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The UK’s Financial Conduct Authority (FCA) has unveiled its long-awaited proposals to overhaul the safeguarding regime for payments and e-money services.
The proposals are now subject to a public consultation until December 17, and going forward, these compliance requirements will apply to all authorised payment institutions, e-money institutions, small e-money institutions and credit unions that issue e-money in the UK under the country’s payment services and e-money regulations.
The changes aim to enhance consumer protection and market integrity by addressing what the regulator perceives as weaknesses in how firms safeguard customer funds.
The FCA's proposal includes interim and end-state rules that would provide more detailed requirements for safeguarding, ensuring funds are protected under a "CASS-style" regime in the long term.
Interim rules aim to strengthen compliance with existing regulations, improve recordkeeping and reporting, and introduce enhanced monitoring, while end-state rules will impose a statutory trust over relevant funds, ensuring consumer claims take priority over creditors in insolvency situations.
The bigger picture
Over the past few years, the payments sector has experienced substantial growth, with £1.9trn in transactions processed annually and £22bn in safeguarded funds, according to the FCA. Despite this, since 2018, there has been an average shortfall of 65 percent in client funds from insolvencies.
This highlights the urgency behind the FCA’s push for reforms, especially in light of the concerns surrounding safeguarding and insolvency risks.
The scale of these shortfalls further underscores the necessity for regulatory reforms and clarity, as well as stronger financial protection measures for consumers.
This debate has been going on for some time, and the FCA had previously made it clear that it would be looking to make changes to the rules that institutions need to abide by.
In March 2023, the regulator issued a letter to CEOs of payments and e-money firms expressing concern about safeguarding practices and wind-down arrangements in particular.
“We have identified a number of common failings in payments firms’ safeguarding,” the letter said, demanding that firms make it a top priority.
In addition, the overhaul has also likely been inspired by the Court of Appeal's ruling in the Ipagoo LLP case [2022] EWCA Civ 302, which highlighted risks within the legal framework when payments and e-money firms enter insolvency.
The court ruled that the Electronic Money Regulations (EMRs) do not establish a statutory trust over customer funds and that any shortfall in a firm's safeguarded asset pool should be topped up.
According to the FCA, this ruling has triggered uncertainty about how safeguarded funds rank against other creditor claims and lacks established legal principles to guide the process. Insolvency proceedings often result in delays and increased costs for returning funds to consumers, a problem exacerbated by similar rulings affecting the Payment Services Regulations (PSRs).
Why should you care?
These changes will no doubt overhaul business as usual for payments and e-money firms that operate in the UK.
The new proposals aim to replace the current e-money safeguarding regime with a framework similar to the Client Assets (CASS) regime , which the FCA says has been used effectively for regulating investment firms. These changes are designed to better align with the business models of payments firms and enhance the protection of customer funds.
If the proposal remains unchanged after the consultation period, the FCA’s two-stage approach will first strengthen interim safeguarding rules by mid-2025, followed by the full implementation of the new regime. These rules will be incorporated into the CASS and SUP chapters of the FCA Handbook, eventually replacing the safeguarding requirements currently outlined in the PSRs and EMRs.
The interim proposals focus on improving safeguarding practices while minimising disruption for firms.
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Enhance books and record keeping |
Firms will be required to implement robust reconciliation processes, ensuring accuracy and consistency in their handling of client funds. Additionally, they must maintain a “resolution pack” containing key information needed by an insolvency practitioner to facilitate timely return of funds to clients in the event of firm failure. |
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Improve monitoring and reporting and accountability |
Firms will be expected to conduct annual safeguarding audits to assess compliance with safeguarding rules, and introduce new monthly regulatory reporting requirements that provide detailed information on safeguarding funds and status. Additionally, firms will be required to allocate oversight of compliance with the safeguarding requirements to an individual in the payments firm. |
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Diversify safeguarding arrangements |
Firms will need to assess whether their safeguarding approach is adequately diversified across third parties. This includes carrying out due diligence on third-party custodians and ensuring funds held with these third parties are backed by acknowledgement letters. The FCA’s proposal for the end-state safeguarding regime introduce statutory trust over client funds and strengthen key aspects of the safeguarding framework: Statutory trust: All funds, assets, and insurance policies/guarantees used for safeguarding must be held on trust for the benefit of clients Clarification of the safeguarding obligations: The FCA will clarify when the safeguarding obligation begins and ends, maintaining the existing approach but introducing more prescriptive rules and guidance. Investing in secure liquid assets (SLAs): Firms can continue using SLAs for safeguarding purposes, but they must assess whether additional permissions are needed for investing client funds in SLAs. |
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Segregation of funds |
Firms must ensure all client funds are paid directly back into a designated safeguarding account with a central bank, an authorised credit institution, or a third-country authorised bank. A template acknowledgement letter is required for each account, except those used solely for accessing a payment system. |
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Agents and distributors |
Agents and distributors must either deposit client funds directly into the principal firm’s safeguarding account, or the principal firm must segregate an estimated maximum of funds likely to be held by agents/distributors in their own designated safeguarding account. |
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Insurance and comparable guarantee |
More stringent criteria will apply to this safeguarding method, with policies required to be held in trust for the benefit of clients. |
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Fixed-term accounts |
Firms will face restrictions on the use of fixed-term accounts, where funds can only be withdrawn with 31–95 days’ notice, with additional safeguards applied to such accounts. |
To help firms adjust, the FCA has proposed a timeline for compliance:
- Six months for the interim rules
- An additional 12 months for the full regime
Although the safeguarding rules are in the interest of customer protection, firms should prepare for an increased regulatory compliance cost burden. Internal processes such as recordkeeping will likely mean more administrative oversight from compliance teams, as will increased annual and monthly monitoring and audits. This could also deter new entrants to the market or force out otherwise sustainable businesses.
Partnerships are also likely to see some change, as there will be tighter rules on how firms manage customer funds. As with regulation such as the EU’s Digital Operational Resilience Act (DORA), firms need to think hard about their contracts with these partners, and will need to factor in this regulatory change going forward.
As these changes evolve, payments and e-money firms with UK operations need to keep a close eye on further guidance from the FCA, ensuring that they make timely updates to their policies and procedures.
The proposals align with the Consumer Duty, which places a clear obligation on firms to deliver good customer outcomes for retail customers, including the protection of client funds. However, the firms will need to consider the practical challenges of implementing these new rules. This could involve stricter oversight and more compliance requirements, but could also spur maturity in the sector.
For firms currently exempt, such as small payments institutions (SPIs), it is worth considering the potential benefits of voluntarily opting into the regime. With regulatory requirements evolving over time, being proactive may offer a strategic advantage, particularly as the availability of safeguarding bank accounts continues to be a challenge for many firms.
Next steps
The deadline for responses to CP24/20 is set for December 17, 2024. Following the consultation, the FCA intends to publish final interim rules, alongside a policy statement, within the first six months of 2025.
In parallel, the FCA will continue to work with HM Treasury to review and consult on the remaining elements of the safeguarding regime currently outlined in the PSRs and the EMRs. The goal is to transition these firm-facing requirements into the FCA Handbook as part of a more integrated regulatory framework.
