Commercial Paper (CP) is basically a short-term debt security issued by highly rated companies to raise funds for funding operating expenses as well as current assets such as account receivables and inventories. Maturities on CP rarely range any longer than 270 days though it can be up to 365 days. CP is being issued in the form of promissory note in Bangladesh. It is typically issued at discount like Treasury Bills, reflecting prevailing market interest rates. That means, investors purchase promissory notes at less than face value and receive the face value at maturity. The difference between the purchase price and face value, called the discount, is the interest received on such investment.
CP is sporadically issued as an interest-bearing note, i.e., investors pay the face value and, at maturity, receive the face value and accrued interest. All the commercial papers issued so far in Bangladesh are interest-bearing only. Generally, companies and financial institutions can issue commercial paper. Even though banks and non-bank financial institutions (NBFIs) can act as arrangers for the issuers, only a scheduled bank can act as an issuing and paying agent (IPA) for the issuance of CP. Banks, NBFIs and corporate bodies are the major investors in CP.
Commercial paper market is experiencing rapid growth in Bangladesh for the last couple of years owing to its low cost and easy access. CP is a highly promising product for a developing country like Bangladesh for at least two reasons: First, it fosters the goal of reducing cost of borrowing which can stimulate growth. Through CP, companies can now get funds at lower cost compared to bank loans. Weighted average interest rate on CPs issued in the last three years stands at 10.34 per cent against the weighted average bank lending rate 13.06 per cent during the same period. Secondly, there are limited investment opportunities in the financial market of Bangladesh. Often banks remain overburdened with surplus liquidity and heavily dependent on government securities amid low credit growth in the economy. The sharp fall in yields on the recently auctioned Treasury bonds highlight the need for additional investment instruments. Yields on the recently auctioned 2-year, 5-year, 10-year, 15-year and 20-year bonds fell sharply by 60, 80, 93, 136 and 161 basis points respectively. Had there been more investment instruments, fall in yields would not have been that much. Volatility of interest rate would have been lower. CP can broaden investment opportunities as it provides additional instrument to the investors. Thus, it can play an important role for development and growth of sustainable financial market.
CURRENT STATUS IN BANGLADESH: Commercial paper market, popular around the world, is in a very early stage of development in Bangladesh. Eastern Bank Limited is the pioneer of CP in the country; it raised Tk. 500 million for ACI Limited in 2013. Since then, this market is growing very fast in our country with approximate growth of 593.10 per cent in 2015. ACI Limited is so far the largest issuer of commercial paper in the country with approximately 20 per cent market share. The amount of current outstanding CPs is close to Tk. 10,050 million.
Commercial paper market: Challenges and prospects
MAJOR CHALLENGES: There is no standard pricing mechanism for CPs in Bangladesh. Pricing is not in line with the risks inherent in different borrowers. All the borrowers are getting access to CP market at almost similar rates. This should not be. Adequate credit risk premium should be added. Bad borrowers should be charged higher interest rates and vice versa.
Secured and unsecured CPs are being priced almost homogenously. Even investors are willing to invest at lower rate compared to secured one finding no better investment opportunities. If this trend continues, bad borrowers will feel more encouraged to enter CP market in future.
For example, Company X borrowed from Bank A for one year. One year has gone by. Company X is about to repay its debt to Bank A. In the meantime, company X is facing severe cash flow problem and unable to repay its debt to Bank A which is on the verge of having NPL (non-performing loan). Bank A might suggest, in its interest, Company X to issue unsecured CP in which Bank A will work as arranger. Bank A is being paid from the proceeds of CP issues and thus it is reducing its NPL but exposing other investors of this CP to credit risk. On maturity of CP, the company might be unable to repay the investors from its cash flows. To get rid of this problem, the company may issue another CP to repay the previously issued CP.
This scenario poses great threat to the future sustainability of CP market. The Bangladesh Bank (BB) as the regulator of banking system has to ensure that no such things happen in the country. The BB could provide guidelines that an arranger in unsecured CP has to invest a certain percentage, for example, 25 per cent of the issue. Thus, risk-based pricing needs to be introduced to develop CP market.
Commercial paper is typically a discount security worldwide. But all the commercial papers issued so far in Bangladesh are interest-bearing only. One of the reasons may be that the borrowers are comfortable with interest-bearing bank loans. They perceive discount basis issuance as cumbersome. They need to be educated about this and encouraged to issue CP on discount basis.
One of the main reasons of why the interest rate on CP is lower than that of bank loan is market tradability. The investors in CP can liquidate the investment prior to maturity by selling it in the secondary market. Because of this liquidity facility inherent in CP, investors are willing to receive lower return than bank loans. But, secondary market for CPs does not exist in Bangladesh. Still, the rate remains at the lower level. The BB should strive for developing secondary market for CP to increase its marketability.
The longer the maturity is on a note, the higher is the interest rate the issuing company must pay. The 9-month CP should contain higher interest rate than that of 6-month CP and vice versa. But, appropriate maturity premium is not being added to the pricing of CPs in Bangladesh.
CPs issued so far in Bangladesh are in the form of promissory notes. CP issues don't contain clear clause regarding tradability. It would be helpful for secondary trading if it were issued in dematerialised form through a depository approved by and registered with the Bangladesh Bank (BB).
Dematerialised CPs can easily be transferred from one investor to another. This will play a pivotal role to bring dynamism in secondary market trading of CP.
MEASURES FOR SUSTAINABLE CP MARKET: It's high time for the BB to come up with comprehensive guidelines regarding issuance of CP. It can consider taking the following measures to help develop sustainable CP market:
A. Setting eligibility criteria for issuers of CP: The BB should set certain conditions to be eligible for issuance of commercial papers. Conditions could be as follows:
1) The companies can't have loss in previous three years as per the audited income statements.
2) The companies should have certain equity as per the latest audited balance sheet depending on the type of companies.
3) The financing banks or institutions haven't classified the account of the company.
4) The company has to have minimum credit rating by credit rating agencies approved by the Bangladesh Bank and
5) The banks or financial institutions have sanctioned working capital limit to the issuer company.
B. Setting eligibility criteria for investors: The Bangladesh Bank should provide guidance as to who can invest in CPs. Individuals, banks, FIs (financial institutions) and other corporate bodies can be allowed to invest in CPs. The BB should decide whether non-resident individuals and institutional investors will be allowed to invest in CPs or not.
C. Setting eligibility criteria for rating agencies: The BB should set certain criteria for rating agencies. Accordingly, it will do rating of them. The topmost five rating agencies can be made eligible by which the issuer has to be rated in order to become eligible for issuing CPs.
D. Setting duties and obligations of issuing and paying agent (IPA):
n The IPA shall ensure that the issuer meets the eligibility criteria set by the Bangladesh Bank.
n The amount of CP is within the limit given by CRM or as approved by its Board of Directors.
n IPA shall verify all documents submitted by the issuer are in order and
n IPA shall notify the Bangladesh Bank about the issuance of CP.
On top of the aforementioned measures, the BB should provide guidelines delineating the issuance procedures, mode of issuance and redemption, as well as accounting procedures. It should provide a platform for commercial papers where participants can provide two-way quotes. OTC (over-the-counter) trades of CPs can be settled through a module like Market Infrastructure (MI) Module for Bill Bonds. The Bangladesh Bank should provide guidelines on settlement cycle which can be T+0 like Bangladesh Bank Bill or T+1 for Treasury Bill-Bonds. At the inception of CP, the issuer shall arrange to credit the Demat (dematerialised) account of the investor with the depository through IPA (Issuing and Paying Agent).
The holder of CP shall be allowed to resell the CP to other investors prior to maturity. On maturity, the holder of CP in Demat form shall get the CP redeemed and receive payment through IPA.
Commercial paper is likely to become popular with investors in the coming days given the limited financial products we have. Corporate dependency on bank loans will then substantially fall.
