In July 2016, Germany's Federal Financial Supervisory Authority (Bundesanstalt fr Finanzdienstleistungsaufsicht, "BaFin") announced its intention to prohibit the marketing, distribution, and sale of "credit-linked notes" to retail clients.5

In making this determination, BaFin indicated that it had significant investor protection concerns about credit-linked notes, particularly due to the relatively high degree of complexity of these products. With credit-linked notes, the interest and repayment of the money invested depend on the credit risks of reference entities. The return on these instruments will particularly depend upon whether a "credit event" relating to the underlying reference entity occurs something which retail clients may not be able to assess or predict. They may not be able to assess the probability of repayment of the investment amount and/or whether they are being adequately compensated for the assumption of the credit risk.

In making this determination, BaFin also viewed the risk of a conflict of interest inherent in the product structure as potentially problematic. Issuers are, on the one hand, manufacturers of the credit-linked notes sold to retail clients. On the other hand, these issuers (or an affiliated entity) may also maintain business or lending relationships with the companies whose credit risk underlies the products.

Moreover, BaFin noted that the product name could be misleading and give rise to investor protection concerns. Despite what the German name may suggest, credit-linked notes ("Bonittsanleihen") are not bonds ("Anleihen") in the traditional sense. That is, when analyzed economically, the role of the investor is not that of a typical (bond) lender; rather, the investor may be deemed to have a role similar to that of a protection seller who assumes the risk of the occurrence of a credit event. This confusion of roles may give retail clients the false impression that the product is a more typical interestbearing security.

BaFin stated that its action results in part of its review of actual practices in its home market. BaFin examined the extent to which credit-linked notes are being actively sold to retail clients and whether the risks involved are explained in sufficient detail to those clients. BaFin found that issuers are producing credit-linked notes specifically for sale to retail clients. BaFin believes that those clients generally do not receive an adequate explanation of how the products work. In the United States, credit-linked notes cannot be issued pursuant to a registration statement.6 As a result, these instruments are currently offered to U.S. investors only in reliance on Rule 144A.