How small businesses can use TReDS to finance their trade receivables
For years, micro, small, and medium enterprises (MSME) have faced constraints in receiving payments for goods or services they supply. The problem was recently exacerbated with the COVID-19 pandemic disrupting cash flow across industries.
The Reserve Bank of India (RBI) has been aware of the challenges well before the pandemic. Post a 2014 paper on setting up an institutional mechanism for financing trade receivables, RBI released guidelines for setting up and operating a system known as Trade Receivables Discounting System (TReDS).
According to RBI, TReDS would "facilitate the discounting of both invoices as well as bills of exchange".
Through TreDS, MSME sellers, corporate buyers, and financiers (banks and non-banking financial companies or NBFCs) are linked on a common platform. After approval from both the seller and the buyer, financiers bid on invoices and make the payment to the seller.
Transactions processed under TReDS would be without recourse to MSMEs, meaning MSME vendors are not responsible for non-payment of trade receivables amount (from buyers).
RBI then decided to grant licences to three TReDS platforms: M1xchange, RXIL, and A.TReDS. In November 2018, Prime Minister Narendra Modi announced that companies with turnover exceeding Rs 500 crore would 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 on board one of the three TReDS platforms.
By December 2020, M1xchange and A.TReDS platform Invoicemart had each discounted MSME invoices worth Rs 10,000 crore, while RXIL has discounted MSME invoices worth Rs 9,214 crore till Feb 2021.
The process to join any of the TReDS platforms is short and quick. To learn about M1xchange and how to join the platform, please follow this link or visit the website. Or, read about Invoicemart here or visit the website. Enrolment on RXIL can be done through this link.
Once registered on a TReDS platforms, here’s how the process flow works:
- 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 seller.
- Based on the invoice or bill of exchange, the MSME goes on the registered TReDS platform and creates a "factoring unit". The buyer also logs on to TReDS and accepts this "factoring unit".
- Based on the invoice or bill of exchange, 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.
- 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.
- TReDS platforms should be able to filter these "factoring units" by any of the above parameters. This provides flexibility of operations to 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 deposited in the MSME seller’s account by the financier on a 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 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 corporate buyer will pay the MSME seller outside of the TReDS platform.
Edited by Lena Saha