A Presentation by: Kedar Gharat 20 Manoj Gupta 21

Pramod Jadhav 24 Arun Pacheco 38

Nilesh Raut 49 Anand Singh 60

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Presentation Flow

Introduction

Review the growth & operation of CP market in India.

International Experience.

Examine factors inhibiting growth of the CP market.

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C. P. Introduction

Unsecured money market instrument issued in the form of a promissory note.

Privately placed instrument

Introduced in India in 1990 with a view to enabling highly rated corporate borrowers to diversify their sources of short-term borrowings & to provide an additional instrument to investors.

Guidelines for issue of CP are presently governed by various directives issued by the Reserve Bank of India.

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Advantages of CP

High credit ratings fetch lower cost of capital.

Wide range of maturity provide more flexibility.

It does not create any lien on assets of the company.

Tradability of CP provides investor with exit options.

It helps in reducing the dependence of some FIs on the inter-corporate deposits (ICD) market.

It is an additional instrument to raise short-term resources.

It helps the FIs in asset-liability and risk management.

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Issuing Guidelines 

Corporates, primary dealers (PDs) and the all-India financial institutions (FIs) under the umbrella limit fixed by the Reserve Bank of India are eligible.

A corporate would be eligible to issue CP provided: Tangible net worth of the company not less than

Rs.4 Cr.; Sanctioned working capital limit (fund based)

by bank/s or all-India financial institution/s; and The borrowal account is classified as a Standard

Asset by the financing bank/s/ institution/s. market instrument issued in the form of a promissory note.

All eligible participants shall obtain the minimum credit rating of P2* from CRISIL, ICRA, CARE or the FITCH.

*This rating indicates that the degree of safety regarding timely payment on the instrument is strong; however, the relative degree of safety is lower than that for instruments rated 'P1'.

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Maturity & Denomination

  Maturity: Between 7 days - 1 yr from the date

of issue but not beyond the date up to which the credit rating of the issuer is valid.

Denominations: Rs.5 lakh or multiples thereof.

Amount invested by a single investor should not be less than Rs.5 lakh (face value).

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Limits and the Amount of Issue of 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.

An FI can issue CP within the overall umbrella limit fixed by the RBI, i.e., issue of CP together with other instruments should not exceed 100% of its net owned funds.

The total amount should be raised within 2 weeks from the date on which the issuer opens the issue for subscription.

May be issued on a single date or in parts on different dates provided that in the latter case, each CP shall have the same maturity date.

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

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Investors

CP may be issued to and held by

1) Individuals, 2) Banking companies, 3) Other corporate bodies registered or

incorporated in India4) Unincorporated bodies, 5) Non-Resident Indians (NRIs) 6) Foreign Institutional Investors (FIIs) subjects

to the limits set for their investments by SEBI.

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Mode of Issuance

CP can be issued in the form of Promissory Note in physical form or in dematerialized form through any of the depositories approved by and registered with SEBI. W.e.f. June 30, 2001 banks, FI and PD are required to make fresh investment and hold CP only in dematerialized form.

CP is issued at discount to the face value as may be determined by the issuer.

The following costs are involved in the issue of CP

CP Format

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Payment of CP

  The initial investor in CP shall pay the

discounted value of the CP by means of a crossed account payee cheque to the account of the issuer through IPA.

On maturity when the CP is held in physical form, the holder of CP shall present the instrument for payment to the issuer through IPA.

When CP s held in Demat form, the holder of the CP have to get it redeemed through the depository and receive payment from IPA.

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Stand-by Facility

As CP is stand alone product, it would not be obligatory in any manner on the part of the banks & FI to provide standby facility to the issuers of CP.

Banks and FI shall have flexibility to provide for a CP issue, credit enhancement by way of stand-by assistance/credit, back stop facility etc. based on their commercial judgment, subject to prudential norms with approval of their Boards.

Corporates may also provide unconditional and irrevocable guarantee for credit enhancement for CP provided:

1. Issuer fulfills eligibility criteria2. The guarantor has credit rating atleast 1 notch

higher than the issuer.3. The offer document properly discloses following:

• the net worth of the guarantor company, • names of the companies to which the guarantor has

issued similar guarantees, • the extent of the guarantees offered by the guarantor

company and conditions in which the guarantee is invoked.

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Procedure for Issuance

The company to submit its proposal to the financing banking company with a certificate issued by Credit Rating Agency.

Issuing company makes arrangements for privately placing the issue & ensure that it completes issue within 2 weeks.

Post issue the financing banking company makes arrangements for reducing WC limit to the extent of issued amount.

Issuing company has to inform RBI within 3 days from the date of completion of the issue.

Underwriting /co-acceptance of the issue is prohibited.

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Procedure for Issue

Every issuer must appoint an IPA (Issuing and Paying Agent).

The issuer must disclose to the potential investors its financial position as per the standard market practice.

After exchange deal confirmation between investor & the issuer, the issuing company shall issue physical certificates / Demat form.

Investor shall be given a copy of IPA certificate to the effect that the issuer has a valid agreement with the IPA & documents are in order.

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Documentation & Defaults

Documentation Fixed Income Money Market & Derivatives Association

(FIMMDA) & RBI may prescribe standardized procedure and documentation, in consonance with the international best practices, for operational flexibility and smooth functioning of CP market.

Issuer/IPAs are required to refer to the detailed guidelines issued in this regard.

Violation of theses regulations will attract penalties and may also include debarring of the entity from the CP market.

Defaults In order to monitor defaults, scheduled banks acting as

IPAs are advised to immediately report, on occurrence, full particulars of defaults to the RBI.

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Genesis of CP market in India

A working group under the chairmanship of Mr. N. Vaghul was appointed by RBI in Sept 1986 to study and give recommendations for broad basing and development of money market.

The Committee, recommended the introduction of Commercial Paper. Accordingly RBI, issued detailed guidelines under "Non-Banking

Companies (Acceptance of Deposits through CP) Directions, 1989" through a notification and these Directions were made effective from 1st Jan 1990.

Initially, only top rated corporates with tangible net worth of not less than Rs. 10 crore were allowed to issue CP with maturity between 3-6 months.

Further, issuance of the CP had to be carved out of the working capital (fund based) limit and it was also stipulated that CP could be issued in multiples of Rs. 25 lakh and the amount to be invested by a single investor should not be less than Rs 1 crore.

Acceptance of funds through issue of CP has been exempted from the provisions of Section 58A of the Companies Act 1956 and brought within the overall purview of the Directions issued by the RBI under Section 45K of the RBI Act, 1934.

CP Policy changes

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Trend of the CP Market

CP market in India has witnessed sharp ups and downs. Since its inception in 1990 and until the end of the financial year 1992-93, the activity in the CP market in India was minimal and volumes were very small.

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Recent Growth of CP Market

Outstanding CPs in India during during 2007 -09

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

Month

Rs

cro

res

Series1

Rs 67,000 crores

(USD 14 Billion)

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Unprecedented & steep rise in CP

The unprecedented and steep rise in CP issuance in the last few years has been on account of the following factors :

1. The stipulation that the request for restoration of working capital (fund based) credit limit (on repayment of Commercial Paper) should be considered by banks on the lines of enhancement of limit was withdrawn and banks were given the freedom to decide the manner of restoration of the working capital limit.

2. There had been sluggishness in the off-take of non-food credit during this period and banks therefore, deployed their resources in short-term instruments.

3. Highly rated blue chip corporates have been issuing CP as an effective instrument for reducing the funding cost of their working capital during periods when money market interest rates have ruled low.

Recent CP Issue in India

SAIL issues Rs 1,000 cr commercial paper

Economic Times, Sunday, Jul 05, 2009The Steel Authority of India has issued commercial paper of Rs 1,000 crore . Papers worth Rs 500 crore for a period of 87 days have been issued at a coupon rate of 3.39 %, with another Rs 500 crore of commercial paper of 79 days’ tenure at a coupon rate of 3.04 %.

In May, SAIL had raised Rs 1,000 crore worth commercial paper of one year tenure at a rate of 5.9 %.

The steel PSU is looking to borrow to the tune of Rs 5,000-6,000 crore for its expansion plans. It is currently undertaking a capacity expansion and expects to double its capex investment to Rs 10,000 crore during this fiscal.

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International Experience

Commercial Paper In U.S.ABecause of the advantages of commercial paper for

both investors & issuers, commercial paper has become one of America's most important debt markets.

Commercial paper outstanding grew at an annual rate of 14% from 1970 to 2009.

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Characteristics of CP in US

The Securities Act of 1933 requires that securities offered to the public be registered with Securities & Exchange Commission (SEC). Registration requires extensive public disclosure.

The maturity of CP must be less than 270 days.

In practice, most CP has a maturity of between 5 & 45 days, with 30-35 days being the average maturity.

Many issuers continuously roll over their CP, financing a more-or-less constant amount of their assets using CP.

In practice, the denomination of CP is large: minimum denominations are usually $100K, although face amounts as low as $10 K are available from some issuers.

Proceeds from CP issues be used to finance "current transactions", which include the funding of operating expenses & funding of current assets e.g. receivables & inventories.

Proceeds cannot be used to finance fixed assets, such as plant and equipment, on a permanent basis. But Firms are allowed to finance constructions.

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Asset-Backed Commercial Paper

A relatively new innovation in the CP market.

The risk of most CP depends on the entire firm's operating & financial risk.

CP risk is instead tied directly to the creditworthiness of specific financial assets, usually receivables.

Asset-backed CP is issued by a Special Purpose Entity (SPE), which purchases receivables from one firm & finances the purchase with funds raised in the CP market.

The sole business activity of the SPE is the purchase & finance of the receivables so the risk of the company & the CP is isolated from the risk of the firm which originated the receivables.

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Commercial Paper In UK

The powers conferred on the Treasury by the Banking Act 1979 allows corporate issues of CP, subject to following requirements:

(i) The issuing company should be listed on the International Stock

Exchange and have net assets of £50 Mn or more, or be the wholly-

owned subsidiary, and issue under the guarantee, of such a company.

(ii) Issues should have an original maturity of between 7 and 364 days.

(iii) Issues should be in denominations of £100k or £1 Mn

(iv) Issues must carry a statement that the issuer or its guaranteeing

parent is in compliance with the International Stock Exchange

Listing Rules.

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International Comparison : Framework of CP Market

Japan United States Europe Excl. UK United Kingdom

Face Amount

¥ 100 million or more Usually $100,000 or more

Usually $100,000 or more

£100,000 or more

Term

2 weeks to 9 months Within 270 days 7 days to 1 year 7 days to 5 years

Issuing Mode

Indirect Indirect and Direct

Indirect Indirect and Direct

Issuing Compani

es

1.Companies which obtained CP ratings of the highest A1

or the equivalent.2.Among companies with CP ratings of the second highest A2 or the equivalent, those with

net assets of ¥33 billion or more.Provided that only securities finance companies and securities companies are approved among finance related companies.

No special restrictions

No special restrictions Listed companies with net assets of £25

million or more or their 100% subsidiaries

Ratings Required from 2 or more companies Required from 2 or more

companies

Not Required Not Required

Backup Line

In principle, required In principle, required

Not Required Not Required

Secondary Market

"Gensaki" transactions are active Almost not-existent

It exists Almost not-existent

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Disadvantages of CP

Its usage is limited to only blue-chip companies

Issuances of CP bring down the bank credit limits

A high degree of control is exercised on issue of CP

Stand-by credit may become neccessary

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Factors Hampering Growth of CP Market in India

(i) The linking of CP to working capital limits. Initially it was not issued as a "stand alone" product.

(ii) At present, for issuance of CP approval or NOC is required from the Financing Banking Company.

(iii) This NOC/approval is valid for a period of 2 weeks from the date of its issuance.

(iv) Furthermore, for the issuance of CP, rating has to be current and not more than 2 months old.

(v) Market participants perceive these stipulations as impediments to the development of CP market.

(vi) The difference in stamp duty rates as between banks and other entities has created operational difficulties.

(vii) Inter-state disparities as also investor-wise differences in stamp duty rates.

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Further, there is tenor-wise slab structure of stamp duty as given below :

Tenor Rate for Banks Non-banksUpto 90 days 0.05 0.12591 - 180 days 0.15 0.375181 - 364 days 0.20 0.50

Secondary market transactions in CP, do not attract any stamp duty. This divergence in stamp duty for banks & non-banks has created distortions in the market and encouraged mal-practices.

All primary issues of CP are almost exclusively subscribed to by

banks and non-banks buy CP from banks in the secondary market. Procedure to issue CP in physical form is quite cumbersome. The

concerned corporates have to arrange for stamping of all the certificates, which is time consuming. Furthermore, copies of all the documents have to be given to all the investors along with the CP certificate.

No reliable bench mark is available in the market for pricing CP.

Factors Hampering Growth of CP Market in India

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Conclusion & Recommendations

1. The concept of raising money through commercial paper was know to the US markets since 20th century.

2. 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.

3. 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

4. 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.

5. The denominations of CP should be reduced further for the growth of secondary market for CP.

References:

•Reserve Bank of India, www.rbi.org.in

•Economic Times

• Ronald Vikram D'Mellow, Commercial Paper –as a money market instrument –Chartered Secretary.

•N.S. Krishnamurthy, The Commercial Paper.

• B.S. Bisht. Commercial Paper in USA, Finance India.

• Domestic and International Commercial Paper Market in Industrialised countries.