconds and publish it on their websites. This helps you judge whether the price you see on your trading app is fair.

Now you may ask: why not just use the latest available iNAV?

SEBI says it could be risky. A single iNAV reading can also be an outlier. So instead of relying on one snapshot, suggest averaging over the past 30 minutes.

The third option is to use the official closing NBW of T-1, if available.

Then there is the price band change.

SEBI wants to move away from the fixed ±20% band as it may not make sense for all ETFs. And there is evidence to back it up. His analysis between April and December 2025 shows that equity and debt ETFs rarely move more than 10% in a day. Commodity ETFs mostly stay within 9%. While overnight ETFs usually stay within ±5%.

So for equity and debt ETFs, SEBI suggests starting with a ±10% initial price band. If the price reaches that limit and there is strong demand, trading will pause for a 15-minute cooling-off period (or 5 minutes if close to market close). After that, the band can be extended by 5%. This bending can happen up to twice per day, with an overall limit of ±20%. For gold and silver ETFs, the initial band will be ±6%, expandable in 3% steps, again limited to ±20%.

It is also considering a short pre-open session before 09:15 specifically for commodity ETFs. In that window, buyers and sellers could place orders to discover a “fair” opening price that reflected overnight global movements – as commodities trade almost 24 hours a day across different markets. It will work just like the regular pre-open session for stocks, but just adjusted for commodity ETFs.

Now remember, this is just a consultation document. SEBI invites comments till March 6. And nothing is final yet.

But if these changes do go through, what could they actually mean?

On the plus side, ETFs will no longer rely on an old two-day old reference price. This is a big deal. Especially for commodity ETFs. Gold and silver move worldwide, almost 24 hours a day. If price bands do not adjust quickly enough, the ETF may begin to trade far away from the actual value of gold or silver. And it’s bad for everyone.

So fresher reference prices and smarter bands can reduce those distortions.

But there is a flip side.

Remember arbitration? The mechanism that keeps ETF prices in line with NAV?

Under SEBI’s tighter curbs and cooling-off periods, ETF trading on the exchange may pause more frequently during volatile movements. Imagine silver picking up sharply. The underlying price continues to climb. But the ETF is hitting its stride and trading breaks. It cannot immediately move in tandem unless the band expands after a cooldown period.

During that pause, large institutions that can transact off-exchange can still find ways to capitalize on price differences. This potentially creates greater arbitrage opportunities for them. Meanwhile, small traders stuck on the exchange screen can only wait. So ironically, the small traders who want to protect SEBI from bad prices may not be able to do much during these breaks. Meanwhile, this so-called solution of tighter price bands may ultimately create greater arbitrage opportunities for large institutions that have the ability to transact outside the exchange framework.

So yes, we will have to wait and see how market participants react to this proposal, and what ultimately plays out if and when it is actually implemented.

Until then…

If this story helped you understand how ETFs are priced and the logic behind SEBI’s latest consultation paper, share it with your friends, family or even curious strangers WhatsApp, LinkedInor x.