Summary
The UK is proposing changes to the safeguarding requirements – CP24-20 for non-bank Payment Service Providers (PSPs). Overall, the proposed changes represent a significant shift in the safeguarding regime for in-scope PSPs. Firms will need to carefully assess the impact of these changes on their operations and prepare for implementation to ensure compliance and maintain consumer trust.
Introduction
The Financial Conduct Authority (FCA) proposes to enhance safeguarding requirements for payment service providers in two stages: interim and end-state. These changes aim to address current weaknesses in safeguarding practices and enhance consumer protection, particularly in the event of insolvency, creditor claims and wind-down situations. The FCA state that they wrote to payments and e-money CEOs in March 2023 about their safeguarding and wind-down arrangements and has since opened supervisory cases relating to approximately 15% of firms that safeguard liabilities to address its concerns.
Current Regime – Scope of Safeguarding
- PIs: Safeguard funds received from customers for the provision of payment services.
- EMIs: Safeguard funds received in exchange for issuing e-money and also for other payment services.
- Mixed Funds: Where only a proportion of the funds that have been received are to be used for the execution of a payment transaction (with the remainder being used for non-payment services) and the precise portion attributable to the execution of the payment transaction is variable or unknown in advance the PSP must estimate the relevant funds based on historical data.
- Notice:
- PIs and EMIs must inform customers that their funds are safeguarded and how safeguarding operates.
- Marketing materials and terms must avoid misleading customers into thinking funds are similar to bank deposits or that they are directly covered by the Financial Services Compensation Scheme (FSCS).
- Timing:
- The safeguarding obligation arises when funds are received from customers (or when e-money is issued if earlier), and it continues until the funds are used or returned.
- Funds must be safeguarded no later than the end of the business day following the day they are received.
- Cash is received when actually received (whether by the PSP or its agent or distributor).
- For EMI’s that issue e-money prior to receipt, funds are also deemed to be received no later than 5 business days after payment is made using a payment instrument (card, account etc) unless the actual settlement occurs sooner.
Methods of Safeguarding
Institutions must choose one of two approved methods to safeguard customer funds:
Segregation
- Customer funds are kept separate from the institution’s own funds.
- Funds must be deposited into a safeguarding account held with an authorised credit institution (bank) or invested in secure, low-risk assets.
- Segregation should ensure funds are clearly identifiable as safeguarded at all times.
- 95% of firms use this method of safeguarding.
Insurance or Guarantee
- Institutions can obtain a policy of insurance or a comparable guarantee from an authorised insurer or financial institution.
- The policy must cover the full amount of customer funds.
Ring-fencing
- Safeguarded funds are ring-fenced from creditors in the event of insolvency.
- These funds must be distributed to customers in priority over other claims.
- PSPs have an obligation to top-up any shortfall in safeguarded liabilities.
Key Proposed Changes:
- Interim Rules:
- Improved record-keeping and reconciliation.
- Mandatory annual external audits for safeguarding compliance.
- Monthly regulatory reporting on safeguarding arrangements.
- Enhanced due diligence for third-party providers.
- End-State Rules:
- Imposition of a statutory trust over relevant funds, providing greater legal certainty for consumers.
- Stricter segregation of client funds.
- Restrictions on agents and distributors holding client funds.
- More detailed requirements for safeguarding using insurance or guarantees.
What is the Problem?
The FCA has evidenced problems related to wind-down, insolvency, and creditor claims to justify the proposed changes to the safeguarding regime. These examples highlight the shortcomings of the current regime and the need for enhanced consumer protection.
- Ipagoo LLP Insolvency: The Court of Appeal judgment in the case of Ipagoo LLP [2022] EWCA Civ 302 highlighted legal uncertainty regarding the status of safeguarded funds during insolvency and the lack of a statutory trust. This case underscored the need for clearer legal provisions to protect consumer funds and streamline redemption or return of funds in insolvency proceedings.
- Shortfalls in Safeguarded Funds: The FCA’s analysis revealed an average shortfall of 65% in funds owed to clients of insolvent firms between Q1 2018 and Q2 2023. This indicates a significant risk of consumer harm due to inadequate safeguarding practices.
- Delays and Difficulties in Identifying Consumer Entitlements: The FCA’s supervisory experience has shown that insolvency proceedings for payment firms often face delays and challenges in identifying and returning funds to consumers. This is attributed to poor record-keeping, reconciliation, and segregation practices.
- Increased Insolvency Costs: The complexities and inefficiencies in the current safeguarding regime can lead to increased insolvency costs, further reducing the funds available for distribution to consumers.
- Lack of Oversight of Agents and Distributors: The FCA expressed concerns about the lack of oversight of agents and distributors who may hold client funds. This can create additional risks and complexities during insolvency proceedings.
These examples, along with the FCA’s supervisory findings, provide a strong justification for the proposed changes to the safeguarding regime. The changes aim to address these issues by enhancing record-keeping, reporting, segregation, and legal certainty, ultimately leading to improved consumer protection and market integrity.
CASS Rules
Proposed changes to the Client Assets Sourcebook rules (CASS).
Interim Rules:
- CASS 15.6: Firms must establish, implement, and maintain adequate policies and procedures for safeguarding.
- CASS 15.7: Firms must keep accurate records and accounts to distinguish between relevant funds and other funds.
- CASS 15.7A: Introduction of internal and external reconciliation requirements to ensure the correct amount of funds are safeguarded.
- CASS 15.7B: Firms must investigate and resolve discrepancies identified in reconciliations.
- CASS 15.7C: Notification requirements for material issues with records, reconciliations, or safeguarding amounts.
- CASS 15.8: Maintenance of a resolution pack with specified documents for easy retrieval in case of insolvency.
End-State Rules:
- CASS 15.3: Imposition of a statutory trust over relevant funds, providing greater legal certainty for consumers.
- CASS 15.4: Relevant funds must be received into designated safeguarding accounts with approved banks, with some exceptions.
- CASS 15.5: Agents and distributors cannot receive relevant funds unless the principal firm safeguards an estimated equivalent amount.
- CASS 15.6: Updated requirements for policies and procedures to reflect the end-state rules.
- CASS 15.7, 15.7A, 15.7B, 15.7C: Reconciliation and record-keeping requirements are updated to align with the statutory trust and new safeguarding processes.
- CASS 15.8: Resolution pack requirements are updated to reflect the end-state rules.
Resolution Packs
The resolution pack requirements are aimed at ensuring that in the event of a firm’s insolvency, critical information can be quickly and easily retrieved to facilitate the timely return of funds to consumers. The proposed rules mandate that firms maintain a resolution pack containing specified documents and records, readily retrievable within 48 hours.
Key Documents and Records to be Included:
- Corporate records: Up-to-date constitutional documents, details of directors and significant shareholders.
- Governance and operational documents: Details of the firm’s governance structure, risk management framework, and operational procedures.
- Financial records: Audited accounts, management accounts, and details of any outstanding debts or liabilities.
- Safeguarding records: Records of safeguarded funds, reconciliation reports, and details of any insurance policies or guarantees.
- Customer information: Customer records, account balances, and transaction histories.
- Other relevant documents: Any other documents or information that may be relevant to the insolvency process.
Purpose of the Resolution Pack:
- To assist the insolvency practitioner: The resolution pack provides the insolvency practitioner with the necessary information to identify and distribute safeguarded funds to consumers efficiently.
- To facilitate the FCA’s oversight: The resolution pack helps the FCA to understand the firm’s financial position and safeguarding arrangements, enabling them to take appropriate action to protect consumers.
- To support the Bank of England and the FSCS: In the event of another firm’s resolution, the resolution pack can assist the Bank of England and the FSCS in their respective roles.
Key Points:
- The resolution pack requirements are designed to improve the efficiency and effectiveness of insolvency proceedings for e-money and payment firms.
- By ensuring that critical information is readily available, the resolution pack helps to minimise delays and disruptions in the return of funds to consumers.
- The resolution pack is a key component of the FCA’s proposed changes to the safeguarding regime, aimed at enhancing consumer protection and market integrity.
Practical Impact on Payment Service Providers:
- Increased Compliance Burden: Firms will need to invest in robust systems and controls to meet enhanced record-keeping, reconciliation, and reporting requirements. This will necessitate additional resources and expertise.
- Operational Changes: The end-state rules, particularly the statutory trust and stricter segregation requirements, may necessitate significant operational changes for some firms.
- Higher Costs: The costs of compliance, including external audits and potential system upgrades, will likely increase for payment service providers.
- Enhanced Consumer Protection: The proposed changes aim to minimise the risk of client fund shortfalls and expedite the return of funds in case of insolvency, leading to improved consumer protection.
- Greater Legal Certainty: The statutory trust provides a clear legal framework for safeguarding, reducing uncertainty and potential disputes.
- Strengthened Market Integrity: The stricter rules aim to improve overall market integrity and reduce risks associated with firm failures.
Timing
The proposed changes to the safeguarding requirements are planned to be implemented in two stages:
- Interim Rules: The FCA aims to publish the final interim rules within the first six months of 2025. Firms will then have a 6-month transition period to implement these changes.
- End-State Rules: These rules will come into effect when the revocation of the safeguarding requirements in the Payment Services Regulations 2017 (PSRs) and the Electronic Money Regulations 2011 (EMRs) is commenced. Firms will have a 12-month transition period to implement these end-state rules.
Impact on Banks
The proposed changes to the safeguarding regime do not apply to banks. They are specifically designed for payment service providers regulated under the Payment Services Regulations 2017 (PSRs) and Electronic Money Regulations 2011 (EMRs). This includes:
- Authorised payment institutions
- E-money institutions
- Small e-money institutions
- Credit unions that issue e-money
Banks are subject to different regulatory requirements and safeguarding provisions under the existing banking regulations.
The exact timing of the implementation of the end-state rules depends on the commencement of the revocation of the existing safeguarding requirements in the PSRs and EMRs.
