n a recent development, the Insurance Regulatory and Development Authority of India (IRDAI) has introduced a significant modification to the Trade Credit Insurance Guidelines, 2021. The new amendment allows for “reverse factoring” to take place on the Trade Receivable Discounting System (TReDS) platforms. This decision comes in the wake of recent regulatory changes by the Reserve Bank of India (RBI) and aims to benefit MSMEs and financiers by facilitating easier trade receivable conversion to liquid funds.
Introduction
The IRDAI introduced the Trade Credit Insurance Guidelines in September 2021 to safeguard businesses against the risk of non-payment for goods and services by buyers. These guidelines established a regulatory framework that extended trade credit insurance coverage to suppliers, banks, and other financial institutions. This move was particularly beneficial for Small and Medium-sized Enterprises (SMEs) and Micro, Small, and Medium Enterprises (MSMEs) by providing customized insurance covers to enhance their business operations.
Reverse Factoring on TReDS Platforms
The Reserve Bank of India (RBI) recognized the challenges faced by MSMEs in converting their trade receivables into liquid funds. As a solution, the RBI issued guidelines in July 2018 for the Trade Receivable Discounting System (TReDS). Leveraging the experience gained in the field, RBI decided in June 2023 to permit insurance facilities for TReDS transactions. This step is expected to assist financiers in hedging default risk, which, in turn, allows insurance companies to participate as a “fourth participant” on TReDS platforms and engage in “reverse factoring.”
IRDAI’s Amendment
In response to RBI’s efforts and recognizing the benefits of providing Trade Credit Insurance cover for “reverse factoring” transactions on TReDS platforms, IRDAI has made a crucial amendment to the Trade Credit Insurance Guidelines, 2021. The guidelines now allow the financiers to secure Trade Credit Insurance cover against the default of the buyer for invoices financed on TReDS platforms. This modification specifically pertains to “reverse factoring” transactions and permits their participation as a “Fourth Participant” on TReDS.
Conclusion
The change introduced by IRDAI to allow “reverse factoring” on TReDS platforms underlines the commitment to enhance the ease of doing business and support MSMEs. With this amendment, financiers can take on the default risk for lower-rated or unrated buyers while being protected by Trade Credit Insurance coverage. This modification aims to facilitate more accessible trade receivable conversion to liquid funds and help boost the overall economy.
The decision comes into effect immediately, and while this change is specific to “reverse factoring,” all other provisions and requirements of the Trade Credit Insurance Guidelines 2021 remain unchanged. The move is expected to have a positive impact on the financial landscape, particularly for MSMEs and financiers participating in TReDS transactions.
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INSURANCE REGULATORY AND DEVELOPENT AUTHORITY OF INDIA
Circular Ref: IRDAI/ NL/CIR/GDL/176/10/ 2023 Dated: Date: 9th October, 2023
ALL GENERAL INSURERS (EXCEPT ECGC and Stand-Alone Health Insurers)
Re: Trade Credit Insurance Guidelines, 2021 – Modification to Guideline 5.3A – allowing “reverse factoring” on TReDS platforms
1. The Authority issued guidelines on trade credit insurance in September 2021 to protect business against the risk of non-payment for goods and services by buyers. The Guidelines set out the regulatory framework that facilitated trade credit insurance covers to suppliers as well as to banks and other financial institutions. It also provided customised covers to improve businesses for SMEs and MSMEs.
2. RBI in order to ease constraints faced by MSME, in converting their trade receivable to liquid funds, issued guidelines in July, 2018 for the trade receivable discounting system (TReDS). Based on experience gained, RBI in June 2023 decided to permit insurance facility for TReDS transactions, which would aid financiers to hedge default risk, thereby allowing insurance companies to participate as “fourth participant” in TReDS and undertake “reverse factoring”.
3. In light of the steps taken by RBI, IRDAI examined the feasibility of Trade Credit Insurance cover against “reverse factoring” transactions on TReDS platforms. Trade Credit Insurance cover is provided to the financiers to cover default of the buyer against the invoices financed on TReDS platform. IRDAI (Trade Credit Insurance) Guidelines, 2021 allows single Invoice covers through bill discounting / factoring on Invoice discounting e-Platforms such as TReDS. However, it restricts cover against reverse factoring transactions to participate as “Fourth Participant” in TReDS.
4. In view of the fact that through “reverse factoring”, the financiers can take exposure on low rated or unrated buyers provided the default risk is hedged with insurers by taking Trade Credit Insurance cover, therefore, in order to facilitate “reverse factoring” transactions on TReDS platform, para 5.3A of the guidelines will be now read as “(a) Reverse Factoring (except on TReDS platforms)”.
5. All the other provisions and requirements of Trade Credit Insurance Guidelines 2021 shall remain unaltered.
6. This circular shall come into force with immediate effect.
-Sd/-
Randip Singh Jagpal
Executive Director (Non-Life)
