Commercial Paper (CP) is a fairly new instrument which was originated in US. It helps private companies with good credit rating to raise money directly from the market and investors. They raise money by issuing commercial papers in tight money market conditions through sources other than banks. CP is a fairly popular instrument and exists in most of the developed economies. Large corporate and private companies find CPs cheaper, simpler and more flexible due to their better credit rating.
By definition, CP is a promissory note issued by leading, reputed and highly rated corporates to raise money for short-term requirements. In India, the maximum period (tenor) is 1 year.
Main characteristics of Commercial Paper are
Commercial paper is a short-term debt instrument (money market instrument) issued by both financial and non-financial companies.
These debt instruments are unsecured in nature, that is, they do not require any charge to be created on the company’s assets.
If the company fails to pay back the investors the amount of commercial papers after their maturity, the investors can not sell a particular asset and recover their dues.
Commercial papers are discount instruments, which mean they are issued at discount and redeemed at face value.
It can have different maturity periods but it varies within 1 year. In India, the maturity period varies between 90 days to 365 days.
In India, RBI regulates the Commercial paper instruments. Companies have to adhere to the norms set by the RBI in order to raise money using commercial papers.
Detail Process of Issuing Commercial paper in India
First meet the criteria set by the Reserve Bank of India, main regulator for commercial paper instruments in India
Make the issue rated by a SEBI registered credit rating company
Select the agents, dealers and merchant bankers for the same
Issuing agent acts as a trustee cum agent to the issue by holding the notes in safe keeping, to deliver the notes to the CP dealer, receive the proceeds and pass them to the issuer.
After that the merchant banker places the CP and then confirms the deal to the company.
Commercial papers are tradable by endorsement in the secondary market and on maturity (maximum 1 year) it is presented for payment.
Investors in CP could be individuals, corporates, banks, unincorporated bodies, NRIs, etc.
CPs in India came into existence in 1990. The idea was to enable highly rated corporate borrowers to diversify their resources of short-term borrowings and also to provide additional instruments to investors. With RBI considerably relaxing the norms for issues of CP, this market has picked up substantially and is reasonably vibrant. Corporates also require prior RBI permission for issue of CPs. The company has to advise RBI through the lead bank or principal bank, the details of the issue in the prescribed format.
Benefits of Commercial papers:
Investors get higher yield compared to other short-term investments.
These are more liquid in nature
For the issuer, the rates are economical because they are in direct contact with the investors.
Issuers can match the exact amount and maturity requirements of investors, and therefore gets favorable exposure to variety of investors.