Micro, Small and Medium Enterprises (MSMEs) continue to face constraints in receiving payments for the goods or services they supply. This translates to an overall inability to convert their trade receivables into liquid funds.
To address this, the Reserve Bank of India (RBI) decided to set up an institutional mechanism for financing these trade receivables. Post a 2014 paper on the same idea, RBI released guidelines for setting up and operating a system known as Trade Receivables Discounting System (TReDS).
According to RBI, the TReDS would ‘facilitate the discounting of both invoices as well as bills of exchange.’
This way, MSME sellers, corporate buyers, and financiers (banks and NBFCs) would be linked on a common platform. After approval from both the seller and the buyer, the financiers would bid on invoices and make the payment to the seller.
And the transactions processed under TReDS would be without recourse to MSMEs, meaning that MSME vendors need not be responsible for non-payment of the trade receivables amount (from buyers).
The RBI then decided to grant licenses to three TReDS platforms: M1xchange, RXIL, and A.TReDS. And in November 2018, Prime Minister Narendra Modi announced that companies whose turnover exceeds Rs 500 crore will have to be registered on TReDS in order to smoothen cash flows for MSMEs.
This set the ball rolling for TReDS, with a large number of MSME vendors, corporate buyers, banks and NBFCs coming onboard one of the three TReDS platforms.
In just two years, M1xchange and A.TReDS platform ‘Invoicemart’ have discounted MSME invoices worth a combined Rs 5,500 crore.
Once registered on one of the three TReDS platforms, here’s how the process flow works, supported by RBI data:
The corporate buyer indicates the intention to buy by sending a purchase order to the MSME seller
The MSME delivers the goods and generates an invoice. At this stage, there may or may not be an accepted bill of exchange between the buyer and the seller.
Based on the invoice or bill of exchange, the MSME goes on their registered TReDS platform creates a ‘factoring unit.’ The buyer also logs on to TReDS and accepts this factoring unit.
Based on the invoice or bill of exchange, the TReDS will standardise the time window available for corporate buyers to ‘accept’ the factoring units.
The MSME seller may decide to go on the TReDS platform and upload documents supporting evidence of the movement of goods.
The TReDS will have separate modules for transactions with invoices and transactions with Bills of Exchange.
Factoring units may be created in each module as required. Each such unit will have the same sanctity and enforceability as allowed for physical instruments under the ‘Factoring Regulation Act, 2011’ or under the ‘Negotiable Instruments Act, 1881’.
The standard format and features of the ‘factoring unit’ will be decided by the TReDS platform. But each unit will represent a confirmed obligation from the buyer to pay. The unit will have all details such as information of the seller and the buyer, issue date, due date, amount due, etc.
The TReDS platforms should be able to filter these factoring units by any of the above parameters. This provides flexibility of operations to the stakeholders.
A notice or advice is created and automatically sent to the buyer’s bank once the factoring unit and all the details have been generated.
These factoring units can be financed or bid for by any of the financiers registered on the TReDS platform. The final amount quoted by the financier can be viewed only by the MSME seller and not other financiers.
There will be a window period provided for financiers to quote these bids against factoring units. Further, financiers are free to choose how long their bids are valid.
The MSME then chooses and accepts any bid. The financier then gets the notification that their bid has been accepted.
Once a bid is accepted by the MSME seller, financiers cannot revise or change their bid.
The factoring unit will then get tagged as ‘financed’ and the funds will be deposited in the MSME seller’s account by the financier on T+2 basis (two business days after the date of acceptance). However, TReDS platforms can choose to speed up the time taken for payment. For instance, MSMEs on the M1xchange platform receive payment in T+1 days (one business day after the acceptance).
Simultaneously, financing by a financier generates another notice to the buyer’s bank which enables a direct debit from the buyer’s account to the financier’s account on the due date. These are based on the settlement obligations generated by the TReDS platform.
On the due date, the corporate buyer transfers the due amount to the financier. All the while, the TReDS platform sends due notifications to corporate buyers and their banks reminding them of the amount due.
If the buyer doesn’t pay on the due date, it will attract penal provisions and enable the banker to proceed against the corporate buyer.
Any action in this regard will be strictly non-recourse with respect to the MSME sellers.
After financing, these instruments are rated by the TReDS platform and may be further transacted or discounted among financiers in the secondary segment.
Any successful trade in the secondary segment will also automatically result in a direct debit authority being enabled by the buyer’s bank in favour of the financier.
In case any factoring unit is unfinanced, the buyer corporate will pay the MSME seller outside of the TReDS platform.