BlackRock will today mark an important evolution of its iShares exchange traded funds business with the launch of a new swap-based ETF platform in London.
Until now, iShares has focused on delivering returns to investors by buying the constituents of a benchmark index.
The new approach, widely used by competitors, will mean iShares has to buy over-the-counter derivatives from an investment bank to provide investors with exposure to a benchmark.
iShares said its move to offer swap-based ETFs was in response to requests from clients for exposure to markets or asset classes that can be hard to access due to operational or liquidity constraints.
Axel Lomholt, iShares head of product development for Europe and the Middle East, said the launch of swap-based ETFs did not imply loss of faith in existing products.
“ iShares remains committed to its physically backed ETF offering, which we believe continues to be the most effective and efficient way for investors to access mainstream asset classes,” said Mr Lomholt.
Physical replication “will always be our first option when launching products”, he added.
Just two swap-based ETFs will be launched initially, offering exposure to the Russian and Indian stock markets.
The iShares MSCI Russia Capped Swap ETF and the iShares S&P CNX Nifty India Swap ETF will have a total expenses ratio of 0.74 per cent and 0.85 per cent respectively.
The launch of swap-based ETFs is the first big new initiative for iShares since it was acquired by BlackRock, the world’s largest asset manager, as part of the $13.4bn Barclays Global Investors deal in 2009.
With assets of almost $470bn at the end of the second quarter, iShares is the largest ETF player in the world, commanding almost 46 per cent of the global market.
However, its previously strict adherence to physically replicated ETFs has allowed other providers an advantage in developing new products such as commodity-linked exchange traded products that use swaps to provide returns.
Mr Lomholt would not be drawn on plans for further product launches but industry observers said the shift should allow iShares to step up competition with other providers as swap-based ETFs have been winning a growing share of the market in Europe in recent years.
The number of swap-based ETFs available in Europe rose to 602 by July 2010 from just 27 in 2005, outpacing growth in physical replication ETFs, which have increased from 138 to 364 over the same period.
Providers of swap-based ETFs, usually investment banks, prefer to sell these products as they can generate valuable revenues from securities lending, synthetic swaps and dividend enhancement programmes.
These revenues are shared with the ETF manager and help to keep charges for investors low, although the majority is usually retained by the parent investment bank.
Swap-based ETFs have been widely criticised for a lack of transparency and for exposing investors to counterparty risk.
To ensure transparency, iShares is to publish daily collateral and index holdings and its aggregate swap exposure on its website.
It will also employ multiple swap counterparties (initially RBS, Credit Suisse and UBS) to reduce counterparty risk, and will require them to provide collateral up to 120 per cent of the investor’s exposure.
Mr Lomholt said both regulators and product providers were working towards a mutual goal - increased transparency of models, methodologies and products.
Reflecting the current heated competition among providers, Credit Suisse also launched a new range of swap-based ETFs last week. In an effort to increase transparency and minimise counterparty risk, Credit Suisse has promised to disclose all the holdings of its swap-based ETFs daily and to make sure their value matches that of the indices the funds are tracking.
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