DEFINITION
Commercial paper is a short term, unsecured license promissory note issued at a discount
to face value by well known or reputed companies, who carry a high credit rating and have a
strong financial background. It is an unsecured obligation issued by a bank or corporation to
finance its short-term credit requirements like accounts receivable and inventories and it is
usually issued at a discount reflecting the prevailing market interest rates.
An unsecured, short-term debt instrument issued by a corporation, typically
for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities
on commercial paper rarely range any longer than 270 days. The debt is usually issued at a
discount, reflecting prevailing market interest rates.
Participants
1. Issuers
Any private sector companies, public sector units, non-banking companies, primary dealers
(PD), satellite dealers (SDs) etc, can raise funds through the Commercial papers. But the
companies have to satisfy the eligibility criteria prescribed by RBI as discussed later. The
condition laid by RBI restrict the entry of issuers into the CP market.
2. Investors
CPs are generally open to all investors-individuals, banks, corporates and also Non-resident
Indians (NRIs). But NRIs can only invest on a non-reportable and non transferable basis. SEBI
has permitted Foreign Institutional Investors (FIIs) also to invest in corporate debts instruments
like CPs. FIIs were allowed to invest their short-term funds in such instruments too. Within a
ceiling of the $ 1.5 billion of the total FIIs were inflows for debt funds set down by the RBI.
Though the market is open to the above segments, usually, banks, large corporate bodies, public
sector units with investible funds functions in the market.
Features
Commercial papers favor both borrowers and investors. It is considered as an optimal
combination of liquidity and returns in the short-term market. To borrowers it implies low cost of
funds, and to investors it implies liquidity, marketability and returns.
I)
Commercial papers does not originate from a specific self liquidating transaction like
normal commercial bills, which generally arise out of specific trade transaction.
II)
CPs is backed by the liquidity and earning powers of the issuer, but is not backed by any
The CP market provides the borrower a cheaper source of funds with less paper work and
formalities when compared to bank finance. Corporate prefer this mode of finance as they can
determine the cost and maturity. Similarly, CP involves less paper work formalities, as it an
unsecured liability, unlike bank finance, which is secured.
IV)
Investors prefer to invest in CPs due to high liquidity, varied maturity and high yield
(when compared to bank deposits). The liquidity is high because it can be transferred by
endorsement and delivery.
1. MATURITY
Commercial paper has a minimum maturity period of 15 days and a maximum of 1 year. Unlike
CD, the issuer can buy back his CP.
2. DENOMINATION AND SIZE
CPs are issued in multiples of Rs.5 lakh and the minimum, size of each issue is Rs.5 lakh as
minimum investment.
3. ISSUE PRICE
The CPs are issued to the investors at a discount to the face value. The discount actually is the
effective interest rate. The issue prices determine by the corporate issuing it in the following
manner. Generally the merchant bankers (Issuing and Paying Agent) IPA on behalf of the
corporate client, approaches various investors and takes quotes, and expected amount of
investment for the proposed CP for various maturity. After obtaining the quotas, the merchant
bankers and issuing company compile the data and arrive at an optimal discount rate with a
feasible maturity date of paper. While determining the discount rate, it considers factors such s
prevailing call money rates, prime lending rates, T-bill rates, maturity of the papers and other
relevant expenses (such as brokerage, rating agencys fees, stamp duty, etc). Once the issue price
and maturity are decided, the IPA places the CP with the investors.
1. Direct Paper:
The Direct Paper is issued by large finance companies and bank holding companies deal
directly with the investor rather than use a dealer as an intermediary.
Though the issuers of direct paper do not have to pay any dealers commission, these
companies must operate a marketing division to maintain constant interaction with active
investors. And also these companies need to pay fees to banks for supporting lines of credit, to
the rating agencies and to agents (i.e. bank trust departments). Hence, this paper must be sold in
large volumes to cover the substantial costs of distribution and marketing.
2. Dealer Paper:
The Dealer Paper is issued by dealers on behalf of their corporate customers. It is mainly
issued by non-financial companies and finance companies. The issuing company sells the paper
directly to the dealer at a discount and commission. The dealer will resell it at the highest
possible price in the market. Companies using dealers to place their paper are generally smaller,
less frequent borrowers than issuers of direct paper. An open rate method is followed by which
the company receives some money in advance but the balance depends on the performance of the
issue in the open market.
ISSUING PROCEDURE
A corporate planning to issue CP requires fulfilling the eligibility criteria prescribed by
the RBI, and then it needs to select merchant bankers and an issuing and paying Agent (IPA)
(mandatory) and obtain a resolution from the company board to issue the commercial papers.
After the resolution is passed, the company needs to get t he CP credit rated by one of the
approved credit rating agencies like CRISIL/ICRA/CARE/DCR, as prescribed by RBI. The
company then has to approach its principle bankers with a proposal along with a credit rating
certificate for approval. The banker will then scrutinize the same and verify whether all condition
stipulated by RBI are met, and forward the application to the RBI for intimation.
On the other hand the merchant bankers or issuing or paying agent will locate the clients
and get their quotas for different maturity periods as discussed above. Then the company and
merchant bankers /IPA decide the maturity, discounts rate and the quantum of the issue. A
company can opt a various maturity periods within the stipulated span, i.e, if a company plans to
issue a CP for a span of 6 months, it can raise the money in trances with different maturity
periods of 1 month, 2 month or 3 months, etc. based on the market quotes. If a company decides
on a 2 month CP, it can raise the finance within a period of 2 weeks from the date on which the
proposal is taken on record by the bank and it can issue the paper on a single day or in parts on
different dates (but the whole issue should be redeemed on the same date).
The issue proposed should be completed within a span of two weeks and the company
should intimate the bankers to reduce the working capital limit to the extent of the amount raised.
The company should pay the applicable stamp duty based on the maturity. After the issue is
completed within 3 days, the company should intimate the RBI the actual amount raised through
CPs. The CP is not allowed to be underwritten. On the maturity the holder of the cp presents the
instrument to the paying agent. Who arranges the payment? The agent will receive the amount
and brokerage for the services provided (the brokerage fees charged by them is given below). No
grace periods is allowed for the repayment of the paper. If the maturity dates falls on the
holidays. The issuer is supposed to make payment on the next working day, every issuer of CP is
treated as a fresh issue (including roll over) and the issuer need intimate RBI while doing so.
The tangible net worth of the company, as per the latest audited balance sheet, is not less
than Rs.4 crore;
Company has been sanctioned working capital limit by bank/s or All-India financial
institutions; and
The borrowable
financing bank/s/institution/s.
2. Rating Requirement
All eligible participants shall obtain the credit rating for issuance of Commercial Paper
from either the Credit Rating Information Services of India Ltd. (CRISIL) or the Investment
Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research
Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd. Or such other Credit Rating Agencies as may
be specified by the Reserve Bank of India from time to time, for the purpose. The minimum
credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies. The issuers shall
ensure at the time of insurance of CP that the rating so obtained is current and has not fallen due
for review.
3. Maturity
CP can be issued for maturities between a minimum of 15 days and a maximum up to 1 year
from the date of issue.
4. Denominations
CP can be issued in denominations of Rs.5 lakh or multiples thereof. Amount invested by single
investor should not be less than Rs.5 lakh (face value).
8. Mode of Issuance
CP can be issued either in the form of a promissory note (Schedule I) or in a dematerialized form
through any of the depositories approved by and registered with SEBI. As regards the existing
stock of CP, the same can continue to be held either in physical form or can be dematerialized, if
both the issuer and investor agree for the same.
CP will be issued at a discount to face value as may be determined by the issuer.
No issuer shall have the issue of Commercial Paper underwritten or co-accepted.
prescribed by them. However, these should be within the prudential norms as applicable and
subject to specific approval of the Board.
12. Procedure for Issuance
Every issuer must appoint an IPA for issuance of CP. The issuer should disclose to the potential
investors its financial position as per the standard market practice. After the exchange of deal
confirmation between the investor and the issuer, issuing company shall issue physical
certificates to the investor or arrange for crediting the CP to the investors account with a
depository. Investors shall be given a copy of IPA certificate to the effect that the issuer has a
valid agreement with the IPA and documents are in order (Schedule III).
PROFORMA
All endorsements upon the commercial paper must be clear and distinct. Each endorsement
should be written within the space allotted.
Serial No.
Or order on the maturity date as specified above the sum of Rs __________ (in words)
upon presentation and surrender of this Commercial Paper at______________for and on
(Name of the Issuing and Paying Agent)
behalf of _______________________
(Name of Issuing Comp.)
Authorized Signatory