Why In News?
Parliament on Thursday passed the Factoring Regulation (Amendment) Bill, 2021, to bring changes in the legislation aimed at helping the MSME sector.
- The Bill, that will help the micro, small and medium enterprises (MSME) sector in the availability of working capital, was passed in the Rajya Sabha on Thursday. It was passed by the Lok Sabha on July 26.
- It will provide relief to the MSME sector and help them in ensuring a smoother capital cycle and healthier cash flow, the finance minister said.
- "It is a very important Bill which will benefit the MSMEs of this country because a difficulty is constantly expressed by the MSME that their receivables are getting delayed.
- "As a result, there is a provision of selling their receivables to a third party. If the third party is going to make an immediate availability of funds, they shall be able to move their business smoothly. There are several such advantages in factoring from payment of the seller," Sitharaman said.
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Why was the Factoring Bill introduced?
The recent Factoring Bill is an amendment of the original 2011 Bill, which allowed only specialized non-bank financial companies (NBFCs) and banks to engage in factoring. Such NBFCs had to have 75 per cent or more of their business coming from factoring income. As a result, only seven NBFCs have so far registered as factoring companies.
This severely limited the scope of MSME financing. In order to mitigate that, an expert committee under U K Sinha, former chairman of the SEBI ((RBI appointed U.K. Sinha-led committee was set up to study the problems faced by MSMEs), proposed on June 25, 2019, that the factoring space should be opened to all NBFCs interested in such business. Incorporating the suggestion, the latest Bill was introduced in the Lok Sabha in September 2020, and cleared earlier this week in July 2021
[Additional Info] Why was the committee formed?
- In India, small businesses have been facing a range of disruptions since the demonetisation decision in 2016.
- This disruptive move was followed by the hasty implementation of the goods and services tax in 2017.
- Now, there is also the liquidity crunch issue triggered by a series of debt defaults by group companies of Infrastructure Leasing and Financial Services Ltd in 2018.
- All these have made the smooth functioning and development of the MSME sector very challenging.
- Given this, in January 2019, the RBI constituted the expert committee on MSMEs to undertake a comprehensive review of the MSME sector.
- It was tasked to study the problems faced by MSMEs, identify the causes, and propose long-term solutions.
The Factoring Regulation (Amendment) Bill, 2020 was introduced in Lok Sabha on September 14, 2020. The Bill seeks to amend the Factoring Regulation Act, 2011 to widen the scope of entities which can engage in factoring business.
The Bill was then referred to the standing committee of the House. After a detailed examination, the standing committee came up with a report on February 3 containing one legislative suggestion and eight non-legislative suggestions. All of those have been accepted by the government and this amendment bill, therefore, is with all those recommendations
What is factoring?
Under the Factoring Regulation Act, 2011, factoring business is a business where an entity (referred as factor) acquires the receivables of another entity (referred as assignor) for an amount. Receivables is the total amount that is owed or yet to be paid by the customers (referred as the debtors) to the assignor for the use of any goods, services or facility. Factor can be a bank, a registered non-banking financial company or any company registered under the Companies Act.
In simple terms, factoring is acquiring bills receivables from MSMEs and releasing money, or giving short-term loans, against these bills to the MSMEs.
- The MSMEs provide goods and services to corporate firms and the government, but the payment is not immediately made. Instead, the MSMEs raise bills, or receivables, against the payment due.
- The bills are given to the banks and factoring firms at a discount, and the acquirer of these bills, realizing full amount against the due from the firm, earns a spread.
- If it is just a loan, or even commission, the factoring earns money, while the MSME gets the liquidity it needs.
- However, credit facilities provided by banks in the ordinary course of business against security of receivables or as commission agents for sale of agricultural produce or goods are excluded.
What are the change in the new Bill?
Change in the definition of receivables: The Act defines receivables as (all or part of or undivided interest in) the monetary sum which is the right of a person under a contract. This right may be existing, arise in the future, or contingent arising from use of any service, facility or otherwise. The Bill amends the definition of receivables to mean any money owed by a debtor to the assignor for toll or for the use of any facility or services.
Change in the definition of assignment: The Act defines assignment to mean transfer (by agreement) of undivided interest of any assignor in any receivable due from the debtor, in favour of the factor. The Bill amends the definition to add that such a transfer can be in whole or in part (of the undivided interest in the receivable dues).
Change in the definition of factoring business: The Act defines a factoring business to mean the business of:
- Acquisition of receivables of an assignor by accepting assignment of such receivables, or
- Financing against the security interests of any receivables through loans or advances.
The Bill amends this to define factoring business as acquisition of receivables of an assignor by assignment for a consideration. The acquisition should be for the purpose of collection of the receivables or for financing against such assignment.
Registration of factors: Under the Act, no company can engage in factoring business without registering with the Reserve Bank of India (RBI). For a non-banking financial company (NBFC) to engage in a factoring business, its:
- Financial assets in the factoring business, and
- Income from the factoring business should both be more than 50% (of the gross assets/net income) or more than a threshold as notified by the RBI.
The Bill removes this threshold for NBFCs to engage in factoring business.
Registration of transactions: Under the Act, factors are required to register the details of every transaction of assignment of receivables in their favor. These details should be recorded with the Central Registry setup under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 within a period of 30 days. If they fail to do so, the company and each officer failing to comply may be punished with a fine of up to five thousand rupees per day till the default continues. The Bill removes the 30 day time period.
Further, the Bill states that where trade receivables are financed through Trade Receivables Discounting System (TReDS), the details regarding transactions should be filed with the Central Registry by the concerned TReDS, on behalf of the factor.
What is Trade Receivables Discounting System (TReDS)?
Trade Receivables Discounting System, or TReDS, is an online platform for factoring purposes. MSMEs can register here as providers of bills, and NBFCs and banks on the other side can bid for such bills. It is basically an online marketplace for bill discounting.
The advantage of TReDS is that the discounting can be done online and in a completely transparent manner. The TReDS platform specifically provides for free, trusted receivables payments to MSMEs within 48 hours, which helps smooth their working capital cycle.
How do MSMEs benefit?
This is a big relief for the MSMEs. The volume on the TReDS platform is very limited as of now. Just about Rs 2,000-3,000 crore are discounted every month across the three platforms. That is because there are not enough buyers for the bills.
Once more participants come on board for factoring, the liquidity constraints faced by MSMEs will significantly reduce.
Now all the large financing NBFCs can come on board and compete for the bills. This will vastly increase competition, liquidity, and pricing for the MSMEs.
What are the Challenges with Factoring?
There will be the associated risk of rising bad debts for NBFCs and banks as more bills against various firms will come for discounting. This is a business risk the discounting party will have to take
It is worth mentioning here that most of the receivables are against government work. And while the government doesn’t default, it is also the slowest to release payment
Corporate receivables, on the other hand, have much shorter payment release cycles against their bills. But they are also susceptible to potential defaults.
However, large NBFCs and banks have the means to recover the dues, which MSMEs don’t. And so, the MSMEs will crowd in for more instant discounting, and factoring should swell in the future.
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