Credit-enhanced commercial paper

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: Since its introduction in the Indian market in 1990, commercial paper (CP) has gained popularity as a convenient short-term debt instrument. Companies use it today to reduce their borrowing costs while investors use the tradable instrument to park their short-term funds. Yet, since commercial paper is a confidence-sensitive instrument, its benefits have been limited to highly rated companies so far. This is evident from the fact that 'P1+' paper accounted for 94 per cent of the Indian CP market. Even globally, instruments rated 'P1' and 'P1+' account for 89 per cent of the total CP market.

CRISIL, however, believes that, if issuers look beyond plain vanilla CPs, the benefits of this short-term instrument can be extended to companies that have not yet been able to take advantage of them. This article takes a look at some popular varieties of credit-enhanced CPs in developed markets and assesses their suitability to the Indian market.

Types of Credit-Enhanced Commercial Papers

Several kinds of credit-enhanced CPs are issued in the developed markets today. These include

Although there are several ways of enhancing the credit quality of a CP programme, guaranteed CPs and asset-backed CPs are by far the most popular.

Guaranteed CPs

Concept: In this case, a higher-rated entity issues a guarantee to enhance the credit quality of a CP that is issued by a lower-rated entity. The guarantee must be irrevocable and unconditional. It can take the form of an irrevocable letter of credit, an irrevocable revolving credit facility, a surety bond, a corporate guarantee or a repurchase agreement. Such an instrument's rating is equated with that of the guarantor and is hence, independent of that of the issuer.

Internationally, 5 to 10 per cent of the CPs issued are guaranteed through any one of the means mentioned above. Closely held companies and those with weaker credit quality typically use this instrument. In India companies like International Cars & Motors Limited have used this by taking guarantee from its stronger parent (International Tractors Limited in this particular case).

Benefits to Issuers