The creation of ETFs (Exchange-Traded Funds) involves a behind-the-scenes process known as the “creation and redemption mechanism” — a unique system that helps keep ETF prices aligned with the value of their underlying assets.

The ETF Creation Process

1.ETF Issuer Designs the ETF

A company like Vanguard, BlackRock (iShares), or State Street (SPDR) creates an ETF.

The issuer defines:

The index or assets it will track (e.g., ASX200, gold, tech stocks)

The fund structure, rules, and expense ratio

But the issuer doesn’t sell ETF shares directly to investors. Instead, they work with Authorized Participants (APs).

2.Authorized Participant (AP) Delivers the Underlying Assets

The AP (often a big investment bank or trading firm) gathers the exact basket of assets that the ETF wants to hold.

Example: For an ASX200 ETF, the AP collects shares of all 200 companies in the correct proportions.

The AP delivers these assets to the ETF issuer.

3.ETF Shares Are Created

In exchange for the basket of securities, the issuer gives the AP a block of ETF shares — usually 50,000 shares, called a Creation Unit.

These shares are then sold on the stock exchange, where regular investors can buy them.

Summary of the Creation Process:

1. AP assembles the ETF’s underlying assets
2. AP delivers them to the ETF issuer
3. ETF issuer gives AP new ETF shares
4. AP sells ETF shares to investors on the exchange

 What About Redemption?

It’s the reverse process:

When APs want to remove ETF shares from the market, they redeem them by:

Returning ETF shares to the issuer

Receiving the underlying assets in exchange

This keeps supply and demand in balance, and it helps the ETF trade close to its Net Asset Value (NAV).

Why This Matters

This creation/redemption system:

Keeps ETF Prices Close to NAV

If ETF prices deviate from the value of the underlying assets, APs can profit by arbitraging — buying or selling ETF shares and the underlying basket — until prices realign.

Provides Liquidity

ETFs don’t need to hold cash to meet redemptions like managed funds do. That makes them more tax-efficient and liquid.

Supports Tax Efficiency

Because redemptions are done in-kind (exchanging shares for securities, not cash), the fund avoids triggering taxable events.

Lauren Hua is a private client adviser at Fairmont Equities.

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