Rating commercial paper
The central bank's ruling imposing stricter requirements on the issuance and trading of commercial paper has at least two main objectives: To protect both investors and banks and to bring Indonesia's commercial paper market up to international standards.
As stipulated in Decree No.28/52 of Bank Indonesia's Board of Directors, dated Aug. 11, 1995, the tougher requirements -- such as compulsory credit rating of commercial paper issued by non- bank companies and the obligation of full disclosure imposed on issuers -- are all designed to provide investors and banks with a framework of risk assessment to help them manage potential loss on their investments.
Why banks? Because banks usually act as the arrangers and issuing and paying agents of commercial paper and so are often exposed to risk.
There is a potential conflict of interest for banks involved in the issuance or trading of commercial paper. The issuers may belong to the same business group as the controllers or owners of the bank. This possibility is recognized in the central bank's prohibition of a bank's acting as the arranger, paying and issuing agent or buyer of commercial paper issued by companies belonging to the same group as that to which the bank belongs.
The tougher rules on commercial paper are imperative now, especially as an increasing number of companies are resorting to unsecured short-term debt instruments to raise funds. Commercial papers with maturities of up to 270 days are often much more flexible than bank loans and their rates are often lower than bank lending rates. However, since commercial papers are not secured and they are mostly discounted in the financial market, there is a greater risk of investment losses in case of default. It is for this reason that compulsory credit rating is important.
Obviously, credit rating means an added cost for commercial paper issuers. But, at the same time, issuers stand to benefit from easier access to capital, lower borrowing costs and enhanced financial flexibility. Issuers also find ratings particularly useful in entering new markets where they are not well known.
A problem, however, is that there is currently only one credit-rating agency, PT Pefindo, already licensed by the government and recognized by the Capital Market Supervisory Agency. Pefindo, which is owned jointly by state banks, members of the Jakarta Stock Exchange and various other financial institutions and pension funds, started operations only late last year.
The central bank is apparently fully aware of Pefindo's limitations. Commercial papers issued prior to Aug. 11 have until Feb. 1, 1996, to comply with the new rules. Those issued after Aug. 11 are obliged to fulfill all the provisions of the new regulation, except the compulsory credit rating.
It is to be hoped that PT Pefindo will be able to increase its credit analysis capacity within the next few months. If it cannot do so, the commercial paper market will be adversely affected. After all, commercial paper is only one of many financing alternatives. If companies have to wait for several months to have their commercial papers rated, or the cost of the credit- rating process makes borrowing through the issuance of commercial paper expensive, companies will simply raise funds by other means.
The credit rating requirement on commercial papers makes it even more urgent than before that the government facilitate the establishment of at least one additional credit rating agency. Investors do not want to rely on only one agency. They tend to feel more secure if there are at least two independent agencies to analyze the creditworthiness of a company. After all, the best-quality product is mostly one made under market competition.