Benefits of Commercial Paper

Introduction

Commercial Paper (CP) is a money market instrument in India, which was first introduced in 1990 in India as a short-term instrument. They are 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.

What is a Commercial Paper?

  • Commercial Paper (CP) is an unsecured and negotiable money market instrument issued in the form of a promissory note issued by companies to raise funds generally for a time period up to one year. 
  • CPs are issued by highly rated corporate entities to raise short-term funds for meeting working capital requirements directly from the market instead of borrowing from banks.
  • CPs are not usually backed by any form of collaterals and are allowed to be issued only by corporate with high quality debt ratings. The issue of CP seeks to by-pass the intermediary role of the banking system.
What is a Commercial Paper?

Why Commercial papers were Introduced?

  • Commercial papers were introduced as a privately placed instrument for the Non-Banking Financial Companies (NBFCs) mainly to enable highly rated corporate borrowers to diversify their pattern of short time borrowings and to provide an enhanced instrument to the investors.
  • Eventually, all the primary dealers and all India Financial Institutions were permitted to issue commercial paper that enables them to meet the short-term funding requirements of their operations.

Few important things to note about commercial papers

Who Can Issue CP?

Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP. Prior approval of RBI is required before a company can issue CP in the market.

Eligibility for issuance of CP
  • The tangible net worth of the issuer company, as per the latest audited balance sheet, should not be less than Rs. 4 crore
  • The issuer company should have been sanctioned working capital limit by bank/s or all-India financial institution/s
  • Borrowal account of the company is to be classified as a Standard Asset by the financing bank/s/ institution/s.
Credit Rating Requirements for Issuer Company
  • The issuer company needs to obtain the credit rating 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. 
Maturity Period & Denomination for CPs
  • CPs 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 instrument typically should not go beyond the date up to which the credit rating of the issuer is valid.
  • They can be issued in denominations of ₹ 5 lakh or multiples thereof. 
Mode of CP

CP has to be issued at a discount to face value. Discount rate has to be freely determined by the market.

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.

Benefits of Commercial Papers

CPs have been introduced in the Indian market so as to provide a diversified source of funding to the borrowers as well as an additional investment option to the investors.

Benefits to the Issuer :

  1. Low interest expenses: The interest cost associated with the issuance of CP is normally expected to be less than the cost of bank financing.
  2. Access to short term funding: CP issuance provides a company with increased access to short term funding sources.
  3. Flexibility and liquidity: CP affords the issuer increased flexibility and liquidity in matching the exact amount and maturity of its debt to its current working capital requirement.
  4. Investor recognition: The issuance of CP provides the issuer with favourable exposure to major institutional investors as well as wider distribution of its debt.
  5. Ease and low cost of establishment: A CP programme can be established with ease at a low cost, once the basic criteria have been satisfied.
  6. No Collaterals – CPs can be issued with any collateral so very less paperwork and formalities required.

Benefits to the Investor :

  1. Higher yield: Higher yields are expected to be generally obtainable on CP than on other short term money market instruments like bank deposits.
  2. Portfolio diversification: Commercial Paper provides an attractive avenue for short term portfolio diversification.
  3. Flexibility: CPs can be issued for periods ranging from 15 days to less than one year, thereby affording an opportunity to precisely match cash flow requirements.
  4. Liquidity: Liquidity in CP is generally provided by a dealer offering to buy it back from an investor prior to maturity, for which a market quote will be available. The investment in CP will therefore be quite liquid.