The Financial Conduct Authority (FCA) has raised concerns about the safeguarding practices of payments and e-money firms, warning that poor practices in this area could lead to customers losing money or facing delays in the event of a firm’s failure.
Although these firms are not covered by the Financial Services Compensation Scheme (FSCS), they are required to safeguard customer funds, but recent supervisory cases show that around 15% of firms are not meeting the necessary standards.
“Making safeguarding rules stronger and clearer for payment and e-money firms”
In a letter to CEOs in March 2023, the FCA highlighted these shortcomings and urged firms to improve their safeguarding and wind-down procedures. Matthew Long, Director of Payments and Digital Assets at the FCA, commented, “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.”
The FCA is proposing to replace the current safeguarding regime for e-money with a Client Assets Sourcebook (CASS)-style system, better suited to payments firms’ business models. Interim strengthened safeguarding rules are expected to be published by mid-2024.
The consultation is open for responses until 17 December 2024. These changes follow the FCA’s Financial Lives Survey, which noted a five-fold increase in the use of e-money institutions between 2017 and 2022. This growing reliance on payments firms has driven the FCA to tighten regulations to protect consumers more effectively.
Analysis of FCA’s Consultation Paper CP24/20
The consultation paper CP24/20 proposes significant changes to the safeguarding regime for payments and e-money firms, with a focus on improving consumer protection and ensuring more efficient fund recovery in the event of firm insolvency. Below is a detailed analysis of key proposals:
1. Why the Consultation is Necessary
The FCA identifies shortcomings in current safeguarding practices, leading to risks for consumers. An average shortfall of 65% in safeguarded funds was observed in cases of insolvency between 2018 and 2023, prompting the need for stronger regulatory frameworks. The current regime under the Payment Services Regulations (PSRs) and E-Money Regulations (EMRs) is deemed insufficient, necessitating a revised approach that includes stronger enforcement and clarity on firms’ safeguarding obligations.
2. Proposed Interim and End-State Rules
The consultation outlines a two-stage approach:
Interim Rules: Designed to improve compliance with existing safeguarding requirements. Key measures include:
Strengthened record-keeping and reconciliation practices.
Monthly reporting requirements to improve the FCA’s supervisory oversight.
Mandatory external safeguarding audits to assess firms’ safeguarding arrangements.
End-State Rules: A more comprehensive overhaul, including:
Replacing the current safeguarding regime with a Client Assets Sourcebook (CASS)-style regime.
Imposing a statutory trust over safeguarded funds, making the firm a trustee of consumer funds, which would offer greater legal protection during insolvency.
3. Key Features of Interim Proposals
Enhanced Record-Keeping: Firms will be required to maintain accurate records, perform daily reconciliations, and keep a “resolution pack” to ensure quick access to information in case of insolvency.
Monthly Reporting: Firms will be required to submit monthly returns detailing the amount of safeguarded funds, reconciliation outcomes, and any identified discrepancies.
Safeguarding Audits: Annual safeguarding audits must be conducted by qualified auditors, and reports must be submitted to the FCA. This extends even to firms that may not have needed to safeguard funds during the audit period.
4. Key Features of End-State Proposals
The end-state proposals represent a more comprehensive transformation of the safeguarding regime, designed to address remaining gaps and vulnerabilities:
Statutory Trust Over Safeguarded Funds:
A key proposal is the imposition of a statutory trust over safeguarded funds. Under this trust, firms will hold consumer funds on behalf of the consumers as trustees, ensuring these funds are protected and separated from the firm’s general assets. This provides greater legal protection and certainty in case of insolvency.
The statutory trust would also apply to assets, insurance policies, guarantees, and instruments used for safeguarding, reducing the risk of misappropriation or delays during insolvency proceedings.
Improved Segregation of Relevant Funds:
The new regime mandates that relevant funds be received directly into designated safeguarding accounts at approved credit institutions. This change aims to minimize risks associated with pre-D+1 handling, where firms previously held funds outside safeguarding accounts for a short period.
Firms will need to exercise due diligence and diversification when choosing third parties (e.g., banks) that hold these funds, reducing the risk of concentration in any single institution.
Agents and Distributors:
The proposal includes new rules for safeguarding funds handled by agents and distributors. Payments firms will either need to ensure that agents deposit funds directly into the firm’s safeguarding account or segregate an amount equivalent to the maximum expected value of funds handled by these agents. This helps mitigate the risks associated with complex agent networks.
5. Strengthening Safeguarding Practices
The FCA proposes several enhancements to current safeguarding practices to ensure stronger oversight and consumer protection:
More Detailed Record-Keeping:
Firms will be required to maintain more detailed records, such as accurate and up-to-date information on safeguarded funds and consumer entitlements. They will also need to prepare resolution packs that can be retrieved within 48 hours to assist insolvency practitioners (IPs) in returning consumer funds quickly.
Regular Audits:
Firms will be required to conduct safeguarding audits annually. These audits must be performed by an independent and qualified auditor. The results of the audit, including any identified breaches and remedial actions, must be submitted to the FCA for review.
Additional Safeguards for Insurance and Guarantees:
Where firms use insurance or guarantees to safeguard funds, there will be stricter requirements to ensure that claims can be processed quickly without restrictive conditions. Firms must also prepare for potential risks, such as the non-renewal of an insurance policy, by having alternative safeguarding arrangements in place.
6. Enhanced Monitoring and Reporting
The FCA’s new proposals aim to enhance the regulatory oversight of firms by introducing more comprehensive monitoring and reporting requirements:
Monthly Reporting Returns:
Firms will be required to submit monthly reports to the FCA detailing the amount of safeguarded funds, the reconciliation process, any shortfalls or excesses identified, and the resolution of discrepancies. This replaces the current practice of annual reporting, which the FCA has identified as insufficient to detect issues promptly.
New Regulatory Return:
The regulatory return will include data on the amount of funds safeguarded, the method of safeguarding, safeguarding audits, reconciliations, and the use of third parties. This allows the FCA to proactively monitor firms’ safeguarding practices and intervene where necessary.
7. Holding Funds Under a Statutory Trust
In the end-state regime, the FCA proposes creating a statutory trust over safeguarded funds. This significant change aims to ensure that consumer funds are legally protected in the event of a firm’s failure. Key elements include:
Legal Status: The funds will be held under a statutory trust, meaning they will not be part of the firm’s general assets. This ensures that consumer claims take priority over other creditors during insolvency.
Trustee Duties: The firm will act as a trustee, which imposes fiduciary duties such as acting in the best interests of the consumers.
Streamlining Distribution: The statutory trust structure will make it easier to distribute funds promptly and reduce insolvency costs, benefiting consumers.
8. Implementation and Transitional Arrangements
The FCA acknowledges that these proposals represent a significant shift in how payment and e-money firms operate. Therefore, a six-month transition period is proposed for firms to adapt to the new interim rules. After the interim stage, the end-state rules will be introduced once the necessary legislative changes are in place.
The consultation process will run until 17 December 2024, and final rules are expected to be published within the first half of 2025.
