What is Commercial Paper? – CP is essentially an unsecured money market instrument issued in the form of a promissory note . It was formally introduced in Indian market in 1990 with the stated intent to enable “highly rated corporate borrowers to diversify their sources of short-term borrowings and also provide an additional financial instrument to investors”.
Reserve Bank of India Act, 1934 gives RBI the authority to regulate all the money market instruments in India. RBI over the past couple of decades has issued three set of directions for Commercial Paper market:
- Guidelines for Issue of Commercial Paper, 2000
- Reserve Bank Commercial Paper Directions, 2012 – superceded the above guidelines
- Reserve Bank Commercial Paper Directions, 2017 – present framework, supercedes above two directions.
The commercials papers are issued under the Reserve Bank Commercial Paper Directions, 2017. Further, the standard procedures and documentation are prescribed by Fixed Income Money Market and Derivatives Association of India (FIMMDA) under ‘Operational Guidelines on CPs’.
Features of the Product:
|Tenor/ Maturity Period Of Commercial Paper||Original tenor of a CP can be between seven days to one year.|
|Rating||Minimum credit rating for a CP needs to be A3|
Rating from two Credit Rating Agencies are required for Issuers whose total issuance volume during a calendar year is INR 1000 Cr or more. In case of different ratings the lower one needs to be adopted.
|Put/Call option||Not permitted|
|Minimum denomination||INR 5 lakhs|
|Form||To be mandatorily issued as a promissory note at a discount to face value and in dematerialize form. Further the exact end use needs to be disclosed at the time of issuance|
|Buyback of CP||The buyback of a CP, in full or part, shall be at the prevailing market price.|
The buyback offer should be extended to all investors in the CP issue. The terms of the buyback should be identical for all investors in the issue.
The buyback offer may not be made before 30 days from the date of issue.
|Trading in CPs||Can be listed on BSE/NSE exchange|
All OTC trades in CP shall be reported within 15 minutes of the trade to the Financial Market Trade Reporting and Confirmation Platform (“F-TRAC”) of Clearcorp Dealing System (India) Ltd
|Issuance Documentation||Standard documentation for Issuers, investors and Issuing and Paying Agents (IPAs) as prescribed by FIMMDA|
|Price calculation basis FIMMDA convention||100/ (1+ Yield* No. of days to maturity/ 365)|
FIMMDA (full form Fixed Income Money Market and Derivatives Association of India) mentions the fact that the stamp duty for Usance Promissory Note (UPN) of short term maturity (up to one year) is lowest among all unsecured debt products as one of the reasons for Commercial Papers to be issued in the form of a promissory note. (This difference of stamp duty for commercial papers and Non-convertible debentures may however disappear as the recent amendments in Finance Act,2019 get implemented starting July 2020).
The operational process and legal documentation of issuing a promissory note is nonetheless still much simpler and straight forward than issuing other forms of debt.
Eligible Issuers & Investors:
|Non-Banking Finance Institutions/ All India Financial Institutions||Should have a fund-based facility availed of from bank(s) and/or financial institutions is classified as a standard asset by all financing banks/institutions at the time of issue||Earlier Directions required issuer to have a working capital limits from bank or FI and minimum net worth of 4 Cr. These have been removed in 2017 guidelines.|
|Co-operative societies/unions, government entities, trusts, limited liability partnerships and any other body corporate||Minimum net worth of 100 Cr and should comply with above condition||2017 Directions broadened the scope of eligible issuers by bringing in co-operative societies, unions, government entities, trusts and LLPs or any other body corporates|
|Any other entity specifically permitted by RBI||Special permission from RBI required|
|All resident investors are permitted to invest in CPs||Related parties as defined in Companies Act cannot invest in commercial papers of the issuer either in primary or secondary market|
Other regulations issued by various regulators likes SEBI, IRDA with respect to investment by various investors will also need to be complied with. For example mutual funds can only invest in listed commercial papers. Similarly banks will need to comply with RBI circular with respect to operation of investment portfolio.
|Non-resident investors||As permitted under Foreign Exchange Management Act (FEMA), 1999 Act. Presently, only Foreign Portfolio Investors can invest in CPs|
Benefits of commercial paper for Issuers:
- Unsecured Money: It does not create a direct security interest on any identified assets of Issuer – the assets can be provided as security to other secured lenders. This feature makes the product very useful to issuers who do not have adequate security to give as collateral to lenders.
- Cheaper Cost of Funding: The cost of financing via CPs can be lower than MCLR rates of banks – hence this route can be cheaper than working capital facilities from banks. Also, many a times the yield curves are so positioned that shorter tenor funding might be much cheaper than longer tenor funding – this can be exploited by entities by issuing commercial papers.
- Bullet Repayment: Since the issuer does not have to make periodic repayments, the working capital can be better managed. For example, expected repayment date of due receivables can be matched to the repayment date for the commercial paper. While in a normal term loan the borrower will need to arrange for funds for periodic repayments.
Benefits of commercial paper for Investors:
- Higher Pricing: The product can offer investors higher returns compared to short tenor alternate options like certificate of deposits.
- Portfolio Diversification: Many entities access the debt market to only bridge the working capital gap by issuing commercial papers – product provides an option to take exposure to such entities and add diversification to the overall portfolio.
- Lower risk: Short tenor of the product reduces credit and interest rate risks for the investors.
In Part II of this article we will analyse the Indian Commercial Paper market in detail covering volumes, depth of issuers & investors etc.
Stay Tuned !