FCA consults on changes to the payments safeguarding regime

Under the Payment Services Regulations 2017 (PSRs) and the E-Money Regulations 2011 (EMRs) payment institutions (PIs), electronic money institutions (EMIs), small EMIs and credit unions are required to protect "relevant funds" which they receive when making a payment or in exchange for e-money that has been issued.

Current safeguarding requirements are set out in the PSRs and EMRs, with guidance contained in the Financial Conduct Authority's (FCA) Approach Document.

The FCA has long held concerns about the adequacy of the current payments safeguarding requirements and the impact this has on consumers, in particular those with characteristics of vulnerability. Although the FCA has issued guidance on safeguarding for payments firms, it is concerned that poor practices still exist across the industry. These have resulted in significant consumer harm where payments firms have entered insolvency as they have, for instance, led to shortfalls in the safeguarded funds held or delays in funds being returned to consumers. FSCS cover also does not apply in these situations which, added to the risks highlighted above, may mean that consumers lose money when a payments firm fails.

The FCA is also concerned about the risk of harm from the current legal framework, particularly following the Ipagoo and Allied Wallet judgments which have led to confusion and misinterpretation of the current requirements and have raised many questions as to the status of safeguarded funds on insolvency.

As a consequence, the FCA recently published its long-awaited consultation on proposed changes to the safeguarding regime for payments and e-money firms.

In its consultation, the FCA proposes radical reforms which will ultimately replace the existing requirements with a new CASS-style regime. The proposals represent a significant shift in how payments firms safeguard funds but the regulator says the changes will improve practices across the sector and minimise the risk of consumer harm.

The changes will be made in two stages – interim rules will provide clarity on (and support a greater level of compliance with) the existing requirements and end-state rules will replace the existing requirements and require relevant funds and assets to be held on trust.

Key proposed changes include:

Interim-state proposed rules

• more detailed record-keeping and reconciliation requirements building on existing guidance (these will be similar to CASS 7 for investment firms)
• requirement for firms to maintain a resolution pack
• new monthly regulatory return and annual audit requirement
• requirement for firms to allocate oversight of compliance with safeguarding requirements to a specified individual
• additional safeguards where firms invest funds in secure liquid assets
• requirement for firms to consider diversification of third parties with which they hold, deposit, insure or guarantee relevant funds and to undertake due diligence
• more detailed requirements on safeguarding by insurance or comparable guarantee

End-state proposed rules (CASS-style regime)

• requirement for firms to receive relevant funds directly into an appropriately designated account at an approved bank (except where funds are received through an acquirer or an account used to participate in a payment system)
• a ban on agents and distributors receiving relevant funds unless their principal safeguards sufficient equivalent funds in designated safeguarding accounts
• imposition of a statutory trust over relevant funds held by payments firms, and relevant assets, insurance policies/guarantees and cheques
• more detail around when the safeguarding obligation starts and when funds become subject to the trust

The new rules will apply to PIs, EMIs, small EMIs and relevant credit unions, and small PIs will be able to opt-in (as they can currently).

What's next?

The consultation closes on 17 December 2024 and the FCA plans to publish its final interim rules in H1 2025.

It is anticipated that firms will have a 6 month implementation window before the interim rules come into effect so firms should start to consider the impact these rule changes will have on their operational processes and governance.