The debt security linked 1 also called credit linked note ( CLN ) is a credit derivative funded that action in its mounting to a credit default swap ( CDS ) to transfer credit risk, but through a special purpose vehicle (Anglo-Saxon term: special purpose vehicle or SPV ). This instrument is particularly interesting for investors who do not have for one reason or another the authorization to contract CDS.
The investor pays to the SPV an amount that corresponds to the nominal value of an asset (in a fully funded structure) that the latter covers by selling a CDS from the protection to the credit institution. The two parts of the CDScontract on the Reference Asset are therefore the credit institution and the SPV (and not the investor). Given that CDS are non-funded instruments, the capital flows that the SPV received from the investor are reinvested in securities rated generally AAA. These securities, now in the balance sheet of the SPV, serve as collateral: in the event of a credit event, the losses caused by the reference asset are offset by a contingent payment financed by the sale of this collateral. If no credit event occurs, the investor receives the premiums under the CDS and the interest paid by the collateral. Given that it carries two credit risks, namely the reference asset risk and the collateral risk, the CLNinvestor has a higher return than the CDS and the collateral separately.
In France, CLNs are often sold as synthetic bonds. They can be sold as part of a life insurance, even if it is not systematic.
Notes and references
- ↑ Security Interests in Financial Markets S. Praicheux, 2004