What Is a Creation Unit?
A creation unit is a block of new shares sold by an exchange-traded fund (ETF) company to a broker-dealer for sale on the open market. Creation unit blocks typically range in size, anywhere from 25,000 to 600,000 shares. Broker-dealers can buy the shares in either a cash purchase or through an in-kind transaction.
- A creation unit is a block of new shares sold by an exchange-traded fund (ETF) company to a broker-dealer for sale on the open market.
- Creation units can vary in size, with most containing between 25,000 and 600,000 ETF shares each. They can be paid for either through receiving cash or in-kind shares for the transaction.
- Valued at the net asset value (NAV) of the fund, creation units have considerable risks for broker-dealers, generating either profits or losses.
How Creation Units Work
An ETF creation unit is central to the process an exchange-traded fund issuer undergoes when providing new ETF shares to the market. ETF issuers work with ETF distributors to issue new shares in creation units to broker-dealers.
Creation units are typically sold to broker-dealers, who can choose to pay for the shares in various forms. When sold, shares are valued at the fund’s net asset value (NAV). However, exchange-traded fund issuers can negotiate with broker-dealers on the terms of the sale, typically receiving cash or in-kind shares for the transaction. In-kind shares are a common way to pay for the shares in a creation unit. In-kind share transactions require the buyer to assemble a portfolio of securities which are then transferred to the issuing company as a kind of trade. Because of this exchange, creation unit sales can generate profits and losses for the broker-dealer prior to exchange listing. These profits and losses can have tax implications. Thus, broker-dealers have considerable risks when buying new creation units.
Exchange-traded fund issuers use creation units for new share issuance through broker-dealers. They also have relationships with broker-dealer trading desks, which act as authorized participants. Authorized participants are unique to open-end ETFs and serve to monitor significant deviation from a fund’s NAV in the trading market. Since ETFs trade actively throughout the day on financial market exchanges, they offer premiums and discounts to their accounting NAV. Authorized participants follow this market mechanism and help manage premiums and discounts to NAV trading.
Common Practices for Creation Units
The State Street Global Advisors SPDR Series is one of the largest in the market for ETF sector investing and offers a good example of how creation units are utilized. For starters, all funds in the Series have the same creation unit provisions. At various times, the Series issues creation units of each sector fund at the fund company’s discretion to market makers or other broker-dealers. For the SPDR series, creation units are issued in blocks of 50,000 shares. Financial institutions provide in-kind securities and/or cash for the market value of the creation unit. Creation unit transactions are facilitated by ALPS Portfolio Solutions Distributor, Inc.