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08 December 2020
With the enactment of the Factoring Regulation Act 2011 (Factoring Act), for the first time a consolidated legal framework governing all aspects of and codifying the law applicable to factoring transactions was introduced in India. The Factoring Act was introduced primarily with the laudable objective to:
The Factoring Act also dispensed with stamp duty on factoring transactions to incentivise increased transactions without the burden of heavy duties which would have otherwise been applicable to assignment of movable property.
While the Factoring Act is an important enactment, its Achilles heel has always been the limitations that it places on the types of entity which can engage in the factoring business– in particular, its peculiar treatment of non-banking financial companies (NBFCs), an important class of lenders in India. To elaborate, while NBFCs are covered within the definition of the term 'factor' under the Factoring Act, they must obtain a separate certificate of registration from the Reserve Bank of India (RBI) to commence or carry on the factoring business under the Factoring Act. Further, an NBFC can be granted registration only if its 'principal business' is the factoring business – namely, only NBFCs whose financial assets in the factoring business exceed 50% of their total assets and whose income from the factoring business exceeds 50% of their gross income can be authorised by the RBI to carry on the factoring business. Pursuant to the provisions of the Factoring Act, the RBI introduced a new category of NBFCs called NBFC Factors and effectively stipulated a time period within which existing NBFCs could either meet the 'principal business' criteria(1) or wind down their factoring business.
In light of these provisions, many NBFCs which prior to the enactment were engaged in the factoring business as part of a larger lending business, were compelled to wind down this element of their business. This is also borne out by the fact that despite almost a decade having passed from the date of enactment of the Factoring Act, only seven entities have registered as NBFC Factors.(2)
The limited impact which the Factoring Act has had on increasing factoring as a means of financing in India was also noted in the RBI Concept Paper on Trade Receivables and Credit Exchange for Financing of Micro, Small and Medium Enterprises published in March 2014 which stressed the need to build a suitable institutional infrastructure to enable an efficient and cost effective factoring or reverse factoring process and ensuring sufficient liquidity is created for all stakeholders through an active secondary market. With this avowed objective, the RBI issued the Guidelines for setting up of and operating the Trade Receivables Discounting System (TReDS) in 2014 providing for a scheme for setting up and operating an institutional mechanism for facilitating the financing of trade receivables of MSMEs from corporate and other buyers through multiple financiers. However, the ambit of entities which could be financiers on the TReDS platform was again limited to banks and NBFC-Factors, thereby limiting the access of MSMEs to a wider set of financiers on the platform. This debilitation was also noted by the recent Report of the Expert Committee on MSMEs of June 2019 which acknowledged that MSMEs find it difficult to discount invoices on the TReDS platform and has recommended widening the scope of financiers by permitting NBFCs other than NBFC-Factors and for necessary amendments in the Factoring Act to be considered by government.
The minister of finance, in her speech on 5 July 2019 when presenting Budget 2019-2020 as well as in her more recent speech on 1 February 2020 when presenting Budget 2020-2021, referred to the proposal to make necessary amendments to the Factoring Act particularly to enable NBFCs to extend invoice financing to the MSMEs through TReDS, thereby enhancing their economic and financial sustainability.
While this issue is not new and several calls for action have already been sounded and taken on board, the need to amend the Factoring Act has taken on a new sense of urgency in light of the COVID-19 pandemic.
One of the pressing issues which the government is focused on in tackling the COVID-19 pandemic is measures which can be taken to encourage the provision of finance to and to generally boost the MSME sector – the amendment of the Factoring Act to widen the scope of lenders who can engage in the factoring business is low hanging fruit and now would be the perfect time to implement the same. In fact, in this regard the Factoring Regulation (Amendment) Bill 2020 was recently introduced in the Lok Sabha and has now been referred to a standing committee. It is imperative that it is expeditiously translated into law after factoring in the recommendations of the standing committee constituted for the purpose.
For further information on this topic please contact Gautam Ganjawala or Bhargavy Ramesh at AZB & Partners by telephone (+91 22 4072 9999) or email (firstname.lastname@example.org or email@example.com). The AZB & Partners website can be accessed at www.azbpartners.com.
(1) The RBI vide the Non-Banking Financial Company – Factors (Reserve Bank) Directions 2012 dated 23 July 2012 at first in exercise of its enabling powers under the Factoring Regulation Act, the RBI stipulated a principal business criteria over and above the 50% criteria set out in the Factoring Regulation Act – namely, a requirement to ensure that its financial assets in the factoring business constitute at least 75% of its total assets and its income derived from factoring business is not less than 75% of its gross income. However, based on industry representation and to encourage the factoring sector in India, the RBI issued the circular dated 10 November 2014 which subsequently aligned the threshold to the 50/50 threshold set out in the Factoring Act.
(2) List of NBFC-factors registered with the RBI (as of 16 July 2020) available here.
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