Payments and e-money: UK FCA consults on two-stage reforms to safeguarding regime

Of particular interest to: Authorised payment institutions (PIs) and e-money institutions (EMIs), small EMIs, credit unions issuing e-money in the UK under the PSRs and EMRs, small PIs opting in to safeguarding requirements, EEA firms in supervised run-off under the financial services contracts regime (FSCR).

What should firms be thinking about and how can Hogan Lovells help?

• The FCA acknowledges that some of the proposed changes for the safeguarding regime – particularly for the second “end-state” stage - are a significant shift in how firms safeguard their relevant funds. It has tried to reflect this in the relative length of its proposed transition periods and in transitional arrangements. However, the two-stage approach that it plans to adopt could make this an even more challenging and costly change management project for affected firms.

• The exact timeline is as yet unclear. The FCA plans to publish final interim rules within the first six months of 2025. There would then be a 6-month transition period to implement the changes in the interim rules. When HMT revokes the safeguarding requirements in the EMRs and PSRs, the FCA will publish the final end-state rules (including new rules for when a payments or e-money firm fails or where a third-party used for safeguarding purposes fails). Firms would be given another 12 months to implement these additional changes.

• This article outlines some key features of the FCA’s proposals. We’re taking a deeper look at what’s planned, so watch this space for our further thoughts on what the changes could mean for payments and e-money businesses. In the meantime, if you would like to discuss how we can help you please reach out to any of the people listed in this article or your usual Hogan Lovells contact.

Key takeaways

• The proposed rules on which the FCA is now consulting will be introduced using its broader powers under the Electronic Money, Payment Card Interchange Fee and Payment Services (Amendment) Regulations 2023.

• The FCA has adapted the approaches in the existing CASS rules to reflect payment services in developing its safeguarding proposals.

• It proposes creating detailed safeguarding rules and guidance for PIs, EMIs and credit unions that issue e-money (together, Payments Firms). While some aspects look to address gaps in the current regime or align it with similar requirements in the FCA Handbook’s Client Assets Sourcebook (CASS) and Supervision Manual (SUP), other aspects codify the existing guidance in its Payment Services and E-Money Approach Document by moving relevant provisions into the Handbook.

The proposed changes to the safeguarding regime would be made in 2 stages:

• Interim-state

  • The aim is to supplement the current safeguarding requirements in the PSRs and EMRs pending legislative change.

  • The proposed rules are designed to support a greater level of compliance with existing PSRs and EMRs safeguarding requirements (note the issues outlined in the FCA’s March 2023 Portfolio letter ‘FCA priorities for payments firms’), support more consistent record keeping, and enhance reporting and monitoring requirements to identify shortfalls in relevant funds, and improve supervisory oversight.

  • Most of the proposed rules will be set out in a new Chapter 15 of CASS. New rules will also be added into SUP. A new Chapter SUP 3A will include new audit requirements and a new sub-chapter in SUP 16 will introduce the requirement for a new regulatory return to be submitted monthly by firms. Where the interim rules cover the same matters as guidance in Chapter 10 of the Approach Document, that guidance will be removed or amended to reflect the new rules.

  • Key features of the interim-state proposals are:

    • Improved books and records: more detailed record-keeping and reconciliation requirements for safeguarding, building on existing guidance and similar to existing requirements in CASS 7 for investment firms; requirement to maintain a resolution pack, including requirements on the types of documents and records to be included.

    • Enhanced monitoring and reporting: requirement to complete a new monthly regulatory return to be submitted to the FCA covering safeguarded funds and safeguarding arrangements; requirement to have compliance with safeguarding requirements audited annually, with the audit submitted to the FCA; requirement to allocate oversight of compliance with the safeguarding requirements to an individual in the Payments Firm.

    • Strengthening elements of safeguarding practices: additional safeguards where Payments Firms invest relevant funds in secure liquid assets; requirements to consider diversification of third parties with which a Payments Firm holds, deposits, insures or guarantees relevant funds that it is required to safeguard and due diligence requirements; additional safeguards and more detailed requirements on how Payments Firms can safeguard relevant funds by insurance or comparable guarantee.

  • End-state

    • The aim is that the end-state proposals will build on the interim-state changes to minimise disruption to firms.

    • The proposed rules will replace the PSRs and EMRs safeguarding requirements with a CASS style regime where relevant funds and assets are held on trust for consumers.

    • The rules in Chapter 15 of CASS which will replace the PSRs and EMRs safeguarding requirements will be amended. Any necessary consequential amendments to the Approach Document to reflect the removal of Chapter 10 will also be made.

    • Key features of the end-state proposals are:

      • Strengthening elements of safeguarding practices: more robust requirements on how Payments Firms must segregate and handle relevant funds. This will include requiring that Payments Firms 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; agents and distributors cannot receive relevant funds unless their principal Payments Firm safeguards sufficient funds in designated safeguarding accounts to cover the funds expected to be received and held by their agents or distributors.

      • Holding funds under a statutory trust: imposition of a statutory trust over relevant funds held by a Payments Firm, and relevant assets, insurance policies/guarantees and cheques (to address legal uncertainty following the judgments in Ipagoo LLP [2022] EWCA Civ 302 and Allied Wallet [2022] EWHC 1877 (Ch)); additional detail around when the safeguarding obligation starts and funds become subject to the trust; creation of a single asset pool for those EMIs who issue e-money and provide payment services that are not connected to issuing e-money (with the aim of making safeguarding cheaper and simpler for these firms); the current requirement that firms must safeguard unclaimed balances for at least 6 years will be retained but the proposed terms of the statutory trust would give firms another option of gifting them to charity if certain conditions were met (although still subject to any legal right of the consumer to return of the funds).  Firms will be required to get acknowledgement letters from third parties to reflect that the relevant funds are now held on trust.

• Chapter 3 of the consultation contains a full summary of the proposed CASS and SUP rules for both interim and end state. Table 1 at paragraph 3.8 summarises the key proposals. The proposed new CASS rules are in Annex B to Appendix 1 and the proposed new SUP rules are in Annex C. In the interim rules “[to follow]” indicates text that will be inserted by the end-state rules.

• Firms are reminded that, notwithstanding the proposed changes to the safeguarding regime, they will need to continue to have regard to their Consumer Duty obligations. This includes highlighting where appropriate that they are not banks, and that funds which they hold are protected by safeguarding arrangements rather than by the FSCS (see also the FCA’s February 2023 Dear CEO letter).

• Further consultation to follow: The FCA is planning to consult separately on the following before implementing the end-state rules:

  • rules for where a Payments Firm fails and enters an insolvency procedure other than the Payments and Electronic Money Special Administration Regime (PESAR) (established by the Payment and Electronic Money Institution Insolvency Regulations 2021), which will specify how to distribute funds to consumers when a firm fails; and

  • rules to mitigate the impact of the failure of a third party used for safeguarding purposes.

• Implementation: Firms would have a transition period of 6 months to implement the changes in the interim rules from when the final version is published. When the revocation of the safeguarding requirements in the EMRs and PSRs is commenced, the FCA will publish the final end-state rules (including new rules for when a Payments Firm fails or where a third-party used for safeguarding purposes fails – see ‘Further consultation to follow’ above). Firms would be given another 12 months to implement these additional changes in recognition that they are likely to need to make more significant changes to implement them.

• Transitional arrangements: Proposed transitional provisions for both the interim and end-state rules include:

Interim-state transitional provisions

• The new CASS rules will not apply to a Payments Firm if an insolvency event happens before they come into force.

• Payments Firms will be required to periodically review their use of third parties for safeguarding purposes. Existing arrangements will have to be reviewed within 3 months of the rules coming into force.

• The proposed new conditions that have to be met to use insurance policies or comparable guarantees will not apply to an insurance policy or guarantee obtained before the rules come into force, provided it was obtained in line with the relevant requirements in the PSRs and EMRs. However, they will apply if the policy or guarantee is renewed or extended.

End-state transitional provisions

• The amendments to the CASS rules will not apply to a Payments Firm if a primary pooling event happens before they come into force.

• The imposition of the trust will apply to funds and assets held at the time the rules come into effect. This is to avoid a situation where those funds and assets would not be subject to any safeguarding regime when the revocation of the current regime in the PSRs and EMRs is commenced.

What’s next?

The consultation closes on 17 December 2024. The FCA plans to publish final interim rules with an accompanying policy statement within the first six months of 2025. See ‘Implementation’ above for more on next steps.

The FCA does not intend to consult separately on the changes to the Approach Document mentioned above as they are consequential to the proposed rules.

The FCA will continue to work with HMT to review and consult on the rest of the current PSRs and EMRs regime, with a view to moving the firm facing requirements into the Handbook.

We’re looking into the FCA’s proposals in more depth. Watch this space for our further thoughts on what the changes could mean for payments and e-money businesses.