Authorized Participant (AP)
An Authorized Participant (AP) is usually a large financial institution, like a market maker, which is responsible for obtaining the underlying assets necessary to create and run an ETF. In short, in the case of gold ETFs, it buys gold and delivers it to the ETF provider. In turn, it gets a block of equally-valued (based on NAV) ETF shares, called a ‘creation unit’. The AP may resell these shares for profit. It may also redeem creation units to get the bullion back (only APs can create or redeem ETF’ shares, retail investors can only resell them in the market).
The authorized participants play a critical role in the redemption mechanism which keeps an ETF’s shares in line with the fund’s NAV. When an AP notices that the ETF shares are overpriced (above the fund’s NAV), it purchases gold bullion and sells the ETF shares in the open market. Conversely, if the ETF shares are undervalued (below the fund’s NAV), the AP buys the ETF shares, redeems them for gold bullion which can be resold. In both scenarios, the AP’s actions drive the ETF’s share price toward fair value (fund’s NAV). Although the arbitrage process is not perfect, it works reasonably well. As the GLD vs. NAV chart below shows, GLD shares are trading at fair value most of the time.
Chart 1: The price of GLD (green line) and the SPDR Gold Trust’ Net Asset Value (red line) for the last twelve months.
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