FCA proposes new safeguarding rules for payments firms

What does this mean?

The FCA notes that while the use of payments and electronic money firms has grown in recent years, the regulator continues to see poor safeguarding practices from these firms. Funds held by these firms are not directly protected by the Financial Services Compensation Scheme (FSCS). Instead, firms must safeguard funds, to avoid customers losing money and minimise delays in getting their money returned if the firm fails. 

However, for firms that became insolvent between Q1 2018 and Q2 2023, there was an average shortfall of 65% in funds owed to clients, i.e., the difference between funds owed and funds safeguarded. As a result, the FCA proposes to make the new rules stronger and clearer for payments and e-money firms, to ensure customers get as much of their money back as quickly as possible if the firm goes out of business. 

The FCA proposes to make changes in two stages. The consultation covers both stages of the proposed regime. In the interim-state, in advance of legislative change, the FCA’s proposed rules will supplement the current safeguarding requirements in the Payment Services Regulations 2017 (PSRs) and E-Money Regulations 2011 (EMRs). In the end-state, the rules will entirely replace the current safeguarding requirements in the PSRs and EMRs, when their revocation is commenced.

Interim-state proposals

Improved books and records

• More detailed record-keeping and reconciliation requirements for safeguarding. This would build on existing guidance and be similar to existing requirements set out 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

• Further details to ensure consistency with respect to the requirement to have compliance with safeguarding requirements audited annually, with the audit submitted to the FCA.

• Requirement to complete a new monthly regulatory return, submitted to the FCA and covering safeguarded funds and safeguarding arrangements.

• 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 payments firms hold, deposit, insure or guarantee funds that payments firms are required to safeguard, as well as enhanced due diligence requirements. 

• Additional safeguards and more detailed requirements on how payments firms can safeguard relevant funds by insurance or comparable guarantee. 

End-state proposals

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.

• Additional detail around when the safeguarding obligation starts and funds become subject to the trust.

Once the new rules have been published, the FCA proposes to give firms six months to implement the interim-state rules and 12 months to implement the end-state rules. Firms will also be required to periodically review their use of third parties for safeguarding purposes. They will be required to review existing arrangements within three months of the rules coming into force.

Small payments institutions will continue to be able to opt-in to comply with safeguarding requirements on a voluntary basis. Small e-money institutions and credit unions (that are required to safeguard funds received in exchange for e-money) will also continue to be able to opt-in to the safeguarding requirements for any unrelated payment services.

The FCA’s proposed rules will apply to European Economic Area firms in supervised run-off under the financial services contracts regime. The rules will not apply to firms subject to unsupervised ‘contract run off’.

What do firms need to do?

The consultation sets out the FCA’s intent to overhaul the existing safeguarding rules. While the new rules will not be confirmed until 2025, firms should start preparing early and undertake a full gap analysis against their existing compliance processes.

Many firms will need to restructure their approaches to safeguarding, including cash collection, reconciliations, control frameworks, and documentation. 

The new obligations are expected to be detailed and prescriptive. Firms should assess how their existing controls would comply with the more nuanced rules compared to those in place today. 

The annual audit requirements will also look and feel different for many payments and e-money firms, as most firms have not yet been subject to formal assurance by audit firms. We recommend firms to engage early to prepare for the audits.

Next steps

The consultation closes on 17 December 2024. The FCA will publish final interim-state rules with an accompanying policy statement during the first half of 2025.