FOR PROFESSIONAL CLIENTS ONLY

Four Steps to ETP Selection

FOUR STEPS TO ETP SELECTION

[ 1 ]  FOUR STEPS TO ETP SELECTION

Due diligence guide: Exchange Traded Product (ETP) selection process It all starts with asking the right questions Exchange Traded Products (ETPs) have grown exponentially within the investment product landscape and enjoy increasing acceptance amongst a broad set of investors. This success has been accompanied by an ever-increasing choice of products and in some instances added complexity of product structures. When selecting an ETP investors are faced with a significant challenge of navigating the maze. Based on investor feedback we have identified the key elements that investors should consider when evaluating an ETP: Structure, Tax, Performance, Trading

and Valuation, Total Cost of Ownership and Securities Lending. While these areas are important to consider in isolation, clients often assess a combination of these criteria in order to extract meaningful and actionable conclusions. In the following we provide a step-by-step approach to conduct an ETP due diligence process using the iShares due diligence framework. This process is not intended to be a ‘one size fits all’ and should depend on an investor’s investment objectives, restrictions and specific considerations. While there are many factors to consider, we believe that using a methodical, thorough selection approach should help an investor make the most informed investment decision.

Figure 1: ETP due diligence process flow 1. Evaluate the ETP provider

2. Quick rule in rule out criteria

3. Evaluate the product structure

Physically replicating ETF

OR

Derivative replicating ETF

OR

ETNs or ETCs

4. Select the product

General

Source: BlackRock.

Performance: tracking error and tracking difference

Trading and valuation of ETPs

Total Cost of Ownership

FOUR STEPS TO ETP SELECTION  [ 2 ]

`` ETP due diligence process flow which charts four key

steps: Evaluating the ETP Provider, Rule In and Rule Out Criteria, Evaluating the Product Structure using the proposed classification, and finally Selection of the Product to be invested in. `` Three case studies to demonstrate how to implement

this process in practice depending on investment criteria and target exposure. `` The essential list of questions that we believe investors

should be asking when assessing any ETP investment. Depending on your preferences and investment objectives you will potentially take a slightly different approach every time when conducting your ETP due diligence to ensure that you are assessing the considerations that are most critical and relevant to you and the ETP in focus.

`` Performance track record over the last ten years: as the

investor is looking for a strategic allocation to the German equities, performance criteria can be more important than trading and liquidity. All ETFs with a track record less than ten years are eliminated. Choice: UCITS-compliant, physically replicating ETF with long-term track record.

Case 2: ETP with exposure to the CAC 40 Index A French-domiciled investor is seeking Domestic Large Cap equity exposure. The criteria which the investor is looking to meet are as follows: `` UCITS-compliance: by choosing UCITS-compliance as the

first criteria, the investor eliminates ETCs and ETNs. `` As physically replicating structure is not one of the

criteria, investor can select derivative replicating ETF. If after your due diligence review you are unhappy with or unclear about any of the responses to the questions, then perhaps you need to reconsider the investment in this ETP.

`` Domicile: a preference for local domicile for local security

investment from a tax perspective. Choice: UCITS-compliant, derivative replicating ETF domiciled in France.

Case 3: ETP with exposure to physical gold

Selection case studies: from theory to practice Figure 1 gives an overview of the considerations an investor may go through when conducting ETP due diligence. Now let’s consider how investors with differing investment objectives would implement this process when investing in three example ETPs below: `` Case 1: ETP with exposure to the DAX 30 Index. `` Case 2: ETP with exposure to the CAC 40 Index. `` Case 3: ETP with exposure to physical Gold.

Case 1: ETP with exposure to the DAX 30 Index A European-domiciled investor is seeking exposure to the German Large Cap equity market as represented by the DAX 30 benchmark. There are several criteria which the investor is looking to meet when selecting the most appropriate product: `` UCITS-compliance: by choosing a UCITS-compliant

Exchange Traded Fund (ETF), the investor eliminates non-ETF structures, such as Exchange Traded Commodity (ETC) and Exchange Traded Note (ETN). `` Physically replicating structure: the preference of

physically replicating type eliminates derivative replicating ETFs.

A UK-domiciled investor is seeking exposure to physical gold. The investor chooses to invest in gold ETPs as investing directly requires storage, transportation, insurance costs and logistics. The investment criteria to be met are: `` Backed by physical gold: this criteria eliminates ETFs

and leaves a choice of ETCs. `` UCITS eligibility: permitted investment for a UCITS fund.

Choice: UCITS permitted ETC, backed by physical gold.

The essential list: key questions for ETP selection We propose four key areas to be assessed as part of the ETP due diligence process: 1. Evaluating the ETP provider. 2. Rule in and rule out criteria. 3. Evaluating the product structure. 4. Selection of the product to be invested in.

FOUR STEPS TO ETP SELECTION

Our reference tools include:

FOUR STEPS TO ETP SELECTION

[ 3 ]  FOUR STEPS TO ETP SELECTION

ETP due diligence process flow 1

Evaluate the ETP provider

1. How do you feel about the stability and longevity of the ETP provider? 2. Is asset management a core business of this ETP provider? 3. Does this ETP provider have a proven track record of managing client assets over multiple market cycles? 4. Does the ETP provider manage a meaningful amount of client assets (AUM) and scale? 5. What are the people, processes and technologies to support the ETP business of the provider? 6. Is the value-chain of the ETP provider transparent? Are there any potential conflicts of interest? 7. Does the ETP provider offer the breadth of products you seek? 8. Does the ETP provider offer listings on the exchange(s) you require? 9. Does the ETP provider deliver a high standard of service demonstrated by responsiveness to questions, accuracy of information provided and generally having experienced personnel available to help?

3

2

Rule in and rule out criteria: tax, legal and compliance

1. Where is the fund domiciled? Can you invest in a fund domiciled in this country? Is the required tax reporting status provided? Is this a UCITS fund? 2. Will the fund distribute capital gains and dividends in a manner which is appropriate for you from a tax perspective? 3. Can a UCITS fund invest in this ETP? 4. Can you invest in derivative replicating products? 5. Can you invest in ETNs/ETCs? 6. Does the fund meet your minimum AUM requirement and fund tenure/track record requirement? 7. In which countries is the ETF registered for sale?

Evaluate the product structure Physically replicating ETFs 1. Are the physical ETFs fully replicating or optimised/ sampled? Is this information clearly shown? 2. Can you see fund holdings on a daily basis? 3. How many stocks are typically held in the portfolio and the index? 4. Does the portfolio hold the same underlying securities as the index? 5. If derivatives are used in the ETF, is it restricted to efficient portfolio management?

OR

Derivative replicating ETFs Unfunded swap structure

Fully funded swap structure

1. Is the swap exposure to a single counterparty, or is it diversified across several counterparties? 2. If a single swap-counterparty, is it also the sole market-maker? 3. Who are the swap-counterparties? What are their credit ratings? Are they independent from the ETF provider? 4. What is the swap spread? If not disclosed, why not? 5. What are the rules that determine the quality of stocks held within the collateral basket? What are the liquidity rules applied to the collateral basket? 6. How is the counterparty exposure managed (frequency of reset, exposure limit, over collateralisation)? 7. How easy is it to gain access to the collateral pool in case of counterparty default (pledge versus transfer of title)? 8. Are basket collateral holdings, swap pricing, counterparties and level of over collateralisation disclosed on a daily basis? 9. Does the swap-counterparty conduct securities lending on the hedge positions? If yes, are there clear investment guidelines for collateral selection and rigorous risk management processes? How is the benefit of any securities lending revenue generated on the swap counterparty’s hedge reflected in the swap spread paid by the fund?

1. Is the swap exposure to a single counterparty, or is it diversified across several counterparties? 2. Who are the swap-counterparties? And what are their credit ratings? Are they independent from the ETF provider? 3. What is the swap spread? If not disclosed, why not? 4. What are the collateral schedules for swap products? What are the liquidity rules applied to the collateral basket? 5. How is the counterparty exposure managed (frequency of reset, exposure limit, over collateralisation)? 6. How easy is it to gain access to the collateral pool in case of counterparty default (pledge versus transfer of title)? 7. Are collateral holdings, swap pricing, counterparties and level of over collateralisation disclosed on a daily basis? 8. Does the swap counterparty conduct securities lending on the hedge positions? If yes, are there clear investment guidelines for collateral selection and rigorous risk management processes? How is the benefit of any securities lending revenue generated on the swap-counterparty’s hedge basket reflected in the swap spread paid by the fund?

1. Does the ETF engage in Securities Lending? 2. If yes, are there clear investment guidelines for collateral selection and rigorous risk management processes? What is the level of securities lending revenue and how is it split between the fund and issuer/securities lending agent? 3. What are the collateral schedules for securities lending? 4. Is the revenue obtained from securities lending disclosed to the investor? What other information related to securities lending is disclosed?

Source: BlackRock.

FOUR STEPS TO ETP SELECTION  [ 4 ]

Select the product

General 1. Please list the custodian, auditor, administrator and registrar for the ETP (if there are such parties). 2. Can you easily find the following data: daily NAV history, total return NAV, fund distributions and performance versus the benchmark?

Performance: tracking error and tracking difference 1. Is total return data available publicly and of good quality? 2. What is the inception date of the fund? 3. What is the tracking difference over a time horizon of 6 months, 1 year and 3 years, since inception? And what are the main reasons for any unusual tracking difference? 4. What is the tracking error over a time horizon of 6 months, 1 year and 3 years, since inception?

Trading and valuation

OR

ETNs or ETCs ETNs 1. Who is the underwriter and what is its credit rating? 2. Is there an SPV structure in place or is there direct exposure to the issuer’s balance sheet? 3. Is the ETN backed by the issuer’s credit? If yes, is that exposure collateralised? 4. For secured ETNs, is there transparency around underlying collateral? 5. Is the framework for holding collateral disclosed? 6. Is there over collateralisation? 7. What fees are paid to the notes promoter? 8. Are there any payments to the fund promoter other than promotion or distribution fees or payments from the notes issuing vehicle? 9. How effective are the segregation of assets between multiple notes exposures? 10. Are assets kept with an independent custodian? Is there a trustee? 11. Can a UCITS fund hold the ETN? 12. Does the ETN embed a derivative? 13. If yes to 12 above, can a UCITS fund hold this ETN embedding a derivative?

ETCs 1. 2. 3. 4. 5.

Is the ETC backed by the physical commodity? Is the ETC backed by securities not related to the ETC exposure? Are assets kept with an independent custodian? How effective is the segregation of assets between multiple notes exposures? Can a UCITS fund hold the ETC?

1. What is the AUM for this particular fund? 2. Does the ETP provider give independent advice on best trade counterparties? 3. Does the ETP provider consistently ensure the level of two-way liquidity in their products you seek? Is there multi market-maker support for liquidity? How many market-makers support the fund? 4. What is the ETP turnover, best bid/offer spread and size on the secondary market? 5. Does the ETP trade at a premium or a discount to NAV? 6. Can the fund be traded at NAV? 7. How has liquidity been affected in past stressed market conditions?

What is the Total Cost of Ownership? Internal factors 1. What is the Total Expense Ratio (TER)? Is the management fee different from the TER? 2. What are the security lending revenues, if any? 3. What is the swap spread? 4. What are the rebalancing costs/revenues? 5. For derivative replicating ETPs, are there additional costs in addition to the swap spread and TER? 6. How much of this data is public? How frequently is it published?

External factors 1. What is the current average spread? 2. What are the creation/redemption costs? 3. Can the ETP units be lent out? If so, what do average lending rates look like?

FOUR STEPS TO ETP SELECTION

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FOUR STEPS TO ETP SELECTION

[ 5 ]  FOUR STEPS TO ETP SELECTION

iShares due diligence tool: Know Your ETP (KYE) Aimed to help simplify the due diligence process, KYE contains the essential questions and can be sent to ETP providers. In a simple four-step process, clients can obtain the key information needed before investing: `` Input your details `` Send the KYE to the ETP provider `` On return review the response `` Analyse and decide which ETP works best for you

Know Your ETP

The simple 4-step process

The KYE tool can be downloaded easily from the iShares website: www.iShares.com

Page 3/19 Date

Your company

ETP name you would like to learn more about

Provider name

15 Mar 2012

Example

iShares Barclays Capital Emerging Market Local Govt Bond

iShares

Questions to be answered by the ETP provider Evaluate the ETP provider

Click box(es) below to enter text or choose an item

Is asset management your core business?

Yes

Flag

What is your track record of managing client assets over multiple market cycles? When did you launch your ETP business?

iShares has a solid track record of managing client assets over multiple market cycles. Since the inception of the iShares ETF platform in 1993, our assets have grown to approximately $600bn and our product offering has expanded to more than 500 funds covering equity, fixed income, commodities and alternatives at year end 2011. Due to the transparency of our product structure, iShares ETPs attracted significant inflows during the credit crisis of 2008 and 2009.

What is your total ETP AUM and number of products across each asset class?

iShares offers a wide range of exposures and asset classes across diversified equity, fixed income and commodities. iShares has $600bn AUM and over 500 products as at year end 2011, and makes up almost 40% of ETP market share globally.

What are the people, processes and technologies that support your ETP business?

iShares is part of the BlackRock organisation. Within iShares there are dedicated teams focusing on the development of new products, supporting the primary and secondary market trading of iShares ETFs and providing analytical support to our clients. In addition, the portfolio management of the funds is conducted within BlackRock by a dedicated team of investment professionals.

Are there any other divisions of the ETP provider (apart from Asset Management) that benefit from the ETP business?

iShares operates a fiduciary business model and is not affiliated with any investment banks.

What are the exchange listing(s) of the ETP?

LSE£/ LSE non£/ LSE other/ Euronext/ Italian Borsa/ Xetra/ SIX *

* Data as of 31 December 2011. ** Over last year as of end June 2011. *** S&P LT Issuer Rating as of 23 January 2012.

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FOUR STEPS TO ETP SELECTION  [ 6 ]

The ETP market has enjoyed outstanding growth and increasing acceptance amongst a broad set of investors over the last 30 years. This success has been accompanied by an ever increasing choice of product and in some instances added complexity of product structure. To assist investors navigating through the wide choice of ETPs we have compiled a range of reference tools, such as the ETP due diligence process flow, selection case studies and a list of essential due diligence questions. We hope this practical brochure to the ETP selection process will enable investors to confidently navigate the ETP landscape as well as result in a more standardised focus of the industry as a whole. To discuss this process in more detail and to find the relevant approach for investors please speak to a local iShares representative. As the leading global provider of ETPs, iShares believes it is uniquely placed to establish a solid framework of key considerations for ETP selection and help you to make the most appropriate choice.

FOUR STEPS TO ETP SELECTION

Summary

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Contact us For more information on all iShares ETFs, please visit our website on www.iShares.com. Alternatively, please call us on: • From Switzerland: 0800 33 66 88 • From the Netherlands: 0800 0233 466 • From the UK: 0845 357 7000 • From Germany and Austria: +49 (0) 89 42729 5858 • From Luxembourg: +32 2 402 49 14 • From Italy: 800 898085 • From Belgium: +32 2 4024914 • From Israel: +44 207 743 1659 • From Spain: +34 91 788 94 00 • From Denmark: 80 88 48 45 • From Finland: 0800 918 277 • From Norway: 800 14 324 • From Sweden: 020 79 62 38

www.iShares.com • ISHARES IS-FSTES-SNUGLIFABIsSpIrJe-DeFiIcNoSw-I-SEP13-EN-009515-13