A Commercial paper (CP) is a new addition in the money market of India. The use of Commercial paper became prominence after 1990. It is the monetary instrument issued by corporate bodies in the nature of promissory note. The commercial paper acts as the debt instrument deployed by corporations to take a loan in the money market. The financial market in India received a boost immediately commercial papers were introduced. The Indian financial market is one of the most robust markets in the world.
Before the injection of a Commercial Paper into the Indian economy, corporate bodies were depending on traditional and crude methods of borrowing Funds from commercial banks to finance their businesses.
Corporate bodies had to use their raw material inventory as collateral. This traditional method was time-consuming because the credit companies wasted a lot of time before releasing funds for the day to day operations of the borrowing companies.
Hence, the introduction of a commercial paper to the Indian money market is a plus to these corporate bodies with a view to seeking short-term credit. In addition, corporate bodies will avoid the hassle of direct negotiation with the credit companies.
This article will take a look at Commercial Papers in India, its benefits, as well eligibility criteria for a Corporation to issue commercial papers.
WHAT IS A COMMERCIAL PAPER?
A Commercial Paper (CP) can be defined as a promissory note issued by corporate bodies when seeking a short-term credit to finance their day to day operations. The issue of commercial papers is highly regulated and supervised by the Reserve Bank of India (RBI). Historically, it was first issued in India in 1990 as a short-term instrument.
The implementation of commercial paper started as a privately placed instrument for companies that are non-banking with a view to enabling them to borrow credit to finance their respective operations without necessarily having to part with collaterals.
Eventually, the entire financial institutions and primary dealers were permitted to issue commercial paper so that they can meet their funding needs to run the operations of the firms. Commercial papers are usually issued for maturities that are between 7days minimum and one-year maximum from the issue date.
BENEFITS OF ISSUING COMMERCIAL PAPERS
Before the injection of a Commercial Paper into the Indian economy, corporate bodies were depending on traditional and crude methods of borrowing Funds from commercial banks to finance their businesses. Corporate bodies had to use their raw material inventory as collateral. This traditional method was time-consuming because the credit companies wasted a lot of time before releasing funds for the day to day operations of the borrowing companies. In view of this, the following are the benefits of issuing commercial papers;
- Simplicity: Commercial papers have the benefit of simplicity. There is hardly the issue of documentation between the creditors and the investors.
- Flexibility: Commercial paper is highly flexible in terms of short-term maturity.
- Diversification at a cheaper cost: A renowned firm finds it easy to diversify its finance sources from the banks to the short-term money market.
- It provides investors with mouth watery returns which would not have been possible with the traditional banking system.
WHO CAN ISSUE COMMERCIAL PAPER?
The following categories of members have the right to issue commercial papers;
- Leasing and Finance Companies
- Manufacturing Companies
- Financial Institutions
ELIGIBILITY CRITERIA FOR ISSUING COMMERCIAL PAPER IN INDIA
The following conditions must be met before a firm can issue commercial papers;
- The firm issuing the commercial paper must have a total worth of at least Rs.4 crore with respect to their recent balance sheet.
- The working capital limit of the firm should not be less than Rs.4 crore.
- With regards to the firm’s recent balance sheet, the current ratio should not be less than 1.33.
- A minimum of P2/A2 rating should be maintained by the firm from CARE/ICRA/CRISIL or any approved credit rating agencies. The credit rating should not be less than two months old.
- The firm’s borrowing account will be classified as a standard asset by financing companies.
CONDITIONS FOR ISSUING COMMERCIAL PAPER
The following are the conditions for issuing commercial papers;
- The commercial paper shall not be issued 15days less than the intended date of issue.
- There is no grace period for the payment of a commercial payment
- The maturity period of commercial papers has been increased by the Reserve Bank of India from a maximum period of 6months to a maximum period of 1 year from the date of issue.
- The absence of a secondary market has created reluctance on the part of investors.
- Commercial papers can be issued to any person such as individuals, banks, as well as corporate bodies that are domiciled in India.
- Commercial papers cannot be issued to NRI’s
- Companies issuing commercial papers may request a bank to guarantee a standby facility provided the amount won’t exceed the issued amount.
NORMS FOR ISSUING COMMERCIAL PAPER
The following are the norms for issuing commercial papers;
- With respect to the guidelines approved by the Reserve Bank of India, a firm will only issue commercial papers through the banks it has a good credit rating with. The bank will deal directly with the issue instead of making advances and loans.
- Another norm is the timing. Firms applying to RBI for the issue of commercial papers must have a good credit rating that is not above 2 months old. What this means is that firms applying for commercial papers must obtain a fresh rating if time elapses.
- Lastly, once the Reserve Bank of India approves a firm’s application, the firm would make arrangement within 15days in order to place the commercial papers private.
COMMERCIAL PAPER CREDIT RATING
All applicants shall obtain a good credit rating from any of the following agencies;
- Credit Rating Information Services of India Ltd. (CRISIL)
- Investment Information and Credit Rating Agency of India Ltd. (ICRA)
- Credit Analysis and Research Ltd. (CARE)
- India Ratings & Research Pvt. Ltd. (Ind-Ra)
- Any other credit rating agency (CRA) as may be specified by the Reserve Bank of India
In addition, applicants must comply with the following criteria in order to obtain CP with credit ratings;
- With respect to the guidelines approved by SEBI, the minimum credit rating to maintain in order to obtain a credit rating is P-2 of CRISIL.
- The issuer must at all times ensure that the credit rating is current and is not due for review.
COMMERCIAL PAPER TENOR
Commercial paper can be issued if:
- From the date of issue, the maturity is a minimum of 7 Days and a maximum of one year.
- CP should not be issued if the credit rating is no longer valid.
- The denomination for issuing CP should be Rs.5 lakhs and multiples of this amount.
- An amount more than Rs. 5 lakh should not be invested by a single investor.
WHO CAN INVEST IN COMMERCIAL PAPER?
The following are the categories of persons/companies that can invest in CP;
- Banking companies
- Other corporate bodies (registered or incorporated in India)
- Unincorporated bodies
- Non-Resident Indians (NRIs)
- Foreign Institutional Investors (FIIs) etc.
However, the limit of investment by Foreign Institutional Investors (FIIs) would be determined by the Securities and Exchange Board of India (SEBI). In addition, investment by FIIs should be in compliance with the following Act;
- 1999 Foreign Exchange Management Act
- 2000 Foreign Exchange (deposit) Regulations
- 2000 Foreign Exchange Management Regulations (Transfer)
WHAT IS RETURN ON COMMERCIAL PAPER?
Usually, a commercial paper is issued at a discount with respect to its face value. Therefore, Return on CP is defined as the difference between face value and the issue price. Also, commercial papers are traded in the OTC markets.
WHAT IS THE MODE OF REDEMPTION
Initially, a commercial paper investor is required to make payment only at the discounted value of the commercial paper using cross-account payee cheque to the account of the issuer via IPA. Once the CP matures;
- The CP is held in physical form
- The CP holder will present it for payment through the IPA to the issuer
- If the CP is held in Demat form, the CP holder will redeem it through the depository and then use IPA to receive payment.
COMMERCIAL PAPER PAYMENT
Any investor who wants to obtain a commercial paper must make a discount payment using a cross-account payee cheque through Issuing and paying agent (IPA) to the issuer. In this case, only a selected bank can stand as an IPA. Once the commercial paper matures and held in its physical form, the CP holder will then present the instrument to the issuer for payment via same Issuing and paying agent (IPA).
CHALLENGES ASSOCIATED WITH THE ISSUE OF COMMERCIAL PAPER
The following are the challenges militating against the issuance of commercial papers;
- CP is an unsecured loan, hence applicants prefer dealing with public sector entities or highly rated corporate bodies because of credit rating.
- The CP market is seasonal and therefore vulnerable to the problem of liquidity. In case of liquidity, the ability of a firm to secure a loan will naturally diminish.
GROWTH OF COMMERCIAL PAPER IN INDIA
The Indian CP market has grown from 1997-98 onward. The amount of commercial paper related transaction as of the 15th of October 1997 was a little above Rs.3377. This amount increased significantly on July 15, 2011, to 1,28,347 crore.
The Growth of commercial paper in India is largely attributed to the rapid expansion of financial and corporate companies in the globalized and liberalized Indian economy during the last 10 years.
After the Financial year 2007-08, the Growth of commercial paper was more pronounced. The total outstanding amount with respect to commercial paper related transaction as of July 15, 2007, was Rs. 28,129. This figure increased to Rs. 48,342 crore the following year. Since then, there has been a continual increment in the number of commercial paper transactions.