Collateral trust certificates are bonds issued by a corporation that are secured with the use of assets that are in the possession of another business entity. In most cases, a collateral trust certificate is backed with underlying securities that are directly owned by a subsidiary of the company issuing the bond. In effect, this creates a situation where a corporation is borrowing against the assets owned by the subsidiary, rather than against assets that are owned by the company proper.
There are a couple of common scenarios in which a corporation would choose to structure a corporate bond issue with a collateral trust certificate approach. First, the company may not wish to commit assets that are in the direct control of the corporation to the bond issue. However, a subsidiary may have assets that are not considered essential to the operation of that entity, and thus may be freely utilized to act as securities for the bonds that the company wishes to issue.
Next, the assets that are directly in the possession of the company may already be committed to other transactions. This means that those assets are not available to act as security for the corporate bonds. When this is the case, the assets of a subsidiary may be pledged to guarantee the bond issue. The actual structure of the collateral trust certificate helps to account for the fact that the underlying assets are in the possession of the subsidiary, so there is no surprises to investors on the nature of the arrangement.
Typically, the use of a collateral trust certificate does not impose any great problems for either the parent company or the subsidiary. Assuming that the project funded by the proceeds from the bond issue is successful, both entities ultimately benefit. As far as any increased risk for the investor, the use of a collateral trust certificate is not any more or any less risky than if the underlying securities were in the direct control of the parent company.