Article submitted by Swetha Dasu, Associate
- Introduction:
The Trade Receivables Discounting System (TReDS) is a transformative digital platform that facilitates invoice financing for Micro, Small, and Medium Enterprises (MSMEs). By enabling MSMEs to secure funds based on pending invoices from corporate entities, government bodies, and public sector undertakings (PSUs), TReDS enhances cash flow and reduces dependency on conventional credit sources. Unlike traditional factoring, TReDS functions as a completely digital system, where MSMEs list their invoices—termed Factoring Units (FUs)—for bidding by financiers. Once a buyer validates an invoice, financiers compete to offer the best discounting rates, ensuring swift disbursal of funds to MSMEs, often within 48 hours. On the due date, the buyer settles the payment directly with the financier, eliminating any recourse to the MSME in case of default.
Given its legally recognized status and robust digital framework, TReDS serves as a game-changer for MSME financing in India, offering greater liquidity, reduced credit risk, and improved operational efficiency.
Key Participants in TReDS
TReDS brings together three main stakeholders: MSME sellers, corporate buyers, and financiers, including banks and Non-Banking Financial Companies (NBFCs). It serves as an integrated platform for invoice submission, acceptance, discounting, trading, and settlement. To optimize its efficiency, TReDS also engages technology providers, system integrators, and dematerialization service providers. The Reserve Bank of India (RBI) introduced TReDS guidelines in December 2014 to improve MSME receivables financing. At present, three licensed entities operate under this framework, facilitating transactions worth approximately ₹60,000 crore annually. Recognizing the system’s effectiveness, the RBI expanded the participant pool by permitting insurance companies to function as a “fourth participant” and widening financier eligibility to include banks, NBFC-Factors, and other financial institutions under the Factoring Regulation Act, 2011. This expansion has strengthened MSMEs’ financial accessibility.
The TReDS Process Flow
TReDS provides MSMEs with a structured and efficient invoice discounting mechanism, ensuring seamless fund flow:
- The MSME seller uploads the invoice on the platform.
- The corporate buyer verifies and accepts the invoice.
- Multiple financiers submit bids, offering competitive discounting rates.
- The seller selects the most advantageous bid.
- The financier disburses funds, covering a substantial portion of the invoice value.
- The seller receives payment within 48 hours of bid selection.
- Upon maturity, the buyer settles the payment with the financier.
- The financier recovers the full amount, completing the transaction.
By eliminating reliance on traditional credit sources, TReDS enhances liquidity for MSMEs while maintaining transparency and efficiency through its digital framework.
Without Recourse Financing
One of the most significant benefits of TReDS is its “without recourse” structure, which ensures that MSMEs face no financial liability if a buyer defaults. Unlike traditional bank loans, where businesses remain responsible for repayment, TReDS transactions place the onus entirely on the buyer. In cases of default, financiers have the legal authority to initiate proceedings against buyers, safeguarding MSMEs from undue financial burdens. This feature instills confidence among small businesses and encourages broader adoption of TReDS as a reliable financing solution.
Technological Infrastructure and Settlement Mechanism
The RBI launched TReDS under a robust regulatory framework, including the Information Technology Act, the Factoring Regulation Act, the Payment and Settlement Systems Act, and SIDBI’s MSME Bill Discounting Scheme. The digital nature of TReDS enhances transparency, allowing sellers, buyers, and financiers to track transactions in real time.
Although digitalization in corporate banking is evolving, TReDS has emerged as a successful model of supply chain financing. By streamlining trade credit transactions, it improves access to finance for MSMEs, creating a level playing field and fostering economic growth. The adoption of TReDS has grown significantly, with Indian MSMEs actively utilizing the platform for invoice discounting.
Under the Payment and Settlement Systems (PSS) Act, 2007, the RBI holds exclusive authority over payment systems, including TReDS, ensuring a secure and regulated ecosystem. India’s financial infrastructure supports a range of wholesale and retail payment mechanisms, including Real-Time Gross Settlement (RTGS), the Clearing Corporation of India Limited (CCIL), and the National Payments Corporation of India (NPCI). The digital payments landscape, powered by innovations like UPI and IMPS, has transformed transaction efficiency, with TReDS playing a crucial role in financial inclusion.
RBI Guidelines Governing TReDS
The RBI has established specific guidelines under the PSS Act, 2007, to regulate TReDS operations:
- Eligibility Criteria for TReDS Operators:
- Entities must have a minimum paid-up capital of ₹100 crore and maintain a net worth of at least ₹100 crore at all times.
- Promoters must hold an initial 40% stake, which is locked in for five years. Thereafter, shareholding must be reduced to 40% within three years, 30% within ten years, and 26% within twelve years.
- Foreign investments must comply with prevailing FDI norms.
- Non-promoter entities cannot hold more than 10% voting equity.
- Due Diligence of Promoters:
- Promoters must demonstrate financial stability, business credibility, and at least five years of operational experience.
- The RBI assesses applications based on inputs from regulatory and investigative bodies such as SEBI, CBI, and the Income Tax Department.
- Insurance Participation:
- The RBI has permitted insurance companies to participate in TReDS to mitigate financier risks associated with buyer defaults.
- MSMEs cannot be charged for insurance premiums.
- TReDS platforms may define eligibility criteria for insured transactions.
- The National Automated Clearing House (NACH) facilitates premium payments and claims processing.
- Automated claims settlement ensures timely processing for financiers.
However, credit insurance does not qualify as a Credit Risk Mitigant (CRM) for regulatory purposes. This initiative primarily aims to encourage financial institutions to extend credit to MSMEs by reducing default-related risks.
- Secondary Market Trading of Factoring Units
To enhance liquidity, the RBI has authorized a secondary market for trading discounted Factoring Units (FUs) on TReDS. This initiative aligns with the RBI’s broader goal of improving credit access for MSMEs. FU transfers must adhere to the Master Directions – RBI (Transfer of Loan Exposures) Directions, 2021, ensuring proper risk assessment. Additionally, a Minimum Holding Period (MHP) applies to loan exposures:
- 3 months for loans with a tenure of up to 2 years.
- 6 months for loans exceeding 2 years.
These measures ensure structured and regulated trading, maintaining financial stability while increasing market depth.
Recent Developments in TReDS
In June 2023, the RBI introduced significant reforms to expand TReDS’ functionality:
- Insurance Participation Expansion: Insurers can now directly engage in TReDS, providing financiers with additional security against defaults. However, MSMEs are protected from insurance-related costs.
- Secondary Market Trading: TReDS platforms are now allowed to facilitate secondary transfers of FUs, subject to RBI’s loan exposure transfer regulations.
Conclusion
TReDS has revolutionized the MSME financing landscape by offering a transparent, digital, and efficient invoice discounting mechanism. By reducing reliance on conventional bank loans and ensuring quick fund availability, it has significantly improved cash flow for small businesses.
The RBI’s continuous regulatory support—through expanded insurer participation, secondary market trading, and stringent governance norms—has reinforced TReDS’ credibility and accessibility. As India’s financial ecosystem continues evolving, TReDS is expected to accelerate economic growth, empower MSMEs, and foster a more secure and equitable financial framework for businesses nationwide.
