CP is a short-term debt instrument issued by companies to raise funds for up to a year
We often come across news such as XYZ company raising funds through commercial paper or commercial paper market falls for the first time in last six months in the country, etc. But most of us are unaware of the meaning of the term commercial paper.
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 364 days. Commercial paper is a money-market security issued (sold) by large corporations to get money to meet short term debt obligations (for example, payroll), and is only backed by an issuing bank or corporation’s promise to pay the face amount on the maturity date specified on the note.
Since it is not backed by collateral, only firms with excellent credit ratings from a recognized rating agency will be able to sell their commercial paper at a reasonable price. Commercial paper is usually sold at a discount from face value, and carries higher interest repayment rates than bonds. Typically, the longer the maturity on a note, the higher the interest rate the issuing institution must pay. Interest rates fluctuate with market conditions, but are typically lower than banks' rates. Let’s know more about commercial paper.
What is a commercial paper?
As mentioned earlier, commercial paper can be defined as an “unsecured money market instrument issued in the form of a promissory note”. These are not usually backed by any form of collaterals and are allowed to be issued only by corporate with high quality debt ratings.
Commercial paper in India
Commercial paper was introduced in India in 1990 to allow highly rated corporate borrowers to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently, primary dealers and all-India financial institutions were also permitted to issue CP to enable them to meet their short-term funding requirements for their operations.
Who can issue CP?
Corporates, primary dealers (PDs) and financial institutions (FIs) are eligible to issue CP.
What is the minimum & maximum period of maturity?
CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue. However, the maturity date of the CP should not go beyond the date up to which the credit rating of the issuer is valid.
What are the rating requirements?
The eligible participants need to obtain the credit rating for issuance of CP either from CRISIL, ICRA, CARE, FITCH or any other credit rating agency (CRA) that may be specified by RBI. The minimum credit rating shall be A-2 as per SEBI guidelines. The issuers also needs to ensure that at the time of issuance of Commercial Paper the rating so obtained is current and has not fallen due for review.
What is the limit up to which a CP can be issued?
The aggregate amount of CP from an issuer shall be within the limit as approved by its Board of Directors or the quantum indicated by the Credit Rating Agency for the specified rating, whichever is lower. As regards FIs, they can issue CP within the overall umbrella limit prescribed in the Master Circular on Resource Raising Norms for FIs, issued by DBOD and updated from time-to-time.
In what denominations a CP can be issued?
CP can be issued in denominations of Rs. 5 lakh or multiples thereof.
How long can the CP issue remain open?
The total amount of CP proposed to be issued should be raised within a period of two weeks from the date on which the issuer opens the issue for subscription.
Whether CP can be issued on different dates by the same issuer?
Yes. CP may be issued on a single date or in parts on different dates provided that in the latter case, each CP shall have the same maturity date. Further, every issue of CP, including renewal, shall be treated as a fresh issue.
Who can act as issuing and paying agent (IPA)?
Only a scheduled bank can act as an IPA for issuance of CP.
Who can invest in CP?
Individuals, banking companies, other corporate bodies (registered or incorporated in India) and unincorporated bodies, non-resident Indians (NRIs) and foreign institutional investors (FIIs), etc can invest in CPs. However, investment by FIIs would be within the limits set for them by Securities and Exchange Board of India (SEBI) from time-to-time.
Whether CP can be held in dematerialised form?
Yes. CP can be issued either in the form of a promissory note or in a dematerialised form through any of the depositories approved by and registered with SEBI. Banks, FIs and PDs can hold CP only in dematerialised form.
Are CP always issued at a discount?
Yes. CP will be issued at a discount to face value as may be determined by the issuer.
Are CPs traded in the secondary market?
Yes. CPs are actively traded in the OTC market. Such transactions, however, are to be reported on the FIMMDA reporting platform within 15 minutes of the trade for dissemination of trade information to market participation thereby ensuring market transparency.