Payments and e-money firms in the regulatory spotlight

On March 16, the FCA issued a Dear CEO letter to payment firms, notable for its stark tone and direct language. The regulator outlines its concern that payment firms ‘do not have sufficiently robust controls’ and therefore are presenting ‘an unacceptable risk of harm to their customers and to the financial system integrity’. This risk is only exacerbated by tightening economic conditions and the cost-of-living crisis.

Actions required by payments firms

In the comprehensive ten-page letter, the FCA covers a wide range of regulatory hot topics, including safeguarding, risk management, wind-down planning, money laundering, fraud, operational resilience, Consumer Duty, ESG, and inclusion and diversity. Firms are reminded of their obligations in each area, including a list of ‘actions to take’.

There's a lot for firms to digest. But in brief, the FCA highlights three outcomes that firms must comply with, and asks them to take appropriate actions to deliver these.

The first priority is the safety of customer money, including in the event that the firm fails. To achieve this, the FCA want firms to prioritise safeguarding, prudential risk management and wind-down planning.

Firms must also ensure that they don't compromise financial system integrity. To achieve this, the FCA outlines actions firms must take to combat money laundering and fraud.

They also need to meet customers’ needs, including through high-quality products and services, competition and innovation, and robust implementation of the FCA Consumer Duty. In February 2023, the FCA issued another Dear CEO letter to payments firms outlining guidance on how to implement the Consumer Duty.

Prudential risk management a priority

The FCA focuses on financial resilience and prudential risk management as a priority. As many payment firms are unprofitable and reliant on external funding for survival, the challenging macroeconomic conditions present a heightened level of risk. Common issues identified by the regulator at payment firms include:

• a lack of appropriate liquidity risk management, including inadequate identification and quantification of liquidity risks faced by the firm
• a failure to consider whether the firm should hold capital above its regulatory requirement in order to adequately mitigate the risks it faces
• a lack of scenario planning and stress testing.

Firms are required to consider holding above the minimum capital requirement where that would be prudent based on the firms’ assessment of the risks it faces. They are referred back to the FCA’s Finalised guidance FG20/1, which provides further guidance on assessing the adequacy of financial resources.

Firms must undertake detailed scenario planning and stress testing to adequately assess risks. Forecasting likely financial performance in a range of severe, but plausible scenarios is a vital part of assessing a firm’s adequate capital and liquidity resources. This is especially important given challenging macro-economic conditions.

Management information should be at an appropriate level of granularity, which will give the Board an accurate insight into the risks facing the business in all scenarios.

Continued emphasis on wind-down planning

Despite guidance issued in July 2020 making it clear that having a wind down plan was a condition of authorisation, the FCA writes that many firms haven't yet created wind-down plans. This needs priority action by firms.

Where payment firms do have a wind-down plan in place, they frequently fail to meet FCA expectations. Again, this has been a repeated message – when the FCA reviewed plans from the payments and e-money firms in January 2021, of a sample of 14 plans, not a single one was judged to meet expected standards.

Common issues include:

• plans which appear over-optimistic about the time it would take to wind down
• insufficient detail about the steps for winding down, which impede the plan being usable in reality
• a lack of consideration of appropriate triggers for winding down
• a lack of adequate analysis of the costs and cash requirements for winding down.

Our team has advised on many wind-down plans, and these comments resonate with what we see in the market. Given the overlap in data sets and modelling capabilities, firms with good underlying liquidity stress-testing capabilities are also able to produce robust modelling of their wind down cash flows, a point emphasised in the FCA’s thematic review.

Warning from the FCA

The FCA is looking for early engagement from management on the contents of this letter and expecting management to act.

It's also important to document and evidence the action that it has taken – if a firm is unable to evidence action taken when asked by the FCA, there may be regulatory consequences.

This letter is thorough and covers many regulatory topics which presents a clear warning to firms. Should an issue arise in the future, a failure to have acted on the contents of this letter could be seen as an aggravating factor by the FCA. The regulator says it will take ‘swift and assertive’ action and is also intending to ‘act earlier and more assertively’ when problems arise.

Payments and e-money firms are in the regulatory spotlight, but sometimes it can be difficult for management to see the wood for the trees and consider what ‘good’ looks like. By seeking advice from experienced advisors on their financial modelling, stress testing and wind-down planning, firms will be best placed to meet regulatory expectations.

For more information and advice, contact Jarred Erceg.

Read more on firms' safeguarding requirements