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Mumbai: In a move aimed at bringing more transparency and standardization to the mutual fund industry, the Securities and Exchange Board of India (SEBI) has proposed a significant change in the way gold and silver Exchange Traded Funds (ETFs) are valued. The market regulator has suggested that fund houses should transition from using international bullion prices as the benchmark to adopting domestic spot prices for valuation purposes.
Current Practice and Its Challenges
Currently, gold and silver ETFs in India use the London Bullion Market Association (LBMA) AM fixing price in US dollars as the primary reference for valuation. Fund managers then convert this price into Indian rupees based on prevailing forex rates. However, this is not the final step. To align with domestic market realities, they add customs duties, taxes, and adjust further for local premiums or discounts in the Indian bullion market.
This multi-step process introduces several layers of complexity and discretion. Different Asset Management Companies (AMCs) often follow varying methods to incorporate these premiums or discounts, and they apply adjustments at different frequencies. Consequently, the same gold or silver may be valued differently across ETFs, leading to discrepancies in Net Asset Values (NAVs).
For investors, this lack of uniformity can cause confusion and even potential mispricing. For instance, two gold ETFs with similar underlying holdings could reflect different NAVs simply because of valuation methodology differences rather than actual performance or market movement.
The Proposed Change
SEBI’s proposal seeks to address these inconsistencies by recommending that gold and silver ETFs shift to domestic spot prices for valuation instead of relying on the LBMA rates. According to the regulator, this move would create a more accurate and transparent pricing mechanism, as domestic spot prices reflect the actual rates at which gold and silver trade in the Indian market.
By standardizing the benchmark, SEBI aims to eliminate the valuation gap between ETFs managed by different fund houses. This change would also reduce reliance on global benchmarks and complex conversion processes involving currency exchange rates, customs duty calculations, and fluctuating local premiums.
Why Domestic Spot Prices?
The Indian bullion market is one of the largest in the world, with gold and silver playing a significant role in household savings and investment portfolios. Domestic spot prices inherently capture the market dynamics, supply-demand conditions, and local taxation structure in India. For investors who buy ETFs to mirror the domestic price of gold or silver, valuing these ETFs based on global prices adjusted for multiple variables introduces unnecessary complexity.
Furthermore, the proposal is expected to align ETFs more closely with the actual cost that Indian investors would incur if they purchased physical gold or silver in the local market.
Implications for Investors and the Industry
If implemented, the shift to domestic spot prices could have several far-reaching implications:
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Transparency and Uniformity: All ETFs would follow the same pricing benchmark, reducing NAV discrepancies and creating a level playing field across the industry.
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Reduced Tracking Error: Since ETFs are designed to track the price of gold or silver, using a domestic benchmark would minimize the deviation between ETF NAVs and the actual price movements in the local market.
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Simplified Valuation Process: Fund houses would no longer need to adjust for currency fluctuations, customs duties, and international premiums, making the valuation process more straightforward.
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Impact on Arbitrage Opportunities: With uniform pricing, arbitrage opportunities arising from valuation differences between ETFs could narrow, leading to better price discovery and improved market efficiency.
Next Steps
The proposal is currently in the consultation stage, with SEBI inviting feedback from stakeholders, including fund houses, market experts, and investors. Once finalized, the regulator will likely provide a transition framework for AMCs to adopt the new valuation methodology.
Industry experts believe this move is timely, considering the growing popularity of gold and silver ETFs among Indian investors as a convenient and cost-effective alternative to physical bullion. With the push towards financialization of gold investments and the increasing appeal of ETFs, this regulatory reform could further boost investor confidence.
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