- Under an unfunded swap, the swap counterparty provides to a synthetic ETF an exposure to the economic gain (or loss) in the performance of the underlying index. The synthetic 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 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 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 ETF will purchase with the net proceeds from issue of its shares. The ETF will own that portfolio of assets.
Similar to the situation under a funded swap, the synthetic ETF manager will manage the ETF so that its net exposure to each single party is no more than 10% of the net asset value of the ETF. 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 90% of the net asset value of the ETF. Where the ETF's gross exposure to a counterparty exceeds 10% at the end of each trading day, the counterparty will make cash payments to the ETF to limit the net exposure of the fund to that counterparty to no more than 10% of its net asset value.
Therefore, if a synthetic ETF invests in an unfunded swap when adopting a synthetic replication investment strategy, the ETF 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 monthly basis.