Revealing The Ultimate Guide To Commercial Papers
Commercial paper made its debut in the financial world more than a century ago. The first money market instrument dealer to buy commercial paper was none other than Marcus Goldman of Goldman Sachs1, whose business grew to become one of the largest commercial paper dealers in the United States after the Civil War. These instruments were first established in India in 19902.
A detailed understanding of the meaning and concept of commercial paper is the only way to explain the rise of this powerful investment tool.
What Is Commercial Paper?
Commercial papers are unsecured, short-term debt instruments issued by credit-rated corporates. It is used for various kinds of working capital financing, such as payroll, accounts payable, and inventory. Moreover, these unsecured promissory notes are used to raise debt without using collateral.
Features Of Commercial Paper
The following features of commercial papers can help investors understand the meaning and essence of commercial papers.
Discounted Issuance
Commercial papers are issued at discounted prices. The discounted rate refers to an amount lower than the face value. The margin between the face value and the purchasing price is the return.
For instance, if the par value of a commercial paper is INR 100. It might be issued at INR 80. However, the investor will redeem it at INR 100, making a return of INR 20.
Issuance And Denominations
Commercial papers can solely be issued by scheduled commercial banks acting as an IPA (Issuing and Paying Agent). It is issued as a stand-alone product, implying the unavailability of collateral against it. RBI regulation on CP states that it can only be multiples of INR 5 lakh. One investor's investment cannot fall below INR 5 lakh.
Moreover, if a company issues CPs worth more than 50%3 of the working capital limit, they would have to get bank clearance.
Short-Term Maturity
RBI regulations state that as a money market instrument, commercial papers enjoy a maturity period of less than one year. The minimum period for which CPs can be issued is seven days.
Regulatory Framework
Currently, the Reserve Bank of India's numerous guidelines control the issuance of CPs. These directives are periodically revised by the central bank. For instance, the RBI guidelines stated that to issue commercial paper, all qualified parties must have a credit rating from some specified agencies like CRISIL, ICRA, CARE and DCR India. Moreover, RBI has restricted retail investment to 25%4 of a CP issue.
Dematerialised Form
Dematerialised form refers to the electronic form of a security. Initially, the form of CPs was left to the discretion of issuers and investors. Although dematerialised form was promoted, they could even store them in physical form. However, with effect to 30 June 2001, CPs can only be stored in dematerialised form.
Tradability
Commercial papers are transacted over-the-counter (OTC) in the secondary market. As per the RBI regulations, every OTC transaction must be notified to the Fixed Income Money Market and Derivatives Association of India (FIMDA) within 15 minutes of the transaction. OTC refers to a trade that happens outside an exchange like BSE or NSE.
Trading In Commercial Papers
The methods of trading in both the secondary and primary markets are discussed below.
Primary Market
Credit-rated corporates, financial institutes and other organisations issue commercial papers through intermediaries like merchant bankers. In the primary market, the issuance is conducted on a private placement basis in dematerialised form through depositories like NSDL. Private placement basis refers to a situation where subscription opportunity to an asset is extended to select individuals and not the public at large.
Secondary Market
Secondary market trading of CP is done by OTC between institutional investors through intermediaries. The trade is facilitated by depositories. The volume of trade in the secondary market is below the primary market.
Example Of Commercial Paper
Commercial papers are often issued by credit-rated agencies to meet their working capital needs. The table below shows the list of commercial papers issued in November 2024 through NSDL5.
Name of Issuer | Maturity Date | Residual Tenor (Days) from Issuance Date | Issue Price (in Rs.) | Yield | Amount in Rs. Cr. (FV) | Name of IPA |
ADANI ENTERPRISES LIMITED | 11/02/2025 | 91 | 489564.00 | 8.55% | 25.00 | HDFC Bank Ltd. |
ADITYA BIRLA FINANCE LIMITED | 07/02/2025 | 91 | 490846.50 | 7.48% | 540.00 | HDFC Bank Ltd. |
AXIS SECURITIES LIMITED | 11/02/2025 | 91 | 490786.50 | 7.53% | 300.00 | Axis Bank Ltd. |
EXPORT IMPORT BANK OF INDIA | 10/11/2025 | 364 | 465162.00 | 7.51% | 2500.00 | Bank of Maharashtra |
Advantages And Disadvantages Of Making An Investment In Commercial Paper
Like any corporate debt instrument, a commercial paper has both advantages and disadvantages.
Advantages
Cost-Effective
CPs are economically advantageous from the perspective of businesses because they allow them to meet their working capital requirements through short-term and mortgage-free debt. In the absence of this, companies would have to take medium-term or long-term loans that require higher interest while creating a charge on assets.
Liquidity And Flexibility
CPs are a form of short-term debt instrument in the money market. The maturity period of less than one year makes these instruments highly liquid and flexible.
Disadvantages
Credit Risk
Since commercial papers are unsecured promissory notes, there is not much recourse available to investors in case of default. Lack of security in the form of a change on asset adds to the credit risk in CP.
Market Dependence
CPs are susceptible to market volatility in the form of interest rate fluctuation. Moreover, changes in the business environment of an organisation will add to this risk.
Conclusion
Commercial papers are a very powerful tool for the money market that primarily allows institutional investments. Since the minimum individual investment in commercial papers is INR 5 lakhs, it is restricted to institutional investors and high net-worth individuals (HNIs). Moreover, it is important to note that in a directive dated 3rd January 2024, RBI has restricted retail investment to 25% of a CP issue.
Although commercial papers are highly liquid and flexible, they are unsecured promissory notes. Lack of charge on assets increases the credit risk of this asset, which requires a substantial investment.
Frequently Asked Questions
1. How does Commercial Paper differ from other debt instruments?
Commercial papers are a form of money market short-term debt instrument. However, they differ from other debt instruments like debentures and bonds in many ways. CPs mature within a year. The maturity period of other debt instruments may extend beyond a year. Moreover, instruments like debentures are convertible into equity shares. CPs are not convertible. Unlike most debt instruments, CPs don’t pay interest. The return earned on CPs is the difference between FV and discounted purchase price.
2. Who can issue Commercial Paper in India?
All-India financial institutions (FIs), main dealers (PDs), satellite dealers (SDs), and highly rated corporate borrowers who have been approved to raise capital through money market instruments up to the Reserve Bank of India's umbrella ceiling are eligible to issue CPs. Furthermore, according to the most recent audited balance statement, the company's working capital and tangible net worth are at least INR 4 crore.
3. Can individual investors purchase Commercial Paper?
Yes, individuals can purchase commercial papers. Commercial papers are most subscribed by institutional investors and high net-worth individuals (HNIs) due to the minimum individual investment of INR 5 lakhs. The RBI limited retail investment in CP issues to 25% in a regulation dated January 3, 2024.
References:
1. Goldman Sachs <https://www.goldmansachs.com/our-firm/history/moments/1932-hathaway-co-acquisition>
2. Reserve Bank of India <https://www.rbi.org.in/commonman/english/scripts/Notification.aspx?Id=798#:~:text=CP%2C%20as%20a%20privately%20placed%20instrument%2C%20was,to%20provide%20an%20additional%20instrument%20to%20investors>
3. Reserve Bank of India <https://rbi.org.in/upload/Notification/pdfs/14258.pdf>
4. Fixed Income Money Market and Derivatives Association of India <https://www.fimmda.org/UploadPopupPageFiles/MasterDirection_RBI_CPNonCovertible_Directions2024.pdf>
5. National Securities Depository Limited <https://nsdl.co.in/downloadables/excel/cp-debt/Commercial-Papers-Issuance-in-the-month-of-November-2024.html>
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