South Korea's financial regulator said on Tuesday that it would introduce a new type of exchange- traded fund (ETF) that tracks an index through swap contracts.

The Financial Services Commission (FSC) approved the revised bill submitted by the main bourse operator Korea Exchange to adopt the synthetic ETF and list the index-tracking product in the first half, according to an e-mailed statement.

ETF is an index-tracking mutual fund that is traded and priced in real-time on exchanges like listed stocks. The investment vehicle holds stocks and bonds to track a certain index, and it has advantages such as low costs and access to a wide range of asset classes.

Synthetic ETF tracks an index, but it uses swap contracts or other derivatives to copy the index. The product can minimize tracking error as the counterparty of the swap contracts would guarantee the promised return, but the inclusion of derivatives would inevitably make the products more complicated and exposed to counterparty risks.

As seen in the 2008 global financial crisis, counterparty risks can be maximized under an emergency situation. The risks may be lessened by demanding reliable securities as collateral, but the ETF collateral will not guarantee the product's safety completely.

The regulator raised entry barriers for synthetic ETFs. Minimum trust amount required to list the index-tracking funds was set at 7 billion won (6.43 million U.S. dollars), up from an initial 5 billion won. Standards for listing was strengthened, and grounds for delisting was laid. Endi

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