Eurocommercial Paper
Eurocommercial Paper (ECP) is short-term unsecured notes issued by firms in markets outside their domestic markets. This instrument is one of the more recent to develop in Euromarkets. Throughout the 1970s and early 1980s, both US and foreign borrowers relied heavily on the US commercial paper market. Even though the first issue of Eurocommercial paper was in 1970 by an American firm, this form of financing did not gain widespread acceptance until 1985.
Arrangements that permit an issuer to request immediate sale of the paper or that allow a securities dealer to solicit an issue when the timing is most advantageous have made the market more appealing as an alternative to short-term bank loans. Advances in communications technology have made precise timing of the issues possible. In addition, commercial paper interest rates compare favourably with other sources of financing[1].
Technical features of ECP
Eurocommercial paper is at present denominated only in United States dollars. It is issued in multiples of $10 000 with a minimum of $50 000. Maturity is three or six months. Notes are issued directly by the company requiring funds or by a finance subsidiary. If the latter they are unconditionally guaranteed. They are made out to the order of the sponsoring bank, which endorses them without recourse. They then become negotiable. To date almost all the issue have been for United States corporations. In terms of OFDI regulations such borrowing qualifies as long-term, i.e. it can be used as an offset against foreign borrowing, provided it is not in fact repaid within twelve months of the original date of borrowing, even though it consists of a series of short-term borrowings which are continuously re-financed[2].
Comparison of US Commercial paper and Eurocommercial paper
There are two major markets, the US dollar market with an outstanding amount in 2005 of just under $1 trillion, and the eurocommercial paper market with an outstanding value of $490 billion at the end of 2005. Commercial paper markets are wholesale markets, and transactions are typically very large. In the US, over a third of all CP is purchased by money market unit trusts, know as mutual funds; other investors include pension fund managers, retail or commercial banks, local authorities, and corporate treasurers[3].
| US Commercial paper | Eurocommercial paper | |
| Currency | US dollar | Any euro currency |
| Maturity | 1-270 days | 2-365 days |
| Common maturity | 30-180 days | 30-90 days |
| Quotation | on a discount rate basis | on a yield basis |
| Interest | zero coupon, issued at discount | fixed coupon |
Advantages of ECP
There are several advantages of Eurocommercial paper:
ECP is often cheaper than bank financing. ECP is a very flexible and simple instrument, and can be rapidly structured to satisfy both issuer's and investors' needs. ECP is usually issued outside the influence of any regulatory jurisdiction of national governments and therefore can be structured in almost any way to satisfy requirements of investors and issuers[4].
Examples of Eurocommercial Paper
- Eurocommercial paper is a short-term unsecured promissory note issued by a company that is not based in its domestic market. Examples of Eurocommercial paper include notes issued by Japanese firms in the US, French firms in Germany, and Italian firms in the UK. Eurocommercial paper is typically used to finance short-term working capital needs, such as inventory, receivables, and other expenses.
- Eurocommercial paper can also be used to finance longer-term projects such as mergers and acquisitions. For example, an Italian firm looking to acquire a French firm may issue Eurocommercial paper to finance the acquisition. Eurocommercial paper can also be used to finance research and development projects.
- Eurocommercial paper is usually issued with maturities ranging from one week to nine months, though some may have maturities up to two years. Eurocommercial paper is generally considered to be a safe and liquid form of financing. It is typically rated highly by credit rating agencies, and there is a strong secondary market for the instrument.
Limitations of Eurocommercial Paper
Eurocommercial Paper, while a convenient and cost-effective way to borrow funds, has certain limitations. These include:
- Credit Risk: Since Eurocommercial Paper is a form of unsecured financing, investors take on the risk of not being paid back in the event of borrower default.
- Duration Risk: Eurocommercial Paper has a relatively short maturity, ranging from one day to 270 days, making it difficult to match liabilities with assets of longer duration.
- Liquidity Risk: Eurocommercial Paper is not as liquid as other forms of short-term borrowing such as bank overdrafts and loans, making it difficult to access funds in times of need.
- Accessibility: Eurocommercial Paper is not available to all types of investors. It is typically only offered to large institutional investors and sophisticated investors.
- Cost: Eurocommercial Paper is not necessarily the cheapest form of borrowing funds, as the cost of issuing paper can be higher than other forms of financing.
One approach related to Eurocommercial Paper is the issuance of Eurobonds. Eurobonds are long-term bonds that are issued in a currency other than the issuer’s domestic currency. It is usually issued in large denominations and is used to finance long-term capital investments. Eurobonds typically offer higher yields than domestic bonds due to the added currency risk.
Other approaches related to Eurocommercial Paper are *issuance of Certificates of Deposit (CDs), *issuance of Commercial Letters of Credit (CLCs), *issuance of Global Depository Receipts (GDRs), *issuance of Medium-Term Notes (MTNs) and *issuance of Structured Notes.
Certificates of Deposit (CDs) are short-term debt instruments issued by banks with maturities ranging from one week to one year. CLCs are documents issued by banks that state that goods of a certain value have been shipped. GDRs are securities issued by foreign companies that are listed on an international exchange. MTNs are short-term debt instruments with maturities typically ranging from one to five years. Structured notes are debt instruments with interest payments or principal repayments based on the performance of a reference asset.
In summary, Eurocommercial Paper is one approach related to debt financing in the Euromarkets. Other approaches include issuance of Eurobonds, Certificates of Deposit (CDs), Commercial Letters of Credit (CLCs), Global Depository Receipts (GDRs), Medium-Term Notes (MTNs) and Structured Notes.
Footnotes
| Eurocommercial Paper — recommended articles |
| Cash and cash equivalents — Negotiable certificate of deposit — External sources of finance — Direct paper — Swingline loan — Interim financing — Core Deposits — Cash bond — Bonds in finance |
References
- Buljevich E.C., Park Y.S., (2007). Project Financing and the International Financial Markets, Springer Science & Business Media, Boston.
- Choudhry M., (2018). An Introduction to Banking,John Wiley & Sons, Copenhagen.
- Johnson H.J., (2000). Global Positioning for Financial Services, World Scientific, Singapore.
- Scott-Quinn B., (2014). The New Euromarkets, Springer, London.
Author: Emilia Trzeciecka
