In a landscape of rising interest rates and evolving credit markets, Credit Linked Notes (CLNs) are making waves among Australian investors looking for yield and diversification. As banks and sophisticated investors seek new ways to manage risk, CLNs are carving out a place in the 2025 financial toolkit. But what exactly are CLNs, how do they work, and what should investors know before diving in?
Understanding Credit Linked Notes: Structure and Appeal
Credit Linked Notes are a type of structured fixed-income security. Unlike traditional bonds, a CLN’s return is linked not only to interest rates but also to the credit performance of a specific reference entity or basket—often a corporation, government, or even a portfolio of loans. Here’s how they work:
- Issuer: Typically a bank or large financial institution structures and issues the CLN.
- Reference Entity: The CLN’s performance depends on the creditworthiness of a company or government (or several).
- Coupon Payments: Investors receive regular interest payments, often higher than standard bonds to compensate for extra risk.
- Credit Event: If a credit event (such as default, bankruptcy, or restructuring) occurs, investors may lose part or all of their principal.
The appeal? CLNs allow investors to access higher yields and take targeted credit risk, often with some level of capital protection, depending on the structure.
Regulatory and Market Developments in 2025
The Australian market for CLNs is still developing, but 2025 has seen several key trends and regulatory updates:
- ASIC Guidance: The Australian Securities & Investments Commission (ASIC) has clarified disclosure requirements for structured products, ensuring greater transparency about CLN risks and payoffs.
- Bank Issuance Uptrend: With tighter capital requirements under the Basel IV framework (phased in from 2023-2025), major banks like CBA and Westpac are increasingly using CLNs to transfer credit risk off their balance sheets.
- Retail Access: Platforms like ASX mFunds and private wealth managers have started offering CLNs to high-net-worth and wholesale clients, though public retail access remains limited.
These shifts mean investors need to pay closer attention to both the issuer’s and the reference entity’s financial health, as well as the detailed terms of each CLN.
Risks, Rewards, and Where CLNs Fit in a Portfolio
CLNs offer unique opportunities—but also significant risks. Here’s what Australian investors should consider:
- Yield Enhancement: CLNs can offer returns 1-3% higher than comparable government or investment-grade corporate bonds in 2025, due to their credit exposure.
- Credit Risk: If the reference entity suffers a credit event, you may lose some or all of your capital—even if the issuer remains solvent.
- Counterparty Risk: The issuer must remain financially healthy; if the structuring bank fails, your investment is at risk regardless of the reference entity’s status.
- Liquidity: Most CLNs are not traded on public exchanges, so selling before maturity can be difficult and may incur losses.
- Complexity: The payoff structure and risk profile can be intricate, sometimes including options, leverage, or multiple reference entities.
Example: In early 2025, an Australian bank issued a 3-year CLN linked to the credit risk of a basket of ASX 50 companies, offering a 6.5% annual coupon. If any company in the basket defaults, investors lose a proportional share of their capital. The product attracted strong demand from SMSFs seeking yield, but required detailed due diligence and risk analysis.
CLNs may fit best in the alternatives or fixed income sleeve of a diversified portfolio, particularly for sophisticated investors comfortable with credit and counterparty risk.
Conclusion: Is a CLN Right for You?
Credit Linked Notes present an intriguing opportunity for yield-seeking Australians willing to accept higher risk and complexity. As the regulatory environment matures and market infrastructure expands, CLNs may become a more common tool for managing portfolio risk and return. However, their suitability depends on your risk tolerance, financial goals, and ability to analyse complex credit exposures.
