Commercial papers are alternative short-term financing sources for the borrowers. Commercial papers are usually issued to raise funds outside of the primary markets i.e. the stock exchanges.
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What is Euro Commercial Paper?
Euro Commercial Paper (ECP) is a short-term debt instrument that is issued in a currency other than the local currency of the issuer. The denomination currency of the EPC can be any international currency e.g. Dollar, Euro, Pound, etc.
It is typically issued for a very short-term usually from one day to a maximum of one year maturity. These commercial papers are a form of unsecured loan which are usually not backed by any collateral. However, many issuers also raise funds through secured or asset-backed commercial papers. The term “euro” refers to the fact that the investor has to be a foreign entity other than from the domestic country of the issuers. Borrowers look for quick and short-term cash offering low cost commercial papers. Due to unsecured nature and short-term maturity, the euro commercial papers are usually offered at a discount price with a low coupon rate. Some euro commercial papers come without any coupon payments offering deep discount prices.
Characteristic of Euro Commercial Paper
Short-Term with Low Rate
The Euro Commercial Papers are usually issued with promissory notes. The maturity date of an ECP can range from one day to a maximum of 365 days. These commercial papers are issued with a minimum of $ 100,000 denomination. Borrowers can issue commercial papers on a rolling basis if the maturity period is too short. The maximum size of a commercial paper on a rolling basis can be decided with an ECP program. Due to large investment and short-term maturity, the trades take place among large corporate institutes. Lately, with commercial paper index funds, the retail investors have been able to make investments with commercial papers too. The low coupon rates and short maturity period of a few days do not attract the retail investors.
Unsecured Type of Loan
As the commercial papers are usually an unsecured type of loan, the borrowers’ high creditworthiness plays a key role. Some reputable rating agencies rate the commercial papers mainly based on the issuer credit profile. Issuers with higher credit ratings may offer lower or no coupon to raise funds. The coupon rates offered on the EU commercial papers are usually below the LIBOR. The only attraction for investors is to invest idle or excess cash balances for the short-term usually a few days.
Not Regulated by SEC
The ECP are not regulated by the Securities and Exchange Commission (SEC). The regulations and restrictions applicable to the parties apply according to the local jurisdiction of the issuer. Most commercial papers work through a euro commercial paper program (ECPP), where the investors and borrowers work through an issuing partner agent.
Standard Contract Terms
Under an ECP program, the contract terms for the euro commercial paper denomination, maximum size, coupon rate, and maturity date are decided. The contract may take place directly between the private investor or through a third-party agent usually a large financial institute.
Not Registered with SEC and Settle through Clearing Houses
For borrowers, the major advantage with an ECP remains that it does not need to be registered with the SEC. The ECP is settled through two clearing houses the Euroclear and the Clearstream. Large transactions between two parties may take place through any other large institutional dealer. However, the third-party arrangements also do not make the ECP any committed or secured form of debt.
Benefits of Euro Commercial Paper
The foremost advantage of the ECP is the reach to the international investors. Large institutes with high creditworthiness use these financial instruments to fund the working capital and other current liabilities. Due to low coupon rates, the investors find the cost of commercial papers lower than bank borrowings.
The Euro Commercial Paper instruments offer certain flexibility and benefits for both investors and the borrowers:
- Issuers can have access to international investors with any international currency denominated commercial paper
- Issuers usually do not require any collateral but have to maintain high credit ratings to attract investments
- Coupon rates if offered are very low usually below the LIBOR
- The maturity terms can be made on rolling terms
- Investors can earn short-term interest or sell in the secondary markets as the issue price is offered below Par value
- Legal complications with ECP are at a minimum for both parties, as the ECP does not require to be registered with SEC.
- Due to simplicity in contractual formation, the costs associated with ECP are low, the terms are flexible, and require a short time to manage the contract
Issuers look to avoid complexities involved with bank borrowings by issuing commercial papers. ECPs offer an incentive to tap into the international money markets. The investors look to make quick returns through a small coupon or by secondary market trading. However, investors must consider the fact that euro commercial papers are not secured and registered form of debts.
Limitations of Euro Commercial Paper
Along with flexible financing and a short-term maturity period, the euro commercial papers also come with some limitations:
- The ECPs require large initial investments that do not attract retail investors
- These commercial papers come with low coupon rates often lower than LIBOR
- Commercial papers come without any collateral and registration
- In case of issuer default, the investors of secured Financial Instruments get priority over the euro commercial paper investors
Euro Commercial Papers and the US Commercial Papers
The US commercial papers also work similarly to euro commercial papers in characteristics of being unsecured short-term borrowing instruments. The clearing house for the US commercial papers is the Depository Trust Company. Issuers and clearing terms differ for both types of commercial papers.
| Decription | Euro Commercial Paper | US Commercial Paper |
|---|---|---|
| Maturity Period | 01 day to a maximum of 365 days | 01 day to a maximum of 270 days |
| Investors | International Investors, non-resident domestic institutions | US large Financial Institutes |
| Required Registration with SEC | Regulated but not Registered | Regulated but not Registered |
| Clearing House | Through Euroclear and Clearstream | Through Depository Trust Company |
Both types of commercial papers do not require collateral but come with Asset-Backed Commercial Papers too. The creditworthiness of the issuer is rated by a rating agency for the commercial papers. The investment purpose and the issuer’s credit rating contribute to the commercial papers final rating. A credit rating for the US commercial papers is mandatory under the SEC regulatory recommendations.
Conclusion
The euro commercial papers are flexible and quick borrowing instruments. The issuers can secure investments for lower costs than bank debts. However, the minimum investment requirements make it difficult for retail investors.
