By Uche Matthew
A Commercial Paper (CP) is an unconditional promise by a person to pay to the order of another person a certain sum at a future date. Such an instrument may or may not carry the bank’s guarantee. Where the bank guarantees the CP to make it more marketable in the money market, the instrument acquires the force of a BA and the bank incurs a contingent liability. Where the CP is not secured 4 or guaranteed by the bank (clean CP), it needs not be reported as a contingent liability.
OTHER DEFINITIONS
• An unsecured, short-term debt instrument issued by large banks and corporations, typically for the financing of account receivable, inventories and meeting short term-liabilities. They are usually issued at a discount from face value and reflect the prevailing market interest rates. Maturities on commercial papers rarely exceed 270 days
• A short-term debt financing securities (no longer than 270 days in tenor) consisting of unsecured and discounted promissory notes issued by large corporations with good credit ratings, which can be readily traded
In simple terms, companies borrow money from the public by issuing commercial papers. It is essentially an unconditional promise to pay back your money on an agreed future date with interest.
FEATURES
• WHO CAN ISSUE: Only financially secure and highly rated organizations can raise money through commercial papers. New and moderately rated organizations are not in a position to raise funds by this method.
• DISCOUNTED INSTRUMENTS: A commercial paper is similar to Treasury bills due to the fact that it is a discounted instrument (interest is paid upfront) and is usually tax free. They usually reflect the prevailing market interest rates, meaning that they borrow at a lower rate than is offered at the bank. The key difference between Treasury bills and commercial papers is that the former is issued by the Federal Government while the latter is issued by corporations. That means commercial papers are a bit more risky than Treasury bills. Consequently, commercial papers often attract higher returns compared to government issued securities.
• ACCREDITED INVESTOR: Investment in commercial papers is open to accredited investors. An accredited investor is any person or institution capable of understanding and affording the financial risks associated with acquisition of unregistered securities. This means you understand what you are doing (financial education) and can handle the risk if things do go otherwise. The accredited investor includes qualified institutional investors or an eligible individual investor. An eligible individual investor, or accredited individual investor is:
(i) Any person who alone, or with a spouse has a net worth of over N2m
(ii) Any person who alone had income in excess of N400, 000 in each of the two most recent years (or with a spouse, in excess of N500, 000 during this period) and had a reasonable expectation of reaching the same income level in the current year (annual income).
• MATURITY: They are usually short-term securities. Maturities on commercial papers rarely exceed 270 days
• CENRAL REGISTRATION: All CPs issued in Nigeria shall be registered with the Central Securities Clearing System (CSCS), which shall serve as the custodian of all issues. The CSCS shall also serve as a central depository for all dematerialized instruments.
• REGULATION: Investment in commercial papers is regulated by the Securities and Exchange Commission. In addition, quotation of commercial papers on FMDQ Platform (financial market daily quotes) is a rigorous process that involves credit rating etc. This is to protect the investing public and create confidence in the market. Since commercial papers are listed on FMDQ, you can buy and sell them on the platform.
• UNSECURED SECURITIES: Commercial papers are not usually backed by any form of collateral, making it a form of unsecured debt. It is regarded as unsecured because it does not have a bank guarantee in the event of default. As a result, only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue. Commercial papers that come with bank guarantees are called bankers’ acceptance.
• CONSUMER SECURITY: Companies seeking funds through issuance of commercial papers cannot afford to default. It would severely impact their credit rating and limit their ability to access funds in future through issuing commercial papers or other financial institutions.
• The proceeds from this type of financing can only be used on current assets, or inventories, and are not allowed to be used on fixed assets, such as a new plant, without SEC involvement.
LEGAL FRAMEWORK- CBN GUIDELINES
CONDITIONS FOR CREATING A COMMERCIAL PAPER
I. A Commercial Paper qualifies as a financing vehicle under these guidelines if:
(a) The issuer has 3-years audited financial statements, the most current not exceeding 18 months from the last financial year end; and
(b) The issuer has an approved credit line with a Nigerian bank acting as an issuing and payment agent (IPA), where the bank guarantees the issue.
II. Investors in CPs shall be made aware of the identity of the issuer.
III. CPs shall only be guaranteed and not accepted since the intermediating bank is only a secondary obligor.
IV. When a bank invests in a CP by disbursing its own funds, the transaction shall be reported on balance sheet and treated as a loan. However, if the bank merely guarantees the instrument, it shall be shown off-balance sheet as a contingent liability.
V. Resale of CPs by banks/discount houses shall be accompanied by adequate documentation which should be provided to Examiners on request.
DOCUMENTATION REQUIREMENTS FOR COMMERCIAL PAPERS
The standard documentation requirements for a CP transaction in Nigeria shall include:
(a) CP raising mandate
(b) Board Resolution to borrow
(c) Issuing, placing and paying agency agreement
(d) Commercial Paper Note
(e) Bank Guarantee, where applicable
(f) Investment Instruction/Investment Mandate
(g) Investment Advice
(h) Custodial Agreement
(i) Information memorandum on the issuer in the case of clean CPs
(j) Latest rating report from the credit rating agency
(k) Backstop loan request for guaranteed CPs
RATING REQUIREMENTS FOR CP ISSUES
(I) Either the issuer of a CP or the specific issue itself shall be rated by a rating agency registered in Nigeria or any international rating agency acceptable to the CBN. An indicative rating must have been obtained by the issuer at the time of submission of the declarations and information to the Central Securities Clearing System (CSCS).
(II) The issuer or the issue shall have a minimum of investment grade credit rating (BBB- or similar rating).
TENOR AND ROLLOVER OF CPS
(I) The CP shall be issued for maturities of between 15 days and 270 days, including rollover, from the date of issue.
(II) Every issue of a CP is therefore, a separate CP.
(III) The capitalization of upfront interest and discount on maturing Commercial papers into a rollover is not allowed.
PROCEDURE FOR ISSUANCE OF CPS
(I) Any company proposing to issue CPs shall submit a proposal to the IPA with its rating report issued by a credit rating agency. The IPA, on receipt of the proposal, shall scrutinize same and, on being satisfied, take the proposal on record or record the proposal in its blotter.
(II) Companies shall ensure that the proposed issue of CP is completed within the period of two weeks from the date of opening of the issue for subscription.
(III) After the exchange of deal confirmation between the IPA and the issuer, the IPA shall issue physical certificates to the investor or arrange for crediting the CP to the investor’s account with the depository.
(IV) All IPAs issuing the CPs shall, within three working days from the date of completion of issue, advise the depository on the amount of CPs actually issued.
ROLES AND RESPONSIBILITIES OF PARTIES TO CP ISSUANCE ISSUER
With the simplification in the procedures for CP issuance, issuers shall now have more flexibility. Issuers shall, however, have to ensure that the guidelines and procedures laid down for CP issuance are strictly adhered to.
ISSUING AND PAYING AGENT
(I) IPA would ensure that issuer has the minimum credit rating as stipulated by the CBN and amount mobilised through issuance of CP is within the quantum indicated by the guidelines for the specified rating. 14
(II) IPA shall verify that all documents submitted by the issuer viz., copy of board resolution, signatures of authorised executants (when CP is in physical form) are in order. It shall also ensure that it has a valid agreement with the issuer.
(III) Original documents, or certified true copies thereof, verified by the IPA should be held in its custody.
PROVISION OF STAND-BY FACILITY FOR CPS
I. Banks and DHs shall have the flexibility to provide for a CP issue, credit enhancement by way of stand-by assistance/credit backstop facility, etc., based on their commercial judgment and as per terms prescribed by them.
II. However, these should be within the prudential norms as applicable and subject to specific approval of the Board.
DISCLOSURE REQUIREMENTS
I. The bank shall fully disclose the issuer risk in the placement memorandum.
II. CP are only redeemable at maturity, as such cannot be pre-liquidated.
III. The investor in a CP may rediscount the paper with the bank before maturity at new market terms if the bank is willing to purchase the risk.
IV. Banks shall expressly state in customer advice/correspondence the difference between bank deposits and clean CP investments as well as highlight the underlying agreement that the bank is not obliged to pay at maturity until the issuer redeems the paper.
V. Investment instructions in CP shall be received from the customer before transaction is booked.
VI. Acceptable channels of communication include:
(a) Logged/recorded telephone conversation
(b) Email from official corporate email addresses
(c) Letter signed according to existing mandate
(d) SWIFT
(e) Bloomberg, Reuters
VI. Every issue of CP, including renewal, shall be treated as a fresh issue.
PENALTY FOR NON-COMPLIANCE
Non-compliance with these guidelines or any part thereof shall attract appropriate penalties as prescribed in Section 60 (1) of the Banks and Other Financial Institutions Act 1991 (as amended) and may also include debarring from the BA or CP market, or as may be prescribed by the CBN from time to time.
