In this second article in our series about the FCA’s consultation on changes to the safeguarding regime for payments and e-money firms, we look at the FCA’s proposals to strengthen elements of safeguarding practices.

Under the current safeguarding requirements, firms may safeguard relevant funds by either segregating them or protecting them through an insurance policy or comparable guarantee. Segregation is used by more than 95% of firms.

The FCA has said that it is concerned that many firms do not have sufficiently robust safeguarding practices in place. It has also stated that there is insufficient detail in the current safeguarding requirements to ensure that a consistent standard is applied across the industry. These inconsistent standards and poor practices mean that relevant funds may not be appropriately protected if a firm becomes insolvent.

Changes to safeguarding requirements proposed by the FCA are aimed at minimising risk through increased rules on due diligence and risk diversification. It is anticipated that the strengthened safeguarding requirements will also result in funds being more quickly returned to customers in the event of a firm’s failure. The FCA considers these changes will create a level playing field for all firms which must comply with the same base standards.

Segregation of relevant funds

The FCA has concerns regarding insufficient oversight and due diligence by firms on third parties which hold relevant assets, and highlights the risk that funds which cannot be clearly identified will cause a delay in returning those funds to customers in the event of insolvency. Further, the FCA has raised concerns around contagion, particularly where there is a chain of accounts, which is exacerbated if funds are held with other payment firms prior to segregation because of the relatively higher risk of failure of such firms. 

Insurance and comparable guarantees

The FCA is concerned with the “cliff-edge” at the end of an insurance or guarantee term if a firm cannot renew its policy or opts not to renew due to increased premiums. Additionally, there is a potential delay in reimbursing consumers while claims are being processed.

Acknowledgement letters

The FCA is concerned that there is no express prohibition on third parties having interests in or rights over funds held outside a designated safeguarding account before the obligation to safeguard relevant funds arises. This means that there is a risk that third-party rights are asserted over funds, and costly and time-consuming disputes occur in the event of an insolvency. This will partly be addressed by the requirement of firms to receive funds directly into a designated safeguarding account in the end state rules. Additionally, acknowledgement letters provided by an authorised credit institution or authorised custodian stating that they have no interest in, recourse against, or right over the relevant funds or assets in the safeguarding account are intended to reduce this risk.

Allocating funds

The FCA is concerned that funds which are not yet placed into a safeguarding account cause risk to consumers, particularly where funds are held in transaction accounts held with other payments firms. This is because these firms have lower prudential requirements and are not protected by the FSCS. Depositing these funds with payment firms also causes a higher risk of contagion which is exacerbated by the higher failure risk of payments firms.

Agents and distributors

The FCA is concerned that, where firms receive and hold funds through an agent or distributor, additional complications may arise if a firm fails. For example, because there are no detailed requirements on how funds are held with an agent or distributor, there is a risk that, if accounts are not in the principal firm’s name, there may be a delay in fund identification. The FCA also has concerns regarding insufficient oversight and due diligence by firms on their agents and distributors.

Secure liquid assets

The FCA notes that some firms experience difficulties accessing safeguarding accounts with credit institutions. This is in part due to the risk appetite of credit institutions. As a result, firms may rely more on safeguarding through investing in secure liquid assets. In the event of firm failure, or high volumes of redemption of e-money, the assets will need to be capable of quick sale, with the proceeds used to meet consumer entitlements.

What does this mean for you?

To comply with the new FCA rules, you will need to review your current policies, processes and procedures for fund allocation, due diligence and periodic reviews of third-party appointments, and diversifying investments and managing risk (in respect of segregated funds and funds invested in secure liquid assets), to ensure compliance with the new requirements. This may highlight the need for operational changes, such as ensuring that the payment flow of relevant funds is compliant with the new requirements.

Firms using the segregation method for safeguarding will need to review and update account names where necessary to ensure compliance. Records of due diligence and periodic review of the safeguarding account providers should be documented for any FCA requests.

Acknowledgement letters will need to be drafted and executed (even where they are currently held using the FCA’s current sample wording), and periodically reconciled to ensure letters are in place and are accurate for safeguarding accounts. The new CASS 15 rules require precise account descriptions and identification, possibly triggering a remediation exercise. Further, firms using vIBANs for client fund identification must review these arrangements to ensure compliance with the new rules.

Firms using the insurance method for safeguarding are likely to face significant changes to address the new rules that are being proposed by the FCA. They will need to review insurance policies to ensure they comply with relevant requirements. Where necessary, they may need to negotiate with insurance providers or guarantors to amend policy terms for compliance. Going forwards, firms will need to implement a process for reviewing and planning next steps before a policy expires. This is going to have to occur well in advance of policy renewal and will require the firm to consider how its plans for policy renewal interplay with its wind-down plans. They will also need to establish a clear, actionable programme for being able to move to safeguarding using the segregation method if they are unable, or choose not to, renew an insurance policy at the end of its term.

Firms will also need to review and adjust the segregation of funds managed by agents or distributors to ensure compliance with new rules in the end state. If direct deposit into safeguarding accounts is not feasible, firms may need external funding to pre-fund these accounts, especially for dispersed or overseas agent networks. An assessment will be needed to determine if these rule changes affect the commercial viability of current agency and distributor networks, and should cause firms to more closely assess the risks that these networks pose to its business. Firms may want to consider whether enhanced due diligence and ongoing monitoring of agents and distributors is required as the firm will be taking the credit risk on the agent/distributor if it is required to pre-fund the safeguarding account. Alternatively, an insurance policy could be used for safeguarding funds collected through agents/distributors but, as noted above, the use of an insurance policy is likely to significantly increase the compliance burden for firms.

As these changes may have an impact on the method a firm chooses to use to safeguard customer funds, it is important that you carefully consider the impact of these reforms on your business model now and are ready to react quickly to the changes once the FCA’s final proposals are published.

1. Regs. 23 PSRs and 21 EMRs↩
2. Para. 10.46 to 10.47 and Annex 6 of the FCA’s Approach Document.↩
3. Reg. 23(5), (6) PSRs and reg. 21(1), (2), EMRs↩
4. Para. 10.32 of the FCA’s Approach Document.↩