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The safeguarding regime for payments and e-money firms is changing. Chris Laverty and Jarred Erceg assess the implications for firms’ wind-down planning, especially for firms who use an insurance policy to safeguard relevant funds.
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The Financial Conduct Authority (FCA) has launched a consultation (CP24/20) on its proposed changes to the safeguarding regime for payments and e-money firms (collectively, payments firms) to improve custody, identification and return of safeguarded funds. The proportion of consumers using payments firms is consistently growing: from 1% in 2017 to 4% in 2020 and to 7% in 2022. The regulator is seeing an increasing number of firms with safeguarding issues, and therefore believes that changes are necessary as a greater proportion of consumers are likely to be exposed to harm if there's a shortfall in safeguarded funds, or a delay in their return to consumers.
Our colleague, Paul Staples, recently set out the case for change and an outline of the new rules in ‘Enhancing customer funds protection: Strengthening safeguards in payment firms’. The intention here is to assess the implications for firms who use an insurance policy to safeguard relevant funds, and to look at what the impact of the new rules will mean for firms’ wind-down plans.
Using an insurance policy to safeguard relevant funds
The proposed changes continue to allow for payments firms to safeguard relevant funds using an insurance policy or comparable guarantee. If a loss event occurs, such as an insolvency, the firm can claim under the insurance policy for any shortfall in relevant funds, up to the agreed cover limit.
For payments firms, the advantage of this method is that it can free up customer funds, which would otherwise need to be segregated to improve working capital. However, this needs to be weighed up against potentially costly premiums (bearing in mind that the payments sector is characterised by relatively thin margins), and the risk that the insurance policy wouldn't pay out for whatever reason.
Risks around policy renewal could impact consumers
The FCA has concerns about the ‘cliff edge’ at the end of any insurance term, and the risk this poses to consumers should the firm be unable to renew its policy. This may occur due to higher premiums or renewal not being available in the market due to lack of appetite, or the need to syndicate the risk leading to a long and costly renewal process.
In the event a firm is facing a level of financial stress due to liquidity constraints, the risk of this cliff edge may be high. The regulator is also mindful that there could be a risk of a delay in reimbursing consumers while any insurance claim is being processed following the trigger of an insolvency. This could impact vulnerable consumers who are more likely to be reliant on payments firms and have low financial resilience to losses or delays in receiving funds.
Proposed changes for firms using an insurance policy to safeguard relevant funds
The interim state measures require firms to:
have no condition or restriction on the prompt paying out of the insurance or guarantee amounts
decide whether to extend an insurance policy at least three months before the expiry of the renewal date
in the event of less than three months remaining and no policy is in place to extend cover, the firm must be able to safeguard all relevant funds using the segregation method, ie, to cash collateralise relevant funds covered under existing insurance arrangements to the expiry of that insurance
if this isn't possible, the firm should consider its financial position, including whether it would be appropriate to place the firm into administration to allow a claim to be made under the policy before the cover lapses
keep the FCA informed so they can consider taking appropriate action, including potentially the appointment of an officeholder.
The end state measures will require firms to ensure that the rights and proceeds under the insurance policy or guarantee are protected by the statutory trust. These measures will need interaction with the trustee of the trust and the insurer following any insolvency. It's unclear how practically this can be accounted for in further insurance policies as to the claimant's and insurer's expectations.
Impact on payments firms’ wind down planning
All firms should consider the interplay of the new requirements set out in CP24/20 with their wind-down plan (WDP). For example, the new resolution pack that will be introduced overlaps with the current requirement that a WDP holds information to enable a third party to quickly identify customer funds in the event of a solvent or insolvent wind-down scenario. This includes guidance of an anticipated 48-hour requirement for information to be available to any insolvency practitioner (IP) appointed.
Payments firms that utilise an insurance policy to safeguard relevant funds should include a section in their WDP demonstrating that they've considered all implications should an insurance policy not be renewed, outlining any cliff-edge risks in relation to their insurance policies. This should include identifying at what stage they would consider placing the firm in a solvent wind down, and how they would manage liquidity in the wind down should they be required to segregate safeguarded funds.
The WDP should also consider the risk if there were a delay in reimbursing customers while a claim is processed and how this would impact vulnerable customers, including how these vulnerable customers would be identified. From recent practical experience, we'd recommend that a WDP includes an operational playbook: setting out day-by-day actions including the reconciliation of relevant funds, how an insurance claim would be made, and how an IP would identify and repay vulnerable customers if required early in the insolvency.
Importantly, the WDP needs to consider how the IP will obtain control of the statutory trust or engage with the third-party trustee to support the distribution process.
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The changes included in CP24/20 signal an enhanced supervisory approach from the FCA. While many form existing FCA guidance or regulations, they're likely to pose a greater compliance burden for firms, and may require significant operational changes and potentially substantial additional costs.
Smaller firms in particular are likely to need to implement far more robust systems and controls. There'll be additional costs for the preparation of resolution packs and requirements dealing with third-party agents or identification and set-up of approved banks. There'll also be operational and legal costs in establishing designated accounts or trust arrangements that they currently have.
Senior managers need to be prepared to face increased accountability for their firms’ safeguarding practices. The greater visibility that the FCA aims to achieve as a result of these changes may well lead to greater oversight by the FCA, and this is something that firms should be prepared for.
