E-Money safeguarding rules: are safeguarded funds safe?

E-money institutions have been at the forefront of financial innovation, providing convenient and accessible digital payment solutions. The safeguarding rules enshrined in the regulatory framework have been central to the success and stability of this burgeoning sector in the UK. These rules are pivotal in ensuring the protection of customer funds, a cornerstone of trust in the UK’s financial system. In this blog, I will delve into the current legal landscape governing e-money institutions in the UK, shed light on the potential risks that customers’ funds may be exposed to under the current safeguarding regime, and consider how the inherent challenges in ensuring safeguarded funds are indeed safe might be overcome.

In the UK, a company that intends to issue electronic money through its business must apply to the Financial Conduct Authority (FCA) to become either an authorised electronic money institution or a registered small electronic money institution. To date, there are over two hundred and fifty e-money firms authorised with the FCA in the UK¹ and the number of applications that the FCA has received within the space of a year has been considerably higher than this figure,² evidencing the interest in being part of this growing sector within the UK.

The UK’s Electronic Money Regulations 2011 (EMR) mandate that authorised e-money institutions safeguard “relevant funds”, being those funds received in exchange for electronic money issued.³ Safeguarding can be achieved through two methods under EMR: the segregation method and/or the insurance or comparable guarantee method. Segregating relevant funds, which I understand to be the go-to method for e-money firms, requires relevant funds to be kept separate from other funds held by an e-money firm, either in a separate account at an authorised credit institution or the Bank of England, or invested in secure, low-risk assets approved by the FCA.

While this system might seem straightforward, it has its drawbacks. Many e-money institutions opt to keep safeguarded funds in a single account with a UK bank. On the surface, this simplifies management, as opening a number of accounts for this purpose can be time consuming, administratively burdensome and costly, but it comes with risks. All client funds are concentrated within one institution, leaving e-money firms vulnerable. Recent incidents, such as the collapse of Silicon Valley Bank UK, have highlighted the potential consequences of this approach.

Consequently, the FCA’s proclamation that “safeguarding requirements are in place to protect customer funds if the institution becomes insolvent” seems in my view to focus solely on the potential insolvency of the e-money firm itself without regard to the plausible risk that it might instead be the bank holding all safeguarded funds that fails.

To safeguard relevant funds in the most effective manner, a well-diversified approach is key so that material exposures of an e-money institution are reduced. While the investment route appears promising for achieving such diversification, current FCA-approved assets are notably limited in scope, namely investments where the exposure is with the UK government or the Bank of England.⁴ This limited approach fails to recognise the wide range of highly rated UK and non-UK counterparties that exist which could be utilised for safeguarding purposes and as a means of achieving diversification to reduce exposure. A mechanism for the FCA to broaden the spectrum of viable assets for safeguarding exists,⁵ however (and to my knowledge), no other assets have been publicly approved by the FCA to date. In addition, I understand that many e-money firms do not currently have the financial infrastructure required to invest in the assets that are permitted by the FCA for safeguarding purposes. The result is that safeguarding relevant funds through a well-diversified portfolio of low-risk assets is near impossible for e-money firms under the current regulatory framework.

The FCA has expressed interest in transitioning to a Client Assets Sourcebook (CASS) like approach, which some argue could offer more robust protection for e-money institutions’ client funds. However, this route would likely significantly reduce the safeguarding options available to e-money firms; it would potentially fail to reduce an e-money firm’s credit exposure to a single bank; and it would deviate from the EU position, which may have its drawbacks. Any shift towards a CASS-like approach is not yet codified in the regulation, leaving e-money providers in a state of uncertainty.

The current regulatory regime surrounding e-money institutions therefore, while well-intentioned, poses significant risks. The lack of diversification in safeguarded funds and the over-concentration of credit risk put many e-money providers and more importantly, their customers, in a vulnerable position. The collapse of a major bank could have severe consequences for an e-money institution and might be catastrophic to the stability of the entire sector if the failing institution is a bank favoured by many large e-money firms for their safeguarding requirements.

Whilst the future of the e-money safeguarding regime remains uncertain, I will be very interested to see the direction that the FCA proposes to take as the industry continues to grow in the UK and we are yet to see what, if any, changes the FCA might make in light of the upcoming EU Payment Services Directive 3.⁶ I believe that the current regulation provides an appropriate framework for meeting the consumer protection objectives that the safeguarding rules under EMR are designed to achieve, although a widening by the FCA of the assets permissible under the investment route for safeguarding would, in my view, be a welcomed enhancement in contributing to a more robust safeguarding framework for the benefit of e-money institutions and their customers.

1. FCA E-Money Firms register, available on the FCA website, https://register.fca.org.uk/servlet/servlet.FileDownload?file=015b0000006CWmx, accessed on 21 February 2024.
2. In the period 1 April 2021 to 31 March 2022 the FCA received 352 applications: see FCA operating service metrics 2021/22, FCA website, https://www.fca.org.uk/data/fca-operating-service-metrics-2021-22, accessed on 21 February 2024.
3. The Electronic Money Regulations 2011, s.20(1) https://www.legislation.gov.uk/uksi/2011/99/regulation/20/made
4. Section 10.53 of the FCA’s Payment Services and Electronic Money – Our Approach (November 2021 (version 5)), https://www.fca.org.uk/publication/finalised-guidance/fca-approach-payment-services-electronic-money-2017.pdf accessed on 4 March 2024.
5. Section 10.54 of the FCA’s Payment Services and Electronic Money – Our Approach (November 2021 (version 5)), states that “An institution may request that we approve other assets.”. https://www.fca.org.uk/publication/finalised-guidance/fca-approach-payment-services-electronic-money-2017.pdf accessed on 4 March 2024.
6. https://ec.europa.eu/commission/presscorner/detail/en/qanda_23_3544 accessed on 11 March 2024.

*TreasurySpring’s blogs and commentaries are provided for general information purposes only, and do not constitute legal, investment or other advice.