On 25 September 2024, the FCA published a consultation paper on proposed changes to the safeguarding regime for payments and e-money firms (CP24/20). The FCA is proposing to implement the changes in two stages, which would ultimately replace the current safeguarding regime and adapt the existing Client Assets and Supervision Sourcebook (CASS) rules to introduce CASS-style requirements for in-scope firms. In the second stage (after revocation of the existing safeguarding requirements in relevant legislation), a statutory trust would be created so that in-scope firms would hold safeguarded funds on trust for consumers.
The proposed rules would impact the safeguarding obligations of UK authorised electronic money institutions, small electronic money institutions, and credit unions that issue e-money (together, EMIs), as well as UK authorised payment institutions (APIs) (together, Payments Firms). Small payment institutions (SPIs) would continue to be able to opt in to comply with safeguarding requirements on a voluntary basis, and small e-money institutions and credit unions that are required to safeguard funds received in exchange for e-money would also continue to be able to opt-in to the safeguarding requirements for any payment services they provide which are unconnected with issuing e-money.
The current approach
Currently, Payments Firms are required to safeguard funds received in connection with regulated payment services or issuing e-money (relevant funds). Safeguarding requirements are intended to allow customers to recover relevant funds as quickly as possible in the event of the failure of a Payments Firm.
Under the existing regulatory framework, relevant funds may be safeguarded in one of two ways under the Payment Services Regulations 2017 (PSRs) and the Electronic Money Regulations 2011 (EMRs). The segregation method, which the FCA notes is used by approximately 95% of Payments Firms, consists of holding relevant funds separately from the firm’s own assets. If the Payments Firm still holds the funds at the end of the business day following receipt (D+1), it must either (a) place the funds into a specially designated safeguarding account with an authorised credit institution or the Bank of England, or (b) invest the funds in certain secure, liquid assets, and place those assets in a separate account with an authorised custodian. Alternatively, an authorised insurer or credit institution can guarantee to cover the relevant funds requirements in the event of the firm’s insolvency by virtue of an insurance policy or comparable guarantee.
Accounts used in connection with the segregation method (safeguarding accounts) must be designated in such a way as to show that the account is (a) held for the purpose of safeguarding relevant funds or assets in accordance with the PSRs or the EMRs, and (b) used only for holding those funds or assets (or for holding those funds or assets together with proceeds of an insurance policy or guarantee held in accordance with the PSRs or the EMRs). Where funds or assets are deposited with an authorised credit institution or custodian, no person other than the Payments Firm may have any interest in or right over the relevant funds or relevant assets in the safeguarding account, except as provided by the PSRs and the EMRs.
Recent case law has confirmed that a statutory trust does not arise by virtue of the safeguarding requirements. Instead, the safeguarding requirements under the PSRs and EMRs create a statutory preference on insolvency.
The FCA’s concerns
The FCA notes that whilst it has issued guidance on the safeguarding provisions, in its view there remain poor practices across the payments industry due to poor implementation of the regulatory framework and the FCA’s supervision teams have seen an increase in the number of firms with safeguarding issues.
These poor practices and safeguarding issues should be read in the context of the wider increase in the number of consumers interacting with payment institutions and e-money institutions. As e-money accounts have become increasingly popular in the UK, more retail customers could be negatively impacted in the event of a Payments Firm’s insolvency. The FCA notes recent data that indicates the number of consumers using an e-money account has consistently grown over the last 5 years, from 1% in 2017 to 7% in 2022 and approximately one in ten e-money holders in the UK use e-money accounts as their main day-to-day transactional accounts. The amount of client funds held by e-money on any given day has also increased over time, rising to approximately £18bn in 2023, and the FCA estimates that Payments Firms held £5bn in relevant funds on any given day last year. The FCA is particularly concerned about the risks of harm to vulnerable consumers - around 40% of e-money account holders have at least one characteristic of vulnerability. These figures have prompted the FCA to protect UK consumers by improving the safeguarding regime.
The proposed approach
CP24/20 aims to address weaknesses in the current system by minimising shortfalls in safeguarded funds in the event of a Payments Firm’s insolvency, ensuring that funds are returned as quickly as possible and strengthening the FCA’s ability to intervene when Payments Firms do not meet its safeguarding expectations. Additionally, the proposed regime aims to strengthen protection of consumers’ rights and provide greater legal certainty for clients in the event of a Payments Firm’s insolvency by imposing a statutory trust over safeguarded funds.
The interim-state and end-state stages are outlined as follows:
Interim-state stage
The features of the interim-state stage are as follows:
- Improved books and records
- More detailed record-keeping and reconciliation requirements for safeguarding, building on existing guidance and similar to existing requirements set out in CASS 7 for investment firms.
- Requirement to maintain a resolution pack, including requirements on the types of documents and records to be included.
- Enhanced monitoring and reporting
- Requirement to submit a new monthly regulatory return to the FCA covering safeguarded funds and safeguarding arrangements.
- Requirement to have compliance with safeguarding requirements audited annually, with the audit submitted to the FCA.
- Requirement to allocate oversight of compliance with the safeguarding requirements to an individual in the Payments Firm.
- Strengthening elements of safeguarding practices
- Additional safeguards where Payments Firms invest relevant funds in secure liquid assets.
- Requirements to consider diversification of third parties with which Payments Firms hold, deposit, insure or guarantee relevant funds that they are required to safeguard, as well as due diligence requirements.
- Additional safeguards and more detailed requirements on how Payments Firms can safeguard relevant funds by insurance or comparable guarantees.
End-state stage
The features of the end-state stage are as follows:
- Strengthening elements of safeguarding practices
- More robust requirements on how Payments Firms must segregate and handle relevant funds. This will include requiring that Payments Firms receive relevant funds directly into an appropriately designated safeguarding account at an approved bank, except where funds are received through an acquirer or an account used to participate in a payment system.
- Agents and distributors cannot receive relevant funds unless their principal Payments Firm safeguards sufficient funds in designated safeguarding accounts to cover the funds expected to be received and held by their agents or distributors.
- Holding funds under a statutory trust
- Imposition of a statutory trust over relevant funds held by a Payments Firm, as well as relevant assets, insurance policies/guarantees, and cheques.
- Additional detail around when the safeguarding obligation starts and funds become subject to the trust.
The FCA’s view is that imposing a statutory trust increases the likelihood that relevant funds will, on an insolvency of the Payments Firm, be available to meet the claims of customers, as it would keep the trust assets separate from the insolvency estate. While distribution costs will be prioritised, other insolvency costs would not affect the claims of payment service users. Only after these claims are fully settled would any leftover trust assets revert to the Payments Firm's estate. In addition, requiring Payments Firms to receive relevant funds directly into a designated safeguarding account would mitigate consumer risk, particularly in the pre-D+1 period.
Key takeaways and next steps
Compliance with the safeguarding regime is clearly an area of focus for the FCA and this is unlikely to change given the increase in consumers using e-money and payment services. Payments Firms should therefore ensure they are compliant with the current requirements and begin planning for future compliance with the interim-state rules (and subsequently the end-state rules). Payments Firms should also review the proposals and engage with the FCA particularly if there are unintended consequences arising from the proposed changes or where it would not be technically feasible to comply.
Once the FCA’s finalised safeguarding rules are published, in-scope Payments Firms will need to conduct a gap analysis of their current safeguarding practices and determine what changes will need to be made to their systems and controls.
The consultation period for CP24/20 will remain open until 17 December 2024, and the FCA plans to publish final rules in the first half of 2025. The interim-state rules are expected to come into force six months after the publication of the final rules, while Payments Firms would be given a further six months to comply with the end-state rules.
