Assignment

On

Commercial Papers

Submitted to: by:

Submitted

Mr. Ashish Arora

Sem

NIHARIKA
MBA(TYC) 4th Roll no. 2010 MGB

1 435

Department Of Management

Guru Nanak Dev University College Jalandhar

MEANING OF COMMERCIAL PAPERS

Commercial paper is an unsecured and discounted promissory note issued to finance the short-term credit needs of large institutional buyers. Banks, corporations and foreign governments commonly use this type of funding. 1. An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing market interest rates. 2. An unsecured and unregistered short-term obligation issued by an institutional borrower to investors who have temporarily idle cash. 3. Short-term, unsecured, discounted, and negotiable notes sold by one company to another in order to satisfy immediate cash needs.

COMMERCIAL PAPER IN INDIA:

INTRODUCTION:
It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers/ to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. CP as a privately placed instrument, was introduced in India in 1990 with a view to enabling highly rated corporate borrowers to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently, primary dealers and satellite dealers were also permitted to issue CP to enable them to meet their short-term funding requirements for their operations. Guidelines for issue of CP are presently governed by various directives issued by the

Reserve Bank of India, as amended from time to time. In pursuance of the Statement on Monetary and Credit Policy for the Year 2000 - 2001, to keep pace with several developments in the financial market, it has been decided to modify the guidelines in the light of recommendations made by an Internal Group. Now, the Reserve Bank inexercise of the powers conferred by Sections 45 J, 45 K and 45 L of the Reserve Bank of india.

FEATURES OF COMMERCIAL PAPERS

1. They are negotiable by endorsement and delivery and hence they are flexible as well as liquid instruments. Commercial paper can be issued with varying maturities as required by the issuing company. 2. They are unsecured instruments as they are not backed by any assets of the company which is issuing the commercial paper. 3. They can be sold either directly by the issuing company to the investors or else issuer can sell it to the dealer who in turn will sell it into the market. 4. It helps the highly rated company in the sense they can get cheaper funds from commercial paper rather than borrowing from the banks. 5. However use of commercial paper is limited to only blue chip companies and from the point of view of investors though commercial paper provides higher returns for him they are unsecured and hence investor should invest in commercial paper according to his risk -return profile.

Maturity
CP can be issued for maturities between a minimum of 7 days and a maximum up to one year from the date of issue.

Denominations
CP can be issued in denominations of Rs.5 lakh or multiples thereof. Amount invested by a single investor should not be less than Rs.5 lakh (face value).

Limits and the Amount of Issue of CP

CP can be issued as a "stand alone" product. 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. Banks and FIs will, however, have the flexibility to fix working capital limits duly taking into account the resource pattern of companies' financing including CPs. An FI can issue CP within the overall umbrella limit fixed by the RBI i.e., issue of CP together with other instruments viz., term money borrowings, term deposits, certificates of deposit and inter-corporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.

Every issue of CP, including renewal, should be treated as a fresh issue.

TYPES OF COMMERCIAL PAPERS:

Direct Papers: A direct commercial paper is issued directly by the company
to the investors without any intermediary. Companies issuing direct papers announce the current rate of commercial paper with different maturities for investors to choose the CP that suits their requirement.

Dealer Papers: A dealer/merchant banker on behalf of a client issues these

types of commercial papers. The dealer arranges for the private placement of the paper and also provides advisory services such as timing of the issue, determination of the discount rate and a suitable maturity period. Companies and financial institutions tend to find alternative sources of funds whenever bank interest rates are higher than the interest rate prevailing in the market. Commercial paper is an easy, cheap and quick source of finance for these companies.

NEW FORMS OF COMMERCIAL PAPERS:

Innovations in the CP market in foreign countries include:

Master Note: This is a new financial paper, generally issued by finance

companies to bank trust departments and other permanent money market investors. The investing firm, in an agreement notifies the issuing company, the amount of paper that it wishes to purchase on a particular day. The issuing company then issues a paper on the agreed amount.

Medium Term Notes: These are unsecured obligations with a maturity

period of 9-10 months. Investment grade corporations generally issue these notes at a particular rate of interest.

Asset-backed Commercial Paper: This paper offers credit at a lower

interest rate to corporate. Asset-backed commercial paper is a combination of loans or credit receivables into packages. These packages are issued in the form of paper, and the loans and receivables are removed from the issuing companys balance sheet and placed in a Special Purpose Entity (SPE). The SPE issues

commercial paper to cover discount price while using the proceeds for the purchase of receivables.

ISSUING PROCEDURE OF COMMERCIAL PAPERS

Who can Issue?

Corporates and primary dealers (PDs), and the all-India financial institutions (FIs) that have been permitted to raise short-term resources under the umbrella limit fixed by Reserve Bank of India are eligible to issue CP. A corporate would be eligible to issue CP provided: (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) company has been sanctioned working capital limit by bank/s or all-India financial institution/s; and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s/ institution/s. A company planning to issue a commercial paper selects a merchant banker and an Issuing and Paying Agent (IPA) and gets the CP credit rated by an approved credit rating agency. The company then approaches its principal banker with the credit rating certificate for their approval. The banker forwards the application to the RBI for intimation after ascertaining that all the guidelines for the issue of commercial paper are followed. Meanwhile, the merchant banker and the IPA locate clients and obtain their quotes for different maturity periods. The company then takes a final decision on maturity, discount rate and quantum of the issue after consultations with the merchant banker and the IPA. The company can opt for different maturity periods depending upon the span of the CP. If the company plans to issue a CP for six months, it can raise money in tranche with different maturity periods of one, two or three months. In cases where a company decides for a two-month commercial paper, finance has to be raised within a period of two weeks from the date on which the proposal is taken on record by the bank. The company can issue the paper on a single day or in parts on different dates. However the entire issue has to be redeemed on the same day. The proposed issue is to be completed within a period of 2 weeks and the banker has to be intimated to reduce the working capital limit to the extent of the amount raised. The company should inform the RBI about the actual amount raised through CP within three days of completion of the issue.

Commercial papers cannot be underwritten. The CP holder should present the instrument to the paying agent on maturity. The agent receives brokerage charges for services rendered by him depending upon the maturity period of the CP. In India, commercial papers are open to individuals, financial institutions, corporate and Non-Resident Indians. Non-Resident Indians can only invest on a non-repatriable and non-transferable basis. CPs are issued in multiples of Rs.5 lakhs with a minimum investment of Rs.25 lakhs.

CP Issue Expenses CP is issued at a discount to the face value. The following costs are involved in the issue of CP: 1. Stamp duty 0.2% - If placed through banks 1.0% - If placed through merchant bankers 2. Rating fees* 0.10% (subject to a minimum of Rs.100,000) (for a rating from CARE) 3. Issuing and paying agent 0.1% fee (All charges are on per annum basis and are subject to changes from time to time) *CARE charges a rating fee of 0.10% of the amount of issue subject to a minimum of Rs.100,000 and a maximum of Rs.30,00,000. For issues above Rs.500 crore, the maximum fee would be Rs.40 lakh

EVOLUTION AND DEVELOPMENT OF COMMERCIAL PAPERS:

Commercial Paper market had relatively higher growth from 1997-98 onward. On October 15 1997, total outstanding amount on Commercial paper

transaction in Indian money market was Rs. 3377 crore. This outstanding amount increased substantially to Rs. 1,28,347 crore on July 15, 2011. This growth of Commercial paper market may be attributed to the rapid expansion of corporate manufacturing and financial companies in liberalized and Globalized Indian economy during the last decade of 20th century and the first decade of 21st century. The growth of Commercial Paper market in India was more conspicuous after the financial year 2007-08. On 15 July, 2007, total outstanding amount on Commercial paper transaction was Rs. 28,129 crore. This amount increased to Rs. 48,342 crore on 15 July, 2008. Since then, there was substantial increase in the outstanding amount on Commercial paper transactions to the highest level of Rs. 1,28,347 until 15 July, 2011. This period was largely dominated by the Late 2000s financial crisis.In this period, RBI reduced Repo rate drastically from 9% to 4%. However, Prime rate of commercial banks in India remained rigid at 12%. The discounting rate on Commercial papers was in the range of 6.5% to 10% in October 2010. It is explicit from these statistics that the cost of borrowing working capital through Commercial paper transaction became relatively lower for the corporate companies in India in comparison to the cost of borrowing the same working capital through cash credit facility from the commercial banks. The obvious result was an absolute growth of the Commercial paper market in India, particularly, after 2007-08 onward.

COMMERCIAL PAPERS AND CREDIT RATING AGENCIES:

Since Commercial paper is unsecured debt instrument in Indian money market, the issuers of Commercial paper are required to maintain relatively higher Credit rating. According to Reserve Bank of India norms, the issuers of Commercial Paper are eligible to issue Commercial Papers only if they have P2 or equivalent credit rating from any of the credit rating agencies in India. The main agencies are Credit Rating Information Services of India Limited (CRISIL), Credit Analysis and Research Limited (CARE), Investment Information and Credit Rating Agency of India Limited (ICRA). This credit rating is essential for the issue of Commercial papers because a Commercial paper is not backed by any collateral and so only corporate with high-quality credit ratings will easily find buyers without having to offer a substantial discount (higher cost) for the issue of Commercial paper.

COMMERCIAL PAPER MARKET

The introduction of commercial paper as debt instrument has promoted commercial paper market as one of the components of Indian money market. In this commercial paper market, the issuers of commercial paper create supply while the subscribers to commercial paper create demand for these papers. The interaction between supply and demand for commercial papers promotes the commercial paper market. The main issuers of Commercial paper in this market are corporate and the main subscribers to the Commercial papers are the banking companies. Commercial Paper is issued by the issuers at a discount to face value of Commercial paper. The face value of Commercial Paper is in the denomination of Rs. 0.5 million and multiples thereof. The maturity period of Commercial paper in the Commercial Paper market ranges between minimum of 15 days and maximum of 1 year from the date of issue. The subscriber to the commercial paper is the investor, and a single investor in the Commercial paper market is not allowed to invest less than Rs. 0.5 million. The other issuers of Commercial paper in this market are Primary dealers and All India Financial Institutions. The other investors or subscribers to Commercial paper in this market are individuals, Non-Resident Indians and Foreign Institutional Investors.

PARTICIPANTS IN COMMERCIAL PAPERS:

1. Issuer 2. Investor

ISSUER OF COMMERCIAL PAPER: Corporate, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP.

ELIGIBILITY CRITERIA FOR ISSUING COMMERCIAL PAPER: A corporate would be eligible to issue CP provided 1. The tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore. 2. Company has been sanctioned working capital limit by banks or all-India financial institutions. 3. The borrowal account of the company is classified as a Standard Asset by the financing banks/ institutions.

To summaries the above discussion on commercial paper

CPs are issued by companies in the form of usance promissory note, redeemable at par to the holder on maturity. The tangible net worth of the issuing company should be not less than Rs.4 crores.

Working capital (fund based) limit of the company should not be less than Rs.4 crores.

Credit rating should be at least equivalent of P2/A2/PP2/Ind.D.2 or higher from any approved rating agencies and should be more than 2 months old on the date of issue of CP.

 Corporates are allowed to issue CP up to 100% of their fund based working capital limits.

It is issued at a discount to face value.

CP attracts stamp duty.

CP can be issued for maturities between 15 days and less than one year from the date of issue.

CP may be issued in the multiples of Rs.5 lakh.

No prior approval of RBI is needed to issue CP and underwriting the issue is not mandatory.

All expenses (such as dealers fees, rating agency fee and charges for provision of stand-by facilities) for issue of CP are to be borne by the issuing company.

ADVANTAGES OF COMMERCIAL PAPERS:

1) It is quick and cost effective way of raising working capital. 2) Best way to the company to take the advantage of short term interest fluctuations in the market 3) It provides the exit option to the investors to quit the investment. 4) They are cheaper than a bank loan. 5) As commercial papers are required to be rated, good rating reduces the cost of capital for the company. 6) It is unsecured and thus does not create any liens on assets of the company. 7) It has a wide range of maturity 8) It is exempt from federal SEC and State securities registration requirements.

DISADVANTAGES OF COMMERCIAL PAPERS:

1) It is available only to a few selected blue chip and profitable companies.

2) By issuing commercial paper, the credit available from the banks may get reduced.

3) Issue of commercial paper is very closely regulated by the RBI guidelines.

RECENT DEVELOPMENT OF COMMERCIAL PAPERS

Until recently commercial paper was not tradable. The Securities Trading Corporation of India (STCI) has sanctioned commercial papers as tradable instruments by allowing the UTI to act as market leader for its commercial papers. Any corporate or mutual fund with liquid cash for a period of one to fifteen days will be able to invest its funds in STCIs CP, the returns of which would be in excess of bank and call money rates and could be redeemed any time. The RBI, public sector banks and financial institutions have promoted STCI with an authorized paid up capital of Rs. 500 crore. Commercial Paper market had relatively higher growth from 1997-98 onward. On October 15 1997, total outstanding amount on Commercial paper transaction in Indian money market was Rs. 3377 crore. This outstanding amount increased substantially to Rs. 1,28,347 crore on July 15, 2011.This growth of Commercial paper market may be attributed to the rapid expansion of corporate manufacturing and financial companies in liberalized and Globalized Indian economy during the last decade of 20th century and the first decade of 21st century. The growth of Commercial Paper market in India was more conspicuous after the financial year 2007-08. On 15 July, 2007, total outstanding amount on Commercial paper transaction was Rs. 28,129 crore. This amount increased to Rs. 48,342 crore on 15 July, 2008. Since then, there was substantial increase in the outstanding amount on Commercial paper transactions to the highest level of Rs. 1,28,347 until 15 July, 2011. This period was largely dominated by the Late-2000s financial crisis. In this period, RBI reduced Repo rate drastically from 9% to 4%. However, Prime rate of commercial banks in India remained rigid at 12%.The discounting rate on Commercial papers was in the range of 6.5% to 10% in October 2010. It is explicit from these statistics that the cost of borrowing working capital through

Commercial paper transaction became relatively lower for the corporate companies in India in comparison to the cost of borrowing the same working capital through cash credit facility from the commercial banks. The obvious result was an absolute growth of the Commercial paper market in India, particularly, after 2007-08 onward.

Looking Ahead
Over the past few months, yields on commercial papers have shown considerable increase (by more than 100 basis points) primarily due to the tight cash conditions and hike in the repo rates. Moreover, the sluggish stock market has not helped the companies cause either. As per estimates by Grant Thornton, total capital raised via IPOs by Indian companies in the first half of 2008 was USD 4.07 billion as compared to USD 7.68 billion for the same period in its preceding year. Corporations are betting on interest rates to come down in the future even though experts beg to differ opining that even if banks start to cut lending rates in the coming six months, overall borrowing costs are expected remain high at least till year end 2009. Meanwhile, Commercial papers being sold by esteemed and well-capitalized companies continue to prove healthy. With the debatable dubious stability of the Indian financial system, Commercial Papers are the current savor for Indian Corporations. Moreover, Converting trade receivable claims into electronic format and creating a structure to allow trading of these as commercial papers would certainly boost credit flow to small and medium enterprises. The essential qualities of commercial papers, that being, shortterm maturity, establishing national credit, self-liquidating nature, keeping reserve of borrowing power at local banks, non-speculative nature and purpose of use are only a few factors contributing to the even though minuscule contribution being made by commercial papers in unlocking the door to future growth of India Inc.

Conclusion
The concept of raising money through commercial paper was know to the US markets since 20th century. On our country though it was introduced in 1990, the RBI constantly watching the growth of the CP market and it is modifying the guidelines from time to time. For further development of CP market, the stamp duty on CP should be abolished since there is no stamp duty in US, UK and France and RBI has to relax the stringent Credit Rating norms from the present Credit rating P2 of CRISIL to P3, since credit rating is not compulsory in many countries like US, UK and France. The denominations of CP should be reduced further for the growth of secondary market for CP.