Equity-Linked Notes (ELNs) are a type of structured product that combines characteristics of both a bond and an equity investment. They offer investors exposure to the performance of an underlying stock, basket of stocks, or an equity index, while providing a principal protection feature or a defined payout at maturity. ELNs are essentially debt instruments whose final payout is directly tied to the performance of the specified equity or equity portfolio.This hybrid nature makes them appealing to investors seeking potential equity-like returns with a degree of risk mitigation.
How ELNs Work
An ELN is typically issued by a financial institution and has a fixed maturity date. At the time of investment, an investor buys a note at a set price. The note’s final value at maturity depends on the performance of the underlying asset relative to a predetermined “knock-in” or “strike” price.
Let’s consider a common ELN structure: the “bullish” note. The issuer promises to return the full principal amount at maturity, as long as the underlying stock’s price remains above the knock-in level. If the stock’s price falls below this level at maturity, the investor receives a certain number of shares of the underlying stock instead of the full principal. The number of shares is usually determined by dividing the principal amount by the strike price. This structure provides principal protection against moderate declines but exposes the investor to potential loss of principal if the stock experiences a significant downturn.
Conversely, a “bearish” ELN would pay a higher return if the underlying stock’s price falls. Other structures can include “range-bound” notes, which pay a higher coupon if the underlying asset stays within a specific price range.
The returns on ELNs often come in the form of a periodic coupon payment or an enhanced return at maturity, depending on the structure. These payments are typically higher than a traditional bond’s coupon but are conditional on the performance of the underlying asset.11
Utility for Investors and Issuers
For investors, ELNs offer several key benefits. They provide a way to gain targeted exposure to a specific equity or market without directly purchasing the shares. This can be particularly useful for investors who wish to hedge against downside risk while still participating in potential upside gains. The principal protection feature appeals to risk-averse investors who want some security in volatile markets. Additionally, the structured nature of ELNs allows for customized risk-return profiles, catering to a wide range of investment strategies.
From the perspective of the issuer, ELNs are a way to raise capital while managing their own risk exposure. By linking the redemption amount to an underlying asset, they can create a bespoke security that meets specific market needs and regulatory requirements.
In a less common but important use case, the term “Equity-Linked Note” can also be used for a security where the redemption amount is fully and solely linked to the realizable value of the underlying equity or equity portfolio. This structure is used when the issuer, often for regulatory or legal reasons, needs to create a debt wrapper for what is effectively a direct equity investment. This allows them to issue a formally debt security (CFI code starts with “D”) that behaves like an equity, with the full upside and downside exposure of the underlying asset. Such an arrangement is typically limited to private placements with professional investors, as the name could be misleading to the general public.
In summary, ELNs are a versatile and sophisticated tool, bridging the gap between traditional fixed-income and equity investments. They offer a unique blend of potential for capital appreciation and principal protection, making them a valuable instrument for both investors and financial institutions.
Tiner Wernow (form. John Tiner & Partners) designs and creates securities and other financial instruments to enable our clients to raise capital, sell managed trading strategies and securitize any type of assets. We provide a full-cycle service from developing the structuring concept to its full implementation (ISIN, issuance, global clearing, exchange listings, placement routes). We help to wrap any type of asset or investing idea into easily tradeable, globally cleared securities. Our global services platform is 208Markets (https://208markets.com). We provide issuance, brokerage, SPV maintenance services in multiple jurisdictions. The educational materials appearing on the internet under the “Tiner Educational Hub” headline are to increase the awareness of the professional audience as to the securitization tools available to more efficiently attain your business objectives.
