- Rules viewed as additional obligation for banks
- E-money needs to be redefined to avoid legal clash – lawyer
The Financial Conduct Authority’s (FCA) determination that e-money institutions hold customer funds on trust has triggered a debate over the legal ramifications of the decision and whether a broader shake-up of safeguarding rules should be considered.
Earlier this month, the UK regulator updated its safeguarding guidance in response to concerns that the coronavirus pandemic could push firms into bankruptcy, placing customers’ money at risk.
Payment institutions (PIs) and electronic money institutions (EMIs) are required to segregate customer funds in bank accounts or low-risk assets, or have the amount insured.
The FCA said in the finalised guidance that e-money firms hold funds in safeguarding accounts “on trust for [their] customers”, despite sharp disagreement from a leading industry association when the regulator first proposed the new wording.
The regulator also asked e-money and payment institutions to obtain letters from the credit institutions providing their safeguarding accounts, which refer to firms as “trustees” of customer funds.
The FCA said in its response to the consultation submissions that its position on payment firms acting as trustees was supported by a recent judgment in a case of collapsed payment institution Supercapital. In its ruling, the UK High Court said that in safeguarded funds held by Supercapital “all the characteristics for [a statutory] trust being in existence are present”.
Although the court’s decision applied to the Payment Services Regulations, the FCA said “we consider that the same reasoning applies to the safeguarding provisions in the [Electronic Money Regulations]”.
The Electronic Money Association (EMA), which represents EMIs across the EU, is deeply opposed to the introduction of a trust concept to safeguarded funds. In its response to the FCA’s consultation on the guidance, the EMA said that “declaring a trust over the safeguarding account of an EMI [is not] appropriate or justified”.
The EMA argued that the UK regulations, which derive from the EU’s Electronic Money Directive, only give purchasers of e-money a right over the price paid in the event of an insolvency, and not during the course of normal business.
Kai Zhang, a lawyer specialising in fintech regulation, argued that the FCA’s decision contradicts the legal definition of e-money, which treats purchases of it like any other product.
“Under the current definition of e-money, a customer essentially ‘buys’ e-money,” Zhang, associate director at law firm Bryan Cave Leighton Paisner, told VIXIO PaymentsCompliance, noting that “once her own money is paid in, it is no longer the customer’s money”.
“So it is awkward to say that the ‘money’ (paid as purchase price) continues to be held by the EMI on trust for the benefit of the customer.”
E-money would have to be redefined as a payment service in order for the customer funds to be held on trust, Zhang said. This would go against the Electronic Money Directive, but the UK would be able to make the change following Brexit.
Some have also argued that the regulator’s introduction of a trust relationship into safeguarding arrangements could unnerve the diminishing pool of banks willing to provide safeguarding accounts to payment firms.
“I think there is very genuine and very deep concern at anything that makes banks feel that it’s more complicated to provide safeguarding accounts to this sector,” Alison Donnelly, director of consultancy FSCom, said during a webinar before the final guidance was released.
“I think part of the concern has been that banks might see that if this is regarded as a trust relationship then they need to understand who the beneficiaries are in greater depth than they do at present,” she said.
“So they would want to know who the underlying customers are and be able to access that information so it’s almost like there’s additional obligations that would be tied in with providing the safeguarding account.”
However, Railsbank, a provider of banking services to the payment services and e-money sector, has called for the FCA to solve the debate by putting its view on client funds being held on trust on a comprehensive legal footing.
“E-money safeguarding regulations in the UK should sit under trust law very much like the FCA’s existing and well-regarded Client Assets Sourcebook client money regime,” Nigel Verdon, Railsbank chief executive, said in a statement earlier this month.
“That way we will avoid a similar crisis occurring in the future, where there is conflict between safeguarding in the Financial Services and Markets Act and company liquidation law under the Companies Act where the liquidator on behalf of creditors under certain circumstances can claim client money.”
This would require a redefinition of e-money, from its current status as a unit of value in and of itself to the definition as a payment service, which Verdon said has been adopted in Singapore.
Zhang said that bringing the e-money safeguarding regime under trust law “makes a lot of sense” and fits the policy rationale behind the safeguarding requirements, but clashes legally with the current definition of e-money.