Synthetic replication strategies. ETFs utilising a synthetic replication strategy use swaps or derivative instruments to gain exposure to a benchmark. Currently, synthetic replication ETFs can be further categorised into two forms:
(i) Swap-based ETFs
(A) Total return swaps allow ETF managers to replicate the benchmark performance of ETFs without purchasing the underlying assets.
(B) Swap-based ETFs are exposed to counterparty risk of the swap dealers and may suffer Losses if such dealers default or fail to honor their contractual commitments.
(ii) Derivative embedded ETFs
(A) ETF managers may also use other derivative instruments to synthetically replicate the economic benefit of the relevant benchmark. The derivative instruments may be issued by one or multiple issuers.
(B) Derivative embedded ETFs are subject to counterparty risk of the derivative instruments’ issuers and may suffer Losses if such issuers default or fail to honor their contractual commitments Even where collateral is obtained by an ETF, it is subject to the collateral provider fulfilling its obligations. There is a further risk that when the right against the collateral is exercised, the market value of the collateral could be substantially less than the amount secured resulting in significant loss to the ETF.
Synthetic replication strategies. ETFs utilising a synthetic replication strategy use swaps or other derivative instruments to gain exposure to a benchmark. Currently, synthetic replication ETFs can be further categorized into two forms:
1. Swap-based ETFs
2. Derivative embedded ETFs
