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Wind-down requirements are front and centre of expectations for payments firms and e-money institutions operating in the UK, as the Financial Conduct Authority (FCA) raises the regulatory bar and treats them increasingly like banks and other financial services companies.
The regulator published guidelines for payments firms on its website earlier this month, outlining the steps they should take to make sure they are able to cease or reduce their operations in an orderly fashion, should the need arise.
Business leaders in the payments sector are more used to planning for breakneck growth than for market conditions to turn against them, with ambitious expansion goals often a key requirement for securing investment.
But analysts say they will increasingly need to show in-depth planning for insolvency scenarios, with these plans evolving in real time as the firm scales up.
The FCA set out guidelines for winding down financial companies in 2020. Payments firms initially believed they were not in the scope of this guidance, but the regulator made clear in a "Dear CEO" letter in March last year that it expects them to be compliant.
It said that its supervisory work had identified that many firms still needed to create wind-down plans and warned that the plans it had reviewed frequently failed to meet expectations.
Payments firms’ plans can be "over-optimistic", have "insufficient detail", a lack of consideration of appropriate triggers for winding down, and a lack of adequate analysis of the costs and cash requirements involved, it said.
New requirements
Max Savoie, a partner at law firm Sidley Austin, said payments firms should expect wind-down planning to become an integral part of their UK regulatory oversight in the near future.
"The FCA has been very focused on this issue and it is an area it will ask firms about in the ordinary course of a review, as it does with safeguarding and the Consumer Duty,” he said.
"My sense is that previously, non-bank payment service providers generally did not have wind-down plans and there was no indication that they had to,” said Savoie. “However, we're now seeing a lot more guidance being issued to these types of firms as well as requests to see plans."
Many such firms have historically done little to no planning for wind-downs unless specifically approached by the FCA, he said. This will no longer pass muster: “Now that communication has ramped up, however, the FCA will be far less sympathetic.”
Often, the entrepreneurial leaders of start-ups find it psychologically difficult to think about scenarios in which their firm might be forced to shut down, and consequently struggle to strike the right tone with regulators, Savoie said.
"A wind-down plan is really about focusing on what could go wrong. If you work in a risk or compliance function, you're used to thinking about that,” he said, but founders of fast-growing firms are not.
“In practice, this can mean that senior executives and business functions can come across to the FCA as being overly optimistic, and not realistic enough about where things could go wrong,” he said.
If a wind-down plan looks like an advocacy piece or a pitch to investors, it is not going to pass regulators’ test, he said.
Alison Donnelly, director at compliance consultancy Fscom, agreed that wind-down planning could take payments firms’ leaders out of their comfort zone: “Often, they are not interested in looking at what happens if a business doesn't go the way they intend."
But proper planning can help them to avoid collapsing entirely in the event that market conditions turn against them, she said. "The true value is understanding when a business is getting into hot water: an early warning that action needs to be taken to avoid having to wind down, and having a range of levers to pull that are realistic … . If recovery isn’t possible, then the wind-down of the regulated activities becomes inevitable.”
Move fast and stay compliant
Another challenge specific to payments firms is making sure that their compliance instruments are keeping pace with the growth of their business.
“If any firm is fast-growing, having the right level of governance and controls can be tricky,” said one source working as a consultant in the insolvency space. “For example, you might have £2m of customer funds at the start of a year and then this becomes £25m by the end of the year. You would expect a firm’s governance and controls to evolve to a higher level as it grows.”
According to John Gidla, head of content and strategy at Vixio, "firms should consider the plan as a living, breathing document, keeping it realistic and up-to-date with business changes”.
"Business models evolve and firms grow. Keeping the document 'alive' will support firms when a trigger is met, and a wind-down — whether solvent or insolvent — is required," he said.
Savoie said that firms unsure of how to pitch their wind-down plans should think about the underlying objectives of the regulator. “The FCA ultimately wants to make sure that, if a firm does fail, it can wind down with minimal disruption and harm to customers … . That means ensuring the return of safeguarded funds, and that you treat customers in a sensible way.”
The impact on the broader market also needs to be considered, he said. “If you're a payments firm providing B2B services on which other firms are reliant, then you need to think about that as well.”
What’s the worst that could happen?
The regulator wants to see evidence of firms thinking about what might cause them to enter difficulty, and how they would respond in each case, Savoie said. “The feedback I've seen is on the need to include a broad range of plausible scenarios that could trigger a wind down.”
These might include an economy-wide disruption like the COVID-19 pandemic and how that might change funding opportunities; or operational, legal and regulatory risks specific to the firm or the sector, such as incoming Payment Systems Regulator (PSR) rules that increase their liability to customers who fall victim to authorised push payment (APP) fraud.
Once the scenarios are in place, firms need to demonstrate a clear idea of how they will respond to them.
“Do you have clear lines of responsibility for a wind down? How will you collect and review relevant management information? This means looking at resources in good times but also in distressed situations,” said Savoie.
“You also need to be able to show that you're not reliant on investors or group affiliates who are not contractually committed to provide additional financial resources, or who may not be able to during a period of financial stress,” he advised. “Non-financial resources are also important to consider, such as thinking about contractual notification periods.”
This should include in-depth information on, for example, whether key suppliers and banking partners can terminate their agreements if a firm is at or near insolvency. “If so, what is the minimum period and do they have any contractual obligations to help your firm transition away from their services?"
Gidla, a former regulator with the FCA, said firms should also pay careful consideration to data, accounts and key persons required to support a wind-down scenario.
“It is important for firms to consider the customer at the heart of the process. Do they have enough staff to contact customers? Is the customer information kept up-to-date? And is the ownership of funds reconciled and kept-up-to-date?” he said.
“These, to name a few, can be costly exercises for the firm to return funds and to limit customer harm as part of the process during a wind-down scenario.”
