"All ETFs trading today operate in a similar way. Unlike traditional mutual funds, ETFs do not sell or redeem their individual shares (‘‘ETF shares’’) at net asset value (‘‘NAV’’). Instead, financial institutions purchase and redeem ETF shares directly from the ETF, but only in large blocks called ‘creation units.’ A financial institution that purchases a creation unit of ETF shares first deposits with the ETF a ‘‘purchase basket’’ of certain securities and other assets identified by the ETF that day, and then receives the creation unit in return for those assets. The basket generally reflects the contents of the ETF’s portfolio and is equal in value to the aggregate NAV of the ETF shares in the creation unit. After purchasing a creation unit, the financial institution may hold the ETF shares, or sell some or all in secondary market transactions."
Securities and Exchange Commission Exchange-Traded Funds; Proposed Rules. Federal Register. March 18, 2008. Vol. 73, No. 53. page 14620.
My translation to the above is:
A financial institution can buy "creation units" or IOUs of questionable value from an Exchange-Traded Fund (ETF.) The acquiring institution can use a basket of stock of equally questionable value to pay for the IOUs. If for some reason the acquiring institution can find someone else to unload the IOU on then it can be sold in part or in whole on the secondary market.
I admit that I'm unfairly maligning the meaning and/or intent behind the language in the SEC's proposed rules for the way an ETF operates. However, there can't be no denying (double neg intentional) that this arrangement sounds a lot like the old collateralization of mortgage debt. Additionally, this is awfully similar to the way unit investment trusts operated from 1926 to 1929. The structure of a scheme like this only works when the market continues higher or new money floods in.
Exactly what do I see wrong with the SEC language? The above text allows firms that have stock of negligible value (or a value far less than what was originally paid) exchanged to another firm that gives "creation units" which are put into the accounts of retail clients who are not interested in dealing with the failure of actively managed mutual funds. At some point after the creation units have been designated to retail clients the financial institution can then sell the creation units to willing buyers on a secondary market.
Who would be willing to buy these creation units? Well, if enough interest is drummed up through advertising and buttressed by positive press then other financial firms can justify buying these units with the hopes of selling to a new wave of retail buyers.
The blowback from something like this is on par with the unwinding of a derivative contract gone bad. I hope that my skewed interpretation of this is due to the fact that it is now 3:30am. Touc.
related article:
Exactly what do I see wrong with the SEC language? The above text allows firms that have stock of negligible value (or a value far less than what was originally paid) exchanged to another firm that gives "creation units" which are put into the accounts of retail clients who are not interested in dealing with the failure of actively managed mutual funds. At some point after the creation units have been designated to retail clients the financial institution can then sell the creation units to willing buyers on a secondary market.
Who would be willing to buy these creation units? Well, if enough interest is drummed up through advertising and buttressed by positive press then other financial firms can justify buying these units with the hopes of selling to a new wave of retail buyers.
The blowback from something like this is on par with the unwinding of a derivative contract gone bad. I hope that my skewed interpretation of this is due to the fact that it is now 3:30am. Touc.
related article:
1 comment:
Take a look at this podcast about ETF.
http://www.financialsense.com/Experts/2008/Ferri.html
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