Bonds – What is the definition? Bonds are interest-bearing securities through which their issuer, also known as the issuer, takes out a loan. The interest rate can be fixed, variable or structured. Read our information on bonds below.

Table of contents

  1. Bonds – Types
  2. Trading with bonds
  3. Bonds: What maturities are there?
  4. Risks for private investors: Bonds
  5. Bonds: risks in detail
  6. Collateralisation options
  7. Bond lawyer: Legal adviceAnleihen Anwalt: Rechtsberatung

Bonds – types

There are different types of bonds. The most important of these are

  1. Public bonds – the federal government, federal states and local authorities can issue bonds themselves. The federal and state governments use these public bonds to finance their budget deficits. These are usually fixed-interest bearer bonds. Public bonds include federal notes, federal bonds and federal treasury notes, and recently bonds issued by countries with strong credit ratings such as Germany have hardly offered any returns. This is why investment advisors are increasingly recommending emerging market government bonds. However, the higher yields that can be achieved are also generally associated with significantly higher risks.
  2. Credit institutions – Credit institutions can also issue bonds. These include mortgage bonds and public sector mortgage bonds as well as
    debentures.
  3. Commercial sector – SME bonds, corporate bonds, income bonds, etc.
    SME bonds are particularly important for private investors. They are an alternative form of financing for medium-sized companies. Companies benefit from the relatively low collateralisation requirements for SME bonds, whereas for a conventional bank loan, companies must be able to offer considerable collateral. Basically, this is a loan that is usually granted to a company by private individuals. Unlike shares, the lender does not receive any shares in the company. However, the company is obliged to pay interest and repay the amount borrowed on maturity.
  4. International bonds are bonds that are not issued in the country of the debtor. There are various innovative bond types on the international capital market.

Bonds – Trading

Bonds can be traded on stock exchanges. In most countries, however, financial products can also be traded over the counter. They are usually issued as bearer securities so that they can be traded more easily. This means that the holder of the share is also the creditor. However, bonds can also be issued as registered, order or recta securities.

In addition to foreign currency loans, bonds in foreign currencies are also very popular with investors – although they are associated with a higher risk for investors.

Bonds – Maturity

Bonds can be agreed for different maturities. Short-term and medium-term bonds have a term of up to five years. Long-term bonds have a term of more than five years. Government bonds can even have terms of between ten and thirty years.

Risks for private investors

Private investors are lured by promises of high returns and very often invest in corporate bonds. In recent years, however, experience has shown that even bonds from renowned and supposedly safe companies often result in considerable losses for private investors. Many private investors are not aware of the considerable risks involved.

Under certain circumstances, they may even lose their entire investment. In addition, defaults on repayments and maturity extensions often occur. Affected investors should contact a lawyer they trust at an early stage and have their claims for damages reviewed. In the area of banking and capital market law, liability claims against investment advisors and investment brokers exist in many cases.

As private investors cannot be expected to have in-depth knowledge of these products, the advice given by bond sellers or bond brokers is crucial. However, investors are very often given incorrect or incomprehensive advice, so that they are then entitled to claims for damages – in the proven case of incorrect advice. This is legally regulated in investor protection. We, Herfurtner Rechtsanwälte, regularly inform you about current warnings in the area of investments.

Bonds – the risks in detail

Bonds, as a sub-area of banking law / capital market law, are associated with various risks. These include in particular

  • Default risk, also known as credit risk – the creditworthiness of a debtor is decisive for the default risk of a bond. It is checked and assessed by specialised agencies. Borrowers with a poorer credit rating must offer investors a higher interest rate than borrowers with a good credit rating in order to honour investors’ higher risk appetite.
  • Currency risk, also known as exchange rate risk, is the risk of exchange rate changes associated with foreign currency bonds. It is disadvantageous for investors if the nominal currency depreciates against the home currency. In simple terms, this means that the currency in which the bond is repaid by the issuer becomes more favourable in relation to the buyer’s home currency.
  • Interest rate risk – Changes in market interest rates are significant insofar as the value of a bond falls when market interest rates rise. This is particularly relevant if the investor wishes to sell the bond before it matures.
  • Inflation risk – the actual value of a bond and future payments are also significantly influenced by the level of inflation.

Bonds – collateralisation options

There are both collateralised and non-collateralised bonds. Government bonds, for example, are not collateralised.

The following collateralisation options are available:

  1. Ship Pfandbriefe and aircraft Pfandbriefe are collateralised by mortgages on ships and aircraft respectively.
  2. Mortgage Pfandbriefe are collateralised by land and are subject to the requirements of the Pfandbrief Act.
  3. Public sector Pfandbriefe are collateralised by claims on the public sector and are also subject to the requirements of the Pfandbrief Act
  4. Mortgage bonds are collateralised by land and are not subject to the requirements of the Pfandbrief Act.
  5. Asset-backed securities (ABS) are collateralised by the portfolio of receivables transferred to the special purpose vehicle (SPV).
  6. In the case of catastrophe bonds, insurance companies have the option of selling the catastrophe risk on the capital markets and thereby hedging themselves. This allows the risks arising from natural events to be hedged or limited.

Bond lawyer: Legal advice

Our lawyers will be happy to answer any questions you may have on this topic. Bond lawyer – We advise on all forms of bonds. We also offer expert legal advice on funds, in particular ship funds and swap transactions.

Bonds: SME bonds

Mittelstandsanleihen – The lawyers at Herfurtner advise investors who have suffered losses on Mittelstandsanleihen. The majority of the SME bonds currently on offer are probably not recommendable when you compare the potential return with the risk of loss.

Investors should always keep an eye on the performance of their bond. In any case, SME bonds are not classic buy-and-hold investments that can be left in the portfolio for many years.

The SME bond trading segment was launched in 2010 and was created specifically for bonds issued by SMEs and was called BondM. After many insolvencies, scandals and newspaper reports, the market is as good as dead. Many issuers entered the market even though they were not fit for the capital market.

In some cases, the balance sheets showed from the outset that the companies would not be in a position to repay the bond from their operating income. With equity ratios of less than 15%, the dependency on debt capital and follow-up financing is often very high.

According to the Deutsche Schutzvereinigung für Wertpapierbesitz (DSW), the losses on SME bonds already amount to around 900 million euros.

Most SME bonds have a term of five years. It is possible that many investors are still facing the horror, as many maturity dates have not yet been reached. By 2019, 147 SME bonds with a volume of 6.9 billion euros must be repaid. This is the result of a study by Apollo Corporate Finance.

If the bond conditions are changed, cancellation is usually possible. In many cases, investors also have claims for damages against companies and/or persons involved in the issue.

Banking law aspects of the issuance of corporate bonds

The issuance of corporate bonds is subject to a number of legal regulations designed to protect both the issuer and the investor. Below we give you an overview of the most important laws and regulations in this context:

  • Securities Trading Act (WpHG): The WpHG regulates, among other things, the admission of securities to trading on a stock exchange, the publication of prospectuses and the obligations of issuers and investors. When issuing corporate bonds, the regulations on the obligation to publish a prospectus (Sections 3 ff. WpPG) and ad hoc publicity (Sections 15 ff. WpHG) are of particular importance.
  • Securities Prospectus Act (WpPG): The WpPG regulates the preparation, approval and publication of securities prospectuses, which are required for public offerings of securities or for the admission of securities to trading on a stock exchange. Issuers of corporate bonds must therefore prepare and publish a securities prospectus approved by the German Federal Financial Supervisory Authority (BaFin) (Section 3 WpPG).
  • German Stock Corporation Act (AktG): Certain provisions of the German Stock Corporation Act (AktG) are also relevant for listed stock corporations wishing to issue corporate bonds. These include the provisions on raising and reducing capital (Sections 182 et seq. AktG) and the provisions on the Annual General Meeting and its resolutions (Sections 119 et seq. AktG).
  • Market Abuse Regulation (MAR): EU Regulation No. 596/2014 (Market Abuse Regulation) is also relevant for issuers of corporate bonds, as it contains regulations on insider information, market manipulation and disclosure obligations. The MAR is intended to ensure a fair and honest financial market and has direct effect in the EU member states.

Issuing procedure for corporate bonds

Corporate bonds are usually issued in a multi-stage process involving various players and legal aspects. The most important steps and players in the issuing process are described below:

  1. Planning and structuring the issue: In the planning phase, the framework conditions of the issue are determined, such as the issue volume, the term of the bonds, the interest rate and the repayment terms. Legal aspects such as compliance with legal regulations and the design of the bond conditions are also taken into account.
  2. Preparation of the securities prospectus: The securities prospectus is a central document in the issuing process and contains all relevant information about the issuer and the bonds offered. The prospectus must fulfil the legal requirements of the WpPG and the EU Prospectus Regulation and be approved by BaFin.
  3. Placement of the bonds: Once the securities prospectus has been approved, the bonds are placed on the capital market. The bonds are either sold directly to selected investors via a private placement or offered to a broader group of investors via a public placement. As a rule, banks and financial service providers are involved in the placement as lead managers or placement guarantors.
  4. Listing and trading of the bonds: Once the bonds have been successfully placed, they are admitted to trading on a stock exchange. The bonds must fulfil the admission requirements of the respective stock exchange. After listing, the bonds can be traded on the secondary market, giving investors the opportunity to sell their bonds before maturity or to purchase additional bonds.
  5. Redemption of the bonds: At the end of the term of the bonds, the nominal amount is repaid to the investors. The contractual provisions in the bond terms and conditions as well as statutory provisions, such as tax aspects or regulations on early cancellation or conversion of the bonds, must be observed.

Liability risks when issuing corporate bonds

The issuance of corporate bonds also harbours liability risks for the parties involved, in particular for the issuer and the banks involved. The most important liability risks are discussed below:

  • Liability for the securities prospectus: In accordance with Section 21 WpPG, the issuer is liable for the accuracy and completeness of the information in the securities prospectus. An incorrect or incomplete presentation of the circumstances can lead to claims for damages by investors. In certain cases, the banks involved may also be liable for the content of the securities prospectus, for example if they act as lead manager or placement guarantor.
  • Liability for insider trading and market manipulation: The use of insider information or the manipulation of prices in connection with the issue of corporate bonds can have consequences under criminal and civil law. The regulations on the prevention of market abuse in the Market Abuse Regulation (MAR) and the WpHG are therefore of great importance.
  • Liability for breaches of ad hoc publicity: Issuers of corporate bonds are obliged under Section 15 of the German Securities Trading Act (WpHG) to publicly disclose insider information that directly concerns their issuer without delay. A breach of this obligation can lead to claims for damages by investors and fines by BaFin.

What role do banks play in the issuance of corporate bonds?

Banks play a central role in the issuing process of corporate bonds, as they act as lead managers or placement guarantors. They support the issuer in planning and structuring the issue, preparing the securities prospectus and placing the bonds on the capital market. Banks can also act as market makers and thus ensure liquidity in bond trading on the secondary market.

Requirements for issuing corporate bonds?

Companies wishing to issue corporate bonds must fulfil a number of legal requirements, such as preparing a securities prospectus that meets the legal requirements of the WpPG and the EU Prospectus Regulation.

They must also comply with the regulations on ad hoc publicity, insider trading and market manipulation set out in the Market Abuse Regulation (MAR) and the German Securities Trading Act (WpHG). Depending on the legal form of the company, certain provisions of the German Stock Corporation Act (AktG) or the German Limited Liability Companies Act (GmbHG) may also be relevant.

What are the liability risks for issuers and banks when issuing corporate bonds?

Issuers and banks may in particular be liable for the content of the securities prospectus if it is incorrect or incomplete. In addition, there are liability risks in connection with insider trading, market manipulation and the violation of ad hoc publicity obligations. Violations of these regulations may result in claims for damages from investors as well as fines and penalties from supervisory authorities.

What role does the Federal Financial Supervisory Authority (BaFin) play in the issuance of corporate bonds?

BaFin is the competent supervisory authority for the securities market in Germany and is responsible, among other things, for monitoring compliance with legal regulations when issuing corporate bonds. It examines and approves the securities prospectus that must be prepared as part of the issue and can impose fines and other sanctions in the event of breaches of the statutory regulations.

Most important laws and regulations for the issue of corporate bonds

The most important laws and regulations to be observed when issuing corporate bonds are the German Securities Prospectus Act (WpPG), the EU Prospectus Regulation, the German Securities Trading Act (WpHG), the Market Abuse Regulation (MAR), the German Stock Corporation Act (AktG) for listed stock corporations and, where applicable, the German Limited Liability Companies Act (GmbHG) for limited liability companies.

List of listed SME bonds

3W POWER S.A. 14/19  WKN: A1ZJZB
ADLER REAL ESTATE 13/18  WKN: A1R1A4
ADLER REAL ESTATE 14/19  WKN: A11QF0
ADLER REAL ESTATE 15/20  WKN: A14J3Z
AIR BERLIN 10/15  WKN: AB100A
AIR BERLIN 11/18  WKN: AB100B
AIR BERLIN 14/19 WKN: AB100L
AIR BERLIN 14/19 WKN: AB100N
ALBERT REIFF IHS 11/16 WKN: A1H3F2
ALBIS LEASING IHS 11/16 WKN: A1CR0X
Alfmeier Anleihe 13/18 WKN: A1X3MA
ALNO AG 13/18 WKN: A1R1BR
ALPINE HOLDING 12/17 WKN: A1G4NY
ARISTON REAL IHS.11/16 WKN: A1H3Q8
ATON GROUP FIN. 13/18 WKN: A1YCQ4
AVW GRUND AG 11/15 VAR WKN: A1E8X6
BASTEI LUEBBE IHS 11/16  WKN: A1K016
BDT MEDIA AUTOM. IS 12/17  WKN: A1PGQL
BEATE UHSE AG 14/19  WKN: A12T1W
BERENTZEN-GRP IHS 12/17  WKN: A1RE1V
BIOENERGIE IS 13(16/20)  WKN: A1TNHC
BKN BIOSTROM IS.11/16  WKN: A1KQ8V
CENTROSOLAR GROUP AG 16  WKN: A1E85T
CLOUD NO 7 13/17  WKN: A1TNGG
CONSTANTIN MEDIEN AG IHS  WKN: A1R07C
DEMIRE ANLEIHE 14/19  WKN: A12T13
DEUT.BOERSE ANL 13/18  WKN: A1R1BC
DEUT.BOERSE ANL 15/25  WKN: A1684V
DEUT.BOERSE MTN 12/22 WKN: A1RE1W
DEUT.BOERSE SUB.ANL15/21  WKN: A161W6
DEUTSCHE ROHSTOFF 13/18  WKN: A1R07G
DEWB ANL.14/19  WKN: A11QF7
DF DT.FORFAIT AG 13/20  WKN: A1R1CC
DIC ASSET AG ANL. 13/18  WKN: A1TNJ2
DIC ASSET AG ANL. 14/19  WKN: A12T64
DT.STUDENTEN WOHN 15/20  WKN: A1ZW6U
DUERR AG ANL.14/21  WKN: A1YC44
E.N.O. ENERGY GMBH 011/16  WKN: A1H3V5
EDEL IHS 11/16  WKN: A1KQYG
EDEL IHS 14/19  WKN: A1X3GV
EKOSEM-AGRAR GMBH 12/17  WKN: A1MLSJ
EKOSEM-AGRAR GMBH 12/18  WKN: A1R0RZ
EKOTECHNIKA GMBH 13/18  WKN: A1R1A1
ENERGIEKONTOR ANL.11/22  WKN: A1K0M2
ENERGIEKONTOR ANL.12/22  WKN: A1MLW0
ENTERPRISE HLDGS 12/17  WKN: A1G9AQ
ENTERPRISE HLDGS 15/20  WKN: A1ZWPT
ESTAVIS AG 13/18  WKN: A1X3Q9
ETERNA MODE HLD 12/17  WKN: A1REXA
EUROBODEN GMBH IHS 130/18  WKN: A1RE8B
EXER D GMBH 11/16  WKN: A1E8TK
EYEMAXX R.EST.AG 11/16  WKN: A1K0FA
EYEMAXX REAL ESTATE AG 17  WKN: A1MLWH
EYEMAXX REAL ESTATE AG 19  WKN: A1TM2T
EYEMAXX REAL ESTATE AG 20  WKN: A12T37
FAIR VALUE REIT WA 15/20  WKN: A13SAB
FCR IMMOBILIEN ANL 14/19  WKN: A1YC5F
FERRATUM DTL. IHS 13/18  WKN: A1X3VZ
FFK ENVI. GMBH 11  WKN: A1KQ4Z
FREUND+PART.HYBR.ANL10/17  WKN: A1EV8U
FRIEDOLA GEBR.HOLZAPFEL17  WKN: A1MLYJ
GAMIGO AG 13/18  WKN: A1TNJY
GEBR.SANDERS IHS.13/18  WKN: A1X3MD
GERMAN PELLETS GEN.  WKN: A141BE
GERMAN PELLETS IHS.11/16  WKN: A1H3J6
GERMAN PELLETS IHS.13/18  WKN: A1TNAP
GERMAN PELLETS IHS.14/19  WKN: A13R5N
GETGOODS.DE AG ANL 12/17  WKN: A1PGVS
GEWA 5 TO 1 GMBH 14/18  WKN: A1YC7Y
GIF MBH 11/16  WKN: A1K0FF
GOLFINO AG 12/17  WKN: A1MA9E
GUENTHER ZAMEK IS.12/17  WKN: A1K0YD
HAHN IMMO.BET. AG 12/17  WKN: A1EWNF
HALLHUBER ANL 13/18  WKN: A1TNHB
HANSEYACHT AG 14/19  WKN: A11QHZ
HELMA EIGENBAU ANL.13/18  WKN: A1X3HZ
HERBAWI IHS 14/19  WKN: A12T6J
HKW PERSONAL ANL.11/16  WKN: A1K0QR
HOERMANN FIN ANL.13/18  WKN: A1YCRD
HOMANN HOLZW IHS.12/17  WKN: A1R0VD
HPI AG ANL.11/16  WKN: A1MA90
IDENTEC GROUP 12/17  WKN: A1G82U
IMM.PROJ.SAL.AR.ANL 12/19  WKN: A1RFBP
INCITY IMMOBILIEN 14/19  WKN: A13R8D
IPM GMBH ANL.13/18  WKN: A1X3NK
J.F.BEHRENS AG ANL.11/16  WKN: A1H3GE
JACOB STAUDER IHS 17  WKN: A1RE7P
JACOB STAUDER IHS 22  WKN: A161L0
JOH.FR.BEHRENS ANL 20  WKN: A161Y5
JUNG, DMS ANL.15/20  WKN: A14J9D
KARLIE GROUP GMBH 13/18  WKN: A1TNG9
KARLSBERG BR.ITV 12/17  WKN: A1REWV
KATJES INT. IHS 15/20  WKN: A161F9
KÉZIZÁLOG ZRT.  WKN: A1HQFG
KSW IMMOBILIEN ANL.14/19  WKN: A12UAA
KTG AGRAR AG ANL.11(17)  WKN: A1H3VN
KTG AGRAR SE 14/19  WKN: A11QGQ
KTG ENERGIE AG 12/18  WKN: A1ML25
LANG+CIE. RE BET. 15/18  WKN: A161YX
LAUREL GMBH 12/17  WKN: A1RE5T
MAG IAS GMBH 11/16  WKN: A1H3EY
MARITIM VERTR.ANL.14/16  WKN: A13R5R
MBB CLEAN ANL 13/19  WKN: A1TM7P
METALCORP GRP 13/18  WKN: A1HLTD
MIFA FAHRRADW.IHS 13/18  WKN: A1X25B
MINAYA CAP WLD.13/18  WKN: A1X3H1
MITEC AUTOMOTIVE 12/17  WKN: A1K0NJ
MORE+MORE 13/18  WKN: A1TND4
MOX TELECOM AG 12/17  WKN: A1RE1Z
MS DEUTSCHLAND 17  WKN: A1RE7V
MS SPAICH. ANL. 11/16  WKN: A1KQZL
MT-ENERGIE ANL.12/17  WKN: A1MLRM
MTU AERO 12/17  WKN: A1PGW5
NEUE ZWL ZAHNRADW. 14/19  WKN: A1YC1F
NEUE ZWL ZAHNRADW. 15/21  WKN: A13SAD
NORDEX SE IHS 11/16  WKN: A1H3DX
PARAGON AG ANL.13/18   WKN: A1TND9
PCC SE ITV.11/15  WKN: A1K0U0
PEACH PROP.ANL.11/16  WKN: A1KQ8K
PEINE IHS 13/18  WKN: A1TNFX
PENELL GMBH IHS.14/19  WKN: A11QQ8
PHOTON EN.INV. 13/18  WKN: A1HELE
PNE WIND AG ANL 13/18  WKN: A1R074
PORR AG 12-16  WKN: A1HCJJ
PORR AG 13/18  WKN: A1HSNV
POSTERXXL AG 12/17  WKN: A1PGUT
PROCAR AUTOFINANZ 11/16   WKN: A1K0U4
PROCAR AUTOFINANZ 14/19  WKN: A13SLE
RENA GMBH IS.10/15  WKN: A1E8W9
RENA GMBH IS.13/18  WKN: A1TNHG
RENA LANGE 13/17  WKN: A1ZAEM
RENE LEZARD ANL.12/17  WKN: A1PGQR
RICKMERS HOLD.ANL 13/18  WKN: A1TNA3
ROYALBEACH ANL.11/16  WKN: A1K0QA
RUDOLF WOEHRL AG ANL 18  WKN: A1R0YA
RWE FIN. 09/21 MTN   WKN: A0T6L6
S+T AG 13/18   WKN: A1HJLL
SAF HOLLAND 12/18   WKN: A1HA97
SAG SOLARSTROM 10/15   WKN: A1E84A
SAG SOLARSTROM 11/17  WKN: A1K0K5
SANHA ANL 13/18  WKN: A1TNA7
SANOCHEMIA PHARM. 2017  WKN: A1G7JQ
SCHALKE 04 ANL. 12/19  WKN: A1ML4T
SCHNEEKOPPE ANL. 10/15  WKN: A1EWHX
SCHOLZ AG 12/17   WKN: A1MLSS
SEIDENSTICK. IHS 12/18  WKN: A1K0SE
SEMPER IDEM GMBH 11/16  WKN: A1H3YJ
SEMPER IDEM GMBH 14/21  WKN: A11QR1
SEMPER IDEM GMBH 15/20  WKN: A13SHW
SENATOR ENT.ANL.15/16  WKN: A14J6U
SENIVITA GMBH IHS 11/16  WKN: A1KQ3C
SENIVITA SOC.WS 15/20  WKN: A13SHL
SENIVITA SOZ.GE.GS 14/UN.  WKN: A1XFUZ
SIAG SCHAAF AG IHS 11/16  WKN: A1KRAS
SIC PROCESSING GMBH 11/16  WKN: A1H3HQ
SINGULUS TECHN. AG 12/17  WKN: A1MASJ
SNP SCHNEID.-NEU.ANL15/20  WKN: A14J6N
SOLAR8 ENERGY AG 11/16  WKN: A1H3F8
SOLEN AG 11/16  WKN: A1H3M9
STEILMANN-BO.ANL.12/17  WKN: A1PGWZ
STEILMANN-BO.ANL.14/18  WKN: A12UAE
STEILMANN-BO.ANL.15/17  WKN: A14J4G
STERN IMMOBIL.AG ANL13/18  WKN: A1TM8Z
STRENESSE AG ANL13/14  WKN: A1TM7E
STUD.GES.WITTEN/HERD. 24  WKN: A12UD9
SYMPATEX IHS 13/18  WKN: A1X3MS
TAG IMMOBILIEN ANL.13/18  WKN: A1TNFU
TAG IMMOBILIEN ANL.14/20  WKN: A12T10
TIMELESS HOM ANL 13/20  WKN: A1R09H
TRAVEL24.COM 12/17  WKN: A1PGRG
UBM REALITAETEN. 14-19  WKN: A1ZKZE
VALENSINA GMBH IHS 11/16  WKN: A1H3YK
VEDES ANLEIHE 14/19  WKN: A11QJA
VST BUILDING TECH. 13/19  WKN: A1HPZD
WIENERBERGER 07/UND. FLR  WKN: A0G4X3
WINDREICH ANL. 11/16  WKN: A1H3V3

Bonds: Credit quality bonds

The German Federal Financial Supervisory Authority (BaFin) criticises the fact that the risks of credit rating bonds are not recognisable for private investors. There could also be a conflict of interest for credit institutions, as banks also grant loans to the companies whose credit risks they securitise. In BaFin’s view, credit rating bonds do not belong in the hands of private customers.

For reasons of investor protection, BaFin therefore intends to prohibit the marketing, distribution and sale to private customers.

This ban would be the first to affect an entire class of financial products for private investors. This could have a dramatic impact on banks, as investors have invested around 6.3 billion euros in credit bonds. Representatives of the credit institutions concerned are currently being heard.

Credit quality bonds Definition

Credit bonds (credit-linked bonds) are derivatives issued by a bank. From a legal perspective, they represent a debt obligation of the issuer. Investors have the opportunity to invest in the creditworthiness (credit rating) of a debtor.

Depending on the borrower’s credit rating, investors receive certain interest payments. In addition to the interest payments, the investor also receives the nominal value at maturity, provided no credit event occurs with the debtor.

As with conventional bonds, there are two variants with regard to interest. The interest rate can be fixed over the entire term or increase over time via a stepped interest rate.

The speciality of bonds such as credit quality bonds is that the interest and repayment is linked to the creditworthiness (credit rating) of a so-called reference debtor. The reference debtor can be a company or a state. Financial success depends on the non-occurrence of so-called credit events at the reference debtor.

There are also bonds whose performance depends on the creditworthiness of several reference debtors. These bonds with two or more reference debtors, which are equally weighted, are called linear credit quality bonds. They usually relate to the creditworthiness of several representatives of a sector.

As a rule, credit quality bonds are labelled and sold as investment products. Strictly speaking, however, the purchaser does not have the function of a lender. Rather, he is in the role of an insurer, as he is liable for the credit risk of the reference debtor. However, the product designation and sales strategy usually give private customers the impression that it is an interest-bearing security.

Credit quality bonds – higher interest with higher risk

The persistently low interest rates have made government and corporate bonds less attractive. In particular, almost no profits can be made from issuers with high credit ratings. For those investors who do not want to enter the speculative equity market, bonds such as credit quality bonds or credit linked notes (CLN) offer an alternative.

Credit-linked bonds offer investors the opportunity to achieve higher returns than with comparable traditional bonds. The bond creditor receives an additional risk premium for accepting the issuer risk of the issuing bank. This generally results in higher profit opportunities.

Higher yields are generally also associated with greater risks. Purchasers of credit-rated bonds are generally liable for two risks – firstly, the so-called issuer risk, i.e. that the bank that issued the credit-rated bond is unable to fulfil its payment obligations due to a deterioration in its financial situation. Secondly, they are also liable for the creditworthiness of the reference debtor.

If the creditworthiness of the reference debtor deteriorates and a credit event occurs, future interest payments are cancelled. In addition, the credit rating bond is terminated prematurely. It is then settled with a so-called cash settlement amount instead of the original nominal amount of the bond. The amount of the cash settlement amount is determined by the market value of the reference debtor’s liabilities. It can be significantly lower and even amount to zero. This would then mean a total loss.

Such a credit event is, for example, the insolvency of the reference debtor. However, even the non-payment of a due liability can be such a credit event and have serious consequences. Mere temporary payment difficulties that are subsequently overcome are also sufficient. It is then irrelevant for the holders of credit rating bonds if the reference debtor stabilises again after a short time, as the losses have already been incurred.

The lawyers at Herfurtner law firm in Munich have reviewed the terms and conditions of various credit rating bonds and found that the issuers often contractually reserve the right to influence the reference obligations on which the credit rating bonds are based even after the contract has been concluded under certain conditions. However, this creates a conflict of interest between the interests of the issuer and the interests of the investor.

Credit quality bonds not suitable as bonds for private investors

Various aspects of credit bonds speak in favour of their complexity and unsuitability for private investors. Unlike other certificates, which are generally based on generally recognised underlying assets, the underlying assets are creditworthiness and credit risks that are difficult to assess.

However, private customers generally have no idea how to assess and evaluate the credit risks of a company or even a country. For a private investor, it is basically almost impossible to realistically estimate when a so-called price event can be expected.

According to Arthur Wilms, a lawyer at Herfurtner Rechtsanwälte, a law firm specialising in banking and capital market law, it is indeed absolutely impossible for a private investor to assess the risks of credit rating bonds whose performance depends on several reference debtors.

This is because with these products, the investor has to assess the creditworthiness of several reference debtors. As soon as the credit event occurs with a single reference debtor, the investment is terminated. In addition, private customers are unable to assess whether the agreed interest rates correspond to the overall risk.

Bonds: It is also problematic that private investors are led to believe that they are investing for the long term, although credit bonds are highly complex financial instruments based on credit risks that mainly arise from trading in credit default swaps (CDS).

However, CDS trading is characterised by highly complex relationships and is therefore reserved for experienced and professional market participants. Private customers do not have the necessary knowledge and experience and are therefore unable to keep up with professional market participants.

The following banks offer these products:

  • Landesbank Baden-Württemberg (LBBW) – market share 45%
  • Dekabank – market share 32
  • Hypo-Vereinsbank – market share 10%
  • DZ-Bank – market share 7%

These banks have currently sold around 6.3 billion euros in credit bonds into investors’ custody accounts.

The market leaders Landesbank Baden-Württemberg (LBBW), Dekabank, Hypovereinsbank and DZ Bank have removed the credit bonds from their range even before the final ban by BaFin.

Gradual interest rate increases: The rights of the step-up bond

The world of investment can be a dangerous jungle if you are not clear about your rights and obligations, particularly in relation to specialised forms of investment such as the so-called “step-up bond”. This form of bond is one of the more complex financial market products and is of particular interest to investors who are looking for opportunities to maximise returns during periods of rising interest rates.

In times of economic uncertainty and market volatility, understanding the exact functioning and legal aspects of step-up bonds can contribute to investment security.

What is a step-up bond?

Before we get into the legal details, let’s first take a look at what a step-up bond actually is. A step-up bond is a type of bond or debenture where the interest rate for the investor increases in predetermined steps over the term – hence the name “step-up”. It should not be confused with the so-called step-down bond, where the interest rate decreases over time.

The rights of investors in a step-up bond

The rights of the investors are set out in detail in the terms and conditions of the bond, although some aspects are subject to the law. In particular, the issuer of the bond must fulfil certain information obligations and may not disadvantage the interests of the investor.

Information obligations of the issuer

In most jurisdictions, the issuer of the step-up bond is legally obliged to provide all types of information that could be relevant for investment decisions. The initial issue of a bond must usually follow a strict procedure of approval and disclosure regulated by the supervisory authorities. A breach of these obligations can lead to significant legal consequences.

Cancellation rights of the investor

Another important aspect of investing in bonds relates to cancellation. The terms and conditions of the bond should clearly state the investor’s rights to call the bond. In most cases, the investor is granted the right to call the bond either after the expiry of a certain period or upon the occurrence of certain events.

In the case of step-up bonds, this right of cancellation becomes particularly relevant if interest rates in the economy generally rise and the investor has the opportunity to switch to an investment with a higher interest rate.

Legal framework for step-up bonds

The legal regulation of bonds and in particular of step-up bonds varies from country to country. In the European Union, for example, Directive 2003/71/EC serves as the basis for the disclosure requirements for the initial issue of a bond.

Applicable law and jurisdiction

A decisive factor that determines the relationship between issuer and investor is the applicable law and jurisdiction. These determine which rules apply, how and where legal disputes can be resolved and which supervisory authorities are responsible.

The issuer and investor usually choose the law and jurisdiction most favourable to them, with international bonds often governed by the law of a major economy such as the US or the UK.

The role of supervisory authorities

Regulatory authorities play a key role in bond regulation. Their job is to monitor and enforce compliance with the law. They also fulfil an important information function by issuing guidelines for investors and issuers and commenting on specific issues. In addition, they are authorised to impose sanctions in the event of breaches of the statutory requirements.

Pitfalls and risks of step-up bonds

Although step-up bonds can be attractive to investors, especially in a rising interest rate environment, investors should be aware of the risks involved.

Credit risk of the issuer

The credit risk is the risk that the issuer of the step-up bond becomes insolvent and is unable to repay the amounts owed. In principle, the higher the risk, the higher the interest rate offered. Therefore, a higher interest payment may indicate a higher credit risk.

Interest rate risk

The risk of interest rate changes should also be taken into account. If general interest rates rise, the investor could potentially realise a higher return by switching to another investment. However, early cancellation of the bond could have adverse consequences, e.g. the issuer could demand a cancellation fee.

Liquidity risk

Liquidity risk is the risk that the investor may not be able to sell his investment at the desired time or at an acceptable price. Step-up bonds are often less liquid than standard bonds because they are more complex and fewer investors understand them or are willing to buy them.

Zero-coupon bonds: What’s behind them?

Zero-coupon bonds – a financial instrument that often causes investors to frown. Its uniqueness and complexity give it a veil of confusion and unfamiliarity. So why write about zero-coupon bonds? Not only is it important to understand this particular type of bond, but it is also crucial to recognise its role in the financial landscape.

Whether you are an investor, a lawyer, a business owner or just a person with an interest in the financial market, this knowledge can help you make informed decisions, minimise risk and diversify your investments.

Let’s delve deeper into the world of zero-coupon bonds

A zero-coupon bond, or in more international terminology a zero-coupon bond, is a bond that is issued without interest payments or “coupons” as they are often called. It is very different from conventional bonds and has an impressive variety of features.

Zero-coupon bond – the difference to the classic bond

While a traditional bond pays out interest to the investor at regular intervals, this feature is completely absent with a zero-coupon bond. No annual or semi-annual “coupon”, i.e. interest payment, is made. Instead, it is issued at a significantly lower price than its nominal value and repaid at full nominal value at the end of the term.

The return for the investor results solely from the difference between the purchase price and the redemption value.

The charm of the zero-coupon bond – yield without ongoing payments

Zero-coupon bonds offer a number of advantages that make them attractive to certain investors. One of the most obvious advantages is the ability to realise a fixed, guaranteed profit if the bond is held to maturity. This is particularly useful for investors who need a certain amount of money at a specific future date, such as to fund a child’s higher education.

Example of an investment in zero coupon bonds

Imagine you buy a zero-coupon bond with a face value of 10,000 euros, a term of 10 years, for only 6,000 euros. After 10 years, the full nominal value of 10,000 euros is paid out. Your profit here is the difference between the purchase price and the amount paid out, in this case 4,000 euros. You only withdraw the money once and then wait for the maturity date to realise your profit. Simple and straightforward.

On the other side of the coin – risks and disadvantages

Despite their attractive yield characteristics, zero-coupon bonds are not risk-free. Like any financial instrument, they are subject to certain disadvantages and risks that investors should be aware of.

The reinvestment risk of a zero-coupon bond

One disadvantage is the reinvestment risk. This is the risk that interest rates at the time your bond matures may be lower than at the time you invested. The fact that zero-coupon bonds pay no current interest means that if interest rates fall in the market, you may make less money because you cannot reinvest your return on an ongoing basis.

Price fluctuations and market volatility

Another risk is the high sensitivity to interest rate fluctuations. Due to their long term and the lack of ongoing interest payments, zero-coupon bonds are generally subject to greater price fluctuations than normal bonds when market interest rates change. This can lead to significant losses if you are forced to sell the bond before maturity.

Understanding zero-coupon bonds – a checklist for investors

Before you invest in zero-coupon bonds, you should make an informed decision. Here is a checklist to guide you:

  • Understand the concept: make sure you understand the mechanics of a zero coupon bond. It is important to understand the type of investment you are making.
  • Risk tolerance: Assess your willingness to take the risk associated with zero coupon bonds. If you can’t or don’t want to take on a lot of risk, they may not be the best option for you.
  • Maturity date: Consider whether you are prepared to tie up your money for a long period of time. Zero-coupon bonds are often long-term instruments.
  • Tax implications: Interest on zero-coupon bonds is often taxed, even though you don’t receive it until after the bond matures. This could reduce your return.

SME bonds: Financial instruments for SMEs at a glance

SME bonds are a relevant and explosive topic. They represent an alternative to traditional financing options for small and medium-sized enterprises (SMEs). But what exactly is behind this financial instrument? What opportunities and risks does it entail? And how can legal stumbling blocks be avoided or at least minimised?

What are SME bonds?

SME bonds are fixed-interest securities issued by small and medium-sized companies to generate capital. They are an alternative to other forms of financing such as bank loans. As the capital is repaid over a fixed period of time, this provides planning security and a stable interest rate for investors.

Opportunities and advantages of SME bonds

The opportunities and advantages arising from SME bonds are many and varied, with key features for both companies and investors:

  1. Flexibility: in contrast to bank loans, the conditions for an SME bond are more flexible. Companies can usually determine the term, interest rate and repayment conditions themselves.
  2. Independence: Another advantage is the independence from banks and their lending decisions. This can be a decisive advantage, especially in times of crisis.
  3. Yield: Investors are particularly attracted by the higher yields compared to traditional forms of investment.

Risks of SME bonds

But where there is light, there is also shadow. Like any investment, SME bonds also harbour risks.

  • Insolvency risk: In the event of a company insolvency, the bond creditors generally stand behind the other creditors. In the event of insolvency, there is therefore a risk of total loss.
  • Market risk: Due to the often low liquidity and the limited number of investors, trading in SME bonds can be difficult.
  • Interest rate risk: Rising interest rates can reduce the value of the SME bond.

Legal aspects of SME bonds

There are a number of aspects to consider regarding the legal structure of SME bonds.

Firstly, the bonds must be issued in accordance with the German Securities Trading Act (WpHG). This means that the company must draw up a prospectus containing key information about the bond and the company.

Secondly, the company should define and publish clear repayment terms. Investors need to know when and how they will get their money back. Not only legal requirements, but also stock exchange guidelines can play a role here.

Thirdly, it may be advisable to obtain an external credit rating. This can increase the acceptance of the bond among investors.

Practical example: The “Brötchenlust” bakery case

The fictitious bakery “Brötchenlust” will serve as a concrete practical example. In order to finance a new production facility and remain independent of the bank, the company decides to issue an SME bond. The conditions are attractive: a fixed term of seven years, an annual interest rate of four per cent and regular repayment of the borrowed capital.

However, despite careful planning and a positive attitude on the part of the investors, “Brötchenlust” gets into financial difficulties. A tragic fire destroys a large part of the production facility and forces the company into insolvency. The bondholders are faced with a total loss. A worst-case scenario that impressively illustrates the risks of SME bonds.