ARTICLE
26 July 2023

Regulatory Framework Of The Trade Receivables Discounting System (TReDS) Platform

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Stratage Law Partners

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The International Monetary Fund has predicted that India together with China will account for half of the global growth in 20231.
India Government, Public Sector

The International Monetary Fund has predicted that India together with China will account for half of the global growth in 20231. On a similar note, India's central bank, the Reserve Bank of India ("RBI") predicted that ".... India will be a US$ 3.7 trillion economy in 2023, maintaining its lead over the UK as the fifth largest economy of the world."2 These assessments are important to indicate the role of all the constituents which contribute to the growth of the Indian economy. In particular, the micro-small-medium enterprises have contributed in a significant way to the growth of the Indian economy- by approximately 26.83%3.

The micro-small-medium enterprises- widely referred to as "MSMEs"- consists of the following enterprises:

  1. If in relation to manufacturing and production of goods, then-
    1. Micro enterprises wherein the investment in plant and machinery is less than INR 25,00,000;
    2. Small enterprises wherein the investment in plant and machinery is more than INR 25,00,000 but less than INR 5,00,00,000;
    3. Medium enterprises wherein the investment in plant and machinery is more than INR 5,00,00,000 but less that INR 10,00,00,000.
  2. If in relation to providing or rendering services, then-
    1. Micro enterprises wherein the investment in equipment is less than INR 10,00,000;
    2. Small enterprises wherein the investment in equipment is more than INR 10,00,000 but less than INR 2,00,00,000;
    3. Medium enterprises wherein the investment in equipment is more than INR 2,00,00,000 but less than INR 5,00,00,000.

On November 2, 2018, the Department of Micro, Small and Medium Enterprises issued a notification stating that all companies registered under the Companies Act, 2013 and having a turnover of more than INR 500 crores and all Central Public Sector Enterprises are required to register with the Trades Receivable Discounting System ("TReDS") platform, thus making TReDS registration mandatory for such companies. The Registrar of Companies (RoC) in every state has been nominated to be the competent authority to monitor the compliance of this notification.

Given their importance, the RBI has consistently set up committees to identify bottlenecks and constraints faced by MSMEs. An important constraint which the RBI recognised related to the challenges faced by MSMEs is to seek financing, particularly to convert trade receivables into liquid funds. In 2018, the RBI issued guidelines pertaining to the TReDS under the regulatory framework of the Payment & Settlement Systems Act, 2007.

This article focuses on the concept, eligibility criteria and setting up of the TReDS platform under the TReDS guidelines4:

1. Concept of TReDS

The TReDS is a digital platform facilitating the financing of trade receivables of MSMEs from corporate and other buyers, including Government departments and Public Sector Undertakings (PSUs), through multiple financiers i.e., banks, non-banking finance companies registered as factors and other permitted financial institutions. In essence, the invoices or trade receivables of MSMEs are factored by the bank on this digital platform. The transactions under TReDS are without recourse to MSMEs. Since the underlying entities on TReDS are the same, TReDS can deal with both receivables factoring as well as reverse factoring to enable higher transaction volumes and better pricing.

The process flow of the TReDS is required to enable, at least, the following on the TReDS platform:

  1. To upload invoices/bills and creation of factoring units by the MSME seller;
  2. Acceptance of the invoices/ bills within a specified time limit by the corporate and other buyers, including the Government departments and PSUs;
  3. To discount, rate and re-discount the factoring units;
  4. To send notifications at each stage to the parties involved in the transaction;
  5. To generate and submit settlement of obligations.

2. Eligibility Criteria to set up TReDS

The RBI has 3 key criteria to assess prior to granting an approval:

  1. Financial Criteria
    1. The minimum paid up equity capital of TReDS is required to be INR 25,00,00,000, as TReDS cannot assume any credit risk.
    2. As per the extant foreign exchange control regulations5, upto 100% foreign investment in TReDS is permitted under the automatic route.
    3. The overall financial strength is an important factor in the selection for the promoters/ entities wanting to set up TReDS.

  2. Fit & Proper Person

To be eligible to operate as TReDS, the entities and their promoters/ promoter groups (as defined under the SEBI (Issue of Capital & Disclosure Requirements) Regulations, 2018) are required to be 'fit and proper'.

To assess the 'fit and proper' status of the applicants, RBI will evaluate the following:

  1. the basis of the applicant's past record of sound credentials and integrity;
  2. financial soundness and track record in running the business for a minimum period of 5 years.
  3. In addition to above, RBI may also seek feedback on the applicants on any other relevant aspects from other regulators, enforcement or investigative agencies, as it may deem fit.

c. Technological Capability

TReDS is required to have minimum technological requirements as set out hereunder:

  1. Electronic platform for all the participants;
  2. Dissemination of information on real time basis in relation to bills, invoices, discounting and quotes, which shall be supported by an MIS system;
  3. Business continuity plan including a disaster recovery site;
  4. Online surveillance capability to monitor positions, prices and volumes in real time in order to check for any system manipulation.

3. Shareholding related restrictions

The non-promoter entities are not allowed to have shareholding more than 10% of the equity capital of the TReDS.6

4. For a wider outreach, the Reserve Bank of India had issued a circular dated June 7, 2023 (available here), to enhance the scope of the trade receivables discounting system ("TReDS"). The key aspects are set out hereunder:

Particulars

Old provision

New Provision

Insurance

Insurance was not permitted for TReDS transactions

Insurance facility is now permitted for TReDS transactions to enable the financiers to hedge default risks. Insurance companies would be the fourth participant in TReDS after buyers, sellers and financiers.

No insurance premium can be levied on the seller.

Financiers

Only banks, NBFC-Factors and other financial institutions permitted by RBI could be financiers

All entities permitted to undertake factoring business under the Factoring Regulation Act, 2011 are now permitted to be financiers. This may include any company engaged in the factoring business and with a registration under the Factoring Regulation Act, 2011.

Secondary transfers

Secondary transfer were not permitted

TReDS platform operators may enable secondary transfers of factoring units within the same TReDS platform, subject to the RBI guidelines for transfer of loan exposures.

Settlementmechanism

Settlement of factoring units which were not discounted or financed had to be done outside the TReDS system.

TReDS platform operators can now undertake settlement of factoring units which are not financed / discounted, using the NACH mechanism for TReDS.

Bid Transparency

Bid details could not be displayed to other bidders

TReDS platform operators have the option to display details of bids placed for a factoring unit to other bidders, without revealing the bidder's name.


Footnotes

1. https://www.imf.org/en/News/Articles/2023/01/31/tr-13123-world-economic-outlook-update

2. https://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/01ART1901202380BC01A60B5943FB90C180B6B41FC29A.PDF

3. pib.gov.in/PressReleaseIframePage.aspx?PRID=1884734

4. https://rbidocs.rbi.org.in/rdocs/Content/PDFs/TREDSGD0241C8FEF214D7DAD76487274D27742.PDF

5. The Foreign Exchange Management (Non-Debt Instruments) Rules, 2019

6. It may be noted that given the wordings of the TReDS guidelines the reference is only to the equity capital of the entity seeking approval as a TReDS platform.

Authored by Shyam Pandya, Senior Partner & Meha Patel, Associate. The contents of this article do not necessarily reflect the views / position of Stratage Law Partners but remain solely those of the author(s). This article is meant for general information and shall not be deemed to be a legal advice or opinion. This article is neither intended to be an advertisement nor solicitation.

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