The ETF creation and redemption process takes place in the primary market between the ETF issuer and authorised participants (APs). APs are entities chosen by an ETF issuer to undertake the responsibility of obtaining the underlying assets needed to create an ETF. Authorised participants are typically large institutional organisations, such as market makers.
Authorised participants create ETF shares in large increments—known as creation units—by assembling the underlying securities of the fund in their appropriate weightings to reach creation unit size, which vary from 25,000 to 100,000 shares.. The AP then delivers those securities to the ETF issuer (like us at SPDR ETFs).
In return, the ETF issuer bundles the securities into the ETF wrapper, and delivers the ETF shares to the AP. These newly created ETF shares are then introduced to the secondary market, where they are traded between buyers and sellers through the exchange.
When demand increases, more ETF shares can be created using this process. In effect, this allows the liquidity of an ETF’s underlying securities to enhance the liquidity of the ETF itself.
APs can also redeem ETF shares by reversing this process. Large increments of ETF shares—known as redemption units—are collected in the secondary market and then delivered to the ETF issuer in exchange for the underlying securities in the appropriate weighting equaling that redemption unit
As redemption is the opposite process to creation, when demand decreases, the ETF can be dissembled back into single securities.
As a result of the creation/redemption process, the ETF’s portfolio manager typically does not need to buy or sell securities except for rebalancing purposes.