CREDIT LINKED REPACKAGING IN THE NETHERLANDS ANTILLES
A bankruptcy-remote vehicle can be used in the Netherlands Antilles
A credit linked note (‘CLN‘) enables an Investor to purchase and fund an asset with a return linked to the credit risk of the asset itself and an additional credit risk transferred by way of a credit derivative between the issuer (a Special Purpose Vehicle or ‘SPV’) and the bank (the Protection Buyer). A credit linked note structure enables the risks transferred using a credit swap (or Loan Default Swap) to be embedded into a security and issued to an Investor. The Investor receives a coupon and par redemption unless there has been a credit event by a Reference Obligation, in which case redemption is equal to par minus a contingent payment. The transaction between the bank (the Protection Buyer) and the medium term note (“MTN”) issuer (the SPV) is a credit swap (or LDS). The issuer (the SPV) receives a premium for taking exposure to the Reference Obligation. This premium forms part of the coupon that is paid to the Investor. Should there be a credit event by the Reference Obligation, the issue redeems early, a contingent payment is made to the bank (the Protection Buyer) and the balance is paid to the Investor.
There are two main risks assumed by the Investor: that of the Reference Obligation (by way of the loan default swap), and that of the Issuer. Should the Reference Obligation default, this event would trigger an early and reduced redemption of the notes. Should the Issuer default, the investor is exposed to its recovery and to the mark to market of the LDS at that time. However, a bankruptcy-remote SPV to repackage the transaction can be used in the Netherlands Antilles. This exposure to two risks is reflected in the yield on the note, which is the sum of the return of the Issuer and the premium of the LDS.
It is a simple matter to package a credit derivative or loan derivative inside a structured note. Typically, the Investor receives a coupon and par redemption at maturity so long as there hasn’t been a credit event. Once a credit event occurs, the Issuer calls the structure away from the Investor and delivers the defaulting notes against them. Credit linked notes look very much like bonds and are, therefore, appealing to certain institutional investors which are prohibited from doing credit default swaps.
Karel Frielink
Attorney (lawyer) / Partner
