The Evolution of Swap-based ETFs

For professional investors only The Evolution of Swap-based ETFs September 2010

Increased investor interest in exchange-traded products has led to the rapid growth of the European ETP market in recent years with assets under management rising from 54.5bn at the end of March 2006 to close to 183bn at the end of March 2010. This has been characterised by substantial asset gathering in both physical- and swap-based ETFs as the market has continued to grow and attract new entrants. The proliferation of new products, with their own unique exposures, structures, risks and tax implications has made the market increasingly complex from an investor perspective. Transparency in some of the new products leaves much to be desired and investors need to research them thoroughly in order to select the most suitable structure and understand the risks involved. This paper looks closely at the evolution of ETF structures and assesses them with respect to the key areas of transparency, diversification of counterparty risk, and trading.

3 The Evolution of Swap-Based ETFs The Evolution of Swap-Based ETFs Table of contents Introduction................................................................................................................................ 1 Why structure matters: looking back at 2008............................................................................ 1 Evolution of swap-based ETF structures.................................................................................... 2 The mechanics of physical-based ETFs...................................................................................... 3 The mechanics of swap-based ETFs........................................................................................... 4 ishares new swap-based ETFs: primary and secondary markets overview................................ 9 ishares new swap-based ETFs: setting the standard for ETF transparency............................. 10 Other ways to get exposure to difficult to access asset classes: ETNs................................... 10 Conclusion................................................................................................................................ 11 ishares Europe Sales Strategy Sofia Antropova Sales Strategist +44 20 7668 4078 sofia.antropova@blackrock.com Vasiliki Pachatouridi Sales Strategist +44 20 7668 4116 vasiliki.pachatouridi@blackrock.com Yvonne Sandford Research Associate +44 20 7668 8162 yvonne.sandford@blackrock.com Wei Li Sales Strategist Wei.li2@blackrock.com +44 20 7668 4762 Dr. Stephanie Lang Sales Strategist +49 89 42729 5841 stephanie.lang@blackrock.com For further information please e-mail insights@ishares.co.uk

1 The Evolution of Swap-Based ETFs Introduction Investor use of ETFs and ETPs in Europe has continued to grow at a rapid pace with 183bn of assets under management at the end of March 2010, compared to 106bn at the end of 2008. The growth of the market has been characterised by investors choosing to use ETFs to gain access to a wide range of asset class exposures. ishares ETF product offering has predominantly been represented by physical-based ETFs that hold the underlying securities, both in the equity and fixed income space. These continue to offer a powerful combination of portfolio transparency, trading efficiency and clarity of investment objective which is to manage asset class exposures on behalf of the investors in the ETFs. In the context of this strategy ishares has always recognised the value of swap-based structures in providing access to markets where the assets are either difficult to hold in a physical form or where UCITS III compliance may be difficult due to index-related issues. In order to expand its asset class coverage and equity exposure, ishares is launching a new range of swap-based Exchange Traded Funds (ETFs) that offer multiple swap counterparties, over collateralised* swap exposure, and full transparency of collateral holdings and fund exposures. This development is in response to the rapidly growing investor appetite for difficult to access markets combined with a desire for transparency, simplicity and security when investing in swap-based funds. Why structure matters: looking back at 2008 2008 was a year of exceptional risks across a wide variety of asset classes; equity, fixed income, property and commodity investments experienced record-high levels of volatility. Increased counterparty default risk, illiquidity and a lack of market confidence changed investor attitudes to issuer risk. There was a meaningful decrease of flows into certificates, structured notes and other financial instruments that offer low transparency and high counterparty risk exposure. Instead, flows increased into exchange traded and transparent instruments with marginal counterparty risk such as physical-based ETFs showing an investor preference for simple, transparent and low issuer-risk investment vehicles. Although market conditions have changed and many lessons have been learnt over the past two years it is apparent that investors have a preference for products that are easier to understand. Both regulators and product providers are working towards a mutual goal increased transparency of products, models and methodologies to satisfy investor demand for safe and transparent financial instruments. ishares unique approach delivers the access to difficult markets and asset classes via swaps whilst maintaining our commitment to transparency, service and risk management. Multiple swap counterparties and multi-dealer primary and secondary market models ensure best execution for the client. The quality of collateral and over collateralisation protects from counterparty default risk at all times. Lastly, the ability to see daily collateral and index holdings, swap spreads and aggregate swap exposure on the ishares website ensures these funds retain the same market leading level of transparency as our physical-based ETFs. * In this context, over collateralisation means that the aggregate market value of collateral taken will exceed the overall counterparty exposure.

2 The Evolution of Swap-Based ETFs The Evolution of Swap-Based ETFs 2 Evolution of swap-based ETF structures In the European market, there are two major ETF structures available: physical-based and swap-based funds. Within these two categories, there are further distinctions. Physical-based ETFs can be either fully replicated or optimised. Swap-based funds can have collateralised or uncollateralised counterparty exposure and a single counterparty or multiple counterparties. The evolution of the structures offered within the swap-based ETF market over recent years is summarised in Table 1. A physical-based fund structure was used in 1993 when the first USlisted ETF, benchmarked to the S&P 500 index, was launched. Since then, many more ETFs have entered the market and the majority of global ETF assets are currently held in physical-based ETFs. The first swap-based ETFs emerged in Europe in 2001. The distinctive feature of the original swap-based funds was that the ETF provider and the swap counterparty (the investment bank providing the swap) were usually the same company. This structure, which was an evolution of the structured product, certificates and notes business in Europe, allowed investment banks to efficiently utilise product related inventory, but also exposed investors to counterparty risk and lacked the transparency historically offered by physical-based ETFs. Figure 1 shows how European ETF Assets Under Management (AUM) have increased from 2000 to date. This chart depicts both physical-based and swap-based funds. The fact that the market consists of two distinctive forms of ETFs coupled with the fact there are substantial differences within the individual product structures means that it is important to consider in detail the various types of physical-based and swap-based ETFs. Table 1: Swap-based ETF structures Phase Year of Number of swap Swap exposure Collateralisation Transparency market entry counterparties 1. 2001 Single counterparty Up to 10% No collateral No 2.1 2009 Multiple counterparties Up to 10% No collateral No 2.2 2009 Single counterparty N/A Up to 20% over collateralisation No 3. 2010 Multiple counterparties N/A Up to 20% over collateralisation Source: BlackRock. For illustrative purposes only. Full transparency of holdings, pricing, exposure and swap counterparties Figure 1: The ETF market in Europe AUM (US$bn) 250 Phase 2.2: First swap-based ETF with over-collateralised exposure Phase 2.1: First swap-based ETF with multiple counterparties Phase 3: ishares Dublin-domiciled swap-based ETFs 900 800 200 150 Phase 1: First swap-based ETF in Europe 700 600 500 100 50 First physical-based ETF in Europe 400 300 200 100 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 AUM All (US$bn) AUM Physical (US$bn) AUM Swap-based (US$bn) # All ETFs # ETFs Physical # ETFs Swap-based Note: Swap-based ETF data is not available before 2005. Source: Global ETF Research and implementation Strategy Team, BlackRock, Bloomberg, as at end December 2009.

3 The Evolution of Swap-Based ETFs The mechanics of physical-based ETFs An important feature of physical-based bond and equity ETFs is that they hold all, or a substantial part, of the index constituents in the fund s underlying basket. The investor is then exposed to the return generated by the underlying basket of assets, adjusted for costs and revenues (taking into account factors such as the total expense ratio (TER) and the addition of any securities lending revenue). Depending on the benchmark, complexity, breadth of holdings, liquidity and ease of access to the underlying securities, physical-based funds can be either fully replicated or optimised. A fully-replicated fund structure is normally used for blue-chip developed market benchmarks, such as the FTSE 100, EURO STOXX 50 or S&P 500. The stocks included in these indices are typically liquid and easy to access and normally the ETF holds all the stocks in the weighting defined by the index. This is shown in Figure 2. The optimisation approach is typically used for very broad indices with a large number of constituents (i.e. Barclays Capital Euro Aggregate Bond Index with close to 3,200 bonds) or those indices tracking illiquid stocks or bonds, where full replication would be either difficult or costly and inefficient (i.e. MSCI Emerging Markets Index). This is shown in Figure 3. In both of the above examples, the fund s assets are held in a ring-fenced segregated account or a ring-fenced fund company, which eliminates fund/issuer risk. There is a high level of transparency with physical-based ETFs, which is widely cited by investors as a major advantage. The ETF s portfolio is typically fully disclosed on a regular basis and can be easily compared to the corresponding index constituents. Figure 2: Simplified example of a physical-based, fully replicated ETF structure Index return Index return Security A Security A ETF investor Index return Fully-replicated ETF Security B Security C Index Security B Security C Costs + Revenues Security D Security D Source: BlackRock. For illustrative purposes only. Figure 3: Simplified example of a physical-based, optimised ETF structure Index return Security A Index return Security A Security B ETF investor Optimised ETF Security B Index Index return Security C Costs + Revenues ~ Security C Security D Security E Security F Source: BlackRock. For illustrative purposes only.

4 The Evolution of Swap-Based ETFs The Evolution of Swap-Based ETFs 4 The mechanics of swap-based ETFs In contrast to the straight forward nature of physical-based ETFs it is important to understand the different types of swap-based ETFs and their structure, in the order of their entry into the market. There are four basic structures, which we will be referring to as Phase 1, Phase 2.1, Phase 2.2 and Phase 3. The four structures will be assessed with respect to the key areas of counterparty risk, best execution for the client and transparency. Phase 1: Swap-based ETF with a single swap counterparty and an uncollateralised swap exposure The first swap-based funds were set up where the single swap provider to the funds was an affiliated bank of the ETF provider. Under this model the fund buys and holds a basket of securities from the swap counterparty. These holdings are often referred to as a reference basket and typically do not contain the securities of the index. At the same time the fund enters into a total return swap agreement with the swap counterparty, which exchanges the performance of this reference basket for the performance of the benchmark index adjusted for the swap spread. The swaps are generally reset on a monthly basis. See Figure 4. The banks determine the securities that they sell to the fund (within UCITS regulatory requirements) and thus look to sell to the fund assets on the banks inventory that are of a lower quality than those that they would need to purchase to hedge themselves in order to pay the fund the index return. This is known as an inventory upgrade trade. This results in a positive economic return for the banks and allows them to pay index return to the fund with low costs. However this puts the ETF investor at risk of being left with illiquid or difficult to trade securities in the event of a swap counterparty default. Typically transparency around the fund s holdings has been low and thus the investor cannot analyse or quantify the risks embedded in this fund structure. From a funds perspective, the main objective is to keep the running costs of the ETF to a minimum and to satisfy UCITS diversification requirements. Figure 4: Structure of a swap-based ETF Authorised Participant Investment Bank A Index Return +/- Swap Spread (1) Swap Counterparty (2) Investment Bank A Basket of Securities (3) ETF Reference Basket Basket Return Source: BlackRock. For illustrative purposes only.

5 The Evolution of Swap-Based ETFs The value of the swap is marked to market on a daily basis and should not exceed 10% of the net asset value (NAV) under UCITS III rules ensuring counterparty exposure below 10% of NAV. Depending on the swap counterparty involved, this UCITS limit can be, and generally has been, decreased to 5%. Whenever the value of the swap approaches the set limit, the swap reset is triggered and the investment bank pays the difference between the value of the reference basket and the index to the ETF. The difference is then reinvested in securities of the reference basket. This is called an extraordinary swap reset and unlike the regular (monthly) resets, can happen at any time when the UCITS limit or issuer determined threshold has been reached. Table 2 provides more details: Table 2: Daily mechanism of a typical swap-based ETF Period Index Reference Basket Value ETF NAV Value of the Swap Day 1 100 100 100 0 No: 0% Counterparty exposure (to the Investment Bank) Day 2 103 100 103 3 Yes: ( 103-100)/ 103 = 2.91% Day 3 97 100 97-3 No: ( 97-100)/ 97 = -3.09% Day 4 112 101 112 11 Yes: ( 112-101)/ 112 = 9.82% Day 5 112 112 112 0 No: 0% Source: Blackrock. For illustrative purposes only. Phase 1 Swap-based ETF: Investor check box Over collateralised swap exposure Multiple swap counterparties Transparency This model carries some significant disadvantages. One of them is counterparty risk. Although outright exposure to the swap counterparty is limited to 10% (i.e. the difference between the swap value and the value of the fund holdings can t be more than 10% of the fund s NAV) it can come close to it without triggering the swap to reset. Additionally, due to the lack of transparency by swap-based ETF issuers, investors cannot see the counterparty exposure at any time. Another drawback is the quality and low transparency of the reference basket. In the majority of cases, it is impossible to track its constituents, as ETF providers would not normally publish this information externally apart from on a semi annual and annual basis. The credit market events of 2007 and 2008 and the resultant lack of market confidence have forced the existing providers of swap-based ETFs to rethink their swap models in order to address client demand for transparency and lower risk exposures. Consequently, new structures have entered the market: multiple swap counterparty models with uncollateralised swap exposure and single swap counterparty models with over collateralised swap exposure.

6 The Evolution of Swap-Based ETFs The Evolution of Swap-Based ETFs 6 Phase 2.1 Swap-based ETF with multiple swap counterparties and uncollateralised swap exposure Phase 2.1 Swap-based ETF: Investor check box These structures were introduced at the end of 2008 and early 2009 by a number of ETF providers. The main benefit of this model is the participation of several swap counterparties which allows for a more competitive swap pricing process. However, uncollateralised swap exposure and a lack of transparency are two significant drawbacks which this phase did not address. Over collateralised swap exposure Multiple swap counterparties Transparency Figure 5 illustrates how the process works. Authorised participant X, Y or Z receives cash from the investor and puts in an order to create the new units of an ETF with the fund custodian (1). The custodian transfers cash to the swap counterparty (2); in exchange the swap counterparty delivers a basket of securities to the fund, i.e. the reference basket (#1). Other orders may be directed to another swap counterparty, resulting in a second basket (#2) being delivered to the ETF (3). There will be a total return swap contract and a reference basket in place for each of the participating counterparties. For each, the performance of the reference basket is exchanged for the index return, adjusted for the swap spread. Figure 5: Swap-based ETF with multiple counterparties Authorised Participants X Y Z Index Return +/- Swap Spread (1) Swap Counterparties Investment Bank A (2) Basket 1 Investment Bank B Basket of Securities #1 ETF Investment Bank C Basket of Securities #2 (3) Basket 2 Basket #1 Return Basket #2 Return Source: BlackRock. For illustrative purposes only.

7 The Evolution of Swap-Based ETFs Phase 2.2: Swap-based ETF with a single swap counterparty and over collateralised swap exposure This structure is similar to the Phase 1 swap model, but with two critical differences: ``there are no securities inside the fund but instead the swap exposures are collateralised using a collateral management process, with cash, bonds or equities being taken as collateral, Phase 2.2 Swap-based ETF: Investor check box Over collateralised swap exposure Multiple swap counterparties Transparency ``exposures can be over collateralised, in fact UCITS requires the exposures to be over collateralised by 20% if equities are posted as collateral The authorised participant receives cash from the investor and invests it in an ETF (1). The ETF then transfers the amount received to the swap counterparty under a fully-funded swap agreement (2). In turn, the swap counterparty delivers the collateral to the custodian, ring-fenced for each ETF. The posted collateral is normally composed of securities (OECD country equities, bonds, cash and funds) diversified in accordance with the UCITS III requirements and is not normally lent out (3). Collateral will be held to the value of the swap, with an additional buffer (margin or over collateralisation level), depending on the asset type of collateral (ranging typically from 0% for cash collateral, and 20% for equity collateral). The level of collateral will be adjusted over the life of the ETF to reflect the changing value of the ETF. According to the swap agreement, the swap counterparty delivers the index return, adjusted for the swap spread, to the ETF. This structure benefits from having over collateralisation, however, it still lacks transparency. Specifically, neither the collateral nor the swap pricing are disclosed to investors. Additionally, with a single investment bank acting as swap counterparty for the fund, it is questionable whether the swap fee pricing is necessarily competitive. Figure 6: Swap-based ETF with over collateralised exposure Authorised Participant Investment Investment Bank Bank Index Return +/- Swap Spread (1) Swap Counterparty Investment Bank (2) ETF Collateral = Swap Valuation + Margin (3) Custodian Collateral Source: BlackRock. For illustrative purposes only.

8 The Evolution of Swap-Based ETFs The Evolution of Swap-Based ETFs 8 Phase 3: Swap-based ETFs with multiple swap counterparties and over collateralised swap exposure (ishares Dublin model) To address investor desire for greater transparency, simplicity and security within swap-based funds, ishares is launching a range of Dublin-domiciled swap-based ETFs. These ETFs will primarily be focussed on creating funds that cannot be efficiently constructed in accordance with existing UCITS III rules using a physical-based approach. Phase 3 swap-based ETFs are based on a new, unique model that differentiates ishares ETFs from other models and ETF providers. The new structure addresses the major investor concerns of existing swap-based ETFs, while preserving all the positive features relating to the transparency of physical-based ishares. A combination of over collateralisation, multiple swap counterparties and a unique level of transparency in one straightforward structure are the key benefits of Phase 3 swap-based ETFs. The structure and the mechanics are described in Figure 7. The authorised participant A, B or C receives cash from the investor and places an order with the custodian to create new ETF units (1). As a second step, the custodian makes a transfer of the creation money to the tri-party collateral agent which in turn, retains the amount delivered until the collateral (including margin) is received (2). This ensures that the ETF is fully/or over collateralised at all times. The approved list of securities which can be used as collateral includes G10 government bonds and developed market equities traded on certain exchanges. The additional collateral requirement (margin) will be 20% for equities and up to 3% for G10 Government bonds. ishares will also specify liquidity and concentration limits to further improve the quality of collateral held. These requirements create an extra safety net in the event of a swap counterparty default and allow the collateral to be swiftly liquidated to provide the investor with protection against losses. The next step is when the swap counterparty delivers the collateral and the margin to the tri-party collateral agent (3). Once collateral has been received, the creation cash is passed to the swap counterparty (4). Redemptions follow a similar process to creations, except in this case the collateral will be returned to the swap counterparty only once the redemption proceeds have been received. In this way, the ETF is over collateralised/fully collateralised at all times. Figure 7: Swap-based ETF with over collateralised exposure and multiple counterparties Authorised Participants A B C D Swap Counterparties Index Return +/- Swap Spread (1) Investment Bank A Investment Bank B Investment Bank C ETF (3) (4) Collateral = Swap Valuation + Margin Tri-party Collateral Agent Collateral (2) only transferred after the collateral and the margin are delivered Source: BlackRock. For illustrative purposes only.

9 The Evolution of Swap-Based ETFs According to the swap agreement, the swap counterparty delivers the index return (plus or minus swap spread) to the ETF. The benchmark return is delivered to the ETF via the fully-funded swap agreement with each of the swap counterparties. The swap spread, which is added or deducted to/from the index return delivered to the investor, is calculated via a pricing algorithm based on the swap spreads quoted by the swap counterparties supporting the ETF and benchmarked to standard market swap quotes. The usage of this swap quote mechanism ensures efficiency of swap pricing for the client whilst the actual swap pricing will be disclosed on a per fund basis. Phase 3 Swap-based ETF: Investor check box Over collateralised swap exposure Multiple swap counterparties Transparency ishares new swap-based ETFs: primary and secondary markets overview The primary market, multi-dealer creation/redemption model used for the new ishares swap-based ETFs operates in the same way as for existing ishares physical-based funds and, depending on the fund exposure, there can be as many as 30 Authorised Participants (APs) supporting primary market activity. This ensures competitiveness and pricing efficiency for the creation and redemption process of ishares ETFs. The secondary market ishares trading model for swap-based ETFs is set up in line with that for physical-based funds. It is based on a multi-dealer platform and consists of up to 52 investment banks, regional brokers, liquidity providers and market makers. The aim is to encourage market makers to participate and create both tight spreads and market depth. From a client perspective, bid/ask spreads are an important component of the total cost of ownership when trading ETFs. The higher the number of market makers, typically the more competitive the pricing and this can lead to tight on-exchange ETF spreads. While primary market liquidity is derived from the creation/redemption process, secondary market liquidity represents on-exchange and OTC trading volumes on a day-to-day basis. The existence of both primary and secondary markets ensures multiple sources of liquidity for ishares ETFs.

10 The Evolution of Swap-Based ETFs The Evolution of Swap-Based ETFs 10 ishares new swap-based ETFs: setting the standard for ETF transparency There are several reasons why ishares has decided to launch the new Dublin-domiciled swap-based ETFs. The main reason is to address client demand for exposures that are difficult to replicate via physical-based UCITS-complaint funds by using swap-based ETFs that are as transparent and safe as existing physical-based funds. ishares unique approach delivers the access and flexibility of swaps while maintaining a commitment to transparency, service and risk management. Multiple authorised participants and swap counterparties ensure best execution for the client. The quality of collateral and over collateralisation protect against counterparty default risk at all times. The ability to see collateral and index holdings, swap counterparties and aggregate swap exposure on the ishares website ensures transparency in line with physical-based ETFs. Table 3: ishares swap-based ETF data available via web ishares swap-based ETFs Availability Update frequency of data Collateral holdings Yes Daily Index holdings Yes Depends on an index provider Swap counterparties Yes Daily Swap pricing Yes Daily Aggregate counterparty exposure Yes Daily Source: BlackRock. Being able to structure a fund that aims to replicate the return of the benchmark without owning the underlying index securities enables certain ETFs to comply with UCITS III regulations on diversification and asset type. For example, for funds with exposures such as commodities or credit default swaps, a swap structure allows the means to create a UCITS III-compliant fund following a purely derivative-based index. Other relevant exposures include markets with foreign investor restrictions, such as India and others with operational issues such as Russia. These barriers sometimes prevent efficient physical ownership in the underlying securities of the relevant index. Additionally, some funds, where the exposure is an alternative asset, can only be constructed as swap-based due to the nature of the investment. Other ways to get exposure to difficult to access asset classes: ETNs Exchange Traded Notes (ETNs) present another type of exchange traded instrument that can be used to gain exposure to various asset classes. ETNs are available on a wide range of indices and asset classes and are frequently used to offer exposures that cannot be achieved with a UCITS III compliant ETF. ETNs have similar features to ETFs in that they are exchange traded delta one products that track a benchmark and can be bought and sold intra day either through a broker or directly with the issuer. The key difference is that ETNs are investment vehicles backed by debt and can be unsecured (full credit risk of issuer) or secured (collateralised). For an unsecured ETN an investor is fully exposed to the ability of issuer to deliver the objective of the ETN, i.e. 100% counterparty risk. There are different sub-categories of ETNs available and these present different levels of counterparty risk which investors may be exposed to. Maturities of ETNs range from 10 to 50 years, although they can also be undated. ETNs are UCITS-eligible but not UCITS-compliant instruments. This is because the UCITS III rules set an absolute maximum exposure of 35% to a single commodity or group of closely related commodities and many of the ETNs deliver single commodity exposure. For UCITS investors this means that not more than 10% of the portfolio assets may be allocated to these notes. In Europe the most popular exposure provided by the ETN structure is commodities and they are commonly referred to as Exchange Traded Commodities (ETCs). The largest ETCs in Europe provide exposure to gold and over 95% of these assets are backed by physical holdings of gold bullion in an ETN structure. It is important to note that levels of transparency and collateral quality can differ for different ETNs. It is up to the investor to assess the product and up to the provider to decide how safe and transparent the structure will be.

11 The Evolution of Swap-Based ETFs Conclusion Increasing investor interest in exchange-traded products has led to the rapid growth of the ETF market in recent years with assets under management rising from 54.5bn at the end of March 2006 to close to 183bn at the end of March 2010. This has been characterised by substantial asset gathering in both physical-based and swap-based ETFs as the market has continued to grow and attract new entrants. Throughout the past few years and in particular following on from the credit events of 2008 investors have shown a greater concern over counter party risk and structure. Over this time, new products with their own unique exposures, risk and tax implications have been brought to the market. As the market becomes increasingly complex with a lack of transparency in some of the new products, investors need to research them closely in order to select the most suitable structure and understand the risks involved. Exchange Traded Notes are sometimes confused with ETFs because of their exchange-traded nature. However, ETNs are not UCITS III compliant collective investment schemes but are in fact debt securities. Investors in these structures will generally assume the credit risk of the issuer although they are often backed by varying forms of collateral. Although the European ETF market is dominated by two major types of ETF: physical-based and swap-based, each has its own distinctive features concerning counterparty risk, transparency and pricing. ishares is launching a new range of swap-based Exchange Traded Funds (ETFs) that offer both multiple swap counterparties and over collateralised swap exposure, as well as high levels of transparency with respect to many hitherto undisclosed aspects of swap-based ETFs. ishares has a focussed strategy of offering physical-based ETFs where the assets underlying the index can be traded and held efficiently in the fund. As ishares looks to expand its asset class coverage and provide access to difficult to trade markets its enhanced swap-based ETF platform has been designed to offer full transparency combined with the minimisation of counterparty risk. Investors will also benefit from the ishares multi-dealer model with respect to primary market trading, so in addition to having multiple swap counterparties, there can be as many as 30 Authorised Participants supporting the fund. In the secondary market the ishares trading model for these new swap-based ETFs will also be the same multi-dealer platform consisting of investment banks, regional brokers, liquidity providers and market makers. Overall, ishares Dublin-based swap-based ETFs aim to provide investors with both the highest level of transparency, support from a wide range of broker dealers and, in conjunction with the physical-based ishares funds, broad asset class coverage. Table 4 summarises the key features of ETNs, physical-based ETFs and swap-based ETFs. Table 4: Structure comparison ETC/ETN Physical-based ETFs Swap-based ETFs Exchange Traded Notes Fully replicated and optimised Swap-based ETFs (Phase 1) Swap-based ETFs (Phase 2.1) with multiple counterparties Swap-based ETFs (Phase 2.2) over collateralised Swap-based ETFs (Phase 3) 1. Exchange listed Yes Yes Yes Yes Yes Yes 2. Holds underlying index securities N/A Yes No No No No 3. Operational counterparty risk Depends No Yes Diversified Yes Diversified 4. Counterparty exposure limit Up to 100% No exposure Capped by Capped by N/A N/A UCITS III at 10% UCITS III at 10% 5. Over collateralisation N/A N/A No No Up to 20% Up to 20% 6. Transparency No Yes No No No Yes Fund/note holdings No Yes No No N/A N/A Collateral holdings No N/A No N/A No Yes Swap counterparties N/A N/A N/A No No Yes Aggregate counterparty exposure N/A No No No Yes Multiple APs Yes Yes Limited Yes Limited Yes UCITS compliance possible No Yes/Depends Yes Yes Yes Yes Source: BlackRock. For illustrative purposes only.

Regulatory Information ishares may not be suitable for all investors. BlackRock Advisors (UK) Limited does not guarantee the performance of the shares or funds. The price of the investments (which may trade in limited markets) may go up or down and the investor may not get back the amount invested. Your income is not fixed and may fluctuate. Past performance is not a reliable indicator of future results. The value of the investment involving exposure to foreign currencies can be affected by exchange rate movements. The value of investments in funds investing in economies and markets which may be less developed than more established economies, may be subject to greater volatility due to increased uncertainty as to how these markets operate. We remind you that the levels and bases of, and reliefs from, taxation can change. Affiliated companies of BlackRock Advisors (UK) Limited may make markets in the securities mentioned in this document. Further, BlackRock Advisors (UK) Limited and/or its affiliated companies and/or their employees from time to time may hold shares or holdings in the underlying shares of, or options on, any security included in this document and may as principal or agent buy or sell securities. The Dublin domiciled funds which include the term swap in their names are swap based funds. These funds enter into fully funded swap agreements with counterparties to obtain the performance of the funds respective benchmarks. Swap transactions are subject to the risk that counterparties may default on their obligations. If this were to occur, the relevant fund may sustain a loss. The funds intend to mitigate much of their credit risk exposure to each counterparty by obtaining collateral from the counterparty which will be held by a third party collateral agent. In the event of a default by a counterparty or collateral agent, the swap funds may still have some counterparty risk exposure to the defaulting counterparty or collateral agent respectively. In some circumstances, counterparties can terminate the swap agreements early which may impact the returns of the funds. In addition, the counterparties may seek to pass on any additional costs relating to the hedging of their risk exposure under the swaps to the relevant fund. In the event that a swap fund is unable to enter into suitable swap arrangements or maintain swap arrangements on acceptable terms, the fund may not be able to achieve its investment objective and policy unless it is able to track its benchmark by other means. 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