Introduction

A Credit Linked Note (CLN) is a type of structured product that combines a bond with an underlying credit risk. It allows issuers to release capital from underlying illiquid strategies or assets.

Benefits of Credit Linked Notes

Investors

Benefit Description
Higher Yield Potential Credit Linked Notes typically offer higher returns than traditional bonds or deposits, compensating investors for taking on additional credit risk.
Asset-backed Exposure  Many CLNs are backed by tangible assets or cash flows, typically income generating assets, offering a layer of security.
Custom Credit Exposure Investors can target specific credit risk (e.g. corporate, property, infrastructure) without owning the underlying asset.
Fixed Income-Like Structure CLNs offer predictable income streams with defined maturity dates, similar to bonds.
Lower Entry Barriers to Investment Professional investors can get access to institutional-grade credit opportunities with lower ticket sizes. They are able to invest via their existing private banks or platform.

Borrowers

Benefit Description
Immediate Liquidity CLNs provide access to upfront capital, which can be used to build or acquire a portfolio of income-generating assets
No Equity Dilution  Unlike raising capital through equity, issuing a CLN does not give away ownership or control in the company.
Offloading Credit Risk Credit risk tired to the reference asset (e.g. tenants, borrowers, or counterparties) is partially transferred to investors.
Custom Structure CLNs can be structured flexibly in terms of maturity, coupon, credit triggers, and collateral
Asset Monetisation Allows the company to unlock value from future cash flows or held assets without outright selling them.

 

 

Risks of Credit Linked Notes

Investors

Risk Description
Credit & Default Risk If the reference entity or collateral underperforms or defaults, the investor could lose some or all of their capital
Issuer Risk Investors depend on the issuer's ability to meet obligations - if the issuer fails, the CLN could be worthless, even if the assets are sound
Illiquidity CLNs are rarely traded on active secondary markets. Early exit may be difficult or only possible at a discount.
Valuation Complexity Understanding the quality of the underlying asset pool and credit structure often requires significant due diligence.

Borrowers

Risk Description
Obligation to Pay Unlike dividends or discretionary payouts, CLNs require fixed payments, even if asset performance weakens.
Collateral Lock-Up Assets used as collateral are encumbered and can't easily be refinanced or sold during the note's term.
Complexity and Regulatory Scrutiny Depending on the structure, CLNs can be difficult to manage and require specialist arrangers, administrators and paying agents.