Lesson 6

Commercial Paper (CP)
After reading this lesson, you will be conversant with: Features of Commercial Paper Issuing Procedure Evolution and Development of Commercial Paper Market Commercial Papers in International Markets Innovations of Commercial Paper

Treasury Management: Theory and Practice

The money market is relevant to the corporate world in terms of short-term surplus or deficit of funds, which it experiences. If a corporate has a short-term surplus, it invests and if it faces deficit, then it borrows. A corporate needs short-term funds to manage its working capital requirements, pay taxes and meet other short-term commitments. These needs are fulfilled, usually, by obtaining short-term finance from banks, trade credit from creditors, loans from Inter Corporate Deposits (ICDs) market, bill discounting and factoring, etc. Corporates are always in search of new instruments to raise funds that provide them with an optimal combination of low cost, flexible and desired maturity. As a result the Commercial Paper (CP) was introduced in 1990.

Definition
Commercial Paper (CP) is an unsecured usance money market instrument issued in the form of a promissory note issued at a discount, and is transferable by endorsement and delivery and is of fixed maturity. It is a short-term money instrument issued to corporate, who have a high credit rating and have a strong financial background. It is an unsecured obligation issued by a bank or a corporation to finance its short-term credit requirements like accounts receivable and inventory. In other words, the Commercial Paper is an unsecured, short-term loan issued by a corporation typically to finance accounts receivable and inventories and it is usually issued at a discount reflecting the prevailing market interest rates. ISSUERS CPs can be issued by Corporate, 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 the Reserve Bank of India are eligible to issue CP. But, the issuer has to satisfy the eligibility criteria prescribed by RBI as discussed later. The conditions laid by the RBI restrict the entry of issuers into the CP market. INVESTORS CPs may be issued to and held by individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs). However, investment by FIIs would be within the limits set for their investments by Securities and Exchange Board of India (SEBI). FIIs were allowed to invest their short-term funds in such instruments too. Within a ceiling of the $1.5 billion of the total FIIs were inflows for debt funds set down by the RBI. When NRIs subscribe to CP issue, the conditions regarding non-repatriability and non-endorsability are indicated on the CP. Though the market is open to the above segments, usually, banks, large corporate bodies, public sector units with investible funds function in the market.

FEATURES OF COMMERCIAL PAPER Maturity
Commercial paper has a minimum maturity period of 7 days and a maximum of one year. Unlike CD, the issuer can buy-back his CP. The maturity date of the CP should not go beyond the date up to which the credit rating of the issuer is valid.

Denomination and Size
CPs are issued at a discount to face value as may be determined by the issuer and no issuer shall have the issue of CP underwritten or co-accepted. CP are issued in denominations of Rs.5 lakh or multiples thereof. A single investor should not invest not less that Rs.5 lakh of face value. ISSUE PRICE The CPs are issued to the investors at a discount to the face value. The discount actually is the effective interest rate. The Issue Price is determined by the corporate issuing it in the following manner: Generally, the merchant banker/ 288

T-bill rate. After obtaining the quotes. or any such other credit rating agencies as may be specified by the Reserve Bank of India for issuance of Commercial Paper.. its primary and secondary market determination of the interest rate. For example.100. as the lenders in the CP market are predominantly banks.Financial Markets and Instruments Issuing and Paying Agent (IPA) on behalf of the corporate client. (CRISIL) or such equivalent rating by other agencies such as the Investment Information and Credit Rating Agency of India Ltd. a corporate issues a CP at an effective rate of 10. Factors affecting the Pricing CP being a short-term instrument. depends upon conditions in short-term money market. due to relative credit perception by the public and also. Prime lending rate.00% for 90 days. rating agency fees. Commercial Bills. F P I N = Face/Maturity Value = Issue Price of CP = Effective Interest p. and expected amount of investment for the proposed CP for various maturities.97. the IPA places the CP with the investors. While determining a discount rate. This is a discounted instrument and hence is actually issued at Rs. two companies with the same rating need not attract the same rate. the discount rate. which are the principal investors. Competing Money Market Investment Products: Interest rates on CPs are determined by the demand and supply factors in the money markets and the interest rate on the other competing money market instruments such as Certificates of Deposit. CPs are issued for periods of 7/15/30/45/60/90/120/270/360 days. its pricing is affected very much by call rates. to an extent.00% x 90/365) = Rs. RBI changed the minimum credit rating to P-2 of Credit Rating Information Services of India Ltd. Also. lower call rates mean cash surplus. The following are the principal factors in pricing the CPs.100. The Issue Price is calculated as below: P= F Ix N 1+ 100 x 365 Where. This means that the corporate gets Rs. stamp duty. Liquidity: Pricing and availability of funds under CPs are determined by the liquidity amongst banks and mutual funds. = Usance Period (No. approaches various investors and takes quotes. call markets affect the CP market rate. Credit Rating: The initial credit rating requirement was P1. The investments in CPs give comparably higher yields than those obtained in bank deposits of similar maturities.a. Banks thus view CPs as an alternative investment route. Ltd. Later. etc. (ICRA) or the Credit Analysis and Research Ltd. it considers factors such as – Prevailing call money rates. (CARE) or the FITCH Ratings India Pvt. 289 .5936 per Rs. of days). maturity of the paper and other relevant expenses (such as brokerages. Short-term Forward Premia and Treasury Bills. the merchant banker and issuing company compile the data and arrive at an optimal discount rate with a feasible maturity date of the paper. the company‟s long-term credit ratings. i. Once the issue price and maturity are decided. This is calculated as follows: Rs.5936 Interest is calculated on an actual/365-day year basis.97. Interbank Call Rates: Since call rates affect all the other short-term rates and banks are the most important investors in CPs. Typically.5936 on issuance and has to redeem Rs..100/(1+10.). However.97. on the maturity date after 90 days.e.

i. 2 months or 3 months. it can raise the money in tranches with different maturity periods of either 1 month. it is further fine -tuned. P4: The degree of safety regarding timely payment on the instrument is minimal and the effect of unfavorable conditions may be adverse. the company needs to intimate the RBI the actual amount raised through CPs. The issue proposed should be completed within a span of 2 weeks and the company should intimate the banker to reduce the working capital limit to the extent of the amount raised. the company needs to get the CP credit rated by one of the approved credit rating agencies like CRISIL/ICRA/ CARE/DCR. scrutinize the same and verify whether all conditions stipulated by the RBI are met. if a company plans to issue a CP for a span of 6 months. P2: The degree of safety is strong. On maturity. ISSUING PROCEDURE A company planning to issue CP requires to fulfill the eligibility criteria prescribed by the RBI. based on the market quotes. the holder of the CP presents the instrument to the paying agent. etc. then it needs to select a merchant banker and an Issuing and Paying Agent (IPA) (mandatory) and obtain a resolution from the company board to issue the commercial paper.e. P5: The instrument is expected to be in default on maturity or is in default. then. The banker will. The total amount of CP to be issued should be raised within a period of two weeks from the date on which the issuer opens the issue for subscription. the Merchant Banker or Issuing and Paying Agent (at times. but the adverse affects due to the unforeseen circumstances will have more impact on the instrument than on the instrument rated as P1 and P2. P3: An adequate degree of safety regarding timely payment. each CP so issued will have the same maturity date. Then the company and merchant banker/IPA decide the maturity. A company can opt for various maturity periods within the stipulated span.. within 3 days. who arranges the payment. After the issue is completed. company appoints IPA as a dealer) will locate the clients and get their quotes for different maturity periods as discussed below. The company then has to approach its principal banker with a proposal (in the form of schedule-II given in Appendix) along with the credit rating certificate for approval. After the resolution is passed. and forward the application to the RBI for intimation (as the approval from RBI is no longer required). On the other hand.. The agent will receive 290 . discount rate and the quantum of the issue. it can raise the finance within a period of 2 weeks from the date on which the proposal is taken on record by the bank and it can issue the paper on a single day or in parts on different dates (but the whole issue should be redeemed on the same date).Treasury Management: Theory and Practice Rating Notches for CPs The 5-notch scale on which the credit rating agencies rate the CPs is given below: P1: The degree of safety regarding timely payment is strong. The amount of CP to be issued should be raised on a single date or in parts on different dates. The company should pay the applicable stamp duty based on the maturity. By adding “+” and “–” symbols after the rating. In case of issuing in parts on different dates. If a company decides on a 2 month CP. but relatively lower than that of P1. as prescribed by RBI. The CP is not allowed to be underwritten.

100 Period of CP 3 months 6 months 6 months and above Every renewal is considered as a fresh issue and it involves expenses. it has to incur issue expenses each time. IPA should make sure that issuer has the minimum credit rating as fixed by RBI and the amount mobilized through issuance of CP is within the limit indicated by Credit Rating Agency (CRA) for the specified rating or as approved by its Board of Directors. Central Office. whichever is lower.050 0. ii. iii. The role of IPA becomes mandatory while issuing CP. No grace period is allowed for the repayment of the paper. the company may have to pay more interest and if it raises for a short period. the issuer is supposed to make the payment on the following working day. Any discontinuation of reporting of CP details to MPD should be communicated separately at a later stage.e. IPA should verify all the documents submitted by the issuer. Mumbai. Role and Responsibilities of Issuing and Paying Agent (IPA) For issuance of CP only scheduled banks act as an IPA. rating agencies fees and other expenses like charges levied by the banks for providing redemption facilities. brokers‟ fees or issuing and paying agents‟ fees. If the maturity date falls on a holiday. vi. all the certified copies of original documents are held in the custody of IPA. It should also certify that it has a valid agreement with the issuer. Hence. etc.025 0. viz. iv. All the CP issues should be reported to the Adviser-in-Charge. After verification. IPA as a member of Negotiated Dealing System (NDS) should report the CP issuance details on NDS platform within two days from the date of completion of the issue. signatures of authorized executants (when CP in physical form) and issue a certificate that documents are in order.. Issue Expenses The issue expenses of the CP include payment of stamp duty. Monetary Policy Department (MPD). a company needs to optimize between the interest cost and issue cost while deciding the terms of maturity.Financial Markets and Instruments the amount and brokerage for the services provided (the brokerage fee charged by them is given below). if an issue is raised for a long period. The brokerage varies depending on the size of the issue and the maximum prescribed brokerage is as follows: Fees charged (% on the issue amount) 0. Every issue of CP is treated as a fresh issue (including roll over) and the issuer needs to intimate the RBI while doing so. Reserve Bank of India.. copy of board resolution. Hence. The role and responsibilities of IPA are as follows: i. 291 . acting as an IPA. i. a company must consider interest paid and issue expenses borne while determining the duration of CP. All scheduled banks. should continue to report CP issuance details within three days from the date of completion of the issue and should incorporate details till NDS reporting stabilizes to the satisfaction of RBI. v. All the expenses related to the issue of CPs are borne by the issuers.

the RBI attempted to rectify this anomaly by abolishing standby facility in October. The real risk associated with corporates was not assessed properly.25 0. As the amount raised by CP is utilized to reduce the working capital finance. In October 2000. Secondary Market and Trading The transactions in secondary market take place in lots of 5 lakh each. This is not only to assure investors that the issuers have access to sufficient liquidity and they would be repaid when the refinancing of outstanding CPs is not possible but also to ensure that there is no systemic disruption in CP market in the event of default of any large CP issuer.12 0.06 0. 1994. Underwriting From the beginning.012 0. a company may experience a liquidity crunch when the CP matures.rbi. Above 12 months Source: http://www.036 0. Standby Facility RBI allowed banks to sanction standby arrangement to the company issuing a CP. it was not obligatory for banks/FIs to provide stand-by facility but they were given the flexibility to provide credit enhancement facility within the prudential norms and subject to specific approval of their Boards. as the banks indirectly assured repayment of the CPs to the investors. The applicable stamp duty structure for banks and non-banks are given below: Structure of Stamp Duty Period I. this issue was resumed after the review of cross-country experiences.. regardless of the issuing entity. This step was intended not only to create a level playing field for banks and non-bank entities to issue commercial paper but also to bring the Indian commercial paper market closer to international standard.5 III. Up to 3 months Above 3 months up to 6 months Banks 0.18 0.org.10 (In percent) Non-Banks 0. banks provide standby facility to redeem the sum at maturity. the RBI did not permit underwriting of CPs. Beside considering all these issues and to further preserve the integrity of the CP market as well as to generate further investment interest in this instrument.05 0.Treasury Management: Theory and Practice Stamp Duty on Commercial Paper The stamp duty payable by the issuer on CP is based on the period for which the CP is issued. these experiences showed that rating agencies insisted on issuers of CPs to have in place back-up liquidity lines with banks at any particular point of time up to a stipulated percentage on the amount of CPs outstanding. RBI encouraged issuers to use back-up credit lines from banks/FIs to a stipulated percentage of their outstanding CP issuance at any particular point of time. Above 9 months up to 12 months V. The secondary market transactions do not attract stamp duty.e. When such a facility is provided by the banks the instrument is secured indirectly. Above 6 months up to 9 months IV. Banks trade in secondary market as CPs are generally placed with them. II.in/scripts/Notification Government of India in its budget 2005-06 propose to rationalize the stamp duty i. CP being a „stand alone‟ product. to make the CP market more realistic. The CP being a discount paper does not 292 . Wherein.024 0. In such instances. Hence. Thus. the stamp duty applies uniformly.

incometaxindia. It is considered as an optimal combination of liquidity and returns in the short-term market. marketability and returns. 293 . this would amount to other Income/Interest Income. the provisions of the Income Tax Act relating to deduction of tax at source are not applicable in the case of transactions in these two instruments. but the trading income. which borrow funds through the issue of CP. Source: www.Financial Markets and Instruments attract income tax. at an interest rate lower than the interest rate on borrowings from the banks. Though these securities are unsecured. varied maturity and higher yield (when compared to bank deposits). On maturity. can take advantage of a situation by following the money market rates. the borrower can reduce the outstanding amount as and when he gets surplus funds. attracts income tax. deductible for tax purpose. it implies low cost of funds. which is the difference between the cost of acquisition and resale value. The cost of funds for the company is reduced because it can raise 75% of its working capital through the Commercial Paper issue. CPs have higher liquidity. For the intermediary market deals. The company cannot have any grace period and it is liable to make payment whenever the paper matures.647 dated 22nd March. every issue of commercial paper including renewal is treated as a new/fresh issue. Hence. The flexibility provided by the instrument enables the company to raise additional funds especially when the market is favorable.in / TDS ADVANTAGES OF COMMERCIAL PAPER Commercial paper favors both borrowers and investors. casting a positive effect on the long-term borrowing program of the company. For the Investor: Profit/loss on sale of investment – Income is taxed under the head “Profits and Losses from Business and Profession”. The holders can get quick payments from the company‟ s banker on its behalf as soon as the permissible working capital limit is achieved. The company‟s image will be improved. In the cash credit system of lending. the brokerage charged is in the range of 0. the instrument is presented to the paying agent for receiving payments. To borrowers. The companies. the standby facility its holders confidence to get the return on the due dates. There are very few market makers who offer two-way quotes in Commercial Paper.05%-0. 1993 clarified that the difference between the issue price and the face value of the Commercial Papers and the Certificates of Deposits is to be treated as „discount allowed‟ and not as „interest paid‟. For. This is because of the administrative lag in aligning the bank‟s lending rates with the overall interest rates. and to investors it implies liquidity.20%. Losses are allowed as business losses for banks and investment companies. The level of access to the national by banks gives CP market is considered as a key factor to accept the issues in the international market. The paper work involved in raising the funds through the Commercial Paper is very less because more funds can be procured without any underlying transaction. As there is no roll over. This results in a reduced effective interest cost. Settlement The transfer is done through endorsement and delivery. Taxation For the Corporate: The discount is treated as an interest expense. From the investor‟s point of view. corporates that invest in other company CPs.gov. Box 1: Tax Deducted at Source The Central Board of Direct Taxes vide Circular No. The liquidity is high because it can be transferred by endorsement and delivery.

the working capital requirement limit. and these guidelines later were revised many times to facilitate the growth of the market. the guidelines have now been finalized.. The changes in the guidelines originally issued are summarized hereunder. issue of CP together with other instruments. As ICDs were unsecured and the transactions were not transparent. The minimum credit rating required was A1 and P1 and the same was reduced to A2 and P2 in October‟93. company has been sanctioned working capital limit by bank/s or all-India financial institution(s) and the borrowed account of the company is classified as a standard asset by the financing bank(s)/institutions. besides this. At the same time. Later. was reduced to Rs.e. It was launched “with a view to enable highly rated corporate borrowers to diversify their sources of short-term borrowings and a lso provide an additional instrument to investors”. viz.10 crore as per the latest balance sheet. Similarly. by which certain categories of borrowers could issue CPs in the Indian Money Market.5 crore and in October ‟93. Earlier. term money borrowings. Initially. the RBI issued guidelines on issue of CPs in January. it permitted even unlisted companies to issue CPs. term deposits. 1990. The introduction of CPs is a result of the suggestions of the Working Group on Money Market in 1987. the RBI felt that CPs may serve as a good substitute for such funds.Treasury Management: Theory and Practice EVOLUTION AND DEVELOPMENT OF COMMERCIAL PAPER MARKET The concept of raising funds through commercial paper is new to Indian corporates. the guidelines will enable companies in the services sector to more easily meet their short-term working capital needs. ‟93. The amount a company was allowed to raise through CP was limited to 20 percent of its Maximum Permissible Bank Finance (MPBF) and the same was raised to 75 percent in October. RBI changed the minimum credit rating to P-2 of Credit Rating Information Services of India Ltd. As far as Financial institution are concerned.4 crore in October ‟93. certificates of deposit and inter-corporate deposits should not exceed 100 percent of its net owned funds. 2000. a company was eligible to issue CP only if it had a tangible net worth of Rs. It was also allowed because the RBI desired to discourage the practice of lending in the Inter Corporate Deposit (ICD) market. banks and FIs will have the flexibility to fix working capital limits duly taking into account the resource pattern of companies‟ finances including CPs. i.. Later. 2000 policy statement that the current guidelines to issue the CPs would be modified in the light of recommendations made by an Internal Group. it was reduced to Rs. In particular. It was indicated in April. 294 . The working group was of the opinion that the CP market had the advantage of giving high-rated corporate borrowers cheaper funds than they could obtain from banks. Taking into account the suggestions received from the participants. The RBI initially stipulated that the company should be listed on one or more of the stock exchanges. a draft of the revised guidelines as also the Report of the Internal Group was circulated in July. while providing the investors higher yields than they could obtain from the banking system. In April ‟90 . (CRISIL) or such equivalent rating by other agencies.25 crore.4 crore as per the latest audited balance sheet. they can issue CP within the overall umbrella limit fixed by the RBI. which was Rs. now a corporate can raise up to 100 percent of its fund-based working capital (without increasing its overall short-term credit). Accordingly. The new guidelines are expected to provide considerable flexibility to participants and add depth and vibrancy to the CP market while at the same time ensuring prudential safeguards and transparency. it was further reduced to Rs. as per the latest audited balance sheet.15 crore and later to Rs. the RBI announced its decision to introduce CPs. In 1989. Since the concept of MPBF was abolished recently.

However.05 4.00 4.90 15.5 lakh. Satellite dealers.61-5.25 16. Later on October 10 th 2000. Currently. RBI permitted the Primary Dealers (PDs) to raise the funds for their operations by issuing CPs hoping that this would.60-6. later this condition was relaxed.25 2 Rate of Interest (percent) @ 3 295 .525.213. The standby facility which was allowed to facilitate redemption has now been abolished to activate the market.90 17. On maturity of CP. Earlier. 1993 and the minimum was reduced to 30 days in 1997.20 4. Also. 2002.597. Market Potential and Interest Rates of Commercial Paper The following table presents an overview of the outstanding amounts and the effective interest rates for CPs in the years from April 2004 to April 2007.51 18.25-7.65 5.51 5. However. RBI permitted all-India Financial Institutions (FIs) to raise short-term resources through the issue of CP under the umbrella limit fixed by RBI. the maturity period of CP was a minimum of 3 months and a maximum of 6 months from the date of issue.95 4.909.56-7.90 17. in later guidelines.33 5.349.95 15 10.328.20 31 10. Earlier.796.50 5. there were many inter year and intra year fluctuations on the amount of CPs. when CP is held in demat form. it is Rs.50-6.20 4.65 5. the minimum was reduced to 15 days and In October 2004.10 lakh and the minimum size of an issue to a single investor was Rs.77-8.50 2 Rate of Interest (percent) @ 3 April Fortnight Total Amount ended Outstanding 1 2006-07 15 30 12.5 lakh.688. Scheduled banks which act as IPA have to report to RBI in case of such occurrence giving full particulars of default of repayment of CPs. Similarly.15 6.50 lakh (face value).65 5. The RBI had taken further steps to activate the market for CPs as there were hardly any market makers offering two-way quotes in CPs.181.968.63-7. in turn.90 17. enable the PDs to access greater volumes of funds thereby enhancing the level of activity in the secondary market. Though the above conditions were relaxed/modified for the growth of CPs.95 6. every issuer must appoint an Issuing and Paying Agent (IPA) for issuance of CP and only scheduled bank can act as an IPA for issuance of CP.50-6. It can be observed that the size of the market is very small.25 lakh in multiples of Rs. the holder of CP will have to get it redeemed through the depository and receive payment from the IPA. RBI in its guidelines further reduced the minimum maturity period to 7 days.50 4. crore) Fortnight ended 1 2004-05 April May June July 15 9. On April 15th 1997. which were allowed to issue CPs earlier.077. 1993 the minimum amount for a single investor was reduced to Rs.353.706.47-5.45-6. the company which was listed on a stock exchange was eligible to issue a CP. the growth was not as appreciable as expected.00 4.5 lakh in multiples of Rs. In October.50-6. Table 1: Issue of Commercial Paper* by Companies (Amount in Rs.25 30 9.156.40-6. The Discount and Finance House of India (DFHI) was expected to be a market maker by giving two-way quotes.848.42-6. IPA monitor defaults in redemption of CP.66-6.11 5. The maximum limit was extended to 1 year in October. the denomination was Rs.45 31 10.45 15 10.38-6.322.45 15 10. the company willing to raise CP had to take prior approval from the RBI which is not essential now.20 4.65 5.35-9.55-6.590.95 30 10.Financial Markets and Instruments According to the initial guidelines.60 July June May Total Amount Outstanding 2 Rate of Interest (percent) @ 3 April Fortnight Total Amount ended Outstanding 1 2005-06 15 30 15 31 15 30 15 31 15. At present. were discounted from issuing with effect from June 1.90 16.521.57-7. the holder of CP shall present the instrument for payment to the issuer through the IPA.90 18.

55-6. the effective cost should be lower than the PLR.215.173.8.71 30 19.75-6.21-7.20 31 10. the individuals and other small investors are away from this market.149.80 February 15 16.35 28 15.68-7.50 7. shares. All these costs have to be incurred each time a company issues a CP thus increasing the effective cost.226.20 30 10.37-7.712. A company is prompted to issue a CP if the cost of funds is lower than the PLR of the banks.35 31 17.33 5.20-7. bonds.20-7.15 31 16.10-6.70 January 15 12. stamp duty.90 March 15 13.180.723.30 October 15 10.418.69-9.90 February 15 13.65-8.23 5..35 5.56 5.876.50-7.10 5.50-6. The minimum size of investment for an individual investor is too high.768.75 6. which is usually the rate the top class companies will be obtaining.80 30 11. Since the cost of CP includes rating charges.00 5. it will not be prudent for a corporate to issue CP. The outstanding amount as on March 27.90 * @ : : Rate of Interest (percent) @ 3 4.30 5.097. there are no tax benefits. Hence.871.70 31 12.60 5.75 7.50 5. Scheduled Commercial Bank’s Investments in Commercial Papers The outstanding amounts of scheduled commercial banks and their investments in the commercial paper.51 November 15 17.71 Rate of Interest (percent) @ 3 5. etc.75 5.45-6.40-7.50 5.90-6.30 31 12.821crore.10 5.90 28 13.35 15 17.561.10 31 10.50 5.25 March January October Fortnight Total Amount ended Outstanding 1 August 15 31 2 19.50 4.50 5.45-7.694.71 15 18.75 6. The stringent conditions laid down by the RBI have made entry of good but small companies difficult. debentures. debentures.60-7.106. Typical effective discount rate range per annum on issues during the fortnight.25 Fortnight Total Amount ended Outstanding 1 2 Rate of Interest (percent) @ 3 September 15 19.35 15 12.35 31 12. When compared with the investments in other instruments like bonds – debentures by private and public sector – the investment in the commercial paper is very less. Bulletin.35 December 15 16. crore) Fortnight ended 1 August Total Amount Outstanding 2 15 11.371.798.4.50 7.69 4. The following table shows the scheduled commercial banks‟ investments in commercial paper.40-6.209. are given in the following table. etc.22-8.95-7.497 crore and on march 31st 2006 it was Rs.50-7.319.30 November 15 9.71 31 18.068. Source: RBI.95 6. 2006 Reasons for Underdevelopment The experts attribute the following reasons for underdevelopment: Restricted entry of corporates into this market.63-7.225.75 6.65 5. to the discount. 296 .35-6.094.266. IPAs‟ fee in addition.35 Issued at face value by companies.71 19.65-6. a company may not be able to come out with a CP issue if the difference in the effective cost and PLR is marginal.76 5. Hence.79 6.902. Otherwise. shares. bonds.206. may.862.10-7.21-10.30 September 15 11.00 4.10-6.193. 2002 was Rs.322.75-8.320.51 30 17.956.33 5.767.50-6.69-7.25 5.Treasury Management: Theory and Practice (Amount in Rs.50 4.10-7.90 31 13.70 December 15 11.03-8.545.

828 4.702 1.305 29.520 31.464 3.321 3.910 32. 29.653 1.714 1. 297 .347 10.608 10.105 46.333 10.891 3.407 28.663 4.090 3. 12.883 30.658 33.877 45. 2002 2003 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2005 2006 2005 2006 2005 2006 2005 2006 2005 2006 2005 2006 2005 2006 Commercial Paper 2 8.891 3.330 10. 18.606 1.620 1.007 3.726 1.131 10.832 31.520 46. 28.695 1.989 3.958 10.492 3.275 11. 17. For example.098 32.839 38.482 33.123 36.217 10. 18.442 43.884 Bonds/Debentures issued by Private Corporate Public Sector Private Corporate Sector Undertakings (PSUs) Sector 4 4. 6.Financial Markets and Instruments Table 2: Scheduled Commercial Bank’s Investments in Commercial Papers (Rs.653 1.416 32. 7.734 33.875 Note: From the financial year 2001-02.338 10.587 1.735 31. 21.529 44.614 4.272 1.821 Shares issued by Public Sector Undertakings (PSUs) 3 1.664 3.571 10.340 31.896 43.734 33. 9.344 10. 17.772 1.915 28.633 3.798 4.904 41. 4.810 9. 3.859 28. 10. 24.288 7.309 43.854 48.798 32.051 1. in spite of which the RBI insists upon a fresh rating (less than 2 months old) every time a CP is issued.227 3.869 3.295 31.022 10.100 10.912 45.697 1.317 10.914 32.861 3. 1.412 10.562 3.937 33.063 28.350 37.170 10.719 1. 25.613 2.764 1.367 3.726 3.417 40.903 31. the rating fees charged by rating agencies is relatively high.928 1.077 3.579 4.036 28.354 3. Such data for the earlier period were based on Special Fortnightly Return (SFR VII).692 1.719 30.312 3.395 10.589 7.613 1.658 1.647 1. crore) Outstanding as on 1 March March March March October September October October October October November November November November December December December December January January January January February February February February March March March March April March 22. which has since been discontinued.430 1.606 33.800 41. data on investments are based on Statutory Section 42(2) Returns.497 4.901 3.934 27.646 45. 19.761 1.286 3.416 40.525 1.915 27. 3.967 1. 21.272 45.653 1.918 5 39.180 11.169 10.843 1.892 42.770 3. 11.372 12.197 28. and it is modifying/relaxing the guidelines for the enhancement of the same. 30. 23.934 31. Future Outlook The RBI is constantly watching the growth of the CP market.260 11. 4.710 1.658 35.461 1.229 10.900 3.694 1. 31. the RBI can consider the following measures to facilitate the growth of the market: Relax stringent conditions to reduce the overall cost of a CP. 18.772 33.725 10.130 10. 15.999 31. 26.593 32.054 32.069 32. While doing so. 20.716 1.327 7.973 27. 14.017 10.574 6 27.183 30.884 34. this in turn pushes up the cost of issue to the issuer. 1.937 45.039 10.288 11.354 3.989 30.115 33.235 28.312 4.057 30.

by funding long-term projects through short-term means. This way. who invest in CPs. Many issuers issue CPs „perpetually‟. the basic objective of a business enterprise is to produce goods and services in the most efficient manner with resources at the lowest cost. However. but corporates would not like to increase the cost of funds. Conventionally. it can facilitate more corporates to issue CPs thereby widening the market. It is a win-win situation. According to guidelines. particularly the subsequent investor. the investor. There is a typical set of investors: banks. short-term funds can be used for long-term purposes. As the concept of MPBF has also been abolished. depending on the credit rating. which would entail a lot of paraphernalia and higher cost. The validity of the credit rating may also be extended beyond two months. a corporate gets working capital limits sanctioned by his banker or consortium of bankers and draws credit as and when required. for which they are entitled to charge fees. which is beneficial both to the issuer as well as to the investor. 298 . Though as a matter of policy CPs are not part of working capital limits. from the issuer‟s perspective as well. the limit to raise funds under CP may be delinked from the fund-based working capital limits. the market for CPs is getting expanded. for project financing. fundamentals and negotiating powers of the corporate. Even if the savings is not 4 percentage points as discussed above. it renders the bank able to keep the corporate within the consortium. a corporate would approach a term-lending institution or bank. the corporate can get another investor to continue with it. a CP can be issued as a „standalone‟ product and banks have the flexibility to fix working capital limits taking into account the resource pattern of the company‟s financing including CPs. banks may provide standby credit facility. there are established usages of a means of finance and any remarkable deviation from the erstwhile norms merits discussion. Though it leads to a deliberate asset-liability mismatch. The corporate can resort to CC/OD during the interlude. The higher cost of CC/OD would be incurred only for a few days during the negligible period. Even if there is a problem in negotiating with the existing or prospective investor. as market conditions may turn averse at the time of maturity of the CP.. with a revolving facility at maturity. As we all know. However. In the bargain. The scope to develop the CP market is high in view of the flexibility a corporate enjoys and the liquidity available in the system. In this fashion. Box 2: Commercialization of Commercial Paper There are no hard and fast rules regarding the means and methods of finance for a corporate. If the existing investor is not interested in re-investing. In this age of competition. all are meant to keep the wheels of the industry moving. The cost of this cash credit or overdraft is the bank‟s PLR at the minimum or anything over and above the PLR. i. the corporate gets access to longterm funds. very few corporates get the facility of standalone CPs. For the company. needs the comfort of fallback on the working capital limits. If the CP is allowed to be underwritten. through a short-term instrument. it is substantial. it means lower cost of funds. it is better to have a fallback. the objectives of a corporate are different from those of a bank. mutual funds and financial institutions. it is a matter of a few days only. Optionally. As a matter of trade usage. While RBI disallowed sanction of standby facility.Treasury Management: Theory and Practice Banks were earlier permitted to sanction standby facility to the companies issuing CPs so that upon redemption the working capital limits would be automatically restored. it has not delinked the amount to be raised from fund-based working capital limits.e.

com COMMERCIAL PAPERS IN INTERNATIONAL MARKETS The concept of raising money through Commercial Papers has been known to the US markets since the 18th century.50. American commercial paper is rated by one or more credit rating agencies and as such the credit risk on it is perceived to be low. apart from the advantages discussed above.debtonnetindia. apart from call and call-linked instruments. 1934 Between one day 15 days and up to and upto one year 1 year Maturity Period Denomination No minimum and Less than 365 Maximum period days but in effect ranges from 1 day to 270 days. who are sitting on surplus cash. i. insurance companies.e. The US firms started selling open market paper as a substitute to the customary bank loan that was required for working capital.000 Amount invested by a single investor should not be less than Rs. the major chunk of inflows in mutual funds is in liquid/money market schemes. 000 Denomination but market practice of $1.5 lakh or multiple thereof. income schemes and gilt schemes. Banks. Nowadays. Decree and CRBF 2. and finance companies.4 trillion. Commercial Paper: A Comparative Position Countries Legal Basis USA Securities Act United Kingdom France English Common 1. Other nations came to know of it only in the earlier part of the 19th century. as there is a dearth of good quality borrowers and it is important to keep them within the consortium. transportation companies. thereby saving cost vis-à-vis regular working capital. by the end of 1999. Banks and financial institutions are happy to invest in CPs even at a lower rate. with a total value exceeding $1. No required Minimum EUR 40. French 1. A major avenue of investment for mutual funds is commercial papers. but existent. insurance companies. insurance companies. state and local governments and non-banking financial institutions mostly buy CPs. unsecured usance promissory notes issued at a discount to face value with fixed maturity by well-known companies that are financially strong and carry high credit ratings. They are referred by different names such as Industrial Paper. 299 . LIC and GIC. EUR 1. bank holding companies (corporations organized to acquire and hold the stock of one or more banks).5 lakh (face value). after Repos.000 A unit value Denominations of equivalent at least Rs. The liquidity of the instrument is also very low.. Source: www. surpassing T-bills. Of late. The CPs are generally issued by the public utilities.00. and corporates would be happy to oblige by supplying papers. Regulation India Non-banking (Acceptance of deposit through CP) Direction 1989 Section 45K of RBI Act. Financial and Law Monetary Code 2. Finance Paper and Corporate Paper depending on the nature of the issuing firm. Issuers and Buyers Commercial paper is the second largest money market instrument in the US.Financial Markets and Instruments The rise in volume of CP issuances can be traced to the profile of investors. Commercial Papers (CPs) are defined as short-term. liquid business concerns. are investing extensively in CPs.

Notes Revolving Underwriting Facilities Placing and Trading Buy back possible No buy back trading open to authorized credit institution or investment firm.rbi. Buy back is possible through central depository Issued in book No central Same day Settlement entry form & same Securities settlement day settlement depository. other corporate bodies registered or incorporated in India and unincorporated bodies. NonResident Indians (NRIs) and Foreign Institutional Investors (FIIs).in Innovation 300 P2 of CRISIL or its equivalent from other rating agencies Individuals. Rating is not compulsory Corporates. purely driven by market convention Institutional Investment firms. no other 365 days. in practice A-1/P1 Money market mutual funds. securities dealers and private and govt. Investors Institutional Asset Backed Euro Commercial Medium Term Commercial Paper Paper. banks companies. public companies. companies making public offer. financial corporations. pension funds Rating not compulsory. – No buy back Generally T+ 2 basis Dematerialization since June 2001 Stamp duty applicable as per maturity. .org. EIG. primary dealers (PDs) and FIs. Market practice is to clear ECP transactions through Euroclear or clearstream. banks. community institutions and international organization of which France is member. Dematerialization Dematerialization DTC immobilised is compulsory global certificate since 1993 with a central depository Taxation and Only Income Tax No withholding Withholding Tax Stamp Duty on the interest and tax and no stamp capital gain tax as duty for CP upto sales. For faxes. NIF.Treasury Management: Theory and Practice Issuers Both Financial and No restriction non-financial corporation Rating Tough not compulsory. No demat. non-residents for CP above 365 days with holding tax applicable Source: www.

Illustration 1 Mr. including Sterling.8% x 1. It is mainly issued by non-financial companies and finance companies. Companies using dealers to place their paper are generally smaller. Some aspects of these regulations were modified when the FSMA (Financial Services and Markets Act. bank trust departments). The markets for Euro Commercial Paper (ECP) emerged in the early 1980s as a derivative of underwritten Note Issuance Facilities (NIFs). 301 . encompassing a number of currencies. to the rating agencies and to agents (i. And also these companies need to pay fees to banks for supporting lines of credit. meeting payrolls and to meet other short-term rather than long-term obligations.Financial Markets and Instruments PURPOSE The funds raised by means of CPs by corporates are used for current transactions – such as purchase of inventories.. Though the issuers of direct paper do not have to pay any dealers‟ commission. the Commercial Paper (CP) is regarded as a flexible short-term instrument through which a cost-effective funding of requirements can be done.000 976. issued for 3 months in the market for $976. accounting and tax matters are provided in the London Market Guidelines on commercial paper issued by the BBA (British Bankers Association) in April. The issuing company sells the paper directly to the dealer at a discount and commission. An open rate method is followed by which the company receives some money in advance but the balance depends on the performance of the issue in the open market..000. Japanese Yen and the Euro. these companies must operate a marketing division to maintain constant interaction with active investors. Determine the rate of return which A earns. The direct paper is issued by large finance companies and bank holding companies deal directly with the investor rather than use a dealer as an intermediary. One important feature of ECP was that it did not meet the terms of Securities Exchange Commission in the US and hence could not be sold to US investors.000 180 Commercial Papers in UK Various aspects relating to the issue. this paper must be sold in large volumes to cover the substantial costs of distribution and marketing. The dealer paper is issued by dealers on behalf of their corporate customers. 2000. Rate of Return The rate of return on a commercial paper is computed by using the following formula in a secondary market transaction: D= Par Value Purchase Price 360 x Par Value Days to Maturity This could be well understood by the following example. The company issued CP with a face value of $1. regulatory. Swiss Francs.000. Types of Commercial Paper There are two major types of commercial paper – direct paper and dealer paper. which resulted in the development of uncommitted US Dollar based ECP programs.000. DR = Par Value Purchase Price 360 x Par Value Days to Maturity = 1.000 360 = 0.000. 2000) came into force in December. Since then the ECP market is being transformed into the only truly multi-currency short-term market. A purchased a commercial paper of Maxwell Inc. Hence.e. In UK. 2001.000. less frequent borrowers than issuers of direct paper. payment of taxes. The dealer will resell it at the highest possible price in the market.048 or 4.

CPs are likely to have good future so long as they can be tailored to meet the needs of both the buyers and issuers in terms of maturity. FIs. corporates. PDs are permitted to make fresh investments and hold CP only in dematerialized form. SPE issues the commercial paper to cover discount price and uses the proceeds for purchase of the receivables. liquidity and returns. The RBI is has set-up a group under the Chairmanship of C. Medium-term notes are unsecured obligations. as soon as arrangements for such dematerialization are put in place. Foreign Exchange and Government Securities Markets had issued notification of reporting of issuance of CP on the Negotiated Dealing System (NDS) platform by the end of the day and holding of CPs in denaturalized form. banks. These guidelines stood as the standard practice in Europe‟s most active CP market. Latest Developments in India The RBI in its mid-term Review of the Annual Policy Statement for the year 2004-05. 1999 altered the earlier CP issuance guidelines made in 1997. SUMMARY Commercial Papers (CPs) are short-term unsecured usance promissory notes issued at a discount to face value by reputed corporates with high credit rating and strong financial background. and these loans or receivables are removed from the issuing companies‟ balance sheet and are placed in a Special-Purpose Entity (SPE). FIIs have also been allowed to invest their short-term funds in CPs. and the issuing company in turn issues a paper on the maximum agreed amount. Similarly. In an arranged agreement.Treasury Management: Theory and Practice The London Market Guidelines for the Commercial Paper market issued by the BBA in April. This paper is nothing but. These papers suit companies with substantial quantities of medium-term assets as they have longer maturities when compared to conventional CPs and IOUs.E.S Azariah. the investing firm notifies the issuing company as to how much paper it will purchase on that particular day. privately placed or otherwise only in demat form. The issuing customer usually services the underlying receivables. As the existing arrangements for dematerialized holding for CP are now considered adequate and satisfactory. As regards the equity instruments they are permitted to be held by the above-mentioned institutions only in dematerialized form. FIs. papers with a maturity period of 9-10 months. In the process a bank is chosen to service the receivables supporting the paper issue. PDs and SDs were advised to invest and hold CP only in dematerialized form. the Chief General Manager. State Bank of India within FIMMDA for viewing the settlement on T+1 basis. Asset-backed commercial paper gives credit at a lower interest rate to the corporates. INNOVATIONS IN COMMERCIAL PAPER Master note is a new financial paper issued by finance companies to bank trust departments and other permanent money market investors. 302 . These are issued by investment grade corporations at a fixed interest rate. they are also permitted to make fresh investments and hold bonds. CPs are open to individuals. collects interest and principal payments and passes the funds to SPE. Preference for Dematerialized Holding – Banks. NRIs and banks. a pool of loans or credit receivables made into packages. but the NRIs can invest on non-repatriable/non-refundable basis. base on the discussion with market participants and Recommendations of the Technical Advisory Committee on Money. from the date notified by SEBI. debentures. These packages are issued in the form of a paper. The interest on daily papers is pooled and taken by the investors during the current month.

In the US markets. CPs are usually placed with the investors by issuing and paying agents. The main reasons for poor development of the CPs market are: restricted entry of corporates. They are unsecured. CPs are defined as short-term. The main purpose of issuing CPs in the US is to finance current assets. issued in multiples of $1. The transfer is done by endorsement and delivery. 303 .5 lakh and the minimum investment is Rs. They are unsecured by nature and tailored to the user requirement as far as maturity period is concerned. CPs can be direct paper if issued directly to the investors by the corporate or dealer paper if issued through an intermediary/merchant banker. involve much less paper work and have very high liquidity. Two types of CPs exist in the US: direct paper (issued directly by the corporates and large banks) and dealer paper (issued by the dealers on behalf of their corporate clients).5 lakh each usually by the banks.5 lakh and multiples of Rs. They are available in denomination of Rs. CPs have a minimum maturity of 7days and a maximum maturity of 1 year. high minimum investment of individual investors and no tax benefits.Financial Markets and Instruments The features of CPs are: They do not originate from specific trade transactions like commercial bills. tendency to issue CPs only if the total cost is lower than the PLR of banks.5 lakh per investor. high quality instruments negotiable by endorsement and delivery. medium-term notes (unsecured obligation papers with maturity of 9-10 months issued by investment grade corporations at fixed rate) and asset-backed commercial papers (packages of pooled loans or credit receivables with lower rates of interest and placed with a special purpose entity). unsecured usance promissory notes issued at a discount to face value with fixed maturity by financially strong companies with high credit ratings. Secondary market trading takes place in lots of Rs. The main features are: high liquidity and safety. The innovations in the American CP market are: master note (financial paper issued by finance companies to bank trust departments with interest pooled by the investors).000 as bearer documents at a discount to the face value.

or order on the (NAME OF THE INVESTOR) maturity date as specified above the sum of Rs. (If such date happens to fall on a holiday. payment shall be made on the immediate preceding working day) For value received --------------------------------------------------------------------hereby (NAME OF THE ISSUING COMPANY/INSTITUTION) Promises to pay ------------------------------------------------------------.Treasury Management: Theory and Practice (Specimen) Appendix* Schedule I Stamp to be Affixed as in force in the State in which it is to be issued --------------------------------------------------------(NAME OF THE ISSUING COMPANY/INSTITUTION) SERIAL NO.Date of issued: -----------------------(PLACE) Date of Maturity:------------------------------------------without days of grace. Issued at:--------------------------------------------. 2005 304 .------------------------------------------(in words) upon presentation and surrender of this Commercial Paper to---------------------------------------------------------------------------------------------------------------(NAME OF THE ISSUING AND PAYING AGENT) For and on behalf of -------------------------------------------------------------------------(NAME OF THE ISSUING COMPANY/INSTITUTION) AUTHORISED SIGNATORY AUTHORISED SIGNATORY * Source: RBI/master circular/commercial paper/July 1.

4. 3.or order (NAME OF TRANSFEREE) the amount within named. For and on behalf of ---------------------------------------------------------------------------------(NAME OF THE TRANSFEROR) ---------------------------------------------------------------------------------- 1. ” ” ” ” ” ” ” ” 305 . 7. 6. 2. 5.Financial Markets and Instruments ALL ENDORSEMENTS UPON THIS COMMERCIAL PAPER MUST BE CLEAN AND DISTINCT EACH ENDORSEMENT SHOULD BE WRITTEN WITHIN THE SPACE ALLOTED Pay to -----------------------------------------------------------------------. 8.

we have issued Commercial Paper as per details furnished hereunder: i. Total Working Capital Limit vii. iv. a) Details of Commercial Paper issued (Face Value) Rate : Date of Issue i. b) Amount of CP outstanding (Face Value) including the present value 306 : Date of Maturity Amount . Mumbai) To: The Adviser-in-Charge Monetary Policy Department Reserve Bank of India Central Office Mumbai – 400 001. Through: (Name of IPA) Dear Sir Issue of Commercial Paper In terms of the guidelines for issuance of commercial paper issued by the Reserve Bank dated August 19. 2003. ii. Outstanding Bank Borrowings : vii. Tangible networth as per latest audited balance sheet : : vi. Name of the Issuer : Registered Office and Address : Business activity Name/s of Stock Exchange/s with whom shares of the issuer are listed (if applicable) : : v.Treasury Management: Theory and Practice Schedule II Proforma of information to be submitted by the Issuer for issue of Commercial Paper (To be submitted to the Reserve Bank through the Issuing and Paying Agent (IPA) within 3 days of the completion of issue of CP to MPD. ii. iii. RBI.

crore xii. the amount of the guarantee : Rs. If yes i. If yes i. crore ii. provided by (Name of bank/FI) : Rs.Financial Markets and Instruments ix. ii. Whether standby facility has been provided in respect of CP issue? xi. Rating(s) obtained from the Credit Rating Information Services of India Ltd. iii. Whether unconditional and irrevocable guarantee has been provided in respect of CP issue? xiii. (CRISIL) or any other agency as specified by Reserve Bank i. x. provided by (Name of guarantor) iii. the amount of the standby facility ii. Credit rating of the guarantor For and on behalf of -------------------------(Name of the issuer) 307 .

Treasury Management: Theory and Practice (Specimen) CERTIFICATE** 1. 3. We have a valid IPA agreement with the---------------------------------------------(Name of Issuing Company/Institution) 2. We have verified the documents viz. 2005 308 . No..___________________(Rupees_________________________________) (in words) tally with the specimen signatures filed by____________________________ (Name of the issuing Company/Instittuion) (Authorized Signatory/Signatories) (Name and address of Issuing and Paying Agent) Place Date : : * (Applicable to CP in physical form) ** Source: RBI/master circular/ commercial paper/ July 1. board resolution and certificate issued by Credit Rating Agency submitted by -------------------------------------------------(Name of the Issuing Company/Institution) and certify that the documents are in order.* We also hereby certify that the signatures of the executants of the attached Commercial Paper bearing Sr. Certified copies of original documents are held in our custody.____________date_________________for Rs.