Actively Managed ETF Creation via AP Representatives

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Solution Overview

Problem

The Securities and Exchange Commission (SEC) requirements for SEC-approved Exchange Traded Funds (ETFs) have impeded the creation of actively managed ETFs, particularly those focused on equity securities, due to concerns about disclosing portfolio securities identities, which can reveal investment strategies and affect pricing.

Innovation Solution

The implementation of mechanisms allowing authorized participants (APs) to create and redeem ETF shares without directly delivering or receiving portfolio securities, using a blind trust, power of attorney, or agency agreements to maintain confidentiality, and employing AP representatives to manage creation and redemption processes while ensuring the identity of portfolio securities is not disclosed.

Engineering Contradictions & Design Principles

VSEngineering Contradiction Analysis

1Ease of operation

If APs directly deliver portfolio securities to ETF for creation, then creation process is simple and direct, but portfolio security identities are disclosed to APs revealing investment strategy

Engineering Contradiction:

Improvecreation process simplicityVSAvoidportfolio security identity confidentiality

Core Design Contradiction:

Ease of operationVSLoss of information

Solution Approach 1:

The patent introduces an intermediary mechanism where the ETF custodian holds portfolio securities in a blind trust account, preventing direct disclosure of security identities to APs while still enabling creation transactions. The custodian acts as a mediator between the ETF and AP, maintaining confidentiality while facilitating the creation process through indirect delivery mechanisms.

Inventive Principle:

Principle #24Intermediary (Mediator)

2Loss of information

If SEC requires daily publication of portfolio holdings, then transparency is improved, but actively managed ETF creation is impeded due to strategy revelation risk

Engineering Contradiction:

Improveportfolio holdings transparencyVSAvoidactively managed ETF creation

Core Design Contradiction:

Loss of informationVSEase of manufacture

Solution Approach 1:

The patent segments the portfolio holdings into two categories: publicly disclosed aggregate holdings and confidential individual security identities. The ETF publishes aggregate portfolio information for transparency while maintaining confidentiality of specific security identities through the blind trust mechanism, allowing active management without strategy revelation.

Inventive Principle:

Principle #1Segmentation

3Ease of operation

If APs receive portfolio securities during redemption, then redemption process is straightforward, but APs learn investment strategy through security identities

Engineering Contradiction:

Improveredemption process simplicityVSAvoidinvestment strategy confidentiality

Core Design Contradiction:

Ease of operationVSLoss of information

Solution Approach 1:

During redemption, the custodian acts as an intermediary who receives portfolio securities from the blind trust and provides them to APs without disclosing their identities. The AP receives securities through the custodian's intermediary process, maintaining the simplicity of redemption while preventing strategy revelation through confidential handling of security identities.

Inventive Principle:

Principle #24Intermediary (Mediator)

Data Source

PatentUS7813987B1Actively managed exchange traded fund using AP representatives for creation and redemption

Publication Date: 2010.10.12 D12 VENTURES LLC

AI summary

An ETF creation and redemption mechanism for use in managed Exchange Traded Fund (ETF) that retains the confidentiality of the ETF assets. An agency relationship is established with an AP representative who receives the underlying securities from the ETF as part of a like kind exchange in a redemption event. In an alternative embodiment, the AP representative may be used to obtain the portfolio securities as directed by the ETF to perform a creation event. The representative relationship is preferably established by an authorized participant (AP) according an agreement between the AP and the ETF.