A Ghanaian case study on commercial paper: a blessing or a curse?

Daniel Addo Asiedu
Consolidated Bank Ghana, Accra
Daniel.Asiedu@cbg.com.gh

What is commercial paper?

Commercial paper is a short-term debt instrument issued by companies. It’s typically used to raise funds quickly for various purposes, such as financing working capital needs, funding short-term projects or covering temporary cash flow shortages to finance short-term liabilities, such as augmenting working capital, fulfilling temporary cash flow gaps and addressing immediate financial obligations. Investors seeking a safe and short-term investment option often find commercial paper attractive due to its relatively low risk and competitive returns compared to other short-term investments. Commercial paper is usually issued at face value and reflects prevailing market interest rates.

Types of commercial paper

There are two types of commercial paper, namely unsecured commercial paper and asset-backed commercial paper. An example of unsecured commercial paper is a promissory note backed by the issuer’s promise to pay the face value on the maturity date specified on the note. On the other hand, asset-backed commercial paper is collateralised by other financial assets, making it a secured form of borrowing.

Commercial paper involves a specific amount of money that is to be repaid by a specific date. Terms to maturity extend from 15 days up to 270 days. Commercial paper is only issued by companies with high ratings from credit rating agencies. These companies can easily find buyers for the debt issued.

The origin of commercial paper

Commercial paper was first introduced over 150 years ago, when New York merchants began to sell their short-term obligations to dealers in order to access the capital needed to cover near-term obligations. These dealers, or middlemen, purchased the paper (also known as promissory notes) at a discount in regard to their par value. They then sold the paper to banks and other investors. These merchants repaid the investors an amount equal to the par value of the note.

Commercial paper terms

Issuer

The issuer of commercial paper is the entity that is creating the short-term debt to fund their short-term cash needs. As mentioned earlier, most issuers are big companies with strong credit, as the issuer needs to be able to demonstrate a high probability of being able to pay back the debt, especially in the short term.

Term/maturity

The maturity of commercial paper designates how long the debt will be outstanding for the issuer. Commercial paper often involves a term from 15 days up to 270 days. At the end of the maturity period, the commercial paper is technically due, and the issuer is liable to return the investor’s capital (though they may choose to simply re-issue more commercial paper).

Secured/unsecured

Commercial paper is often unsecured, which means there is no collateral for the debt the issuing company is taking on. If the issuing company goes bankrupt, holders of the issuer’s commercial paper may not have recourse to receive the funds. The idea is because commercial paper’s maturity is so short and the creditworthiness of issuers is high, the debt does not need backing by corporate assets.

Discount/face value

Commercial paper is issued at face value, meaning that a debt instrument has a value that is often in denominations of no less than an amount to be determined by the laws of the Republic of Ghana. Instead of paying interest, commercial paper may be issued at a discount or a price that is less than the face value. When the commercial paper reaches maturity, the investor will receive the face value amount of the instrument, even though they paid a lower discounted amount.

Liquidity

Commercial paper is often tied to liquidity, namely the measurement of how well a company’s short-term cash flows will be able to cover its short-term debt. Therefore, issuers often create commercial paper to increase their liquidity, as it may need cash in the short term. On the other hand, buyers of commercial paper may not need cash right away, so they are willing to buy and hold the instrument to increase their cash in hand in the future.

Advantages and disadvantages of commercial paper

Advantages

Commercial paper is typically issued by financially stable and creditworthy companies. As a result, investors view it as a safe investment option with relatively low risk of default. Additionally, commercial paper usually has a short maturity period (usually ranging from a few days to 270 days), providing investors with quick access to their funds.

Compared to holding cash in a bank account or investing in Treasury bills, commercial paper often offers higher returns, making it an attractive option for investors seeking to earn competitive yields on their short-term investments.

Including commercial paper in an investment portfolio can help diversify risk. By investing in various commercial papers issued by different companies and industries, investors can spread their risk and reduce their exposure to any single company’s performance.

Commercial paper allows investors to tailor their investment horizon to their specific needs. They can choose from a range of maturity dates, enabling them to match their investments to expected cash flow requirements or other financial goals.

In many countries, the commercial paper market is well-regulated, providing investors with transparency and standardisation, further enhancing the appeal of this type of investment option.

Disadvantages

Companies must have extremely good credit to issue commercial paper. So, this option doesn’t offer access to capital for all institutions.

What’s more, the proceeds from this type of financing can only be used on current assets or inventories. They are not allowed to be used on fixed assets without the Securities and Exchange Commission Ghana’s (SEC) involvement.

Low interest rates for issuers mean low rates of return for investors. Also, due to the large minimum denomination of GHS, commercial paper typically isn’t directly available to smaller investors. However, they can invest indirectly through companies that buy commercial paper.

The issuance of commercial paper in Ghana

To issue commercial paper in Ghana it must be acceptable to the SEC and the commercial paper that the SEC will allow fund managers to invest in must satisfy the following criteria:

1. it must be issued by a limited liability company registered under the Companies Act 2019 (Act 992) or a corporation established under an enactment that is currently in force;
2. it must be issued by an issuer with a tangible net worth of no less than GHS 500,000 as per its latest audited financial statements, which should not be more than 15 months old;
3. it must be denominated in the local currency;
4. it must be issued at face value with a fixed coupon rate;
5. it must be issued for maturities of 15 to 270 days from the date of subscription;
6. it must be issued by an issuer without any other unretired commercial paper; 
7. it must be issued by an issuer with no overdue loans or defaults as per any report obtained from any credible credit referencing bureau (CRB) in Ghana. The said report should not be more than two months old;
8. it must be issued by an issuer who has, as per its latest audited financial statement (which should not be more than 15 months old), a minimum current ratio of 1:1 and debt/equity ratio of 60:40;
9. it must be issued by an issuer that has at least three years of audited financial statements and has made profit in at least two of the last three years preceding the issuance of commercial paper;
10. it must be issued to raise funds solely for operating capital purposes and must not be used for the granting of loans; 
11. pledged assets (if any) for the purpose of security regarding the issuance of commercial paper should be registered with the Collateral Registry;
12. the commercial paper must not be issued in tranches and the amount issued must be within the limit as approved by the issuer’s Board of Directors; and
13. the issuance of commercial paper must include a selling memorandum, which should contain the following information, as a minimum,
    (i)  the name of the issuer;
    (ii)  the names of the directors and key management staff;
    (iii)  the name of the auditor;
    (iv)  the Board of Director’s resolution authorising the issuance of commercial paper;
    (v)  the amount to be raised;
    (vi)  the currency applicable;  
    (vii)  the risks associated with the issuance of commercial paper;
    (viii)  the purpose of the issuance of commercial paper;
    (ix)  the total number and amount of commercial paper already issued by the issuer and not retired;
    (x)  the denominations and multiples thereof;
    (xi)  details of the repayment plan, including conditions for early redemptions;
    (xii)  whether the commercial paper is to be secured or unsecured;
    (xiii)  the form of security (if any);
    (xiv)  the directors’ guarantee (if any);
    (xv)  the name of the investment advisor/arranger (if any);
    (xvi)  the tenor of the commercial paper;
    (xvii)  the coupon rate;
    (xviii)  the period of the offer; and
    (xix)  whether or not there has been any material adverse change in the issuer’s financial position since the date of its last audited financial statements.

It’s important to note that while commercial paper is considered a relatively safe investment, it still carries some level of risk. Investors should conduct thorough research and consider their risk tolerance and investment objectives before investing in any financial instruments.

References

Securities Industry (Amendment) Act, 2021 (Act 1062)

Securities and Exchange Commission (Amendment) Regulations, 2019 L.I.2387

Securities Industry Act, 2019 (Act 929)

Securities and Exchange Commission Regulations 2003 (L.I. 1728)