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The A – Z Guide Of commercial paper

Commercial Paper (CP) is an unsecured money market instrument issued in the form of promissory note or in a dematerialised form through any of the depositories approved by and registered with SEBI. It is a short-term funding tool which enables highly rated companies, primary dealers, and All India Financial Institutions to meet their working capital requirements. It was first introduced in 1990.

Features

  • CP are negotiable instruments and hence they are flexible.
  • CP is issued at a discount to face value as may be determined by the issuer. The difference between the issue price and face value is return.
  • 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.
  • Reserve Bank of India (RBI) issues guidelines for governing the issue of CPs.
  • CPs are actively traded on the OTC market.
  • CPs are unsecured instruments, not backed by the assets of the issuing company.

Eligibility

Companies fulfilling the following criteria are eligible to issue CPs-

  • The tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs.4 crore.
  • The company has been sanctioned working capital limit by bank/s or FIs; and
  • The company should be a standard asset in the books of banks or financial institutions.

In addition, all companies, primary dealers and All India Financial Institutions (AIFIs) should obtain credit rating for issuance of Commercial Paper either from Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE), FITCH Ratings India Pvt. Ltd. or such other credit rating agency (CRA) as may be specified by the Reserve Bank of India from time to time, for the purpose.

Denominations and maturity of CPs

The maturity of Commercial Paper is a minimum of 7 days and a maximum of up to one year from the date of issue. CP can be issued in denominations of ₹5 lakh or multiples thereof.

Who can invest in CPs:

  • Individuals
  • banking companies
  • other corporate bodies (registered or incorporated in India)
  • unincorporated bodies
  • Non-Resident Indians (NRIs)
  • Foreign Institutional Investors (FIIs) within the overall limits set for them by Securities and Exchange Board of India (SEBI).

Advantages

  • It is quick and cost-effective way of raising working capital
  • It is unsecured and thus does not create liens on the assets of the company
  • It has high liquidity as it is freely transferable instrument
  • It provides continuous source of funds because it’s maturity can be tailored to suit the requirement of the issuing firm
  • As commercial papers required to be rated, good rating reduces the cost of capital
  • Through commercial paper, company can take advantage of short-term interest rate fluctuations in the market
  • It is cheaper than bank loan

Limitations

  • Only firms which are financially sound and have high credit ratings can raise money through commercial paper. New and moderately rated firms cannot raise funds through it.
  • The amount of money that can be raised through this source is limited.
  • If a firm is not in a position to redeem its commercial paper, an extension of its maturity is not possible.

The procedure of issuance of commercial paper:

Following points describe the procedure of issuance of commercial paper:

  • Every issuer must appoint an IPA for the issuance of CP.
  • The issuer should disclose to the potential investors, its latest financial position as per the standard market practice.
  • After the exchange of confirmation of the deal between the investor and the issuer, the issuer shall arrange for crediting the CP to the demat account of the investor with the depository through the IPA.
  • The issuer shall give to the investor a copy of IPA certificate to the effect that the issuer has a valid agreement with the IPA and documents are in order.

A procedure of redemption of commercial paper:

Following points describe the procedure of issuance of commercial paper:

  • The investor in CP (primary subscriber) shall pay the discounted value of the CP to the account of the issuer through the IPA.
  • The investor holding the CP in physical form shall, on maturity, present the instrument for payment to the issuer through the IPA.
  • The holder of a CP in dematerialized form shall get the CP redeemed and receive payment through the IPA.

Role of IPA:

RBI guidelines allow only a scheduled commercial bank to act as an IPA. The role of an IPA is as under:

  • IPA would ensure that issuer has the minimum credit rating as stipulated by the RBI and amount mobilized through the issuance of CP is within the quantum indicated by CRA for the specified rating or as approved by its Board of Directors, whichever is lower.
  • IPA has to verify all the documents submitted by the issuer viz., a copy of board resolution, signatures of authorized executants (when CP in physical form) and issue a certificate that documents are in order.
  • Certified copies of original documents verified by the IPA should be held in the custody of IPA.
Varun Baid

Varun Baid

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About Me

I’m a Commerce Graduate & CFP Professional, engaged in blogging since 3 years. I’m not affiliated with any financial product. The purpose of writing blog is to spread financial awareness and help people in achieving excellence for money. Please note that the views expressed on this Blog/Comments are clarifications meant for reference and guidance of the readers to explore further on the topics. These should not be construed as investment advice or legal opinion.

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