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The Financial Conduct Authority (FCA) has unveiled its much anticipated safeguarding proposals aimed at enhancing customer protections when payments and e-money firms go out of business.
The move from the FCA comes in response to growing concerns over inadequate safeguarding practices within the industry, despite its rapid expansion in recent years.
“There remain poor practices across the industry due to poor implementation of the regulatory framework,” the consultation paper reads, as it sets out proposals to overhaul the current framework.
Unlike traditional financial institutions, funds held by payments and e-money firms are not protected by the Financial Services Compensation Scheme (FSCS).
Instead, the onus is on firms to safeguard customer funds, and the watchdog says that this has created a scenario where customers could lose money or face delays in having their funds returned if the firm fails.
“We’re consulting on proposals to make safeguarding rules stronger and clearer for payment and e-money firms so customers get as much of their money back as quickly as possible if the firm goes out of business,” commented Matthew Long, director of payments and digital assets at the FCA.
A long time coming
In March 2023, the FCA issued a letter to CEOs of payments and e-money firms, which expressed concern about safeguarding practices and wind-down arrangements in particular.
For example, approximately 15 percent of firms that safeguard client funds were subject to FCA supervisory cases, illustrating the seriousness of the issue.
The overhaul has also likely been inspired by the Court of Appeal's ruling in the Ipagoo LLP case [2022] EWCA Civ 302, which highlighted risks within the legal framework when payments and e-money firms enter insolvency.
The court ruled that the Electronic Money Regulations (EMRs) do not establish a statutory trust over customer funds and that any shortfall in a firm's safeguarded asset pool should be topped up.
According to the FCA, this ruling has created uncertainty about how safeguarded funds rank against other creditor claims and lacks established legal principles to guide the process, with insolvency proceedings often resulting in delays and increased costs for returning funds to consumers, a problem exacerbated by similar rulings affecting the Payment Services Regulations (PSRs).
CASS for payments?
The new FCA proposals aim to replace the existing e-money safeguarding regime with a framework similar to the client assets (CASS) regime that is used by investment firms.
The changes are designed to be more suitable for the business models of payments firms, ensuring a higher standard of protection for customer funds, says the FCA.
“The CASS regime is well established and currently applies to around 3,500 firms collectively holding approximately £18 trillion of custody assets and £183 billion of client money,” the FCA said, adding that the regime has been strengthened over the last 20 years, “particularly to reflect lessons learned following the previous financial crisis” and new sectors being regulated, such as debt management firms.
Under the FCA’s two-stage proposal, interim safeguarding rules will be strengthened by mid-2025, followed by the full implementation of the new regime.
These new rules will be integrated into the CASS and SUP chapters of the FCA Handbook and will eventually replace the current safeguarding requirements set out in the PSRs and EMRs.
What are the proposed changes?
The FCA’s interim safeguarding proposals aim to improve practices while minimising disruption for firms.
As part of the proposals, firms will be required to maintain more detailed records and perform regular reconciliations, similar to the standards set in CASS 7 for investment firms. This includes maintaining a "resolution pack" containing key documentation.
“Robust record-keeping and reconciliation requirements will help firms put in place adequate processes to protect relevant funds,” the consultation says, adding that complying with these requirements will help firms ensure that issues with safeguarded funds are identified quickly and that any shortfalls in safeguarded funds are “made good by the firm as early as possible”.
In terms of monitoring and reporting, payments and e-money firms will be required to submit a new monthly regulatory return outlining their safeguarded funds and arrangements, annual audits of safeguarding practices will be mandatory, and firms will need to allocate oversight of compliance with the safeguarding requirements to an individual in the Payments Firm.
To strengthen safeguarding practices, firms will need to adopt additional measures when investing customer funds in secure, liquid assets. This includes diversification of third parties holding the funds, due diligence and more comprehensive safeguards for funds covered by insurance or comparable guarantees.
Once the full regime is implemented, stricter measures will be introduced to further protect customer funds, and payments firms will need to segregate relevant funds into designated accounts at approved banks, while agents or distributors cannot receive customer funds unless the principal firm has safeguarded sufficient amounts in those accounts.
Additionally, a statutory trust will be imposed over the relevant funds, assets and insurance policies, with safeguarding obligations commencing once the funds are subject to the trust.
Going forward, the FCA's proposals are subject to industry consultation, with firms encouraged to respond by December 17, 2024.
