Corporate Finance & Capital Markets
31st December 2020.
Uche Matthew and Oluwademilade Odutola
Understanding the Use of Commercial Papers in Corporate Financing[1]
1. Introduction
Commercial papers are short-term debt securities typically issued by credit worthy corporations looking to raise funds from the public to meet working capital requirements, as a viable alternative to bank credit. In simple terms, companies borrow money from the public by issuing short-term promissory notes, usually unsecured, with the promise of repayment at the date of maturity.
The difference between the CP and the redemption value at the date of maturity is the discount, which is fixed for the tenor of the instrument. Given that the interest applicable to the instrument is fixed prior to the issuance, CPs are considered fixed-income securities.
In Nigeria, the Securities and Exchange Commission (“SEC”) and the Investments and Securities Act (“ISA”) regulate the issuance of securities to the public. However, commercial paper issuances are exempted from SEC regulation because CPs are usually traded over the counter (OTC) via private placement. Accordingly, trading commercial papers on the Financial Market Dealers Quotation (“FMDQ”) OTC Exchange platform is not an issue to the public but a bilateral exchange between the issuer and the holder of the instrument, which is not subject to regulation by the SEC.[2]
Being short term debt instruments, CPs are traded on the money market[3] as opposed to the capital market which is better suited for longer-term securities. CPs may be issued to and held by individuals, deposit money banks, corporate bodies registered in Nigeria, unincorporated bodies, non-resident Nigerians and foreign institutional investors.[4]
Basically, commercial papers provide a convenient financing method because they allow issuers to avoid the hurdles and expense of applying for and securing other lines of credit from financial institutions. Funds are provided by investors who are willing to purchase these obligations on a discounted basis. Furthermore, investors can diversify investment portfolios and earn good returns.
2. Features of CPs
2.1 Discounted Instruments
Typically, commercial paper offerings are sold at a discount from face value. [5] Commercial papers are akin to treasury bills because they are both offered at discount rates which may be paid upfront or capitalised. Also, the interest earned on both instruments is tax exempt. Whereas treasury bills are issued by the Federal Government, commercial papers are issued by corporate entities. Consequently, commercial papers are inherently riskier and attract higher returns compared to government issued securities.
2.2 Pricing of the Issuance
The pricing of the instrument is dependent on the issuer’s investment grade, market conditions and demand.[6] Firms with excellent credit ratings from a recognised rating agency can sell at lower discount rates, meaning that they borrow at a rate lower than the prevailing market value. Commercial paper offerings with lower ratings pay higher interest rates.
Due to the similarity of CPs to treasury bills, treasury bills are the benchmark used in pricing CPs, so the issue competes favourably in the market.
2.3 Programme and Discreet Issue
By the FMDQ rules, a CP may be registered as a single issuance (Discreet issue) or under a programme via shelf registration. A programme registration allows for multiple issues with separate maturity dates covered by a programme memorandum, modified by supplemental offer documents.[7] CP programmes are valid for three years but may be extended[8] by filing necessary documentation, no later three (3) months to the expiration of the validity period. [9]
2.4 Issuance and Trading of CPs
CPs could be purchased either in primary or secondary markets.[10] The issuer can market the securities directly to a “buy and hold” investor such as money market funds or issue the paper through a dealer/arranger, who then sells to investors.
The minimum subscription in the primary market depends on the size of the issue and the limit set by the issuer.[11] The CBN rules set the minimum issue value at ₦100,000,000 (hundred million Naira), to be issued in multiples of ₦50,000,000.00 million thereafter.[12] The major drawback for secondary market trading of CPs is the scale of capital involved, given that the dealers usually buy large volume sizes. Therefore, individual and retail investors may not afford to buy CPs traded in the secondary market.
2.5 Maturity/Tenor of CPs
Maturities on commercial papers range between a minimum of 15 days[13] and a maximum of 270 days (nine months).[14]
However, issuers may choose to rollover the offering within the 270-day threshold, if investors are satisfied with the Issuer’s performance. A CP rollover is treated as a fresh issue and issuers may be required to provide additional disclosures and documentation. As earlier stated, CPs can also be issued under a programme which is valid for three years and renewable upon fulfilment of certain conditions.
2.6 Central Registration
In line with its commitment to govern and uphold the integrity of the Nigerian financial market, the CBN released a circular in 2016 mandating all deposit money banks in Nigeria, to participate only in CPs registered and quoted on authorised securities exchanges. Having approved the FMDQ Commercial Paper Registration and Quotation Process and subsequent Rules developed by FMDQ to govern the CP market, the CBN has given its clearance for FMDQ to serve as the primary registration and quotation platform for CPs in Nigeria.
Registered CPs are issued and held in dematerialized form with the Central Securities Clearing System (“CSCS”), which serves as a Central Securities Depository recognised by the FMDQ.
2.7 Regulation
Issuance of CPs are primarily regulated by Central Bank of Nigeria through the FMDQ. Commercial paper offerings in Nigeria are presently regulated by the following regulations:
i. CBN Guidelines on the Issuance and Treatment of Bankers Acceptances and Commercial Papers, 2009 (reissued 2019) (“CBN Guidelines”); and
ii. FMDQ Commercial Paper Registrations and Quotation Rules 2019 (“FMDQ Rules”).
Issuers intending to register and quote their commercial paper on the FMDQ must follow the FMDQ Rules.[15]
2.8 Unsecured Securities
Per definition, CPs are unsecured debt securities. Where the bank guarantees the CP, to make it more marketable in the money market,[16] the instrument acquires the force of a Bank Acceptance,[17] and the bank incurs a contingent liability.[18] Where the CP is not secured or guaranteed by the bank (Clean CPs), it is backed solely by the financial strength of the Issuer.
2.9 Time to Market
Subject to the Issuer’s timeliness in fulfilment of the regulatory requirements, a CP Programme or Discreet Issuance may be registered within five (5) working days. The issuance of the CP is to be completed within two weeks from the date of opening of the issue for subscription.[19] IPAs are expected to make returns to the relevant securities depository in three working days from the completion of the issuance.[20] Although CPs may be traded in the secondary market before maturity, they are only redeemable at maturity, as such cannot be pre-liquidated.[21]
2.10 Investment Security:
Given their short-term maturities, CPs are a relatively low-risk investment offering competitive returns to investors/ holders of the instrument.
To safeguard investors interests, issuers/promoters are mandated to disclose their identity, details of funding plan for the issue and all material financial facts which may impact the issue. The placement/information memorandum must fully disclose the Issuer’s credit risk. A Deed of Covenant is executed by the issuer, to guarantee the rights of the investors against the issuer/promoter.
To promote effective monitoring of investment, the FMDQ publishes updates on all quoted CPs from live to matured.[22] Once the issuer’s credit risk crystallizes, the CPA/ guarantor is to settle the beneficiaries.
In order to ensure that funds mobilised are not tied down, the proceeds from CP issuances can only be used on current assets,[23] or inventories, and are not allowed to be used on fixed assets, without SEC’s involvement.
Lastly, Blue-chip corporates approaching the debt market to raise short-term funds through commercial papers are less likely to default because it would severely impact their investment grade rating and limit their ability to raise funds in future through the issuance of commercial papers or other financial instruments.
3. Conditions for Issuance of Commercial Papers
The CBN guidelines stipulate that issuers must meet certain conditions to qualify for issuance. To qualify, the issuer must have 3-years audited financial statements with the most recent not exceeding 18 months from the last financial year end, as well as an approved credit line with a Nigerian bank acting as an issuing and payment agent (IPA), where the CP is bank guaranteed.[24]
The CBN requires either the issuer or the issue to be rated by a credible rating agency licensed or recognised by the CBN[25] and meet the minimum investment grade credit rating of BBB- or its equivalent.[26] An indicative rating must be obtained by the issuer at the preliminary stage of the transaction, prior to the submission of declarations and relevant information to a securities depository.[27]
The FMDQ Rules in addition to the requirements stipulated by the CBN, prescribe further requirements for issuers/promoter’s commercial papers. The issuer/promoter must:
i. be a company incorporated for at least five (5) years and in operation for three (3) years prior to the date of its application for registration of CPs on the OTC Exchange.
ii. be guided by its Memorandum and Articles of Association and other relevant corporate documents with regards to capacity to issue debt securities, borrowing limits and other relevant considerations.
iii. have and maintain shareholders’ funds (unimpaired by losses) of not less than N500,000,000.00 (Five Hundred Million Naira), indicated by audited financial statement, prepared no later than twelve (12) months before submission of the application, for the tenor of the issuance/ CPs quoted on the exchange.[28]
Where the issuer/promoter cannot satisfy these requirements, the prospective CP issuance/ programme must be backed by a guarantor or any other credit enhancement provider, satisfying the above listed requirements.
The FMDQ rules provide for similar credit rating report, to be issued by any CBN licensed credit-bureau prior to the registration of the CP on the OTC Exchange.
4. Documentation and Disclosure Requirements for Commercial Papers
By the CBN rules, the documentation requirements for a CP transaction in Nigeria include:[29]
- CP raising mandate
- Board Resolution authorising the issuance
- Issuing, placing, and paying agency agreement
- Commercial Paper Note
- Bank Guarantee, where applicable
- Investment Instruction/Investment Mandate
- Investment Advice
- Custodial Agreement
- Information memorandum on the issuer in the case of clean CPs
- Latest rating report from the credit rating agency
- Backstop loan request for guaranteed CPs
The FMDQ rules also provide for certain disclosures and documents[30] to be furnished in respect of the issuer and the issue in relation to the registration of its platform, and amongst them are:
- FMDQ Application Form
- Evidence of payment of application fee
- Memorandum and Articles of association, certificate of incorporation or other relevant corporate documents.
- External auditor’s comfort letter on the issuer/ promoter
- Corporate profile of the issuer/ promoter
- Documentation providing information and details of any indebtedness.
- Particulars of directors and shareholders
- 3(three) years audited accounts, the most recent not exceeding 12 (twelve) months from the date of submission of the application for registration
- Latest unaudited interim reports and accounts
- Comprehensive schedule of current debt profile
- Details of any material litigations/ claims by an external solicitor
- Evidence that the amount to be mobilised from the issuance does not exceed the limit of the issuer’s borrowing powers
- For non-bank corporate issuers/promoters, a bank reference on the issuer or promoter
- Declaration of Compliance by the Issuer/Promoter. [31]
5. Procedure for Issuance, Registration and Quotation and Post-Quotation of CPs
Issuers and transaction parties must ensure that the guidelines for CP issuance are strictly adhered to. A company intending to issue CPs is expected to procure requisite board/ shareholder’s approval, engage professional parties to the transaction, particularly the rating agency, agree on transaction structure (one-off, rollover or programme), prepare information memorandum and other transaction documents, submit a proposal to the authorized IPA (Investment Placing Agency) with its rating report issued by a recognised rating agency. The appointed IPA, on receipt of the proposal, shall scrutinize same and, being satisfied, take on the issuance. The IPA engages with relevant authorities to ensure that the issue follows the provisions of the FMDQ Rules and other applicable laws.
The Information Memorandum and accompanying documents are filed with FMDQ for approval and registration. After registration comes the pricing and marketing of the issue. At this stage, the offer is opened, interested investors indicate their commitment by filing legally binding commitment forms, and the offer is closed. The CPs are then allotted, registered with a recognised CSD[32] and quoted on the FMDQ Exchange platform for trading, provided the requirements for quotation are met.[33]
It is instructive to note that registration of the issuance/programme with the FMDQ is a pre-condition for quotation and listing on the FMDQ Exchange platform.[34] All relevant quotation requirements for CPs must be fulfilled within five (5) business days from the effective settlement date.
Post-quotation compliance obligations are categorised into Disclosure Obligations (any information that may affect the price of the securities) and Notification Obligations (information that will keep investors and the general public informed about material changes or developments that may impact the Issue or the Issuer). Where the tenor of the issue exceeds three (3) months, the Issuer, through its Sponsor (IPA/IPCA) shall be required to file a quarterly Compliance Report.[35]
These procedural requirements are aimed at protecting the interest of investors and ensuring transparency and compliance in the market.
6. Penalty for Non-Compliance
Non-compliance with the CBN guidelines attracts sanctions including being debarred from the CP market, and penalties specified in Section 60 (1) of the Banks and Other Financial Institutions Act 1991 (as amended) prescribing penalties or other administrative punitive measures imposed by the CBN.[36]
Furthermore, the FMDQ Exchange Commercial Paper Infraction and Penalties Guide (“CPIPG”) provides a non-exhaustive list of infractions and attendant penalties related to the registration and quotation of CPs on the Exchange.[37] Failure of the issuer/promoter to comply with the post-listing/quotation regulations may lead to the de-listing of such CP.[38]
The IPCA/IPA shall provide the applicable pricing supplements for each CP sought to be issued, no later than forty-eight (48) hours prior to the opening of the offer/presentation of the pricing supplement to prospective investors. The pricing supplements filed with the OTC Exchange shall include information on the size, tenor of the proposed CP issue, and such other information as may be required by FMDQ.
7. Roles and Responsibilities of Parties to CP Issuance
Parties to the transaction each have a role to play to ensure the success of the issuance. Key parties to the issuance include:
7.1 Issuing and Placing Agent
For CPs, Issuing and Placing Agent (IPA) are the capital market equivalent of Issuing Houses. The IPA is the financial institution sponsoring the registration and quotation of CP Programmes and Issues on the Exchange, and the placement of CPs with investors at the primary issuance.[39] The IPA is to ensure that issuer meets the minimum credit rating, reviews all transaction documentation, advises on the viability of the issue in terms of timing, pricing and size, and assists with post issuance obligations. Agency agreements executed between the issuer and the agents (IPA and CPA or the IPCA), extensively outlines each party’s rights and obligations.[40]
7.2 Issuers/Promoters
The issuer is the company looking to finance short-term liabilities using commercial papers. Only highly rated organizations can raise money through commercial papers. Organizations with low credit ratings may use credit enhancement facilities to boost their ranking.
Also, an SPV may be incorporated for the purpose of the issuance. Where the issuer is an SPV, the promoter (parent company) of the SPV remains the primary obligor and is deemed to have the same obligations as the issuer.[41]
7.3 Guarantor
Banks and non-banks may provide issuers with credit enhancement facilities by way of stand-by credits or guarantees to the issue, based on their prudent commercial judgment. For guaranteed CPs, the intermediating bank is a secondary obligor.
7.4 Solicitors/Transaction Counsel
The solicitor identifies all legal and regulatory issues that will impact the issue and advises accordingly. The solicitor prepares a legal opinion on the issue, the transaction agreements, reviews other transaction documents and ensures the issuer is in good corporate standing to effect the transaction.
7.5 Auditors
The auditors ensure clarity and correctness of all material financial facts pertaining to the issue, issue financial reports and comfort letters.[42]
7.6 Collecting & Paying Agent
These are deposit money banks authorised by the issuer/promoter to remit funds to issuer and facilitate the distribution of payments to the investors, where the CP is sponsored by an IPA.
7.7 Issuing, Placing, Collecting & Payment Agent
Issuing, Placing, Collecting & Payment Agent (“IPCPA”) combines the functions of IPAs and CPAs. Only CBN licenced banks can act as an IPCA on a CP issuance. The IPCA must also be an FMDQ licensed Registration Member (Quotations).
7.8 Dealers
Dealers effect the settlement and lodgement of CPs on the Central Securities Depository (CSD).
7.9 Credit Rating Agency
Credit Rating Agencies conduct a thorough assessment of the Issuers/Issue to ascertain the issuer’s ability to meet their debt obligations and issues a rating report. A high credit rating is indicative of low-risk and may encourage investors to buy the security.
7.10 Commercial Paper Investors
Investment in commercial papers is open to both Qualified Institutional Investors (QII) and Eligible Investors (EI), as defined in the rules. The IPCA/IPA are obligated to ensure that QIIs and EIs meet the qualifying criteria set out in the FMDQ rules. Whilst guaranteed CPs may be sold to all investors (QIIs, EIs and any other investor), clean CPs shall only be sold to QIIs and EIs upon the execution of a declaration attesting to the investor’s awareness of the risks involved in investing in the clean CPs.[43]
8. Conclusion
There is a robust demand for CPs in the domestic debt capital market, occasioned by the current COVID-19 pandemic and the resulting liquidity crisis for corporates.[44]
Commercial CPs are an attractive funding alternative for several reasons. Unlike standard bond issues, CP programmes do not require engagement with the SEC. Thus, there are no due diligence and extensive disclosure requirements. Also, issuers can easily roll over the programme, which means that the proceeds from new issuances are used to settle maturing issuances.
Furthermore, holders of the instrument are entitled only to repayment of their investment and have no direct claim on future profits of the business. Unsecured debt securities do not dilute the ownership interest, nor do they create a lien on the company’s assets. Also, interest on the debt is normally tax exempt and can be deducted from the company’s tax return, lowering the actual cost of the loan to the company.
Unfortunately, the surge in the CP market favours first-rate issuer companies with impeccable financial track records. While this resonates with CBN’s objective to spur lending in the private sector while limiting the exposure of investors to unsecured risks, smaller companies, which account for the larger percentage of the private sector, cannot take advantage of lower borrowing costs in the CP market.
Commercial Papers are now the most common form of short-term debt instruments issued by companies or organizations to meet sizeable borrowing needs. In response to favourable CBN regulations, we expect that more indigenous corporations seeking to bridge financial deficits will look to the commercial paper space as a viable market for this purpose.
_______________________________________________________________
For further information on this article and area of law,
please contact Uche Matthew or Oluwademilade Odutola at S. P. A. Ajibade & Co.,
Lagos by Telephone (+234.1.270.3009; +234.1.460.5091) Fax (+234 1 4605092)
Mobile (+234.8151191 865, +234.8097904768)
Email: umatthew@spaajibade.com, oodutola@spaajibade.com
[1] Uche Matthew and Oluwademilade Odutola, Associates, Corporate Finance and Capital Markets Department, SPA Ajibade & Co., Lagos, Nigeria.
[2] Nnanke Williams and Adetayo Adetuyi The Legal Framework For The Issuance Of Commercial Papers In Nigeria (11 March 2020), available at: https://www.mondaq.com/nigeria/securities/902696/the-legal-framework-for-the-issuance-of-commercial-papers-in-nigeria accessed 15 December 2020.
[3] Money market is the platform where instruments characterized with high liquidity and short maturities are traded.
[4] Paragraph 10.1 of the CBN Guidelines.
[5] Commercial papers may be interest bearing or issued at a discount to face value, based on the issuer’s discretion.
[6] The IPA conducts a market analysis for optimal price discovery.
[7] Pricing supplements contain the specific terms and conditions, details, and material changes, if any with respect to each series of securities issued under a program.
[8] Rule 3.2(vi) of the MDQ Commercial Paper Registrations and Quotation Rules 2019.
[9] Ibid, Rule 3.2(vii).
[10] The primary market is where the investors buy financial instruments at issuance while the secondary market is the platform for the sale of instruments purchased in the primary market issuances.
[11] The minimum level of subscription for an issue is either stated in the Offer Documents or set at 50% of the amount approved by the Board of Directors of the Issuer/Promoter’s.
[12] Paragraph 7.2.1 of the CBN Guidelines on the Issuance and Treatment of Bankers Acceptances and Commercial Papers, 2009 (reissued 2019).
[13] The FMDQ rules allow for maturities as short as 15 days. See Paragraph 3.2(i) of the FMDQ Rules.
[14] CPs are hardly used to fund longer term obligations because there are other instruments better suited for that purpose.
[15] Lisa Esamah Overview Of Commercial Papers Issuance In Nigeria (01 July 2020) available at: https://seftonfross.com/wp-content/uploads/2020/07/OVERVIEW-OF-COMMERCIAL-PAPERS-ISSUANCE-IN-NIGERIA.pdf accessed December 2020.
[16] Where a CP is guaranteed by a bank or any credit enhancement provider, a Deed of Guarantee is drawn up clearly stating the terms and conditions of the guarantee as well as obligations of the issuer to be guaranteed and the guarantor.
[17] A Bank Acceptance is also a short-term debt instrument that allows banks to finance customers borrowing needs using funds provided by investors.
[18] Conversely, where a bank invests in a CP by disbursing its own funds, the transaction shall be treated as a loan. See Paragraph 3(b)(ii, iii and iv) of the CBN Guidelines on The Issuance and Treatment of Bankers Acceptances and Commercial Papers, September 2019.
[19] Ibid, Paragraph 14.2.2.
[20] Ibid, Paragraph 14.2.4.
[21] Rule 3.1(v) of the FMDQ Commercial Paper Registrations and Quotation Rules 2019.
[22] Quoted Commercial Papers Status – as at December 22, 2020 available at https://fmdqgroup.com/qcsr-running/ accessed on 27 December 2020.
[23] Current assets are all the assets of a company expected to be sold, consumed or used in facilitating standard business operations.
[24] Paragraph 3(b) of the CBN Guidelines on the Issuance and Treatment of Bankers Acceptances and Commercial Papers, 2019.
[25] Ibid, Paragraph 5.1
[26] Ibid, Paragraph 5.2
[27] Ibid, Paragraph 5.2
[28] Rule 4.3-4.5 of the FMDQ Commercial Paper Registrations and Quotation Rules 2019.
[29] Paragraph 4.2 of the CBN Guidelines on the Issuance and Treatment of Bankers Acceptances and Commercial Papers, 2019.
[30] Electronic copies of the documentation and disclosure requirements outlined may suffice unless hard copies are expressly requested by FMDQ. A Declaration of Prior Disclosure may be executed by the Issuer/ Promoter where the documents/disclosures requested had previously provided and remain valid and subsisting.
[31] Rule 5 of the FMDQ Commercial Paper Registrations and Quotation Rules 2019.
[32] Rule 7.8 of the FMDQ Commercial Paper Registrations and Quotation Rules 2019.
[33] See Rule 7 of the FMDQ Commercial Paper Registrations and Quotation Rules 2019.
[34] While registration is the administration of the review and approval processes in respect of CP Programmes, prior to the issuance of such CPs to investors, while Quotation is the admission of issued CPs to the FMDQ Exchange platform for trading. See Frequently Asked Questions: Commercial Papers (Cps)
(January 2020) available at: https://www.fmdqgroup.com/wp-content/uploads/2020/01/Commercial-Papers-FAQs-Jan-2020.pdf accessed on 12 December 2020.
[35] Ibid, Rule 8.
[36] Paragraph 22.1 of the CBN Guidelines on the Issuance and Treatment of Bankers Acceptances and Commercial Papers, 2019.
[37] Frequently Asked Questions: Commercial Papers (Cps)
(January 2020) available at: https://www.fmdqgroup.com/wp-content/uploads/2020/01/Commercial-Papers-FAQs-Jan-2020.pdf accessed on 12 December 2020.
[38] Rule 8.4 of the FMDQ Rules.
[39] The IPA must be a duly licenced Registration Member (Quotations) of the FMDQ.
[40] The FMDQ Commercial Paper Registration and Quotation Template Guide (FMDQ Template Guide) provides a template of the general contents of the agency agreement.
[41] Rule 4.1 of the FMDQ Commercial Paper Registrations and Quotation Rules 2019.
[42] A comfort letter only contains an opinion, and it is not an assurance or guarantee that the issuer being reported upon will remain financially viable. See https://seftonfross.com/wp-content/uploads/2020/07/OVERVIEW-OF-COMMERCIAL-PAPERS-ISSUANCE-IN-NIGERIA.pdf, accessed on…
[43] Frequently Asked Questions: Commercial Papers (Cps) available at:
(January 2020) https://www.fmdqgroup.com/wp-content/uploads/2020/01/Commercial-Papers-FAQs-Jan-2020.pdf accessed on 12 December 2020.
[44] Olufikayo Owoeye Here’s what you need to know before buying that commercial paper (30 March 2020) available at: https://businessday.ng/wealth-and-investing/article/heres-what-you-need-to-know-before-buying-that-commercial-paper/ accessed on 14 December 2020.
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