The Insurance Regulatory and Development Authority of India (IRDAI) has made a significant modification to the Trade Credit Insurance Guidelines, 2021, specifically related to “reverse factoring” transactions on the Trade Receivable Discounting System (TReDS) platforms. In this article, we will delve into the details of this change and its potential impact on the insurance and financial sectors.
The Background
i. IRDAI’s Trade Credit Insurance Guidelines: In September 2021, IRDAI introduced guidelines on trade credit insurance aimed at safeguarding businesses against the risk of non-payment for goods and services by buyers. These guidelines established a regulatory framework to provide trade credit insurance coverage to suppliers, banks, and other financial institutions. The objective was to offer customized coverage options to enhance the business environment, particularly for Small and Medium-sized Enterprises (SMEs) and Micro, Small, and Medium Enterprises (MSMEs).
ii. RBI’s Role in Easing MSME Constraints: In July 2018, the Reserve Bank of India (RBI) issued guidelines to create the Trade Receivable Discounting System (TReDS), with the goal of helping MSMEs convert their trade receivables into liquid funds. Based on the experience gained from TReDS implementation, the RBI decided in June 2023 to permit insurance facilities for TReDS transactions. This change was aimed at assisting financiers in hedging the risk of defaults, effectively allowing insurance companies to participate as the “fourth participant” in TReDS and engage in “reverse factoring.”
The Modification
i. Trade Credit Insurance Cover for “Reverse Factoring”: In response to RBI’s efforts and recognizing the potential of Trade Credit Insurance cover against “reverse factoring” transactions on TReDS platforms, IRDAI reevaluated the Trade Credit Insurance Guidelines, 2021. While these guidelines had allowed single invoice covers through bill discounting and factoring on invoice discounting e-platforms like TReDS, they had restricted coverage for reverse factoring transactions to be designated as a “fourth participant” in TReDS.
ii. Facilitating “Reverse Factoring” Transactions: Considering the benefits of “reverse factoring,” wherein financiers can engage with lower-rated or unrated buyers while mitigating default risks through Trade Credit Insurance cover, IRDAI decided to modify the guidelines. Para 5.3A will now specify “Reverse Factoring (except on TReDS platforms)” to enable financiers and insurance companies to participate in such transactions.
Conclusion
IRDAI’s modification to allow “reverse factoring” transactions on TReDS platforms is a positive step toward improving liquidity and reducing risks for the financial and insurance sectors. This modification aligns with the evolving needs of businesses, particularly MSMEs, and demonstrates the regulatory bodies’ commitment to fostering a more dynamic and supportive economic environment.
The change will potentially encourage more financiers and insurance companies to participate in TReDS transactions and provide comprehensive trade credit insurance cover. This, in turn, can bolster confidence among businesses, facilitating smoother trade and mitigating financial risks.
In conclusion, IRDAI’s proactive approach to adapting regulations to contemporary financial practices reflects a commitment to India’s economic growth and stability.
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Insurance Regulatory and Development Authority of India
Ref: IRDAI/ NL/CIR/GDL/176/10/ 2023 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)
