The T-2 Lag – Why ETFs sleep while markets run (and how SEBI plans to fix it)
Exchange Traded Funds (ETFs) are scheme of a fund holding underlying assets traded on the exchanges similar to an individual stock/scrip. ETFs therefore are subject to same mechanisms as applicable to a scrip such as circuits, price bands et al, without any deviation in norms for a scrip. SEBI vide its consultation paper dated February 13, 2026 (CP) has stepped in especially in light of extreme volatility in Gold and Silver, and exposure of retail clientele in these ETFs, and to assess whether the market mechanics allow for a fair price discovery.
Currently, the difference in price discovery mechanism exists between the stocks and ETFs. The opening price of a stock is determined in a pre-opening session. All the orders (buy and sell) are pooled on exchanges from 9:00 AM to 9:08 AM, a random cut off time is determined by exchange, then the price at which most of the shares are tradable is fixed by the exchanges as the opening price. Thereby, price of each stock is dynamic from 9:15 AM itself.
For ETFs, the lag is significant. To reflect the price of ETF – Net Asset Value (NAV) of T-2 (2 trading days prior to the trading day) is taken as the base price (i.e. the opening price for trading of the ETF). For instance to determine the base price for an ETF on Wednesday, the closing price on Monday would be considered. This reflects a significant lag/gap.
Now, one might think of an arbitrage opportunity to drive/trade in the direction which reflects the real price, however, with equilibrium kicking in, arbitrage is not a major issue. However, the core issue arises in terms of circuits and price bands, which SEBI attempts to fix vide consultation paper dated Feb 13, 2026.
Currently, the price band for ETFs is +/- 20%; the issue is illustrative as follows: On Monday the closing NAV is Rs.100, which becomes the base price on Wednesday, however, Tuesday there is massive volatility, raising the price to Rs. 125. On Wednesday, the base price is set to Rs. 100, and whilst the market forces will drive the price to Rs. 125, but the circuit will kick in at Rs. 120 thereby trapping investors. It may seem absurd, but the same is highlighted and acknowledged by SEBI vide the need for review in terms that “The closing NAV of ETFs typically differs between T-1 and T-2 Day. Accordingly, the existing practice of using the T-2 Day closing NAV for determining the base price for ETFs, results in an inherent lag of one trading day in the base/reference value used for applying price bands.” The accompanying chart demonstrates a similar issue in pricing of Silver ETFs.
Proposed change: The CP proposes to transition from T-2 to T-1 for determination of base price, which fixes the 15 year old gap (SEBI has asked for the best method – which I suppose should be Closing Price at T-1 basis). Further, SEBI has proposed to make the price bands elastic – an initial price band would be set (For Index ETFs – 10% and 6% for Commodities) instead of fixed band of 20%. Once the first step of price band is hit, there would be a cooling period of 15 minutes, post which the price band would be further increased to 20% (for both Index and Commodity ETFs).
Further the CP has posed two important questions: (1) Should the ‘Upper’ Daily Price Limit for Gold/Silver ETFs be removed – it absolutely should keeping in mind the current volatility, while protecting the downside, and if such options with possible upsides are not given to investors, a chunk of speculation would shift from ETFs to commodity derivatives. (2) Pre-opening session for commodity ETFs: Since the commodities trade across the globe, and even till 11:00 PM on MCX, pre-opening is a better mechanism even for investor participation.
What Next: Sometime back, I was reading the SEBI AIPAC Report 2016, chaired by Narayana Murthy. It had a thoughtful line as core principles of the committee, i.e. “Adopt global best practices and innovate “NEXT” (best) practice”.
Following the same, the thought on Pre-Opening is commendable, however, we need to adopt on immediate basis to Limit Up Limit Down (LULD) system as introduced by FINRA in 2011, wherein, bands would be set at a percentage level above and below the average reference price of the security over the immediately preceding five-minute period (base price is the average price of preceding 5 minutes of trading).
Further, the concept of market timings to me seems inefficient and irrational (across the globe). Markets are reflective of economy, borrowing the words of WP Hamilton’s book the Stock Market Barometer, exchanges are the financial barometers of economy. The current market timings across the globe are a result of the physical rings, the Amsterdam Stock Exchange reportedly operated from 11 Am to noon on weekdays, since it was all physical, in eras of algo and compute, there is little economic rationale to halt trading even for a minute and the same should go across for 24x7x365 (just like crypto trading).
Source: SEBI Proposes New Base Price Norms for ETFs to Remove T-2 NAV Lag
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