On 25 September 2024, the Financial Conduct Authority (FCA) published Consultation Paper 24/20 on proposed changes to the safeguarding regime for payments and e-money firms. The aim of the proposals is to make safeguarding rules stronger and clearer for these firms so that customers get as much of their money back as quickly as possible if the firm goes out of business.

Background

Payment institutions, e-money institutions and credit unions that issue e-money (collectively known as payments firms) are required to protect funds that they receive in connection with making a payment or in exchange for e-money issued, and this protection must begin immediately on receiving the funds. These requirements are intended to ensure that consumers are protected so that, if a firm fails, consumers receive the maximum value of their funds as quickly as possible. Funds held by payments firms are not directly protected by the Financial Services Compensation Scheme (FSCS).

The current safeguarding requirements are set out in the Payment Services Regulations 2017 (PSRs) and the E-Money Regulations 2011 (EMRs), and the FCA has also issued guidance on these provisions in its Approach Document.  However, it explains that it continues to see poor safeguarding practices from firms.

The FCA wrote to payments and e-money CEOs in March 2023 regarding their safeguarding and wind-down arrangements and has since opened supervisory cases relating to approximately 15% of firms that safeguard, to address its concerns.

The FCA’s proposals

In CP24/20, the FCA is proposing to replace the existing e-money safeguarding regime with a client assets (CASS) style regime designed to work with payments firms’ business models. It also plans to publish strengthened interim safeguarding rules for firms by the middle of next year.

By making these changes, the FCA is seeking to improve the safeguarding regime to ensure that:

  • Funds received in exchange for issued e-money or received for the execution of a payment transaction are held safely and securely by payments firms at all times or are covered by an appropriate insurance policy or comparable guarantee.
  • The right amount of funds are segregated from the firm’s own funds.
  • It is clear that the funds are held on behalf of consumers.
  • The claims of e-money holders or payment service users can be met from the asset pool and these claims take priority over other creditors.
  • Safeguarded funds can be returned to consumers as quickly, and as whole, as possible in the event that a payments firm fails.

The FCA proposes to make changes to the safeguarding regime in two stages – the interim and end-state – and in CP24/20 it is consulting on rules and guidance for both stages of the proposed regime:

  • The interim rules are designed to support a greater level of compliance with existing safeguarding requirements as set out in the EMRs and PSRs, to support more consistent record keeping, and to enhance reporting and monitoring requirements to identify shortfalls in relevant funds and improve supervisory oversight.
  • The end-state rules will replace the safeguarding requirements of the EMRs and PSRs with a CASS-style regime, where relevant funds and assets are held on trust for consumers. The FCA says this second stage will address remaining shortcomings of the regime when the revocation of the safeguarding requirements in the PSRs and EMRs by the Financial Services and Markets Act 2023 is commenced.

CP24/20 explains that these changes would be made by creating detailed rules and guidance for payments firms, setting out how they must protect the funds they hold on behalf of consumers, by:

  • Seeking to address gaps in the current regime or align it with similar requirements in the FCA Handbook (in CASS or SUP).
  • Codifying the existing guidance in the FCA’s Approach Document by moving relevant provisions into the Handbook.

Interim rules

In summary, the interim rules seek to:

  • Improve books and records by:
    • introducing comprehensive rules to ensure firms carry out accurate and consistent reconciliations; and
    • requiring payment firms to keep clear records of client funds and to put in place a resolution pack, containing information an insolvency practitioner would need to achieve a timely return of funds to clients.
  • Enhance monitoring and reporting by:
    • requiring firms to complete annual audits of compliance with safeguarding requirements; and
    • requiring payment firms to submit a new monthly safeguarding regulatory return.
  • Strengthen elements of the safeguarding regime by:
    • requiring payment firms to consider whether their approach to safeguarding is appropriately diversified;
    • ensuring payment firms undertake due diligence in the selection of third parties; and
    • requiring payment firms to have acknowledgement letters.

End-state rules

In summary, the FCA’s proposals for end-state rules concern the holding of funds under a statutory trust and strengthening elements of the safeguarding regime:

Statutory trust

  • Statutory trust:
    • all funds, assets and insurance policies/guarantees used for safeguarding are held on trust in favour of clients.
  • When the safeguarding obligation starts and ends:
    • maintain the existing approach but clarify when the safeguarding obligation begins and ends with more prescriptive rules and guidance.
  • Investing client funds in secure liquid assets (SLAs):
    • continue to allow payment firms to safeguard using SLAs; and
    • payment firms will need to consider whether they need additional permissions to invest client funds in SLAs.

Strengthening elements of the safeguarding regime

  • Segregation of relevant funds:
    • payment firms must ensure that all client funds they receive are paid directly into a designated safeguarding account (DSA) with a central bank, an authorised credit institution or with a bank authorised in a third country, with a template acknowledgement letter except for accounts with acquirers and used solely to access a payment system.
  • Agents and distributors:
    • agents and distributors have to deposit any client funds directly into the principal firm’s safeguarding client account; or
    • principal firms have to segregate the maximum value of estimated funds likely to be held by agents or distributors, in their own DSA.
  • Insurance and comparable guarantees:
    • setting out more stringent criteria that need to be satisfied by this safeguarding method and ensuring the policy is written in trust.
  • Fixed term accounts:
    • restrict the use of fixed term accounts, applying additional safeguards where funds can only be withdrawn with 31 to 95 days’ notice.

Next steps

The deadline for responses to CP24/20 is 17 December 2024. The FCA then plans to publish final interim rules with an accompanying policy statement within the first 6 months of 2025.

Following the consultation, the FCA intends to continue to work with HM Treasury to review and consult on the rest of the regime currently set out in the PSRs and EMRs, with a view to moving the firm facing requirements into the FCA Handbook.