Expansion Of The Scope Of TReDS by RBI

Background

On February 8th, 2023, while delivering the Monetary Policy Committee report, the Reserve Bank of India (RBI) announced the expansion of the scope of Trade Receivables Discounting System (TReDS) and the objective is to introduce an insurance facility for invoice financing. This entails allowing all entities and institutions engaged in factoring business to participate as financiers in TReDS. Additionally, the plan involves permitting the rediscounting of invoices.

As per the notification [1]issued by the RBI on June 7, 2023, in accordance with the Guidelines for the Trade Receivables Discounting System, 2014, [2] the scope of the Trade Receivables Discounting System has been expanded. This expansion aligns with the commitment made by the RBI and comes into effect on June 7, 2023.

Salient Features

Through the new notification, the following enhancements have been made to the TReDS guidelines:

1. Facilitate insurance for transactions:

The RBI has authorized insurance companies to participate as a “fourth participant”, alongside Micro, Small and Medium Enterprises (MSMEs) sellers, buyers, and financiers. This inclusion of insurance companies introduces new opportunities to manage default risks and safeguard the interests of financiers.

However, if the cost of insurance is relatively high compared to the earnings from these transactions, the additional insurance cost may reduce the overall spread. It is important to note that the decision to utilize insurance remains optional for the participants involved.

Also, the utilization of the National Automated Clearing House (NACH) system will be employed to facilitate the collection of insurance premiums and with the approval of both financiers and insurance companies, TReDS platforms have the capability to automate the processing of insurance claims.

• Expand the pool of financiers:

Previously, the participation in the discounting of trade receivables for the seamless provision of credit to MSMEs was restricted to banks, NBFC-Factors, and specific financial institutions authorized by the RBI.

However, recent developments have expanded the eligibility criteria to include other entities and institutions permitted under the Factoring Regulation Act, 2011[3]to participate as financiers in TReDS.

• Enable secondary market for Factoring Units (FUs):

The Reserve Bank of India (RBI) has recently authorized TReDS platforms to establish a secondary market for the trading of discounted FUs. Additionally, the RBI has provided clarification that all transactions involving the transfer of discounted FUs in the secondary market would be governed by the provisions outlined in the Master Directions – RBI (Transfer of Loan Exposures) Directions, 2021[4] issued on September 24, 2021. These directions specify the eligibility requirements for both the transferors and transferees involved in loan transfers.

• Settlement of FUs not discounted / financed:

The RBI has authorized the TReDS platform to handle the settlement of all uploaded Financing Units (FUs), regardless of whether they are financed or discounted, by leveraging the NACH mechanism.

Previously, when FUs were not financed or discounted, buyers had to make payments to sellers outside the system, leading to manual processes that often resulted in delays, difficulties in tracking payments, and increased efforts for reconciliation.

By allowing the TReDS platform to manage the settlement of all FUs, the challenges faced by MSME sellers and buyers are expected to be significantly reduced. Integrating the settlement process into the TReDS platform through the NACH mechanism enhances overall efficiency and transparency,providing greater convenience for all stakeholders involved.

• Display of bids:

TReDS platforms enable financiers to engage in transparent and competitive bidding. In order to enhance transparency, the platforms have the option to display bid details for a Financing Unit (FU) to other bidders, while keeping the identity of the bidders undisclosed.

Conclusion

Expanding the scope of TReDS signifies the RBI’s commitment to further promote and strengthen the system. By expanding its scope, more entities, such as non-banking financial companies (NBFCs) and other eligible market participants, can participate as financiers in the TReDS platform. This move helps to increase competition, improve liquidity, and enhance financing options for MSMEs.

Overall, although the expansion of the scope of TReDS by the RBI is a positive step towards enhancing access to credit for MSMEs, boosting their working capital management, and supporting their growth and contribution to the Indian economy, it should be noted that entities that fall under the jurisdiction of the TLE Master Directions are the only ones allowed to engage in trading discounted FUs in the secondary market. As a consequence, this exclusion would prevent other entities or companies, which have recently been granted permission to trade FUs on the TReDS platforms, from participating in the secondary market for FUs.

[1] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=12510&Mode=0

[2] https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=3504

[3] https://lddashboard.legislative.gov.in/sites/default/files/A2012-12.pdf

[4] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12166