On March 16, 2023, the UK Financial Conduct Authority (the FCA) published a letter1 to the CEOs of UK electronic money and payment institutions (payments firms) setting out the FCA’s current priorities for the UK payments sector. The letter gives a timely reminder of, among other things, the importance of ensuring that customer funds are protected in the event of the insolvency of payment firms.
Safeguarding Client Funds
The FCA’s first priority is that payments firms have adequate arrangements in place to ensure that if they become insolvent, customer funds are protected. UK rules require payments firms to protect customer funds received for the issue of e-money and/or the provision of payment services either by taking out adequate insurance coverage or a comparable guarantee, or by holding those funds in an insolvency remote, segregated account at a bank. The FCA notes that if customer funds are not adequately safeguarded, returning those funds could take longer than is necessary and/or customers could receive less than par in return.
Common failings that could lead to this outcome include inadequately documented processes for consistently identifying which funds must be safeguarded, inadequate reconciliation procedures to ensure that the correct sums are protected on an ongoing basis, and a lack of due diligence and acknowledgement of segregation from banks providing safeguarding accounts.
The FCA uses the letter to remind payments firms that they are required to comply with the UK safeguarding regime, in particular by:
- appropriately documenting the firm’s process to identify which funds must be safeguarded;
- undertaking internal and external reconciliations at least once a day to ensure that safeguarded funds are adequate and not excessive;
- ensuring that the accounts in which relevant funds are held (or the insurance policy or comparable guarantee) meet the FCA’s requirements and are supported by the appropriate documentary evidence; and
- maintaining appropriate records to enable the firm or a third party, such as an insolvency practitioner, to identify the customer relating to which funds it holds.
Financial Resilience and Prudential Risk Management
The FCA’s second priority is that payments firms ensure they are financially resilient and have sound prudential risk management in place. In a pointed remark, the FCA observes that this is of particular relevance to payments firms that are unprofitable and reliant on external funding for survival.
Common issues in this area that the FCA sees include a lack of appropriate liquidity risk management, 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, and a lack of scenario planning and stress-testing.
The FCA expects firms to review their prudential risk management arrangements on a regular basis, and, in particular, expects firms to:
- meet their regulatory capital requirement at all times;
- consider the particular financial risks they face, based on the business model it operates, and consider how those risks may be heightened by macroeconomic conditions;
- set or review their risk appetite, including key risk indicators;
- forecast likely financial performance in a range of plausible scenarios, including stressed scenarios, and use this analysis to validate their assessment of adequate capital and liquidity resources;
- consider holding additional capital above the minimum requirement under the UK payments regime where that would be prudent based on their assessment of the risks they face; and
- plan well ahead to ensure they have adequate financial resources on an ongoing basis. This may include arranging access to additional resources, such as credit lines, that can be drawn on when needed.
Wind-Down Planning
Payments firms are required to maintain wind-down plans designed to ensure orderly, solvent winding down of their business, if triggered. The FCA notes that many payments firms do not yet have wind-down plans and where firms have plans in place. Common issues with those plans include that they are over-optimistic about the timeframe for a wind-down, insufficiently detailed, lacking consideration of appropriate triggers for winding-down, and contain inadequate analysis of the financial requirements for winding-down.
The FCA’s observation on remedies to this problem is straightforward: firms should have regard to relevant FCA policy and guidance in this area in ensuring that they have appropriate wind-down plans in place.
A Timely Reminder
The FCA’s letter will no doubt be the result of months of work by the regulator. Nonetheless, its publication is timely given that many payments firms have been affected in some way by the recent collapse of Silicon Valley Bank and may be considering their own financial soundness.
We expect that the FCA will continue to be focused on payments firms ensuring that they adequately safeguard customer funds held at banks, that they are financially resilient (e.g., having access to sufficient liquidity in the form of bank lending facilities), and that they have appropriate wind-down plans in place should the worst happen.
More Information
For more information on that or any of the other regulatory obligations referred to in this alert, and how to approach compliance, please contact Wilson Sonsini partner Josh Kaplan.
[1] https://www.fca.org.uk/publication/correspondence/priorities-payments-firms-portfolio-letter-2023.pdf.