FAQ on Commercial Papers
- What are the important changes in Commercial Paper Issuance as per the new guidelines issued by RBI?
The important changes as per the new guidelines are the following:
i) Commercial Paper can be issued as a “stand-alone” product, i.e it is delinked from the working capital limits.
ii) Commercial Paper can be issued either in the form of a promissory note or in a dematerialised form.
iii) Banks/Financial Institutions have the flexibility to provide credit enhancement by way of stand-by assistance/credit backstop facility for a Commercial Paper issue.
iv) The new guidelines do not insist on a minimum working capital of Rs. 4 crore or a minimum current ratio of 1.33.
- What are the various forms of Commercial Paper issued under the new regulations?
CRISIL foresees the following forms of Commercial Paper issuances under the revised guidelines:
- Commercial Paper issued within the existing working capital limits
- Commercial Paper issued in excess of existing working capital limits
- Commercial Paper issued with standby facility (within or outside bank limits)
Though there are several other forms of Commercial Paper existing in international money markets such as Asset backed Commercial Paper, Guaranteed Commercial Paper, Lease-backed Commercial Paper, etc., CRISIL envisages only the three above-mentioned forms to be more prevalent in the Indian market in the near future.
- Under the new guidelines, will CRISIL’s methodology for Short Term Debt rating differ from Commercial Paper rating?
CRISIL’s rating methodology is common for rating both Commercial Paper and other Short Term Debt. CRISIL will insist on similar covenants for rating of both commercial paper as well as short term debt.
- What is CRISIL’s approach to rating various forms of Commercial Paper/Short Term Debt?
CRISIL’s rating approach for Commercial Paper/Short Term Debt starts with the fundamental analysis of the business risk, financial risk and management risk of the issuer, similar to assigning the rating to a long term debt instrument. For assigning a Commercial Paper/Short Term debt rating, in addition to the above, CRISIL focuses on the liquidity back-up available for meeting the timely redemption of short term debt. The rating methodology adopted by CRISIL for the various forms of Commercial Paper are as follows:
- Commercial Paper/Short Term Debt issued within the existing bank working capital limits: CRISIL factors in the built-in liquidity back-up facility for such issues and does not insist on a separate back-up line. In such instances, CRISIL undertakes a commitment from the issuer “to keep the drawing power with respect to the sanctioned fund based working capital bank limits, unutilised to the extent of Commercial Paper outstanding, through the tenure of the instrument”.
- Commercial Paper/Short Term Debt issued in excess of bank working capital limits: CRISIL insists on a ‘Liquidity Plan’ from the issuer to cover the entire rated Commercial Paper/Short Term Debt quantum. Liquidity plan may include, among other things, pre-approved bank facilities, marketable securities, identified cashflows earmarked for the redemption of Commercial Paper , etc.
- Commercial Paper/Short Term Debt issued with standby facility (within or outside bank limits): CRISIL factors in the standby facility by equating the rating to that of the facility provider, irrespective of the stand-alone rating of the issuer.
- Under the new guidelines, how would CRISIL evaluate the Short Term Debt/Commercial Paper quantum for awarding ratings?
Commercial Paper/Short Term Debt quantum would be decided on the basis of the following factors
¨– the standalone credit rating of the issuer,
¨– the company’s current and future short term cash flows and liquidity position,
¨– the company’s sanctioned working capital limits,
¨– the liquidity plan submitted by the management team.
- What is a Liquidity Back-up facility?
A ‘liquidity back-up facility’ is a mechanism which allows Commercial Paper issuers to draw funds from a pre-arranged line, if they choose not to roll-over the Commercial Paper (or are unable to do so). In the Indian context, the most commonly available liquidity facilities are the ‘bank lines for working capital’. Till the recent revision in the guidelines, these bank lines were typically reduced to the extent of Commercial Paper placed, and reinstated at the time of redemption. They functioned as a liquidity facility for Commercial Paper redemption. Other examples of Liquidity back-up facilities include Revolving Credit Facilities, Pre-arranged bank facilities, Compensated Lines, etc.
- Why is a Liquidity Back-up facililty required for Commercial Paper/Short
Liquidity back-up facilities are essential for assigning ratings to Commercial Paper Programmes. These back-up lines protect against the risk of default under circumstances in which the investors are unwilling to rollover the issuer’s Commercial Paper, even though the issuer remains credit worthy. Liquidity Back Up is also required because unlike long term ratings, payments are not made from accumulation of cash flows from operations. The Commercial Paper issuer may be required to utilise the back-up facility to fund Commercial Paper debt repayment obligations when the market for Commercial Paper is disrupted due to lack of liquidity in the banking system or other company-specific reasons which prevent Commercial Paper rollovers.
The highly confidence-sensitive nature of short term debt markets, where investors might not be willing to bear even a few days’ delay as compared to Long Term debt markets, underscores the criticality of liquidity back-up facilities which can be used to make timely payment on short-term debt instruments. This is also the reason why the market is comprised only of high credit quality issuers. Internationally, only companies of very high credit standing can sell their Commercial Papers (equivalent of P1 and P2 only). In India also, Reserve Bank of India has allowed only companies with “strong credit quality” (rated P2 or higher) to access the Commercial Paper market.
- What is the international practice on Liquidity Back-up facilities for Commercial Paper?
Internationally, the concept of having back-up for Commercial Paper came into vogue since the US Commercial Paper market was disrupted in June 1970 when Penn Central Railroad defaulted on its $ 82 million Commercial Paper. This first ever default of a prime-rated corporate increased nervousness among investors, which made roll-over of outstanding Commercial Papers difficult even for highly rated companies. Today, all Commercial Papers issued in international markets are backed-up by a liquidity facility, though the nature and extent of coverage vary depending on the maturity pattern of Commercial Paper and other short term debt, issuers’ stand-alone rating, etc. The importance of liquidity back up was recently highlighted in the case of Xerox Corporation, USA, which could not roll-over its maturing Commercial Paper in the light of rumours of its tight liquidity position, and Xerox had to utilise its liquidity back-up line for Commercial Paper redemption.
- Can Liquidity Back-up facilities enhance the rating of Commercial Paper?
No. Although liquidity back-up facilities are a pre-requisite for rating Commercial Paper, the disbursements against pre-approved liquidity facilities are not unconditional and irrevocable and are often contingent upon certain conditions (such as availability of drawing power, currency on all other obligations, etc.) In case of non-compliance of these conditions, a liquidity facility can be cancelled by the facility provider even if the Commercial Paper backed-up by this facility is outstanding. Thus, the presence of a liquidity facility does not, per se, enhance the credit risk of the Commercial Paper.
- What is the difference between a Liquidity Back-up line and a standby credit facility?
Reserve Bank of India, in its recent guidelines, has allowed commercial banks to provide ‘back-stop facilities’ for credit enhancement such as a Standby Credit facility. Such Standby Credit facility provided by banks is distinct from Liquidity facility and works similar to a guarantee. A Standby Credit facility is ‘unconditional’ and ‘irrevocable’ and is available at all circumstances to meet the obligations on the issue, if the primary issuer fails to do so. In such instances, the Commercial Paper rating is generally equalised to that of the facility provider irrespective of the stand-alone rating of the issuer. Examples of such facilities in international Commercial Paper markets include Letter of Credit (LOC) backed Commercial Paper, Guaranteed Commercial Paper, Lease-backed Commercial Paper, Asset- Purchase Supported Commercial Paper, etc. In contrast, a liquidity back-up facility is not unconditional and irrevocable and in all likelihood, might not be available for draw-down if the stand-alone credit quality of the issuer weakens significantly. CRISIL clearly distinguishes a liquidity back-up facility from a credit facility based on these covenants and reflects the same in the rating assigned to the Commercial Paper.
FAQ on Commercial Papers
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