Sebi’s New ETF Rules: Dynamic Price Bands and Base Price Changes Explained

Market regulator, Securities Exchange Board of India (Sebi) has announced a set of reforms which seek to address issues related to the trade of Exchange Traded Funds (ETFs). Through the reforms the market regulator seeks to address issues such as the lag of 1 trading day in the base price of ETFs and the fixed price band of ETFs not being commensurate with the price range of the ETF.

Highlighting these structural issues, Sebi has decided to overhaul the existing ETF rules, according to a Sebi circular these modifications seek to tightly align the operational mechanics of the secondary market with actual, real-time price movements.

Base Price Mechanism Realignment

In order to establish a more update pricing baseline, the capital market regulator has mandated that the base price for determining the daily price bands of ETFs will now be the previous day's closing price. Notably, the price will be calculated using the last 30 minutes' Volume Weighted Average Price.

Prior to the introduction of the new rule, a rigid framework was used to calculate the base price which determined the base price by utilising the net asset value (NAV) from two trading days earlier. This in turn used to create an outdated pricing anchor. Sebi highlighted the need for this shift and mentioned that the old NAV based pricing hindered efficient secondary market operations.

"The existing framework creates challenges because of the one-day lag in price discovery," Sebi said.

Dynamic Price Band Framework

The regulator also mentioned in the circular that it plans to roll out a dynamic price band system for equity and debt ETFs. The dynamic price band will be set at an initial operating range of plus or minus 10 per cent that can be gradually expanded up to 20 per cent after a specified cooling-off period.

Prior to the introduction of the new rule, all stock exchanges enforced a flat, fixed 20 per cent price band on equity and debt ETFs regardless of intraday volatility shifts. Addressing the issues related to the existing regulations Sebi pointed out how unyielding thresholds decoupled the funds from their underlying portfolios.

"The fixed price bands of ETFs not being commensurate with the price range of the underlying," Sebi said.

Commodity ETF Pricing Adjustments

Sebi has also introduced new rules for commodity ETFs that track gold and silver prices. The market regulator has introduced a distinct dynamic price band with an initial threshold of plus or minus 6 per cent that can widen in stages of 3 per cent based on prevailing market movements.

Before the new rule was introduced, commodity-based funds were subjected to static price bands. This new rule has been introduced because underlying physical commodities trade continuously across international boundaries while domestic fund structures remain bound to standard Indian market hours.

Surge in Investor Appetite For ETFs

The changes introduced by Sebi come at a time when ETFs are garnering significant investor interest. Thus the new rules announced by the Sebi are expected to offer structural benefits to investors by enhancing transparency and efficiency in the trading ecosystem.

Retail participants are expected to benefit directly from narrower bid-ask spreads and enhanced liquidity, as market makers will no longer face the operational risk of getting stuck within mis-aligned trading limits. Additionally by ensuring that the daily base price reflects real-time portfolio valuations, investors are protected against sudden opening price distortions, allowing them to enter and exit positions at more accurate market rates.