Performance-Linked Notes (PLNs) and Performance-Linked Bonds are sophisticated structured financial instruments that have become essential tools in modern portfolio management. They bridge the gap between traditional fixed-income investments and direct investment in complex strategies or asset portfolios, offering investors customized risk-return profiles.

A note on terminology. The term “performance-linked bonds” is sometimes used for issues of debt securities purchased by a government or an international financial organization where interest or a part of the principal may be forgiven if the loan recipient meets certain benchmarks, i.e. on climate parameters (that will be ‘performance’). We do not cover these in this article. This explainer is dedicated to ordinary market instruments which provide the investor with an exposure to the performance of an asset or a portfolio of assets. Such notes are generically referred to as structured instruments.

Functionality and Purpose

Performance-linked debt instruments are debt securities whose ultimate redemption value and/or coupon payments are linked to the performance of an underlying reference asset. This asset can be a single stock, a stock index, a basket of assets (like commodities or foreign currencies), or a proprietary investment strategy. In theory, any asset, even a unique business can be financed with an instrument whose redemption value / yield is linked to specific performance parameters of the instrument’s Underlying.

The link to the undelying asset may be real (that is, when the issuing SPV in fact owns the asset to which the instrument’s performance is linked) or synthetic (when the issuer assumes the obligation to make payments dependent on the performance of an asset, but does not hold the asset. The issuing SPV may or may not hold derivative instruments as a way to be able to meet its performance-linked obligations).

What Need Do They Address?

The primary need addressed by performance-linked notes and bonds is the ability to offer investors a security that may yield a return well over the ordinary bond yields. This comes at a risk: should the reference asset perform poorly, the investor may never see the expected returns and in some cases (non-principal protected notes) even lose all or part of the principal.

There are two main needs addressed by such notes for the side of the issuer. One is offering the investors a typical structured instrument, but differently named. In this scenario the term ‘note’ or ‘bond’ is more a marketing tool, to denote higher stability or value than if the instrument is called a ‘structured note’ which is the industry standard.

Such instruments essentially repackage complex financial exposures, typically achieved through derivatives, into a familiar, bond-like format, making them an accessible vehicle for:

• Customized Exposure: Offering targeted, bespoke exposure to asset classes or strategies that would otherwise be difficult or costly for individual investors to access directly.
• Risk Mitigation (Defined Outcomes): Structuring payoffs with specific features like principal protection (full or partial) or defined buffers against downside market movements, in exchange for potentially capped upside returns.

The other reason to have performance-linked debt securities issued may be regulatory. Wrapping a managed strategy (an actively managed portfolio) into a security (as opposed to an investment fund) may in some cases (e.g., in Switzerland) avoid the investment being treated as a collective investment scheme by the regulator. So, the need addressed is:

• Regulatory Efficiency: Providing a regulated security that avoids the stringent compliance and administrative requirements associated with licensed collective investment vehicles.

Issuance Mechanics: SPVs vs. Direct Issuance

The issuance process of Performance-Linked Notes or Bonds is critical, particularly concerning the separation of risk.

• Direct Issuance: The PLN is issued directly from the balance sheet of a financial institution (e.g., a large investment bank). In this scenario, the investor is subject to the credit risk of the issuer. If the issuing bank / investment house defaults, the investor stands to lose their principal even if the underlying reference asset performed well.
• Special Purpose Vehicle (SPV) Issuance: A more common way is to have such instruments issued by a Special Purpose Vehicle (SPV) which is legally ring-fenced from the originating financial institution. In this scenario the investor holds only the exposure to the SPV’s underlying assets and the proficiency of the asset’s management team.

Best Jurisdictions for Global Issues

Global structured note issuance tends to concentrate in jurisdictions with sophisticated financial markets, robust legal frameworks, favorable tax treaties, and established listing and regulatory regimes. The best jurisdictions for GLOBAL issues of such securities generally include:

1. Luxembourg: Popular due to its established capital markets expertise, extensive tax treaty network, and well-regarded listing venue (Luxembourg Stock Exchange). It is a top choice for cross-border private placements and public offerings. The important minus is the overly complicated taxation regime and the onerous EU regulation of securities markets.
2. Switzerland: our personal top choice because of the clear position of the regulator (FINMA) that structured financial instruments of debt nature are not to be treated as collective investment undertakings (this clarity lacks in the EU).
3. Cayman Islands: this is, strictly speaking, not an issuance venue but a popular jurisdiction for setting up an SPV for the issues discussed in this article. We love it because of regulatory clarity regarding collective investment schemes – the law states that collective investment schemes regulation does not apply to securitization vehicles (such clarity is absent in the majority of other popular issuance venues).

A further note on terminology

The use of the term “Performance-Linked Bond” is, in many instances, a slight overstretch of terminology and is thus sometimes criticized in the industry.

A bond, strictly defined, is a debt instrument where the issuer owes the holder a debt and is obliged to pay interest (coupon) and/or repay the principal (par value) on a defined maturity date. The obligation to repay the principal is a defining feature. If the security provides no principal repayment guarantee (i.e., it is a fully-at-risk note), and its redemption amount is entirely dependent on the Net Asset Value (NAV) of the underlying assets (effectively a synthetic replication of an investment fund or portfolio), it functions as an equity-like instrument or a certificate.

However, issuance practice is generally very tolerant to slight abuses of terms used in the marketing names of securities, especially if the issue is:

• For Professional (Qualified, High Net Worth) Investors who are presumed to understand the legal and commercial nuances, irrespective of the marketing name.
• Entirely Privately Placed, where strict public marketing rules are less restrictive.

The market uses “bond” loosely to signify a listed debt security format, even if the principal is at risk.