The market regulator’s recent proposal to revise the base price mechanism for Exchange Traded Funds (ETFs) could result in better price discovery in case of market volatility, industry experts said. When there are sharp movements in the market, the current mechanism of using the Net Asset Value (NAV) data from two days prior is inadequate or inappropriate as it leads to a higher gap between the ETF’s market price and its actual NAV, they said.
Why the Shift to T-1 Matters
“During periods of significant price volatility, the revised mechanism will ensure that the applicable trading price band remains more current and reflective of prevailing market conditions,” Siddharth Srivastava, head of ETF product and fund manager at Mirae Asset Investment Managers (India), said.
Last week, the Securities and Exchange Board of India (Sebi) proposed using the closing NAV of the previous trading day, or T-1, instead of the current T-2 mechanism. The regulator also proposed narrowing the initial price band to 6% (plus or minus) for gold and silver ETFs and to 10% for equity and debt ETFs and can be extended to 20% after the cooling-off period. Currently, a fixed price band of 20% is applicable to all ETFs and 5% band is applied on overnight ETFs investing only in Triparty Repo Dealing and Settlement (TREPS).
From Fixed to Flexible
The T-2 mechanism was introduced with an aim to provide a stable anchor price and reduce the immediate and rapid swing in prices in the initial trading sessions. This also allowed enough time to make manual adjustments of corporate actions such as bonus share issues and dividends that might occur on T-1 day. However, this also came with the risk of errors or omissions due to the reliance on such manual adjustments.
Srivastava of Mirae Asset also said that stock exchanges will need to evaluate and confirm whether the process can be modified to adopt T-1 NAV for determining base prices, given that the NAV is typically declared late at night.
Meanwhile, there are views that there should not be any price bands for ETFs whose underlying assets have exposure to the futures market.
“Ideally, there should be no price band for equity ETFs whose underlying have futures,” Hemen Bhatia, executive director and chief executive officer of Angel One Asset Management Company, said. Even gold and silver ETFs should not have a price band as both assets are held physically with no band on the underlying, he added.
An ETF is a mutual fund scheme which invests in securities in the same proportion as an index of securities and ETF units are mandatorily listed and traded on an exchange platform. Currently, only passive ETFs are allowed to be launched by asset management companies of mutual funds in three broad categories such as equity, debt, and commodity.