India: RBI Expands Scope Of Trade Receivables Discounting System (TReDS)

1. INTRODUCTION

The Reserve Bank of India ("RBI") by way of notification dated June 7, 2023 ("Notification") has expanded the scope of the Trade Receivables Discounting System¹ ("TReDS") as prescribed under the Guidelines for the Trade Receivables Discounting System, 2014² ("TReDS Guidelines"). The RBI had in its Statement on Developmental and Regulatory Policies dated February 8, 2023³ proposed the expansion of scope of the TReDS with an aim to further ease operation of the TReDS, including: (a) introduction of insurance facility; (b) permitting all entities eligible under the Factoring Regulations Act, 2011 ("FRA") to enter into TReDS transactions; and (c) enabling secondary market operations on TReDS platforms.

2. KEY TAKEAWAYS FROM THE NOTIFICATION

Set out below are the key takeaways from the TReDS Guidelines:

2.1. Introduction of insurance facility for factoring transactions:

The RBI has recognised that financiers of 'factoring units' ("FUs") did not bid for buyers with a lower credit rating. To overcome this issue, the RBI has now permitted insurance companies to act as 'fourth participant' in the TReDS in providing insurance facility for TReDS transactions to reduce potential risk faced by financiers in case of default by buyers. The Insurance Regulatory and Development Authority of India ("IRDAI") pursuant to the IRDAI (Trade Credit Insurance) Guidelines, 2021⁴ already permits general insurance companies to provide trade credit insurance for factoring transactions where such insurance can be obtained by a factoring company/'financier'. However, the RBI has clarified that if the financiers avail benefit of insurance for TReDS transactions, then such credit insurance is to be excluded as a Credit Risk Mitigant (CRM) to avail any prudential benefits.

2.2. Expansion of the definition of 'financiers':

While the FRA under Section 2(i) permits banks, non-banking financial companies ("NBFCs"), statutory corporate entities, and eligible companies engaged in the business of factoring, to enter into factoring transactions, the RBI under the erstwhile regime only permitted banks, NBFCs and other financial institutions (as permitted by RBI) to act as 'financiers'. To bring parity between the FRA and the TReDS Guidelines, the RBI has pursuant to the Notification now permitted all companies engaged in the factoring business to act as financiers under the TReDS. While Section 5 of the FRA prescribes that banks and statutory corporations are not required to obtain registration as a 'Factor' to commence business of factoring, the RBI pursuant to the Registration of Factors (Reserve Bank) Regulations, 2022⁵ only prescribes for registration of a company as a 'Factor' upon being registered as a NBFC-Factor. Accordingly, pursuant to the Notification, the registration requirements for the additional category of companies proposed to be included within the scope of the Notification (other than the exempted category of financiers) remain unclear.

2.3. Introduction of secondary market for factoring transactions on TReDS:

The RBI had under the TReDS Guidelines suggested setting up of a secondary market to enable trading of discounted FUs by financiers, as part of the second phase of the TReDS. The RBI has now permitted TReDS platforms to set up a secondary market for trading in discounted FUs.

Having said that, the RBI has also clarified that all transfers of discounted FUs in the secondary markets would be subject to the provisions of the Master Directions - RBI (Transfer of Loan Exposures) Directions, 2021⁶ ("TLE Master Directions") dated September 24, 2021, which specify the eligibility criteria for transferors and transferees for loan transfers. It is pertinent to note that the TLE Master Directions prescribe a minimum holding period of (a) 3 months, in case the tenor of the underlying loan is 2 years; and (b) 6 months, in case of loans with a tenor of more than 2 years; for transfer of loans. Accordingly, discounted FUs by eligible financiers will be subject to a minimum holding period as stated period.

2.4. Settlement of undiscounted FUs:

The RBI had observed that few FUs on the TReDS platforms were not discounted, and in such a scenario the undiscounted FUs were mandated to be settled outside the TReDS. To optimize the process of factoring on the TReDS platform, the RBI has now permitted that settlement of such undiscounted FUs shall also be undertaken on the TReDS platform.

2.5. Display of bids:

With an aim to improve transparency in the biding process undertaken by financiers, the RBI has proposed that TReDS platforms may display details of bids being placed for a FUs to other bidders/financiers.

3. INDUSLAW VIEW

The proposed changes to the TReDS Guidelines are a step in the right direction to ease and promote operations on the TReDS and generally enhancing the scope of regulated trade receivable discounting transactions by introducing a secondary market participation and introducing insurance facilities to allay credit concerns around buyers which may not be highly rated. Having said that, whilst the proposal to establish a secondary market for trading of discounted FUs is definitely a welcome step in deepening the landscape for trade receivable financing transactions generally, it is interesting to note that only entities governed under the TLE Master Directions are eligible to trade discounted FUs in the secondary market. Resultantly, this would render other entities/companies, which have now been permitted to trade in FUs on the TReDS platforms, from being ineligible to trade in the secondary market for FUs.

Footnotes

1 Available here: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12510&Mode=0

2 Available here: https://rbi.org.in/scripts/bs_viewcontent.aspx?id=2904

3 Available here: https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=55179

4 Available here: https://irdai.gov.in/home

5 Available here: https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12222&Mode=0

6 Available here: https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12166

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