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

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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 likely know what it is. Some of you might even own one. But for anyone new to this, an ETF, or Exchange Traded Fund, is simply an investment fund that mirrors something else. It could 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 shares.

This also means that an ETF’s price is shaped by two forces. First, there’s the underlying asset it mimics. That determines the NAV or the 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’s regular market demand and supply — all the buying and selling on the exchange, which decides 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, authorised participants, often called market makers, step in to close the gap.

For example, let’s think of an ETF that tracks apples. One unit equals 1 kg of apples which cost ₹100 per kg. But if heavy demand pushes the ETF’s market price to ₹105, the ETF trades above its actual value.

Here, market makers respond by buying apples directly from the farmer’s 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, which is why 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 tiny gap between an ETF’s NAV and market price. This is called a tracking error.

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

Well, market regulator, SEBI put out a consultation paper a few days ago saying it’s thinking of changing how ETF prices are determined and how extreme volatility is handled. And all that context we discussed was needed to understand what SEBI is now trying to fix.

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

When we spoke about ETF pricing, we explained how an ETF gets its value. But there’s another layer to this, i.e., 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. Simple. But in the real world, with stocks and commodities, you can’t use live prices to declare the official NAV. The fund house managing the ETF calculates and publishes the final NAV only at the end of the day, usually around 11 pm. In some cases, like certain commodity ETFs, it can even be 9 am the next morning. Exchanges and brokers then use that published NAV as a reference.

But because of these timing 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.

That creates problems, especially if an ETF tracks a bunch of stocks. Because let’s suppose a stock (company) inside the ETF announces a dividend on T-1 day, the NAV should reflect that as cash comes into the ETF because it owns that stock. That cash doesn’t come directly into your bank account, but rather, automatically gets reinvested back into the fund, either by buying more of the same stock 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 errors.

But the bigger issue shows up when you look at price movements.

Since ETFs trade like regular shares, they’re subject to price bands too. A price band is simply a limit on how much a security can rise or fall in a day. For most stocks, that can go 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, though, exchanges currently apply a fixed ±20% band on the base price. And others like overnight ETFs — the low-risk ones that track assets such as one-day debt instruments, have a tighter ±5% band.

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

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

So on Wednesday, the ETF can trade between ₹80 and ₹120 (±20%). Even if nothing dramatic happens, it could legally trade at ₹120, which is nearly 9% above its actual value. That’s mispricing right?

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

SEBI’s ideas are actually quite straightforward.

First, on the base price. If we’re moving 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 it every 10–15 seconds and publish it on their websites. It helps you judge whether the price you see on your trading app is fair.

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

SEBI says that could be risky. A single iNAV reading could also be an outlier. So instead of relying on one snapshot, it suggests averaging the last 30 minutes.

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

Then there’s the price band change.

SEBI wants to move away from the fixed ±20% band because it may not make sense for all ETFs. And there’s evidence to back this up. Its analysis between April and December 2025 shows that equity and debt ETFs rarely move beyond 10% in a day. Commodity ETFs mostly stay within 9%. Whereas, overnight ETFs usually stay within ±5%.

So for equity and debt ETFs, SEBI proposes starting with a ±10% initial price band. If the price hits that limit and there is strong demand, trading will pause for a 15-minute cooling-off period (or 5 minutes if it’s close to market close). After that, the band can be expanded by 5%. This flexing can happen up to two times in a day, with an overall cap of ±20%. For gold and silver ETFs, the starting band would be ±6%, expandable in 3% steps, again capped at ±20%.

It’s also considering a short pre-open session before 9:15 AM specifically for commodity ETFs. In that window, buyers and sellers could place orders to discover a “fair” opening price that reflects overnight global moves — since commodities trade almost 24 hours a day across different markets. It would work just like the regular pre-open session for stocks, but tailored only for commodity ETFs.

Now remember, this is just a consultation paper. SEBI is inviting comments till March 6th. And nothing is final yet.

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

On the positive side, ETFs won’t rely on a stale two-day-old reference price anymore. That’s a big deal. Especially for commodity ETFs. Gold and silver move globally, almost round the clock. If price bands don’t adjust fast enough, the ETF can start trading far away from the real value of gold or silver. And that’s bad for everyone.

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

But there’s a flip side.

Remember arbitrage? The mechanism that keeps ETF prices aligned with NAV?

Under SEBI’s tighter bands and cooling-off periods, ETF trading on the exchange could pause more often during volatile moves. Imagine silver is rallying sharply. The underlying price keeps climbing. But the ETF hits its band and trading pauses. It can’t immediately move in tandem unless the band expands after a cooling-off period.

During that pause, large institutions that can transact off-exchange may still find ways to capitalise on price differences. That potentially creates bigger arbitrage opportunities for them. Meanwhile, small traders stuck on the exchange screen can only wait. So ironically, the small traders SEBI wants to shield from bad prices may not be able to do much during these pauses. Meanwhile, this so-called solution of tighter price bands could end up creating larger arbitrage opportunities for big institutions that have the ability to transact outside the exchange framework.

So yeah, we’ll have to wait and see how market participants respond to this proposal, and what ultimately plays out if and when it actually gets implemented.

Until then…

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