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How ETFs are Created
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Canada is a world leader in the development of the investment product we know today as the ETF. The creation of the modern ETF has roots on Toronto Stock Exchange with a security called TIPS; short for Toronto 35 Index Participation Units. This investment product allowed investors to participate in the performance of the TSE 35 Composite Index without having to buy shares of each constituent company in the index. TIPS was followed by HIPS, a participation unit for the Toronto 100 index. These early ETFs have since been replaced by a wide variety of ETFs offered by a number of providers.
New Exchange Traded Funds (ETFs) are created when designated brokers buy the basket of securities underlying the index and exchange them with the ETF provider for newly created ETF shares. Creation units are large blocks of ETF shares, usually 100,000 or 200,000 shares per unit. The designated broker will then break up the creation units into individual ETF shares which trade on a stock exchange and can be purchased by individual investors. New ETF shares are created in the same manner to meet demand in the secondary market.
The reverse process occurs when the designated broker redeems a creation unit. The broker purchases ETF shares on the open market to form the quantity needed for one creation unit (i.e. – 100,000 or 200,000 shares as in the example above), and then turns the shares over to the ETF provider in exchange for the individual securities underlying the ETF.
Through the creation process, shares move from the ETF provider, through the designated broker, to the stock exchange and into the hands of individual investors. Through the redemption process, shares move in the opposite manner – from investor through the exchange to the broker, and finally to the ETF provider.
Most ETFs in Canada are organized as continuous offerings, meaning that additional shares may be created by the ETF provider in the same manner as the original creation units.
