The Thought of Chairman Liu

Commercial paper has become an important debt market because of the advantages of commercial paper for both investors and issuers. Commercial paper outstanding grew at an annual rate of 14% from 1970 to 1991, totaling $528 billion at the end of 1991. Until the recent market seizure, the commercial paper market was a $3 trillion market with half of the market consisting of bank-financed “conduits” of asset backed commercial paper (ABCP). The ABCP market shrank 13% in August 2007 as US companies struggled unsuccessfully to raise short-term funds to roll over maturing outstanding debts

Characteristics of Commercial Paper

Securities offered to the public must be registered with the Securities and Exchange Commission according to the Securities Act of 1933. Registration requires extensive public disclosure, including issuing a prospectus on the offering. It is a time-consuming and expensive process. Most commercial paper is issued under Section 3(a)(3) of the 1933 Act which exempts from registration requirements short-term securities with certain characteristics. The exemption requirements have been a factor shaping the characteristics of the commercial paper market. The key requirement for exemption is that the maturity of commercial paper must be less than 270 days. In practice, most commercial paper has a maturity of between 5 and 45 days, with 30-35 days being the average maturity. Many issuers continuously roll over their commercial paper, financing a more-or-less constant amount of their assets using commercial paper. The nine-month maturity limit is not violated by the continuous rollover of notes, as long as the rollover is not automatic but is at the discretion of the issuer and the dealer. Many issuers will adjust the maturity of commercial paper to suit the requirements of an investor.
Notes must be of a type not ordinarily purchased by the general public. In practice, the denomination of commercial paper is large: minimum denominations are usually $100,000, although face amounts as low as $10,000 are available from some issuers. Typical face amounts are in multiples of $1 million, because most investors are institutions. Issuers will usually sell an investor the specific amount of commercial paper needed.

That proceeds from commercial paper issues can be used to finance “current transactions”, which include the funding of operating expenses and the funding of current assets such as receivables and inventories. Proceeds cannot be used to finance fixed assets, such as plant and equipment, on a permanent basis. The SEC has generally interpreted the current transaction requirement broadly, approving a variety of short-term uses for commercial paper proceeds as proceeds are not traced directly from issue to use. Firms are required to show only that they have a sufficient "current transaction" capacity to justify the size of the commercial paper program. For example, a particular level of receivables or inventory. Firms are allowed to finance construction as long as the commercial paper financing is temporary and to be paid off shortly after completion of construction with long-term funding through a bond issue, bank loan, or internally generated cash flow.

Liu excerpted from http://www.eagletraders.com/neg_financial_instruments/commercial_paper_o.htm