Reserve Bank Commercial Paper Directions, 2017:A synopsis of the changes and our analysis

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BackgroundAs part of efforts to develop the money market, commercial papers (CPs) were introduced in India in 1990, with a view to enabling highly rated corporate borrowers to diversify their sources of short-term borrowings and also provide an additional financial instrument to investors. Subsequently, primary dealers and satellite dealers (no more in existence, as they were discontinued by RBI in 1997) were also

permitted to issue CPs to enable them to meet their short-term funding requirements for their operations. With more and more corporates and NBFCs in India using CPs rather than the conventional channels of borrowing, RBI has come up with revised draft regulations that have a greater focus on disclosure from CP issuers, which will enable investors to make informed decisions.

A comparison of the revised draft guidelines with the extant regulations:

Draft regulation1

a. Companies and All India Financial Institutions (AIFIs) subject to following conditions:

i. the entity has been sanctioned working capital limit by bank/s or FIs; and

ii. the account of the company/AIFI is classified as a Standard Asset by the financing bank/institution.

b. Standalone Primary Dealers.

c. Other entities with a net worth of ₹100 crore or higher subject to conditions under 3 (a)(i) and 3 (a)(ii) above.

d. Any other entity specifically permitted by the Reserve Bank of India (RBI).

a. Companies, PDs and FIs are permitted to raise short term resources through CP.

b. A company would be eligible to issue CP provided:

i. the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs.4 crore;

ii. the company has been sanctioned working capital limit by bank/s or FIs; and

iii. the borrowal account of the company is classified as a Standard Asset by the financing bank/institution

1. The following two new issuer categories have been introduced:

a. any entity permitted by RBI

b. entity other than company and AIFI, i.e. partnerships (LLPs)

2. The net worth limit of 4 crore INR for companies and FIs has been removed, which means that small companies can also issue CPs.

Changes in the draft regulations vis-à-vis the current regulations

Eligible issuers: Eligible issuers:

Extract from Master Direction on Money Market Instruments: Call/Notice Money Market,Commercial Paper, Certificates of Deposit and Non-Convertible Debentures (original maturity up to one year)2

1. https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=39451 2. https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10495

Reserve Bank Commercial Paper Directions, 2017 3

a. All residents, and non-residents permitted to invest in CPs under Foreign Exchange Management Act (FEMA), 1999 are eligible; however, no person can invest in CPs issued by related parties.

b. Investment by regulated financial sector entities will be subject to such conditions as the concerned regulator may impose.

a. CP shall be issued in the form of a promissory note and held in a dematerialized form through any of the depositories approved by and registered with SEBI.

b. CP shall be issued in minimum denomination of ₹5 lakh and multiple of ₹1 lakh.

c. CP may be issued at a discount to face value.

d. No issuer shall have the issue of CP underwritten or co-accepted.

e. Options (call/put) are not permitted on CP.

a. Individuals, banks, other corporate bodies (registered or incorporated in India) and unincorporated bodies, Non-Resident Indians and Foreign Institutional Investors (FIIs) shall be eligible to invest in CP.

b. FIIs shall be eligible to invest in CPs subject to (i) such conditions as may be set for them by the Securities and Exchange Board of India (SEBI); and (ii) compliance with the provisions of the Foreign Exchange Management Act, 1999, the Foreign Exchange (Deposit) Regulations, 2000 and the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000, as amended from time to time.

a. CP shall be issued in the form of a promissory note (as specified in Annex III to this Direction) and held in physical form or in a dematerialized form through any of the depositories approved by and registered with SEBI, provided that all RBI regulated entities can deal in and hold CP only in dematerialised form through such depositories.

b. Fresh investments by all RBI-regulated entities shall be only in dematerialised form.

c. CP shall be issued in denominations of Rs. 5 lakh and multiples thereof. The amount invested by a single investor should not be less than Rs. 5 lakh (face value).

d. CP shall be issued at a discount to face value as may be determined by the issuer.

e. No issuer shall have the issue of CP underwritten or co-accepted.

f. Options (call/put) are not permitted on CP.

RBI has prohibited related parties from investment in CPs. This prohibition was not present in the extant guideline and will ensure that issuers do not abuse the guideline.

A CP can be issued with a minimum denomination of 5 lakh INR and in multiples of 1 lakh INR. This will ensure better liquidity in the secondary markets as earlier, issue was restricted to denomination of 5 lakh INR only.

Eligible investors:

Form

Eligibility for investment in CP

Form

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a. Eligible issuers shall obtain credit rating for issuance of CPs from at least two CRAs registered with SEBI and should adopt the lower of the two ratings.

b. The minimum credit rating for a CP shall be ‘A3’ as per rating symbol and definition prescribed by SEBI

c. CRAs shall take approval from RBI for the purpose of rating CPs.

Issuers, investors and Issuing and Paying Agents (IPAs) shall follow the standard procedures and documentation prescribed by Fixed Income Money Market and Derivatives Association of India (FIMMDA) as ‘Operational Guidelines on CPs’.

Eligible participants/issuers shall obtain credit rating for issuance of CP from any one of the SEBI registered CRAs. The minimum credit rating shall be ‘A3’ as per rating symbol and definition prescribed by SEBI. The issuers shall ensure at the time of issuance of the CP that the rating so obtained is current and has not fallen due for review.

a. Standardised procedures and documentation for CPs are prescribed in consultation with Fixed Income Money Market and Derivatives Association of India (FIMMDA) in consonance with international best practices.

b. Issuers/IPAs shall follow the operational guidelines issued by FIMMDA, from time to time, with the approval of RBI.

1. Rating agencies that intend to rate CPs will now have to take approval from RBI.

2. Credit ratings for issuance must now be obtained from two rating agencies and the lower of the two ratings will need to be adopted.

This will ensure that investors are safeguarded against toxic investments.

Issuers and IPAs will need to follow the guidelines issued by FIMMDA.

Rating requirement

Documentation procedures

Rating requirement

Documentation procedures

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Reserve Bank Commercial Paper Directions, 2017 5

a. All OTC trades in CP shall be reported within 15 minutes of the trade to the Financial Market Trade Reporting and Confirmation Platform (“F-TRAC”) of Clearcorp Dealing System (India) Ltd. (CDSL).

b. The settlement cycle for OTC trades in CP shall be T+1.

c. OTC trades in CP shall be settled through the clearing house of the National Stock Exchange (NSE), the Bombay Stock Exchange (BSE), the Metropolitan Stock Exchange of India Limited or any other mechanism approved by RBI.

a. All OTC trades in CP shall be reported within 15 minutes of the trade to the Financial Market Trade Reporting and Confirmation Platform (“F-TRAC”) of Clearcorp Dealing System (India) Ltd. (CDSL).

b. The requirement of exchange of physical confirmation of trades matched on F- TRAC is waived subject to the following conditions:

i. Participants entering into one time bilateral agreement for eliminating the exchange of confirmation or multilateral agreement drafted by the Fixed Income Money Market and Derivatives Association (“FIMMDA”) ;

ii. Participants adhering to the extant laws such as stamp duty as may be applicable; and Participants ensuring adherence to a sound risk management framework and complying with all the regulatory and legal requirements and practices, in this regard.

c. The list of entities, which have signed the multilateral agreement, will be published by FIMMDA and the Clearing Corporation of India Limited (CCIL) on their websites.

d. OTC trades in CP shall be settled through the clearing house of the National Stock Exchange (NSE), i.e., the National Securities Clearing Corporation Limited (NSCCL), the clearing house of the Bombay Stock Exchange (BSE), i.e., Indian Clearing Corporation Limited (ICCL), and the clearing house of the MCX-Stock Exchange, i.e., MCX-SX Clearing Corporation Limited (CCL), as per the norms specified by NSCCL, ICCL and CCL from time to time.

e. The settlement cycle for OTC trades in CP shall either be T+0 or T+1.

1. There is no mention of physical exchange of confirmation by counterparties in the draft regulation. Hence, RBI is pushing towards the exchange of confirmation via the F-TRAC platform.

2. The settlement will only be on T+1 basis as against the option of settling the trade on T+0 or T+1 basis.

Secondary market trading and settlement of CP Trading and settlement of CP

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a. The buyback of CP, in full or part, shall be at prevailing market price.

b. The buyback offer should be extended to all investors in the CP issue.

c. The buyback offer may not be made before 60 days from the date of issue.

d. CPs bought back shall stand extinguished.

a. Issuers may buyback the CP, issued by them to the investors, before maturity.

b. Buyback of CP shall be through the secondary market and at prevailing market price.

c. The CP shall not be bought back before a minimum period of 7 days from the date of issue.

d. Issuer shall intimate the IPA of the buyback undertaken.

e. Buyback of CPs should be undertaken after taking approval from the Board of Directors.

1. Buyback shall be made only after 60 days from the date of issue as against 7 days from the date of issue.

2. Buyback of CPs can now be in full or part at the prevailing market price as against the requirement of full buyback in the current regulation. This will ensure that if the company has sufficient funds and does not want to carry forward the liability for the future, it can avail of the part buyback option.

Buyback of CP Buyback of CP

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Reserve Bank Commercial Paper Directions, 2017 7

a. Comply with all relevant requirements under these Directions.

b. Appoint an IPA for issuance of CP.

c. Ensure that the proceeds from CP issues should be used to finance only current assets and operating expenses. The end use must be explicitly disclosed in the offer document.

d. Furnish the Board Resolution authorizing the company to borrow through issuance of CP to the IPA.

e. Keep the bank (s) from whom it has outstanding credit facility (ies) informed of its market borrowings, including through CPs, latest by the date of borrowing.

f. Arrange for crediting the CP to the Demat account of the investor with the depository through the IPA.

g. Route all subscriptions/redemptions/payments through the IPA.

h. Make minimum disclosures in the offer document as given in Annex I.

i. Submit a certificate from the CEO/CFO to the concerned IPAs on quarterly basis that CP proceeds are used for disclosed purposes, and certifying adherence to other conditions of the offer document.

The issuer shall ensure that the guidelines and procedures laid down for the issuance of CP are strictly adhered to.

1. Proceeds from the issuance can only be used for current assets and operating expenses.

2. The end use needs to be mentioned in the offer document.

3. Banks providing credit facilities to the issuer have to be informed of any borrowing raised through CPs.

4. A quarterly compliance certificate from the CEO/CFO needs to be submitted to IPA by the issuer.

Duties and obligations: Issuer Duties and obligations: Issuer

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a. Ensure that the borrower is appropriately authorised to borrow through CPs.

b. Verifying all information disclosed in the offer document before issuance.

c. Verify all documents submitted by the issuer are in order and issue a certificate to this effect (Annex II).

d. Make available the IPA certificate in electronic form on the website of the depositories for the CPs.

e. Verify and hold certified copies of original documents in its custody.

f. Report the details of issuance of CP and instances of default on the F-TRAC platform by close of business hours, of the day of issuance or default as the case may be.

a. The IPA shall ensure that the issuer has the minimum credit rating as stipulated by RBI and the amount mobilised through issuance of CP is within the quantum indicated by CRA for the specified rating or as approved by its Board of Directors, whichever is lower.

b. The IPA shall certify that it has a valid agreement with the issuer.

c. The IPA shall verify that all the documents submitted by the issuer, viz., copy of board resolution, signatures of authorised executants (when CP is issued in physical form) are in order and shall issue a certificate to this effect.

d. Certified copies of original documents, verified by the IPA, shall be held in the custody of IPA.

e. All scheduled banks, acting as IPAs, shall report the details of issuance of CP on the Online Returns Filing System (ORFS) module of the RBI within two days from the date of issuance of the CP.

f. IPAs, shall immediately report, on occurrence, full particulars of defaults in repayment of CP to the Chief General Manager, Financial Markets Regulation Department, Reserve Bank of India, Central Office, Fort, Mumbai-400 001 (email) in the format as given in Annex V of this Direction.

g. IPAs shall also report all instances of buyback of CPs undertaken by the issuer to the Chief General Manager, Financial Markets Regulation Department, Reserve Bank of India, Central Office, Fort, Mumbai–400 001 (email) in the format as given in Annex VI of this Direction.

1. The requirement on reporting of the issue via ORFS by the bank acting as IPA has been removed in the draft regulation. The reporting of both issue and default in repayment—both need to be done via the F-TRAC platform. This will ensure that only one system is used for tracking all CP activities as against the multiple systems/platforms used earlier.

2. IPA certificate needs to be displayed on the website of the depository participant.

3. The requirement of reporting instances of buyback of CP has been removed.

IPA IPA

Reserve Bank Commercial Paper Directions, 2017 9

a. Credit Rating Agency (CRA) must act responsibly in rating CP issuances and continuously monitor the rating assigned to an issue and revisions, if any, to the rating and disseminate to public through their publications and website.

b. Advise the concerned IPA about the ratings of the CP and any subsequent change in the ratings, on the date of rating or change in rating.

Nothing contained in the Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 shall apply to the raising of funds by issuance of CP, by any NBFC in accordance with these directions.

a. CRAs shall abide by the Code of Conduct prescribed by the SEBI for CRAs for undertaking rating of capital market instruments, which shall be applicable for rating CPs.

b. The CRAs shall have the discretion to determine the validity period of the rating depending upon their perception about the strength of the issuer; and they shall, at the time of rating, clearly indicate the date when the rating is due for review.

c. The CRAs shall closely monitor the rating assigned to issuer’s vis-à-vis their track record at regular intervals and shall make their revision in the ratings public through their publications and website.

Nothing contained in the Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 shall apply to the acceptance of deposit by issuance of CP, by any NBFC in accordance with these guidelines.

The credit rating agency will need to intimate IPAs about a change in rating.

Credit rating agency

Non-applicability of certain other directions

Credit rating agency

Non-applicability of certain other directions No change

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a. Details of outstanding CPs as on date of new issuance including date of issuance, credit rating, name of credit rating agency and name of IPA

b. Summary of last three years audited financials

c. Details of default including technical default, if any, along with description of the issue, IPA, amount, dates of issue and maturity date for past three years

d. Details of current tranche including amount, current credit rating, name of credit rating agency, its validity period and details of IPA

e. End-use of funds

f. All outstanding credit facilities from banks, facility-wise, and their asset classification.

1. With the mention of the minimum disclosure requirement in the draft regulation, RBI is ensuring that issuers provide relevant information related to the end use of the proceeds from the issue, that there is no misuse of funds thus raised, and that investors are making informed decisions.

2. Further, by linking the funds raised via CPs with credit facilities, RBI is ensuring that no issuer classified as NPA/technical NPA uses the primary market to raise any borrowings through CPs.

Minimum disclosure in the offer document No mention

* The draft directions on the issue of CPs were published by RBI on 2 Feb 2017 and comments on the same could be sent by 24 Friday 2017.

Vernon DcostaAssociate Director vernon.dcosta@in.pwc.comMobile: +91 9920651117

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