Prompted by the COVID-19 crisis, the FCA is consulting on temporary guidance which will apply to payment service providers (PSPs) and electronic money institutions (EMIs). While the proposed guidance focuses on safeguarding obligations, it also addresses the management of prudential risk and the requirements for wind-down plans. Feedback for the consultation can be submitted up until 5 June 2020 by emailing [email protected]

Why has the FCA proposed this guidance?

Although the COVID-19 crisis has been the immediate cause of the FCA's proposed guidance, payment services and electronic money has been a general supervisory focus of the FCA since its most recent business plan published for 2020/21. Some of the reasons for this include:

  • a significant number of a new firms and products entering the market;
  • the fact that many PSPs and EMIs grow rapidly and without profitability while seeking to increase their market share; and 
  • a concern that some PSPs and EMIs are not complying with their regulatory obligations particularly in relation to safeguarding in terms of fund commingling, record keeping and risk management procedures.

The COVID-19 crisis has therefore prompted the FCA to examine the safeguarding requirements applicable to PSPs and EMIs. The priority of the FCA is to ensure that the current crisis does not jeopardise the protection of consumer funds.

What is the status of the guidance?

Following the feedback received during the consultation period, the FCA will issue its guidance in the form of a 'Dear CEO' letter. Later in the year, the FCA will propose to integrate the contents of the letter (prompted by the immediate concerns caused by the COVID-19 crisis) into its Approach Document on Payment Services and Electronic Money (Approach Document). 

What guidance does the FCA propose to issue in relation to safeguarding?

Both PSPs and EMIs are subject to strict rules which require that funds held for customers are safeguarded. The rules setting out how the funds must be safeguarded are contained in the UK's Payment Services Regulations 2017 (PSRs) and Electronic Money Regulations 2011 (EMRs), as supplemented by the guidance in the Approach Document.

The following measures in relation to safeguarding will be set out in the proposed guidance:

  • As already indicated in the Approach Document, the FCA confirms that PSPs and EMIs must document, and provide a rationale for, their reconciliation processes to assist with the distribution of funds in an insolvency situation;
  • Guidance in the Approach Document already requires PSPs and EMIs to notify the FCA of any material non-compliance with safeguarding requirements or where reconciliation of discrepancies cannot be achieved.  The proposed guidance sets out examples of the types of circumstances requiring notification: (i) not keeping records of relevant funds and safeguarding accounts, and (ii) the inability to comply with safeguarding due to a closure of the safeguarding account held with the credit institution;
  • The Approach Document requires that the safeguarding account must be appropriately named to indicate that the purpose of the account. In the proposed guidance, the FCA is further requiring that (i) the name of the account should, where possible, include the word 'safeguarding' or 'client' and (ii) PSPs and EMI should obtain a letter of acknowledgement from the credit institution or custodian confirming that the credit institution or custodian has no interest in or right over the account but rather acts as a trustee (the FCA has provided a template acknowledgement here).
  • The FCA has confirmed in its proposed guidance the importance of the ensuring that the safeguarding account only contains relevant funds (i.e. funds held by the PSP or EMI for a customer) and no other funds;
  • As part of their due diligence obligations in relation to selecting a credit institution, custodian or insurer to perform the safeguarding function, PSPs and EMIs are required to carry out periodic reviews of this other party. These reviews should be carried out following any material changes (e.g. a credit downgrade) and no less than annually;
  • Where an EMI issues e-money and allows a customers to use that e-money to make payment transactions before the customer’s funds are credited or otherwise, the EMI must not treat relevant funds it is required to safeguard as being available to meet its scheme commitments;
  • The proposed guidance confirms that when a PSP or EMI receives funds from an unidentified customer (e.g. due to an incorrect identifier being supplied), such funds are not relevant funds for the purposes of the safeguarding rules. Instead, these funds must be segregated from the PSP or EMI's own funds and any other relevant funds, and placed into a separate account until the customer can be identified. Further, the proposed guidance confirms that the e-money on low value pre-paid gift cards will be relevant funds regardless of whether the customer is identifiable;
  • If PSPs and EMIs are subject to the requirement to be audited, the proposed guidance requires the PSP or EMI to arrange a specific audit in relation to compliance with the requirements under the PSRs or EMR. This audit should be conducted annually or upon any material change in relation to safeguarding (e.g. changing to using the insurance method of safeguarding). Firms should use due skill, care and diligence in selecting the auditor; and
  • PSPs and EMIs must not, under the proposed guidance, make misleading claims as to the protections afforded by the safeguarding.

What guidance does the FCA propose to issue in relation to the management of prudential risk?

The following measures in relation to the management of prudential risk will be set out in the proposed guidance:

  • PSPs (when an authorised payment institution) and EMIs must have robust governance arrangements, effective procedures and adequate internal control mechanisms;
  • PSPs and EMIs must regularly calculate their capital requirements and report these correctly to the FCA;
  • PSPs and EMIs should carry out liquidity and capital stress testing to  analyse their exposure to severe business disruption, with a view to mitigating such risks by making appropriate decisions in relation to liquidity and capital resources; and
  • Firms should assess whether they have sufficient liquidity and funding to remain solvent (or whether a committed facility is required).

What guidance does the FCA propose to issue in relation to wind-down plans? 
The proposed guidance requires PSPs and EMIs to have in place an effective wind-down plan in response to liquidity and resolution risks (under both solvent and insolvent scenarios). The plan would address:

  • Funding to cover a solvent wind-down, including the triggers for a solvent wind-down;
  • The need for counterparties to find alternative providers; and
  • Further triggers for seeking advice during the insolvency process and information to help an administrator or liquidator quickly identify and return customer funds.

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