- Under an unfunded swap, the swap counterparty provides to a synthetic passive ETF an exposure to the economic gain (or loss) in the performance of the underlying index. The synthetic passive ETF, in return, provides to the swap counterparty an exposure to the economic gain (or loss) in the performance of an asset portfolio purchased with the net proceeds from issue of its shares.
Under an unfunded swap, as illustrated in the diagram below, the synthetic passive ETF will receive from the counterparty, through the unfunded swap, an exposure to the economic gain (or loss) in the performance of the underlying index (net of fees, charges and indirect costs, if applicable). In return, the synthetic passive ETF will, under the unfunded swap, provide the counterparty an exposure to the economic gain (or loss) in the performance of a portfolio of assets which the fund will purchase with the net proceeds from issue of its shares. The synthetic passive ETF will own that portfolio of assets.
Similar to the situation under a funded swap, the synthetic passive ETF manager will manage the fund with the objective to reduce to nil its single counterparty net exposure. In other words, the net value of the portfolio of assets, marked to market at the end of each trading day, shall be no less than 100% of the net asset value of the fund. Where the fund’s gross exposure to a counterparty exceeds 0% at the end of each trading day, the counterparty will generally make cash payments to the fund to limit the net exposure of the fund to that counterparty to no more than 0% of its net asset value.
Therefore, if a synthetic passive ETF invests in an unfunded swap when adopting a synthetic replication investment strategy, the fund manager will be required to disclose the components of the invested assets portfolio and their top 10 holdings in the portfolio on their websites. Such information will have to be updated on a weekly basis.