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November 11, 2010
Transparency of Swap-based ETFs
October 8, 2010
STRICTLY PRIVATE & CONFIDENTIAL
Professional Clients Only
Martin Bednall Director, Product Development iShares EMEA
Agenda
October 8, 20102
• Review of how the European ETF structures have evolved – Physical structure– Swap overview– Unfunded swap ETF– Funded swap ETF– Dublin iShares Swap Platform
• Investors view: criteria to evaluate, questions to ask
• Highlighting the benefits to investors from a fully transparent swap-based product
Physical ETF Structure
Investor
Physical ETF
CashIndex Constituents
Cash or In- specie
ETF
Market
AP
Cash ETF
The fund gains exposure through holding the index constituents directly. Additional revenue can be received through securities lending arrangements.
Securities Lending
Loan
SL Fee
Securities Lending Agent
Securities held are ring-fenced in a custody account in the funds name
3 October 8, 2010
EVOLUTION
Phase 1
Phase 2.1
Phase 2.2
Phase 3
Over collateralised swap exposure
Multiple swap counterparties
Transparency
Source: BlackRock. For illustrative purposes only.
Swap-based ETF Structures
4 October 8, 2010
Swap ETF Structures: Unfunded Swap
Investor
Swap ETF
Swap
CashBasket Return Stock
BasketIndex
Return
Cash
ETF
Swap Collateral
Swap Counterparty
AP
Single – Swap counterparty
Cash ETF
The fund enters into a swap with a single counterparty (or multiple counterparties) to receive the index performance in return for a stock basket return purchased by the fund with the investor’s cash, which collateralises the swap notional.
Other Swap CounterpartiesMulti – Swap Models Exist
5 October 8, 2010
Swap ETF Structures: Funded Swap
Investor
Swap ETF
Total Return Swap
CashReceivable
(cash principal)
Index Total
Return
Cash
ETF
Swap Counterparty
AP
Single – Swap counterparty
Cash ETF
The fund enters into a funded swap with a single counterparty (or multiple counterparties) to receive the index total return. The fund pays over the cash notional to the swap counterparty who uses the cash to hedge the exposure. The counterparty posts collateral
Other Swap CounterpartiesMulti – Swap Models Exist
Collateral Pool
May be over- collateralised
This may be a tri-party collateral agreement
Swap counterparty uses cash to hedge the swap by buying securities to provide index performance
The counterparty can post UICTS quality assets
already within its inventory as collateral
6 October 8, 2010
7
iShares Dublin Swap-based ETF Platform
FullyFundedSwap
All cash is transferred to the swap counterpartiesOne swap per counterparty per fundSwap pays index performance +/- swap spreadStart with 3 counterparties (RBS, UBS, Credit Suisse)First funds: India (Nifty Fifty) and Russia (MSCI Russia Capped)
Tri-Party
Collateral
Counterparty exposure collateralised via tri-party arrangementsApproved collateral schedule including equities with 20% over-collateralisationCash transferred to counterparty only when position fully collateralisedCollateral moved daily
Improving the Transparency of Swap-based
ETFs
‘Swap’ in the fund nameSwap counterparties namedSwap spreadIndex constituents displayed on the web (subject to index provider restrictions)Collateral holdings updated daily (yesterday’s positions shown on the web)Swap exposures shown on web
October 8, 2010
iShares remains committed to physical replication
• As of 30 December 2009 Irish UCITS can now collateralise OTC derivative exposure subject to:– Only equities traded on stock exchanges in the certain (developed) countries– 20% over-collateralisation– Diversification (no more than 10% in any one entity)– Liquidity (we will apply a 40% average daily volume limit for all securities
posted by a counterparty)– Counterparties own equity not allowed
• G10 Government bonds (margin)– Remaining maturity less than 1 year (100%) – Remaining maturity greater than 1 year less than 5 years (101%) – Remaining maturity greater than 5 years less than 10 years (102%) – Remaining maturity greater than 10 years less than 30 year (103%)
Collateral Schedule
8 October 8, 2010
9
Investor’s View: Criteria to Evaluate, Questions to Ask
Counterparty exposure
management
Does the fund undertake securities lending?How is this managed? What is the collateral process?How many counterparties provide swaps to the fund?How independent are the swap providers?At what exposure level is the swap reset?What level of collateral is posted to protect the fund?How liquid is the collateral?
How easy is it to
evaluate the funds?
How clear is the fund structure?How easy is it to get the collateral positions? How often is this
updated? Is it in a format which allows you to analyse?Are their clear rules in how the collateral is managed?Can you easily tell who provides swaps to the fund?Is it easy to see any uncollateralised exposures?
Transparency is key
October 8, 2010
Without transparency, how do you know what you are buying?
Why is Transparency Important?
10 October 8, 2010
iShares Unique Level of Transparency
The new iShares swap-based ETFs offer unique level of transparency in line with our physical-based fund range
iShares Swap-based ETFsAvailability
of data Update frequency
Collateral holdings Yes Daily
Index holdings Yes Depends on an index provider
Swap counterparties Yes Daily
Swap pricing Yes Daily
Aggregate counterparty exposure
Yes Daily
11 October 8, 2010
Transparency in Action
12 October 8, 2010
Key Facts Tab
13 October 8, 2010
Collateral Tab
14 October 8, 2010
• ETFs have evolved over time and not all swap-based ETF are created equal
• Investors should demand– Good counterparty risk management– High degree of transparency
• iShares has developed a leading edge swap-based ETF platform– Transparent– Multi-counterparty– Over-collateralised with liquid collateral
• iShares remain committed to physical replication ETFs
Key Summary Points
15 October 8, 2010
Disclaimer
Regulatory InformationBlackRock Advisors (UK) Limited, which is authorised and regulated by the Financial Services Authority ('FSA'), has issued this document for access in the UK only and no other person should rely upon the information contained within it. iShares plc, iShares II plc, iShares III plc, iShares IV plc and iShares V plc (together 'the Companies') are open-ended investment companies with variable capital having segregated liability between their funds organised under the laws of Ireland and authorised by the Financial Regulator.
For investors in the UKThis document is directed at 'Professional Clients' only within the meaning of the rules of the FSA. Certain of the funds mentioned in this document are not registered for public distribution in the UK. In respect of these funds, this document is intended for information purposes only and does not constitute investment advice or an offer to sell or a solicitation of an offer to buy the funds described within and no steps may be taken which would constitute or result in a public offering of the funds in the UK. This document is strictly confidential and may not be distributed without authorisation from BlackRock Advisors (UK) Limited. With respect to the funds that are registered for public distribution in the UK, most of the protections provided by the UK regulatory system do not apply to the operation of the Companies, and compensation will not be available under the UK Financial Services Compensation Scheme on its default. The Companies are recognised schemes for the purposes of the Financial Services and Markets Act 2000. Important information is contained in the relevant prospectus, the simplified prospectus and other documents, copies of which can be obtained by calling 0845 357 7000, from your broker or financial adviser, by writing to BlackRock Advisors (UK) Limited, iShares Business Development, Murray House, 1 Royal Mint Court, London EC3N 4HH.
Restricted InvestorsThis document is not, and under no circumstances is to be construed as, an advertisement, or any other step in furtherance of a public offering of shares in the United States or Canada. This document is not aimed at persons who are resident in the United States, Canada or any province or territory thereof, where the Companies are not authorised or registered for distribution and where no prospectus for the Companies has been filed with any securities commission or regulatory authority. The Companies may not be acquired or owned by, or acquired with the assets of, an ERISA Plan.
Risk WarningsiShares may not be suitable for all investors. BlackRock Advisors (UK) Limited does not guarantee the performance of the shares or funds. The price of the investments (which may trade in limited markets) may go up or down and the investor may not get back the amount invested. Your income is not fixed and may fluctuate. Past performance is not a reliable indicator of future results. The value of the investment involving exposure to foreign currencies can be affected by exchange rate movements. We remind you that the levels and bases of, and reliefs from, taxation can change. Affiliated companies of BlackRock Advisors (UK) Limited may make markets in the securities mentioned in this document. Further, BlackRock Advisors (UK) Limited and/or its affiliated companies and/or their employees from time to time may hold shares or holdings in the underlying shares of, or options on, any security included in this document and may as principal or agent buy or sell securities. In addition, investing in emerging markets involves certain risks and special considerations not typically associated with investing in other markets.
16 October 8, 2010
Disclaimer
Index Disclaimers
iShares funds are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such funds or any index on which such funds are based. The Prospectus contains a more detailed description of the limited relationship that MSCI has with BlackRock Advisors (UK) Limited and any related funds.
'Standard & Poor’s®', 'S&P®', 'S&P CNX Nifty' are trademarks of The McGraw-Hill Companies, Inc. and have been licensed for use by BlackRock Advisors (UK) Limited.iShares S&P CNX Nifty India Swap is not sponsored, endorsed, sold or promoted by S&P and S&P makes no representation regarding the advisability of investing in this product.
'iShares' is a registered trademark of BlackRock Institutional Trust Company, N.A. All other trademarks, servicemarks or registered trademarks are the property of their respective owners. © 2010 BlackRock Advisors (UK) Limited. Registered Company No. 00796793. All rights reserved. Calls may be monitored or recorded.
The Dublin domiciled funds which include the term ‘swap’ in their names are swap based funds. These funds enter into fully funded swap agreements with counterparties to obtain the performance of the funds’ respective benchmarks. Swap transactions are subject to the risk that counterparties may default on their obligations. If this were to occur, the relevant fund may sustain a loss. The funds intend to mitigate much of their credit risk exposure to each counterparty by obtaining collateral from the counterparty which will be held by a third party collateral agent. In the event of a default by a counterparty or collateral agent, the swap funds may still have some counterparty risk exposure to the defaulting counterparty or collateral agent respectively. In some circumstances, counterparties can terminate the swap agreements early which may impact the returns of the funds. In addition, the counterparties may seek to pass on any additional costs relating to the hedging of their risk exposure under the swaps to the relevant fund. In the event that a swap fund is unable to enter into suitable swap arrangements or maintain swap arrangements on acceptable terms, the fund may not be able to achieve its investment objective and policy unless it is able to track its benchmark by other means.
Specific Indian wording only for the iShares S&P CNX Nifty India Swap
Shares in the iShares S&P CNX Nifty India Swap have not been and will not be registered under the laws of India and are not intended to benefit from any laws in India promulgated for the protection of shareholders. Shares in the iShares S&P CNX Nifty India Swap are not being offered to, and may not be, directly or indirectly, sold or delivered within India, acquired by, transferred to or held for the benefit of (i) any “person resident in India” as such term is defined in the Indian Foreign Exchange Management Act 1999 (as amended or supplemented from time to time), (ii) any person who is a “Non-Resident Indian”, an “Overseas Corporate Body” or a “Person of Indian Origin” as such terms are defined in the Indian Foreign Exchange Management (Deposit) Regulations 2000 (as amended or supplemented from time to time), (iii) any person for re-offering or re-sale, directly or indirectly, in India or to a resident of India or any entity incorporated or registered in Indian, and/or (iv) any person who has the intention of purchasing shares in the fund to circumvent or otherwise avoid any requirements applicable under the Securities and Exchange Board of India (Foreign Institutional Investors) Regulations 1995 (as amended or supplemented from time to time) and/or any other subsidiary regulations or circulars issued pursuant thereto, each an “Indian Origin Restricted Entity”. iShares IV plc does not knowingly permit the sale of such shares or any beneficial interests therein to Indian Origin Restricted Entities.
A prospective investor in the iShares S&P CNX Nifty India Swap may be required at the time of acquiring shares (or subsequently) to represent that such investor is not, and is not acquiring shares for or on behalf of, an Indian Origin Restricted Entity. Shareholders in the iShares S&P CNX Nifty India Swap are required to notify iShares IV plc and its investment manager immediately in the event that they become, or hold shares for the benefit of, Indian Origin Restricted Entities. Any person who breaches any of the above restrictions shall indemnify and hold harmless iShares IV plc, its manager and its investment manager from any losses or claims suffered or incurred by any of them in connection with such breach. If it comes to the attention of iShares IV plc that any shares in the iShares S&P CNX Nifty India Swap are legally or beneficially owned by any person in breach of the above restrictions, it may compulsorily redeem the shares so held.
iShares IV plc (and its investment manager) may be required by the swap counterparties, in accordance with the requirements or requests of the Securities and Exchange Board of India or any other Indian governmental or regulatory authority, to provide information relating to its shareholders and/or beneficial owners. By investing in the iShares S&P CNX Nifty India Swap, investors are deemed to consent to any such disclosure. Shareholders may be required to provide information on themselves and beneficial owners of the shares. If any shareholder or beneficial owner fails to disclose the requested information, iShares IV plc may compulsorily redeem their shares in the iShares S&P CNX Nifty India Swap.
Further, the counterparties to the swap agreements for the iShares S&P CNX Nifty India Swap require assurances in the swap agreements that iShares IV plc will not dispose of the swaps to an Indian Original Restricted Entity and that iShares IV plc will provide information on shareholders and beneficial owners of shares in the iShares S&P CNX Nifty India Swap to the counterparties in connection with such assurances. iShares IV plc may be unable to comply fully with such requirements as it has no control over the transfer of shares of the iShares S&P CNX Nifty India Swap on the secondary market and, as a consequence, it is possible that the counterparties may ultimately seek to terminate the swap agreements.
17 October 8, 2010