Are Commercial Papers a Safe Investment in Nigeria? What You Need to Know
Before you buy in, here’s what commercial papers really offer, and the risks you shouldn’t ignore.
It’s not unusual for investment opportunities to look inviting at first glance. Some promise quick returns, others come with low-entry barriers that make them feel accessible and even ideal for beginners or cash-rich businesses looking for somewhere to invest funds in the short term.
But as with most financial instruments, what you see on the surface rarely tells the full story. Commercial papers (CPs) are one of those options. While they offer appealing short-term returns and are often pitched as safer alternatives to riskier assets, they also come with important nuances you shouldn't overlook.
If you're considering adding CPs to your portfolio, especially in a market like Nigeria's, here are the key things to keep in mind:
David Adubiina
What Do Commercial Papers Offer?
First and foremost, you need to understand that commercial papers are designed to provide short-term investment opportunities with relatively stable returns. They’re usually issued by reputable companies looking to raise quick capital for things like payroll, inventory restocking, or bridging cash flow gaps, without going through traditional bank loans.
For investors, CPs offer a few key advantages:
- Higher returns than Treasury Bills: Since commercial papers carry more risk than government-backed securities, they typically offer slightly better yields, especially from top-rated companies.
- Short maturity periods: With tenors ranging from 30 to 270 days in Nigeria, CPs allow investors to commit their funds for a short term while earning fixed returns.
- Low entry barriers: You don’t need millions to get started. Many CPs in Nigeria are available through money market platforms or brokerage firms that allow relatively small minimum investments.
- Predictable returns: CPs are usually issued at a discount and redeemed at face value, so you know your exact return upfront, as long as the issuer doesn’t default.
In essence, commercial papers are a way to earn steady returns over a short period without tying up your money for too long. However, those returns are only worth it if the issuer is financially sound and the instrument is properly regulated, which is why due diligence is key.
7 Key Things You Need to Know About Commercial Papers
1. The CP Program Should Be Registered with Both the FMDQ and the SEC
Before you even think about investing, check if the commercial paper program is registered and quoted on the FMDQ Securities Exchange. That’s your first layer of protection.
But quoting on the FMDQ is no longer enough. Recent regulations now require that all CP programs receive approval from the Securities and Exchange Commission (SEC), not just the FMDQ. This dual-layer approval helps ensure that only companies that meet certain financial and compliance standards are allowed to raise money from the public.
Why this matters: It protects you from investing in unregulated or poorly vetted debt instruments. Always verify the listing and approval status before committing funds.
2. They’re Issued at a Discount but Still Prone to Interest Rate Risk
Like Treasury Bills, commercial papers are typically issued at a discount and redeemed at full face value at maturity. This means your return is essentially “locked in” from the moment you buy.
However, that doesn't mean CPs are immune to market fluctuations like interest rates. Interest rate risk still exists, especially if you plan to sell before maturity. When interest rates rise, the value of existing CPs in the secondary market can drop, since newer ones might offer better returns.
Why this matters: If you hold your CPs to maturity, you get your agreed return. But if you need to sell early, changing rates could affect how much you’re able to recover.
3. Risk Profile Depends on the Issuer
Since commercial papers offer no collateral, they rely entirely on the financial health and credibility of the issuing company. This means you're taking on the issuer's short-term credit risk; if the company runs into financial trouble, nothing is backing your investment.
Therefore, always assess the issuer's business model, recent financial performance, and overall stability before investing. A slightly lower return from a stronger company is often a safer bet than chasing high yields from risky issuers.
Why this matters: You're basically trusting that the company will have enough cash flow to repay its debt when the CP matures. If the issuer is already showing signs of financial stress or inconsistent earnings, that CP could carry a much higher risk of default.
4. Assess the Issuer’s Creditworthiness Carefully
Beyond just looking at the general risk profile, dig into the company’s credit rating. Some CPs are rated by local credit agencies, which can give you insight into the likelihood of default.
Look at the company’s recent earnings reports, debt obligations, and history of meeting financial commitments. Stick to companies with solid reputations and consistent cash flow.
Why this matters: Without collateral, your only safety net is the issuer’s ability to pay. Don’t just chase the highest return—check the company’s fundamentals first.
5. Returns Are Subject to a 10% Withholding Tax
Just like Treasury Bills and other fixed-income instruments in Nigeria, the interest earned on commercial papers is subject to a 10% withholding tax.
Why this matters: The effective return you earn will be slightly lower than what’s quoted. Always factor tax into your return calculations so you’re not caught off guard.
6. Unsecured Means Higher Default Risk
Because CPs are unsecured, they carry a higher risk compared to government-backed securities. If the company runs into financial trouble or files for bankruptcy, there’s no collateral for you to claim.
How to reduce this risk: Stick with CPs from reputable, well-capitalized companies with a history of honoring debt obligations. Consider those backed by top-tier banks or with third-party guarantees, where available.
7. Know What the Funds Will Be Used For
Aside from taking note of interest rates and tenor, it’s crucial to understand why the company is raising money. Are the funds going toward routine operating expenses, like payroll or inventory? Or is the company using the CP to refinance old debt, cover cash flow gaps, or service existing CPs?
Understanding the purpose behind the issuance helps you gauge the financial health and intent of the issuer.
You can ask for the issuer’s offering memorandum or disclosure documents. Reputable companies will outline the intended use of proceeds—read that section closely.
Why this matters: If a company is consistently rolling over CPs to repay older ones or cover chronic shortfalls, that’s a red flag. It suggests the business might be struggling to generate enough internal cash. On the other hand, if the funds are being used for short-term working capital or seasonal needs, that’s usually a healthier signal.
David Adubiina
Conclusion
Commercial papers can be a smart addition to a diversified investment strategy if you're looking for fixed short-term returns with slightly higher yields than government bills. But one key thing to take note of is they're not without risk.
You need to do your due diligence if you want to be successful in it. With the right research, CPs can offer a solid balance between return and risk, without locking up your capital for too long.
