Commercial paper was the name given to notes, drafts, bills of exchange, and bankers' acceptances representing trade acceptances or trade receivables given by buyers to merchants and manufacturers in exchange for merchandise and goods. These documents typically had short-term tenors, usually not more than 30 or 60 days. In turn, the merchants and manufacturers would sell the notes at a discount to investors and dealers in the money market, a market for short-term instruments such as Treasury notes and bills of exchange. The proceeds were used as working capital to finance the production of or an inventory of merchandise and goods.

Commercial paper developed perhaps as early as the late 1700s in New York as the economy of the new country struggled to develop in an environment where bank credit was scarce. The use of commercial paper expanded significantly in the mid-1800s in New York and other U.S. financial centers when the industrial sector was booming and high immigration rates were driving a surging economy. This practice of discounting paper evolved into the issuance of short-term promissory notes by merchants and manufacturers to professional investors and dealers to finance the receivables they held from buyers. Financial institutions also began issuing commercial paper notes to fund their short-term requirements, including their purchase at discount of commercial paper in the marketplace.

The notes were issued as noninterest bearing, principal only notes sold at a discount to the face amount. As the issuance of commercial paper continued to develop, the market for commercial paper began to concentrate in financial institutions. The money market has always been a separate market from the securities market for stocks and bonds. To this day, the commercial paper trading desks at banks are usually separate from the trading desks for other debt and equity

securities and staffed by a different group of people. This is true perhaps because commercial paper is viewed as more in the nature of a liquid trade receivable than an investment security.

Commercial paper held by banks has long been viewed as highly liquid. In the Federal Reserve Act of 1912, commercial paper was recognized as discountable at the Federal Reserve. During the Depression or the 1930s, legislation was drafted to permit Federal Reserve Banks to issue notes up to the amount of the notes, drafts, bills of exchange, and bankers' acceptances they held.

Treatment under the 1933 Act By the time of the adoption of the Securities Act of 1933 (the 1933 Act), the commercial paper market was well[1]developed, but it was an anomaly in the world of corporate securities. Commercial paper was typically short-term, predominantly with 7- to 10-day maturities, although sometimes with longer maturities out to nine months. The proceeds of the sale of commercial paper notes continued to be used as working capital to finance wages and other production costs and inventory. Commercial paper was often repaid by the issuance of new commercial paper and this revolving nature of the obligation, together with the short tenors, contrasted with typical corporate securities. The short-term, revolving nature of commercial paper was not conducive to the securities registration scheme contemplated by the 1933 Act. It was simply not practical to prepare and submit a registration statement for notes that were to be issued every seven to ten days. And the registration fees for such constant repeat issuance would have been prohibitive. Registration fees for securities were to be based on the principal amount of securities to be sold without regard to their maturity. Moreover, as noted

above, the commercial paper market had historically been viewed as separate and distinct from the securities market. These characteristics of commercial paper led the Federal Reserve to request Congress to carve-out commercial paper from the registration requirements of the 1933 Act. As a result, commercial paper is exempt from registration under the 1933 Act by the terms of Section 3(a)(3), which exempts "any note, draft, bill of exchange, or banker's acceptance which arises out of a current transaction or the proceeds of which have been or are to be used for

current transactions, and which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited." Commercial paper is, however, subject to the anti-fraud provisions of Section 12(2) and Section 17 of the 1933 Act.

Investors in the commercial paper market at the time of enactment of the 1933 Act were usually banks, dealers, other financial institutions, and sophisticated individual investors. This was not a market for retail investors. And the high turnover rate of commercial paper required a continuous market presence of investors who were making credit decisions about an issuer as often as weekly, if not daily, as its commercial paper notes rolled at maturity.

Current Market Insights Nonfinancial Issuers Issuers of commercial paper notes today continue to be merchants, manufacturers, finance companies, and financial institutions, with the addition of some structured finance issuers. The total market is around $1.1 trillion outstanding with seasonal fluctuations; the highest outstanding are typically over year-end. Merchants and manufacturers continue to use commercial paper to fund receivables from buyers of their products, inventory, raw materials, supplies, wages, and construction costs, but not permanent financing or capital equipment. Nonfinancial entities issue about 20% of commercial paper outstandings. Financial Issuers Financial issuers of commercial paper notes tend to be money center banks, finance companies, and foreign banks. These issuers represent about 60% of market outstandings. Financial institutions use the proceeds as working capital, including to fund loans with maturities of up to five years. Asset-Backed Commercial Paper The most common structured finance issuers of commercial paper are asset-backed commercial paper conduits (ABCP Conduits), but over the last 20 years, many other asset-backed issuers have utilized commercial paper, including structured investment vehicles (SIVs) and issuers of collateralized debt obligations (CDOs). Asset-backed commercial paper (ABCP) outstandings came to rival the traditional commercial paper market. By 2007, ABCP outstandings stood at $1.2 trillion and total commercial paper outstandings were around $2.2 trillion. (See the chart below.) However, many of these ABCP issuers failed during the financial crisis due to liquidity concerns. Unlike traditional commercial paper issuers, these structured issuers were funding long-term asset-backed securities with commercial paper and when the market for those securities seized up in the crisis, they were unable to roll their outstanding commercial paper at maturity, leading to a fire sale of assets into rapidly declining markets. Many of these asset-backed issuers were wound down and the losses were absorbed by their sponsors (many of which were financial institutions), but the losses to commercial paper investors were still staggering. Today, issuance of commercial paper by structured issuers has shrunk back to those issuers funding short-term trade receivables or those issuers with solid liquidity lines of credit to cover any mismatch between the assets funded and the commercial paper issued. They represent about 20% of commercial paper outstandings today and no longer dominate the market. ABCP is discussed in more detail in the following section.

How did the structure and usage of commercial paper evolve from its origins in the late 1700s to the modern financial instruments utilized today, and what role did industrial expansion in the mid-1800s play in this evolution?