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Open in new tab Securitisation of MSME receivables in India
Vinod Kothari l finserv@vinodkothari.com
- Financing needs of MSMEs in India: Working capital constitutes a major part of SMEs’ funding requirements
There are considerable gaps in funding for SMEs: In India, the total addressable demand for external credit is estimated to be USD 173 billion[1] while the overall supply of finance from formal sources is estimated to be USD 441 trillion. The Expert Committee on Micro, Small and Medium Enterprises, constituted by Reserve Bank of India in December, 2018 has estimated the overall gap in India to be USD 238 – 298 billion[2].
Read more: Securitisation of MSME receivables in IndiaTraditional sources of funding are working capital facilities with banks; however, given their unorganised nature, lack of formal financial statements, etc., many SMEs find it difficult to have formal lines of credit from banks.
| The marketplace is trying alternative sources of working capital for SME. The avenues tried based on the different components of the working capital: | |
| Accounts receivables | Inventory |
| Trade Receivables Discounting System (TREDS) Factoring/ supply chain financing | Credit period for accounts payable, funded by way of reverse factoring/ supply chain financing |
- Trade Receivables Discounting System (TReDS/TREDS)
TREDS is almost India’s own innovation, though it was inspired by Mexico’s NAFIN Cadenas Productivas Program. TREDS as a mechanism for discounting and unitisation of trade receivables was launched in 2014. Currently, there are 4 of them – RXIL, M3, InvoiceMart and C2FO Factoring Solutions Private Limited. The first one is the largest.
Limited number of funding participants. However, given that there are quite a limited number of funding participants in the TREDS ecosystem currently (as informed by some of the participants in the TREDS platform(s), only 5-6 banks are currently actively bidding), there is very little competitive bidding for invoices currently. The cost of funding, we were given to understand, is about 0.25% – 0.40% higher than bank finance, if the buyer happens to be a BBB rated entity.
Figure: Trend in TREDS over 3 years[3]
- Supply chain financing
Supply chain financing is growing, as present-day trade needs to move fast; working capital availability is key to achieving turnover with low spreads, to service the ultimate consumer affordably and efficiently. Supply chain finance is a key mode of financing for upstream procurements as well as downstream supplies by an entity with a good credit standing, say Anchor. Usually, the financing is done by setting a limit based on the Anchor’s credit standing, with a bank or NBFC. Both banks and NBFCs are active in the space. Financing may be done by discounting of supply bills, either accepted by the Anchor as due for payment, or drawn by the Anchor on the dealers/ customers of the Anchor.
Most supply chain financing programs work on first loss guarantee by the Anchor. For the downstream supplies, Anchor usually has to provide a first loss guarantee support, to the extent of 5% to 10% of the pool of receivables funded by a lender under the facility.
- Factoring
Factoring law, intended to encourage factoring, has not lived to its purpose due to regulatory overtone. The Factoring Regulation Act was enacted to facilitate and encourage factoring; however, its regulatory stance has served to stifle factoring. Only a handful of NBFCs are currently registered as factors, while banks are not required to register[4]. As a result, the volume of factoring in India is trivial, as compared to global jurisdictions.
- Potential for securitisation of SME receivables
Direct securitisation by SMEs is not feasible. There are 2 ways in which securitisation of MSME receivables can take place: securitisation of trade receivables by SME itself; and secondly, receivables are funded by intermediaries (banks, NBFCs), aggregated by intermediaries, and securitised by them.
Securitisation by SMEs directly is not feasible, as volumes are not sufficient. Plus, it requires direct access to investors, which is unviable. Hence, the discussion below focuses on securitisation of receivables funded by intermediaries.
Intermediated securitisation is the way the world does it. However, regulations in India have scuttled the possibility. Acquisition of receivables by intermediaries (either on their balance sheet, or in the balance sheets of trade finance conduits) is quite common world-over[5]. However, this activity has not picked up in India, for several reasons:
- There is a bar on securitisation of revolving credit facilities in the RBI SSA Directions. Naturally, a trade receivable funding program has to be structured as a revolving facility, to allow the SME continued and assured access to working capital. Issuance of asset backed commercial paper is also barred under the same Directions.
- Regulated financial lenders cannot do a securitisation transaction outside of SSA Directions. If unregulated entities (not regulated by the RBI, say, a conduit vehicle) does a securitisation outside of SSA Directions, no regulated lender can invest in such a transaction, as any investment so made will be a full charge against regulatory capital.
As a result, securitisation of trade receivables is currently a near impossibility under the regulatory regime.
Will trade receivables securitisation help?
Table below compares securitisation with TREDS, supply chain financing and securitisation:
| TREDS | Supply Chain Financing | Securitisation | |
| Consistent availability of funding | While the funding limits are established based on the rating and credit of the buyer, the funding happens on invoice-by-invoice basis. There is no assurance as to either availability or the cost of funding | As limits are assigned for each vendor/ dealer, there is an assured availability at a pre-agreed cost of funding | As limits are assigned for each vendor/ dealer, there is an assured availability at a pre-agreed cost of funding by the intermediary, who, in turn may take receivables to capital markets |
| Disintermediation | Involves financial intermediaries | Involves financial intermediaries | Involves intermediaries at the inception, but eventually, the intermediaries offload the receivables to capital market |
| Burden on banks’ balance sheets | Receivables are on the balance sheet of the lender | Receivables are on the balance sheet of the lender | Receivables are off the balance sheet for regulatory capital purposes |
| Pricing | While pricing is primarily done on the strength of the Anchor, at times, SME gets good pricing based on the liquidity in the banking system | Pricing is done based on the FLDG support provided by the Anchor; hence, priced based on achor’s credit rating | Availability of capital market access, coupled with credit enhancements may bring down the cost of funding |
Policymakers need to enable alternative instruments, and leave the choice to the marketplace. The Table above makes a case for securitisation of trade receivables. Such securitisation does not conflict with TREDS; TREDS may continue as an option, leaving the choice to SMEs /lenders the benefit of choice.
Role of credit enhancements in trade receivables securitisation
The potential structure of securitisation of trade receivables, as it commonly works in global jurisdictions, is as follows:
Figure: Structure of Trade Receivable Securitisation
In essence, there are two levels of credit support – one, at the level of each SME (seller), which sells receivables to the Intermediary/conduit. This is typically by way of over-collateralisation or a first loss facility.
Having thus acquired credit enhanced receivables from the SMEs, the intermediary arranges a program-wide credit enhancement. This enhancement essentially becomes a mezzanine support.
The entire program works as a revolving facility, such that the SME sellers continue to sell receivables on an ongoing basis. On the other hand, the securised paper has a fixed maturity, subject to roll-over at the discretion of the paper holders. Hence, there needs to be liquidity support provided to the conduit, typically by a bank.
Providers of credit enhancement:
- SIDBI, as credit enhancer for SME funding, may provide the program credit support.
- SIDBI, in turn, may be counter-guaranteed by MDBs
Policy/regulatory changes required:
The bar on securitisation of revolving credit facilities, introduced looking at the experience during GFC, needs to be withdrawn. There is an inherent liquidity risk on the part of the intermediary that does securitisation (the risk that early amortisation triggers may cause the facility to wind down, while the committed funding still will have to be continued by the intermediary), but this may be addressed by appropriate capital charge. Note that there is no bar on revolving credit securitisation either in the EU Capital Directions, or in Basel Securitisation Framework.
Likewise, the bar on issuance of asset backed commercial paper needs to be removed. The provider of liquidity facility needs an appropriate capital charge for the maximum value of the facility.
[1]https://www.ifc.org/content/dam/ifc/doc/mgrt/financing-india-s-msmes-estimation-of-debt-requirement-of-msmes-in-india.pdf
[2]https://dcmsme.gov.in/Report%20of%20Expert%20Committee%20on%20MSMEs%20-%20The%20U%20K%20Sinha%20Committee%20constitutes%20by%20RBI.pdf
[3] Source: RBI Statistics on TREDS: https://www.rbi.org.in/Scripts/TREDSStatisticsView.aspx?TREDSid=8, and VKC Analysis
[4] See blog by Vinod Kothari: https://www.linkedin.com/pulse/factoring-india-fractured-opportunity-vinod-kothari/
[5]https://www.euromoney.com/article/2cs68xnhl90cxtg3n64n4/treasury/trade-receivables-deals-buck-broader-market-slump
Read our other articles:
Transparency in lending: RBI Mandates KFS for Retail and MSME Loans
– Chirag Agarwal, finserv@vinodkothari.com
The RBI has vide its Statement on Developmental and Regulatory Policies dated February 08, 2024, announced its decision to mandate Regulated Entities (REs) to provide Key Fact Statement (KFS) for retail and Micro, Small & Medium Enterprise (MSME) loans.
What is KFS? What are its contents?
- A crisp, clear and key information about loan terms. KFS typically includes details such as the all-in-cost of the loan, interest rates, fees, repayment terms, and any associated risks.
- Because KFS is standardised, it enables borrowers to make comparison with terms offered by other lenders.
- Plus, it is at-a-glance view, enabling the borrower to avoid the legalese.
The big buzz on small business payment delays
Mahak Agarwal | corplaw@vinodkothari.com
The Micro, Small and Medium Enterprises Development Act, 2006 (‘MSME Act’) has been around for close to 2 decades now, providing for penal interest for delayed payments to MSMEs; yet, it is only of late that there has been buzz around this. Why?
This attributes to clause (h) of Section 43B of the Income Tax Act, 1961 (IT Act, 1961), inserted by the Finance Act, 2023, effective FY 23-24. That is to say, its impact will be faced for outstanding payments as on 31st March, 2024. Now, with the year end fast approaching, there’s a sense of confusion amongst taxpayers who buy goods or services from MSMEs.
Read more →Measures for promoting MSMEs: credit guarantees and timely payments
The MSME segment represents 30%[1] of the Gross Domestic Product of the country and is a key to India’s vision to become a USD 5 trillion economy. As a result, this has always been a focus area so far as macro-economic policy-making is considered.
During the present year’s budget, the FM highlighted that one of the key areas where the Government has worked on is ease of access to finance.
Access to finance has always been a problem for the MSMEs in the country, and the reasons for this are many, including lack of standardisation of business processes, lack of credit history, lack of formal collateral, etc. To plug the demand and supply gap in MSME financing, the Government of India has over the years launched several schemes to directly or indirectly channelise institutional finance to this segment.
Of the several initiatives taken by the Government, the one which has gained the most popularity is the Credit Guarantee Scheme for Micro & Small Enterprises. To operationalise this, the GOI and SIDBI together formed the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE). The CGTMSE primarily extends guarantee in case of collateral-free loans and loans with insufficient collateral to micro and small enterprises.
Read more →Revision of criteria of non-company entities on which AS shall be applicable
CS Aisha Begum Ansari and Harsh Juneja (corplaw@vinodkothari.com )
Introduction
For the purpose of applicability of Accounting Standards (“AS”), The Institute of Chartered Accountants of India (“ICAI”) has classified the entities into two segments – company entities and non-company entities. Non-company entities such as sole proprietors, partnership firms, trusts, Hindu Undivided Families, association of persons and co-operative societies are further classified into various levels. Currently, the ICAI has categorized non-company entities into 3 levels.
With increasing number of non-company entities, the ICAI has, now, further classified them into 4 levels. The amendments have been brought to reduce stringency on non-company entities which were earlier required to comply with all AS in pursuance of being level I entities as the norms for the same have been revised.
Since most of the Special Purpose Vehicle(s) (“SPV”s) are in the form of non-company entities, they were required to comply with all accounting standards as most of these were covered under level I category. However, with the proposed changes, the burden of strict adherence to AS will be reduced for SPVs falling under level I category.
This Article is an attempt to cover the proposed revision criteria for application of AS on non-company entities.
Proposed applicability
It is proposed that this scheme be made effective in respect of accounting periods commencing on or after April 1, 2020. However, the same shall be effective once the required changes are incorporated in the AS while publishing the updated Compendium of AS.
Non-company entities[1] on which Ind AS is not applicable. It should be noted that such entities have been classified in 4 levels basis different criteria including turnover and borrowing and classified as large – medium – small and micro entities- last three referred to as MSMEs.
Entities belonging to level II, III, IV have been granted certain exemption. It is to be noted that the applicability of AS has been made milder as one goes down the four level of entities i.e to say, maximum relaxations / exemptions are given to level IV entities.
Disclosures
All non-company entities which are covered under this Proposal, are required to make following disclosures:
- That the AS has been complied by the entity;
- The level to which the entity belongs and whether it has availed exemptions granted to such level;
- Availing of partial exemption – It is to be noted that the entities are allowed to cherry-pick the exemptions they intend to avail. However, such partial availing of exemption should not be misleading. That the entity has cherry-picked the exemptions and not availed all the exemptions granted to such level should be disclosed as to which all exemptions it has availed;
Transition
The Proposal also talks about disclosure / rules of transition from one level to another, which are as follows:
- From transition from a higher level to a lower level – relaxations / exemptions of the lower level may be availed only on staying at such level for two consecutive years.
- From transition from a lower level to higher level – while the disclosures pertaining to the higher level becomes applicable, however no change / revision is required to be made in the previous year [where the entity was classified as a lower level, and had availed exemptions / relaxation as such] is required to be made. However, disclosure of such fact is required to be made in the notes to financial statement.
| Levels | Existing criteria for classification [2019][2] | New criteria for classification | Applicability |
| I
[Large] |
1. Equity / Debt Listed / to be listed entity
a) Entities listed on overseas exchanges also included 2. Banks (including co-operative banks), FIs, Insurance entities 3. Entities having [3]turnover in the (excluding other income) > 50 crores 4. Borrowings (including public deposit) > 10 crores 5. Holding and subsidiary entities of the above |
1. Listed / to be listed entity
a) Entities listed on overseas exchanges also included 2. Banks (including co-operative banks), FIs, Insurance entities 3. Entities having turnover in the (excluding other income) > 250 crores 4. Borrowings (including public deposit) > 50 crores 5. Holding and subsidiary entities of the above |
All 29 AS applicable in full. |
| II [Medium] | 1. Entities having turnover in the (excluding other income) > 40 lakhs ≤ 50 crores
2. Borrowings (including public deposit) > 1 crores ≤ 5 crores For turnover / borrowing criteria – only such entities shall be regarded which are engaged in commercial, industrial or business activities Holding and subsidiary entities of the above |
1. Entities having turnover in the (excluding other income) > 50 crores ≤ 250 crores
2. Borrowings (including public deposit) > 10 crores ≤ 50 crores For turnover / borrowing criteria – only such entities shall be regarded which are engaged in commercial, industrial or business activities 3. Holding and subsidiary entities of the above |
A. Accounting Standard(s) not applicable:
AS 3 – Cash Flow Statements AS 17 – Segment Reporting AS 20 – Earnings Per Share
B. Accounting Standard(s) applicable with disclosure exemption: AS 19 – Leases AS 28 – Impairment of Assets AS 29 – Provisions, Contingent Liabilities and Contingent Assets
C. Accounting Standard(s) applicable with exemptions: AS 15 – Employee Benefits
D. Accounting Standard(s) applicable with Note: [following AS, being related to CFS, the same is not applicable to Level II, III, IV entities unless they voluntary decide to consolidate the financial statements] AS 21 – Consolidated Financial Statements AS 23 – Accounting for Investments in Associates in Consolidated Financial Statements AS 25 – Interim Financial Reporting AS 27 – Financial Reporting of Interests in Joint Ventures (to the extent of requirements relating to Consolidated Financial Statements)
|
| III
[Small] |
Remaining non corporate entities | 1. Entities having turnover in the (excluding other income) > 10 crores ≤ 50 crores
2. Borrowings (including public deposit) > 2 crores ≤ 10 crores For turnover / borrowing criteria – only such entities shall be regarded which are engaged in commercial, industrial or business activities 3. Holding and subsidiary entities of the above |
All exemptions provided to Level II shall be applicable. Further exemptions:
A. In addition to full exemptions as given in Level II, further Accounting Standard(s) not applicable:
AS 18 – Related Party Disclosures AS 24 – Discontinuing Operations
B. In addition to disclosure exemption as given in Level II, further Accounting Standard(s) applicable with disclosure exemption:
AS 10 – Property, Plant and Equipment AS 11 – The Effects of Changes in Foreign Exchange Rates |
| IV [Micro] | There were only III levels | Remaining non corporate entities | All exemptions provided to Level III shall be applicable. Further exemptions:
A. In addition to full exemptions as given in Level III, further Accounting Standard(s) not applicable:
AS 14 – Accounting for Amalgamations AS 28 – Impairment of Assets AS 22 is applicable only for current tax related provisions.
B. In addition to disclosure exemption as given in Level III, further Accounting Standard(s) applicable with disclosure exemption:
AS 13 – Accounting for Investments |
Conclusion
As discussed above, the intent to revise the criteria for classification of non-company entities is to provide exemptions/ relaxations from applicability of all AS to certain entities covered under level I as they will now be shifted to descending levels. These proposed amendments will also lessen the difficulties faced by non-company entities falling under the existing levels as they will be provided with partial or full exemptions by getting transferred to descending levels.
[1]This Announcement supersedes the earlier Announcement of the ICAI on ‘Harmonisation of various differences between the Accounting Standards issued by the ICAI and the Accounting Standards notified by the Central Government’ issued in February 2008, to the extent it prescribes the criteria for classification of Non-company entities (Non-corporate entities) and applicability of Accounting Standards to non-company entities, and the Announcement ‘Revision in the criteria for classifying Level II non-corporate entities’ issued in January 2013.
[2] https://resource.cdn.icai.org/56169asb45450.pdf
[3] For turnover / borrowing criteria – only such entities shall be regarded which are engaged in commercial, industrial or business activities
Comments on Proposed Framework for Prepacks
-Sikha Bansal & Megha Mittal
While there had been murmurs of a prepack insolvency resolution framework, the Report of the Sub-Committee of the Insolvency Law Committee, on Pre-packaged Insolvency Resolution Process[1] issued on 8th January, 2021 (“Sub-Committee Report”/ “Report”) comes as the first concrete step in bringing prepacks to India. In an earlier write-up, we have discussed possible framework for bringing pre-packs in India; see here- Bringing Pre-Packs to India
Below we discuss the various facets of the Report in terms of application and feasibility, both legal and practical.
IBC and related reforms: Where do MSMEs Stand?
The MSME industry, colloquially referred to as the power engine of the economy has been a focal point of several reforms over the years. The recent reforms w.r.t. MSMEs and the Insolvency and Bankruptcy Code, 2016 (“Code’) has altered the stance of MSMEs, both as creditors and debtors. In this article, we shall discuss some significant reforms/ amendments w.r.t. MSMEs (due to COVID, or otherwise), and those under the Code and analyse the cumulative impact of these reforms on the sector in the prevailing scenario
Resources on MSME financing
Major reforms have been introduced for the MSMEs, providing the required boost to the sector. MSMEs have recently been put into the limelight with several regulatory and financial reforms concerning them.
We have put up this page to provide the access to all relevant resources on the subject at one place, along with our analysis. Hope that the readers find it useful.
Another couple of step ladders for the MSMEs
IBC and related reforms: Where do MSMEs stand?
Self-dependent India: Measures concerning the financial sector
Regulator’s move to repair the NBFC sector
FAQs on delayed payment to MSMEs
Interest subvention scheme for MSMEs
Filing of return for delayed payment to MSMEs- Effective or frittering?
Snapshot of the initiatives for MSMEs
Transitory liberalisation of asset classification norms for MSMEs
Slew of measures for MSME sector
Help in the hour of need: RBI relaxes asset classification norms for MSME accounts
MSME factoring gets a priority sector status: Likely to give boost to sagging factoring volumes
Waking up from slumber: Government notifies revival and rehabilitation scheme for MSMEs