Summary of what's happening

On 25th September 2024, the Financial Conduct Authority (FCA) published a consultation with their proposed changes to existing safeguarding rules that apply to authorised electronic money institutions (EMIs) and payment institutions (PIs).

The ultimate goal is to make the safeguarding rules stronger and clearer for payment and e-money firms which in turn will hopefully minimise shortfalls in safeguarded funds and help ensure a timely repatriation of money to customers should an EMI or PI fail.

The FCA's proposals are structured around two main stages:

• Interim rules, which aim to improve record keeping, enhanced reporting obligations, additional monitoring through an external safeguarding auditor, improve governance and operational practices; and
• End-state rules, which envisage a transition of the safeguarding rules into a Client Asset Sourcebook (CASS) style rule-based regime and introduce a statutory trust over relevant funds, liquid assets, the proceeds of any claim under a safeguarding insurance policy or guarantee and any cheques and other payable instruments received for the execution of a payment transaction or purchase of e-money.

The deadline to respond is 17 December 2024. The FCA plan to publish final interim rules with an accompanying policy statement within the first six months of 2025.

In Detail

Key Proposals

Under the consultation, the FCA proposed the following key changes:

1.    Improved record-keeping and reconciliation requirements

• Whilst firms have been expected to have in place policies and procedures for complying with the safeguarding regime and to maintain accurate records, much of this detail has been set out in FCA guidance. The FCA is proposing to codify existing expectations, with the aim of strengthening the status of the requirements.
• Firms will be required to perform reconciliations based on the values contained in their internal records and ledgers at least once each business day to ensure they are safeguarding the correct amount of relevant funds.
• Where relevant funds are held with external third parties, reconciliations will be required at least once a day on those balances and compared to the internal records.
• If discrepancies are identified, firms will need to determine the reason for those discrepancies and resolve it.
• As part of record-keeping, firms will also be mandated to keep a resolution pack to ensure that they maintain and can retrieve the information, primarily to assist insolvency practitioners in promptly identifying and returning relevant funds to consumers. According to the proposed rules, specified documents must be retrievable within 48 hours.

2.    Enhanced monitoring and reporting

• Firms will need to notify the FCA (in writing and without delay) if: (i) their internal records are materially out of date, inaccurate or invalid; (ii) they will be unable to perform a reconciliation; (iii) they cannot resolve a discrepancy arising out of a reconciliation; or (iv) if, at any time during the previous year, there was a material difference between the amount which the firm should have been but actually was safeguarding.
• Firms will be required to submit a new monthly regulatory return in relation to its safeguarding processes, including whether shortfalls have been identified from reconciliation processes and the actions taken.
• Appoint an annual audit of their compliance with safeguarding requirements. This audit will adhere to a standard set by the Financial Reporting Council and must be submitted to the FCA.
• Firms are also required to appoint an individual within the firm that will be responsible for ensuring compliance with the safeguarding requirements.

3.    Strengthening elements of safeguarding practices

• They must also periodically reassess their third-party relationships, consider diversifying these relationships, and ensure non-designated safeguarding accounts are clearly marked for safeguarding purposes, using the term ‘safeguarding’ in account names where possible.

4.    Holding funds under statutory trust

• A requirement that Payment Firms using the segregation method receive relevant funds directly into the designated safeguarding account, except where funds are received through an acquirer or another account used to access payment schemes.
• The imposition of a statutory trust over relevant funds, liquid assets, the proceeds of any claim under a safeguarding insurance policy or guarantee and any cheques and other payable instruments received for the execution of a payment transaction or purchase of e-money.
• Where relevant funds are received by agents or distributors of e-money, the firm must safeguard in the designated safeguarding account prior to sufficient funds to cover the anticipated agent/distributor receipts, using its own funds.

What does this mean for EMIs and PIs?

For EMIs and PIs, the FCA's consultation represents a pivotal shift in regulatory expectations and operational requirements. Here's what it means for these firms:

1.    Increased Operational Costs: Implementing the new safeguarding measures, including the statutory trust arrangement and enhanced record-keeping requirements, may result in increased operational costs for EMIs and PIs. Firms will need to invest in system upgrades, staff training, and potentially, external auditing services to ensure compliance.

2.    Audit and Reporting Requirements: The requirement for annual audits of safeguarding arrangements and the introduction of a new monthly regulatory return will increase the regulatory reporting burden on EMIs and PIs. Firms should be prepared for more frequent and detailed scrutiny of their safeguarding practices.

3.    Greater Accountability: Firms will need to appoint a person responsible for ensuring compliance with the new regime. If the end-state rules come in, we expect they will be coupled with a new regulatory framework which will also introduce the FSMA Senior Managers Regime to EMIs and PIs. In all likelihood, in time, this will mean the person responsible for safeguarding will be expected to take on personal liability for failures.

4.    Arrangements with Agents and Distributors: Existing models of using agents and distributors for e-money solutions will need reviewing. Funds flows may need to be updated or contractual arrangements tightened to back-off the additional risk exposure the EMI will encounter if it needs to "top-up" relevant funds while funds received through agents and distributors are in flight.

5.    Statutory Trust: The impact of this on existing business models needs to be considered carefully.