The Next Generation Reforms Required on TReDS to Boost MSME Financing in India

Receivables financing is a short-term funding option that allows business sellers to borrow money against the value of their accounts receivables. Accounts receivable are invoices issued to debtors that have not yet been paid. Similarly, payable financing mechanism allows business buyers to access funds needed to pay their outstanding bills. These are two sides of the same coin, as the former is an asset account and the latter is a liability account. Typically lending institutions such as banks, Non-Banking Financial Company (NBFCs) discount the invoices based on the risk assessment of the underlying transaction.

As per Section 15 of the Micro, Small and Medium Enterprises Development Act, 2006 “Where any supplier supplies any goods or renders any services to any buyer, the buyer shall make payment therefore on or before the date agreed upon between him and the supplier in writing or, where there is no agreement in this behalf, before the appointed day: Provided that in no case the period agreed upon between the supplier and the buyer in writing shall exceed forty-five days from the day of acceptance or the day of deemed acceptance.”

The implementation of the said section faces challenges as the MSMEs often do not receive the payment within the stipulated time. This in turn leads to a chain reaction impacting cash flow cycles, impeding creditworthiness and the sustainability of business. This issue is popularly understood as delayed payments.

The extent of the problem of delayed payments, according to a report, is Rs 10.7lakh crore. Further, there is an interest burden of Rs 1 lakh crore. This is tantamount to 3.6% of India GDP at current prices.

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The solutions framework available to address the issue of delayed payments includes:

1. Bill Discounting governed under the Negotiable Instruments Act, 1881.

2. Factoring governed under the Factoring Regulation Act, 2011.

3. Factoring through Trade Receivables Discounting System (TReDS).

4. Dynamic Discounting by corporates.

5. Micro Small Enterprise Facilitation Council (MSEFC) for Dispute Resolution.

While various policy actions and regulatory forbearance have been developed over the years, for the aforementioned solution framework, clearly TReDS has emerged as one of the most effective tools in recent times as it offers a win-win for all three players, viz, seller, buyer and financer. 

Trade Receivables Discounting System (TReDS) allows seller businesses to unlock the best value of their receivables, reduce dependency on informal funding sources and encourages formal financing solutions. TReDS is a more practical and useful tool over the other mechanisms for delayed payments. Unlike conventional solutions, where the interest rates are fixed and often dependent on MSME credit score, TReDS provides a transparent, auction-based platform that allows for multiple bids, leading to a competitive interest rate for the MSME to choose from.

The process is completely digital and paperless, resulting in faster processing and reduced turnaround time. Therefore, the advantage for MSME lies in the most optimal solution in terms of affordable, adequate and timely credit. 

Similarly, the buyer also gains from the system as it provides them with enhanced liquidity during trying times, besides helping them fulfil legal and regulatory compliances under MSMED Act. 

The financier or the factor stands to benefit by leveraging the platform for growing their business footprint and building short-term term granular assets with PSL benefit. This is in line with the government and regulatory mandate to help direct credit flow to small businesses. The lenders, always on the lookout for risk mitigation, get a readymade financial product with credit guarantee, insurance, buyer acceptance and NACH mandate. The fact that interoperability is being established with other digital systems such as Udyam, Digilocker, E-invoice, GSTN and GeM, further enhances the ability to manage risk and also promotes ease of credit. 

The geometric progression under TReDS can be witnessed by the numbers. Since its inception in 2017, the platform has been a witness to muted growth till 2022. The same year saw the launch of the Raising and Accelerating MSME Performance (RAMP), which redefined the game.

The value of invoices factored has increased from Rs 5,000 crore to more than Rs 4 lakh crores, indicating exponential growth. Similarly, the participants have increased manifold, with sellers jumping from 34,000 to 1.35 lakh, the buyers have grown from around 2,000 to almost 8,000, and the lenders increasing from 45 to 69. Further, the TReDS operators have increased from three to five, and the regulator has allowed insurance companies as 4th participants on the platform. 

Under the Viksit Bharat goals, next generation reforms have been identified as a key pillar to drive economic growth and development. The TReDS regime needs to align itself with the growth trajectory by strongly participating in the next generation reform. 

In the last two years, significant path-breaking reforms have been initiated to deal with the challenge of delayed payments under the TReDS regime. In a decisive step towards fostering better liquidity and financial inclusion for MSMEs, corporates with a turnover of Rs 250 crore and above have been mandated to register on the TReDS platform. Further, guidelines allowing for secondary market operations on the TReDS platform have been introduced.

These guidelines permit the transfer of discounted factoring units (FUs) or invoices within the same TReDS platform. Reflecting the growing focus on cash flow protection for MSMEs, a more structured, transparent disclosure framework from companies has been developed and incorporated in MSME Form 1in the Companies Act 2013. This will enable a stronger and robust monitoring system to reduce delayed payments. TReDS is now also available as a non-financing option for payments to MSMEs. The next generation reforms agenda is as clear as the day.

Regulatory Aspects

While a big chunk of the working capital financing is through the Scheduled Commercial Banks (SCBs), it is the NBFCs and Microfinance Institutions (MFIs) that have deep roots in the MSME hinterland when it comes to making the connection and undertaking due diligence. Presently, on the TReDS platforms, a handful of NBFCs are participating from an identified universe of more than 150. It goes without saying that these numbers can be increased simply by tweaking the norms for eligibility to include other types of NBFCs and MFIs. Also, the license approval process needs to be smoothened out and expedited so as to increase the choice and provide the most optimal pricing to an invoice. 

The UK Sinha committee had recommended creating a second TReDS window for removing the difficulty of buyer affirmation. As a first GSTN GSTN-linked buyer invoices for input tax credit may be treated as implicit buyer confirmation, or may be permitted as an assignment without buyer acknowledgement. This buyer-less credit regime can prove to be a watershed movement in the history of factoring in India.

Presently, the MSME can participate as a buyer or seller provided it holds a UDYAM registration. Opening up the platform for non-UDYAM MSMEs would further push the cause of TReDS as a delayed payment solution provider

Currently classification of exposure under TReDS is treated as unsecured, directly impacting the profitability of the lending institutions. There's a growing recognition of the need for a more nuanced approach to TReDS exposure classification, potentially allowing for a shift towards a more secure or partially secured classification based on the specific transaction and the creditworthiness of the buyer. This needs to be read with the fact that the underlying assets of the receivable/payable are the primary security. 

The definition of MSME has been expanded to include units with a turnover up to Rs 500 crore. Many of these entities generate significantly higher receivables, which can be routed through TReDS. However, the existing Rs 5 crore working capital cap under the turnover method limits their access to proportionate bank finance, despite their eligibility for TReDS. Enhancing the Rs 5 crore working capital cap would align with the revised MSME definition will ensure proportional funding, push financial inclusion, and comply with the regulatory norms.

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Operational Aspects

Interoperability between TReDS, other digital platforms and marketplaces will further provide ease of access to credit, reduce the cost of funds to the buyers and sellers, while providing a stronger risk mitigation system for lenders through validation and authentication. As a first step. Government e Marketplace (GeM), Good and Services Tax Network (GSTN), e-invoice, account aggregator, Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI), Vendor Invoice Management System (VIMS) and MSME Samadhaan need to be interlinked. 

Interoperability among TReDS platforms is critical to ensure seamless integration of receivables and payables. By enabling sellers and buyers to transact across platforms, it significantly broadens access to invoice financing, enhances liquidity, and fosters healthy competition among financiers. With improved price discovery and enhanced visibility into credit risks, interoperability supports better lending decisions.

Lenders on TReDS have risk aversion for discounting lower-rated invoices. In order to incentivise the banks and other lenders, it is imperative that a credit guarantee regime is established for factoring. This would not just mitigate the default risk but also encourage deeper market participation.

The secondary market operations is a recent enablement which has the potential to bring great volumes into the factoring landscape. Allowing insurance companies. Pension funds and mutual funds, amongst others can deepen the architecture and consolidate the functioning, bringing in overall resilience and robustness. 

Sharing best practices and learnings from each other has always found its mark. In the present context, the Goa model can be replicated wherein State PSUs and government departments have been mandated to conduct their invoice transactions through TReDS. 

While the government and the regulator have been constantly endeavouring to redefine the construct, amend the operational guidelines and strengthen the system, the onus of leveraging and building upon these new reforms clearly rests with the TReDS operators. There is a clear-cut realisation that the financial offerings by the operators remain limited and rigid.

Every new reform or amendment or change brings in the opportunity to build and develop new products, which the TReDS operators are yet to capitalise. With the advent of AI technology and the fact that the TReDS operators are sitting on a gold mine of data, innovative and focused products should not be difficult to develop. 

There are two very clearly visible areas that need product development – Downstream trader financing and forfaiting. 

Let’s get to work!

The author is the Joint Secretary (AFI) at the Ministry of Micro, Small & Medium Enterprises.