Authorized participant

An authorized participant is a large financial institution, typically a major bank or trading firm, that has a contractual relationship with an ETF issuer allowing it to create new ETF shares or redeem existing ones directly with the fund. Ordinary investors cannot do this, they can only buy and sell existing ETF shares on the exchange from other investors.

When an ETF's market price rises above the value of its underlying holdings, an authorized participant can profit by assembling the basket of underlying securities, delivering it to the fund in exchange for newly created ETF shares, and then selling those shares on the open market. When the ETF trades below the value of its holdings, the authorized participant can do the reverse, buying cheap ETF shares on the exchange, redeeming them with the fund for the underlying securities, and selling those securities at their higher combined value. This creation and redemption activity is what keeps an ETF's market price closely tied to its net asset value.

Because authorized participants are financially motivated to act whenever a meaningful gap opens up, most ETFs trade very close to their underlying value throughout the day. Thinly traded ETFs, or ETFs holding hard to trade assets, can see wider and more persistent premiums or discounts because fewer authorized participants are willing or able to step in and correct the mispricing.