Crown Currency Exchange, a business based in Cornwall that sold currency mainly to consumers for holiday spending but was also a small payment institution, collapsed on 4 October 2010 owing £22 million to more than 12,000 customers. In the days and weeks that followed there were, naturally, many angry questions put to the government and the regulator, the Financial Services Authority (FSA), by those who lost money and their representatives as to why this was able to happen.
One of the many questions posed was why, when consumers could clearly see the FSA’s logo on the business’s website, was their money not covered by the compensation scheme.
In the UK, if your UK-authorised bank or building society goes bust, you can apply to the Financial Services Compensation Scheme (FSCS) for reimbursement up to £85,000, or £170,000 if the money was held in a joint account (balances up to £1 million are also covered in certain cases where the funds are held in the account temporarily, for example because of the sale of a home). This compensation scheme also kicks in if a credit union, mortgage adviser, investment firm, pension provider, insurance company or debt management company fails, but not if a payment institution or an e-money institution collapse.[1]
When a payment or e-money institution collapses
If that happens, you have to rely on the payment institution or e-money institution having ‘safeguarded’ the funds it holds for you. The safeguarding provisions are stipulated by the second Payments Services Directive (PSD2) and the second Electronic Money Directive (EMD2), implemented through the Payment Services Regulations 2017 (PSRs) and the Electronic Money Regulations 2011 (EMRs) and interpreted by the regulator, the Financial Conduct Authority (FCA), in their approach document. They require authorised payment institutions, authorised e-money institutions and registered small e-money institutions to either hold funds received from customers for payment services or e-money separately from all other funds and place them in a special account held with an European Economic Area (EEA)-authorised bank or to cover the funds with an insurance or guarantee policy.
The vast majority of payment and e-money institutions opt to segregate their funds and keep them in the special safeguarding account, mainly because this has been the only option available to them until recently.[2]
The legislative requirements for this safeguarding method are straightforward but, as is often the case, the devil is in the detail of the interpretation. As I have set out in detail previously,[3] and has been illustrated by the FCA’s report of its thematic review of safeguarding,[4] the implementation of the safeguarding rules into the real life scenarios of the various business models, is very difficult and many firms are struggling to meet the FCA’s expectations.
The difficulty with interpreting the rules
In some business models, it’s difficult to agree when funds should be safeguarded. For others, difficulties arise in immediately stripping profit and fees from the funds as they arrive from payment service users throughout the day, 24/7. And what surprises those new to safeguarding the most is that the FCA says that over-safeguarding (putting too much money into the special safeguarding account) is as bad as under-safeguarding because a judge may decide, in the event of the insolvency, that the funds in the account actually belong to the company, even though they are clearly marked and documented as being held for the benefit of its payment service users!
To further illustrate my point, consider an example. The legislation is clear when the safeguarding obligation begins (on receipt of the funds) but doesn’t clearly specify when the obligation ends. The FCA’s approach document states that it remains in place until the funds are ‘paid out’ to the payee or the payee’s payment service provider (PSP).
‘Paid out’ isn’t defined but we’re going to assume it means when the instruction is given for the funds to be taken from the payment or e-money institution’s account for sending to the payee, rather than when the payee actually receives the funds into their account (though this has been the subject of much discussion already with conflicting guidance coming from the FCA).
The difficulty arises when the payment or e-money institution wants to use a correspondent to hold or move the funds for them because it is cheaper and quicker. If the correspondent is not a bank or is outside of the EEA, the payment or e-money institution cannot safeguard with the correspondent (because it is not a credit institution in the EEA). Instead, it will have to either hold matching funds in their EEA-authorised safeguarding account or cover it with insurance/a guarantee, both of which come with increased cost.
There are three solutions to this problem.
- One is to allow non-bank PSPs to be able to safeguard for the underlying payment service user without entering into the contract.
- The second is that payment and e-money institutions should be allowed to safeguard with credit institutions anywhere in the world[5], providing the institutions meet specific criteria. This is, in fact, what will be the case for UK payment and e-money institutions when the implementation period comes to an end following Brexit.
- The third is to allow the customers of payment and e-money institutions the benefit of coverage by the FSCS. This brings me back to the reason I mentioned Crown Currency Exchange. As a payments policy specialist in the FSA at the time, I was involved in working with HM Treasury to consider the options. The extension of FSCS coverage was considered and dismissed, as it had been when we implemented the second E-money Directive the year before, for being expensive and operationally complex.
No easy answer to protecting consumers’ money
However, the FCA’s findings in respect of how poorly safeguarding is implemented at present demonstrates there is no easy answer to this essential objective of consumer protection. This raises the importance of formalising the protection scheme so that protection is no longer left to chance but is guaranteed. The overwhelming problem with the method currently used by most payment and e-money institutions is that it relies on the safeguarding procedure being correct and properly followed on the day the payment or e-money institution calls in the administrator. Let’s face it, running the safeguarding procedure on that day is unlikely to be the top priority.
This article is part of a collection from the EPA’s whitepaper ‘The Future of Payments Regulation: Voices of the EPA’. The whitepaper has been written by me and fellow members of the EPA’s Project Regulator as we hope to start an important discussion on the future landscape of payments legislation. To download the full document hot off the press click here: https://www.emergingpayments.org/article/the-future-of-payments-regulation-voices-of-the-epa/
[1] For example, see https://www.fscs.org.uk/news/firm-news/premier-fx-limited-customers/ for a statement from FSCS regarding Premier FX, an authorised payment institution, also with permission for money remittance only, that went into administration in August 2018.
[2] While there are very few EEA-authorised credit institutions that serve the payment and e-money institution sector with accounts, there is even fewer providers of insurance/guarantee policies. The difficulty in securing safeguarding accounts is a significant and well documented problem.
[3] Payment Services: Making Safeguarding Work
[4] Dear CEO: Safeguarding attestation required by 31 July 2019
[5] Under the directives, safeguarding accounts can only be held with EEA-authorised banks.
