J. Parsons Interview

By Jim Wiandt, Managing Editor

J. Parsons, Director of Sales for U.S. Individual Investor Business at Barclays Global Investors, talks to Jim Wiandt about how exchange-traded funds are traded.

Editor's Note: All terms in bold text are defined in a glossary at the end of the interview.

Jim Wiandt: When a creation unit for an ETF is first formed, is it a market maker who decides that unit is going to be formed and then approaches you?

J. Parsons: Yes. We use the term "market maker" with respect to the advertising, because it's emblematic in peoples' minds of what the function is. Technically, within the prospectus, you'll see the term "Authorized Participants."

And so those terms are synonymous. But the Authorized Participants have signed an agreement with us, allowing them to do the creation and the redemption. So they're set up. They would then, at some period during the day, call SEI (Simulated Environments Inc.) systems and say, "I'd like to place an order for X creation units of such and such a fund." That then triggers the whole process of the creation. Do you want me to run through the whole cycle for you?

JW: Please.

JP: At the end of the day, SEI then places the order with National Securities Clearing Corporation (NSCC), which is a part of the Depository Trust Company (DTC). And basically that kicks off the settlement process. And what the NSCC does is look into the DTC box of the authorized participant to make a match. Let's use the S&P 500 so I can actually discuss some real numbers. They would look in the box for the 500 securities that are needed to match up with the portfolio composition file. And they have to be in deliverable form - they could be borrowed shares - but they have to not be assigned. And they then post, if you will, that trade. So what the authorized participant will see is in effect a transfer out of their box of 500 securities and a transfer into their box of 50,000 iShares, one creation unit. And that would be for a three-day settlement forward.

JW: Where do iShares go ultimately?

JP: The underlying assets then go into the 500 securities that came out of the AP's DTC box and into the fund, into the [40-Act] fund that we have created.

JW: You're holding those?

JP: Correct. The fund is. So the iShares, the S&P 500 Fund, are organized under the iShares Trust Board family. The fund family is called the iShares Trust. And they're the actual holders of that, but obviously it stays with DTC also. And it requires for all 500 securities to be in transferable form for the issuance of the 50,000 shares of the underlying iShare.

JW: Then you issue that through the NSCC. Who holds all the paperwork?

JP: SEI is the fund administrator, so they're the ones that are basically keeping track of the net asset value, the shares outstanding, etc., just to make sure that the fund evaluation is correct.

JW: When the trading starts, do you select specialist firms who set the ask/bid?

JP: Correct, we work in conjunction with the exchanges to select what we feel are the best specialists for each type of market that we're looking at.

JW: So basically SEI is doing all the management?

JP: SEI is doing the fund distribution work. BGI, Barclays Global Fund Advisors, is the fund manager.

JW: So you're tracking the indexes and making sure that everything matches with the ETFs?

JP: Yes. In-house here, using the portfolio management team on both the domestic and the international fund side. They look at the fund itself to make sure it has the right stocks in it, that the dividends are being reinvested, and that it's being managed the way we manage an index fund. And they also then look at the changes that are going on in the indexes themselves and produce each night what's called the PCF, or the Portfolio Composition File, that then gets posted out to the NSCC that determines what we will accept for a creation or what we'll pass out for a redemption. So they're creating that file. And then in each, any rebalancing changes that need to be done with the portfolio itself to reflect the index changes are done by the portfolio managers here.

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