Credit note

A credit note provides a certain type of agreement concluded by the bank with investors - an agreement on participation in credit risk. By concluding an agreement on participation in credit risk, the bank that granted the loan to the borrower gets the opportunity to transfer to a third party (investor) the right to a share in this loan, as well as part of the risks associated with the full or partial default of the borrower on a loan issued by the bank. The execution of such an agreement takes place by issuing a security - a credit note, which subsequently can be traded on the stock market. Thus, the bank has the opportunity to split large and risky loans into small parts and sell them individually to outside investors.

Under a contract of participation in credit risk, the size of the bank's monetary obligations cannot exceed the amount of the amount of payments made by the borrower under the loan agreement. Fulfillment of obligations by the bank to the parties to the agreement may be secured by a pledge of the right to claim the bank under the loan agreement.

A pledge agreement is considered concluded from the moment the first owner of the rights to credit notes arose, but not earlier than the issuer's right to receive payments from the borrower.

A bank can act as both a lender and an organizer of credit notes, but in any case, a bank issuing a loan does not bear the credit risks of the borrower, as it actually sells them to investors who buy credit notes and accordingly take on the bank's credit risks in relation to the borrower.

In case of non-fulfillment or improper fulfillment of obligations under the agreement on participation in credit risk by the issuer of credit notes (bank), the rights of claims of the issuer of credit notes under the loan agreement, which are the subject of a pledge, shall be exercised upon written request of any of the owners of credit notes.

At the same time, the borrower is the final person responsible for repaying the loan and fulfilling the obligation to repay the credit notes, including in the event of a credit event. In the event that no credit event occurs before the loan maturity, for example, loan obligations are not fulfilled or the borrower is declared bankrupt, then the credit notes will be repaid at par. In the event that a credit event does occur, the credit notes will be repaid ahead of schedule at a nominal value reduced by the compensation amount, which can be defined as the difference between the nominal value of the note and the value of the obligation after the credit event.

The structure of a credit note (CLN) includes a credit default swap (CDS, Credit Default Swap). Thus, a credit note is an equity security for which payments are determined by CDS.

Usage Example

This tool works as follows: there is an investor A. His portfolio includes bonds of the issuer X. He buys CDS (Credit Default Swap) to insure himself in case of default of the bond issuer. On the other hand, there is investor B , who insures investor A (is the seller of CDS), and in case of default receives bonds equal to the initial cost of investments, but loses 100% of the invested funds. Between them stands Bank C (issuer of a credit note). Money B is held by the bank, and in case of default of the issuer of bonds X, the bank pays A 100% of the value of the bonds and transfers the default bonds to client B.

The advantages of issuing credit notes by foreign banks to the borrower, in contrast to traditional loans, are the absence of collateral, since one of the obstacles to obtaining a loan is often the bank's requirement to provide collateral, real estate mortgages, and sureties. The issue of credit notes is characterized by the relative speed of the transaction. This, in turn, is associated with less stringent requirements, for example, with Eurobonds, for the provision of financial statements in accordance with international standards and information disclosure. When issuing CLN, the company does not require an international credit rating and listing on foreign stock exchanges. In addition, by issuing credit notes, the borrower becomes more famous among foreign investors and with further possible planning for issuing Eurobonds and entering an IPO, he will already have an international credit history and experience in external borrowing.

The simple CLN issuance technology makes it possible to convert unsecured loans issued in accordance with the laws of any country into CLN under English law, and such instruments are more popular with investors than instruments subject to the legal law of other countries ^[1] .

• Euronote

• Simon Vine. Resource optimization of a modern bank. - M .: Alpina Publisher , 2013 .-- 194 p. - ISBN 978-5-9614-4377-6 .