The additional temporary guidance aims to strengthen the arrangements for safeguarding customers’ funds and firms’ prudential risk management in light of the impact of COVID-19.
By Stuart Davis, Brett Carr, and Anna Lewis-Martinez
On 9 July 2020, the FCA published its finalised guidance on safeguarding customers’ funds during the COVID-19 crisis. The finalised guidance applies to payment and e-money firms.
The FCA’s guidance for firms on safeguarding and managing prudential risk is already available in the FCA’s payment services approach document (Approach Document). However, in light of the exceptional circumstances of COVID-19 on firms’ business models, the FCA has provided additional temporary guidance to strengthen firms’ prudential risk management and arrangements for safeguarding customers’ funds in this period of economic stress.
On 22 May 2020, the FCA published a consultation paper on its proposed guidance on COVID-19 and safeguarding customers’ funds. The consultation closed on 12 June 2020. The FCA also published its feedback statement on the same day as its finalised guidance, along with a portfolio strategy letter to the CEOs of payment services and e-money firms.
The FCA has found evidence that some firms are not complying with the relevant regulations and hopes that this additional temporary guidance will clarify ways that firms can comply with these regulations, as well as prevent potential harm to their customers in the event of insolvency during the pandemic.
Keeping records and accounts and making reconciliations
The FCA explains in its additional temporary guidance that the requirement to safeguard applies to “relevant funds” in both the Electronic Money Regulations 2011 (EMRs) and the Payment Services Regulations (PSRs). The FCA highlights that a firm should keep records and accounts necessary to identify what relevant funds a firm holds at any time and without delay. These records should also enable the firm and any third party, such as an insolvency practitioner or the FCA, to distinguish relevant funds from the firms’ own money, and relevant funds held for one customer against those held for another. Where there is potential for unavoidable discrepancies, firms should carry out reconciliations as often as practicable and not less than once each business day.
The FCA expects firms to clearly document this reconciliation process and to provide an accompanying rationale. Firms should notify the FCA in writing without delay if they cannot comply, in any material respect, with the safeguarding requirements of the EMRs or PSRs. Firms must also notify the FCA if they cannot resolve reconciliation discrepancies in the way described in the Approach Document. Examples of the type of non-compliance which must be notified to the FCA include:
- When a firm is unable to keep records of relevant funds and safeguarding accounts up to date
- When a firm is unable to comply due to the decision by a safeguarding credit institution to close a safeguarding account
Safeguarding accounts and acknowledgement letters
Firms must have an acknowledgement, or be able to demonstrate, that the safeguarding credit institution or custodian, has no interest in or right over the relevant funds or assets in the safeguarding account. The FCA confirms that such an acknowledgement should be in the form of a letter (a template letter is included in the Annex to the finalised guidance). The letter must clearly state that the funds in the safeguarding account are held for the benefit of the firm’s customers and that the safeguarding credit institution or custodian has no interest in or right over the relevant funds or assets in the safeguarding account.
Selecting, appointing, and reviewing third parties
The FCA confirms that firms must carry out periodic reviews of credit institutions, custodians, and insurers as often as appropriate, and at least annually, and whenever a firm might reasonably conclude that anything affecting the appointment decision has materially changed.
Annual audit of compliance with safeguarding requirements
The FCA expects firms that are required to arrange an audit of their annual accounts under the Companies Act 2006 to arrange specific annual audits, to be carried out by an audit firm, of their compliance with the safeguarding requirements under the PSRs/EMRs. The auditor should provide an opinion addressed to the firm on whether the firm has maintained organisational arrangements adequate to enable it to meet the FCA’s expectations of its compliance with these safeguarding provisions throughout the audit period, and whether the firm met those expectations as at the audit period end date.
Small Payment Institutions
Under Principle 10 of the FCA’s Principles for Businesses all firms, including small payment institutions (SPIs), are required to “arrange adequate protection for clients’ assets when they are responsible for them”. In addition, the FCA now states that when complying with Principle 10, all firms including SPIs should keep a record of the customer funds that they hold.
SPIs can choose to opt in to the safeguarding regulations in the PSRs. The FCA encourages SPIs to consider safeguarding their customers’ money voluntarily. The FCA also confirms that the additional temporary guidance applies to small electronic money institutions in respect of payment services unrelated to issuing e-money.
In the additional temporary guidance, the FCA sets out its expectations with regards to certain prudential risk and capital issues and rules for payment and e-money firms, including with regards to governance and controls, liquidity and capital stress testing, risk management arrangements, and capital adequacy.
The FCA clarifies a new requirement that payment and e-money firms must now have wind-down plans in place. The information that firms should address in their wind-down plans includes:
- Information which would help an administrator or liquidator to quickly identify customer funds and return them as a priority
- Funding to cover the solvent wind-down of the firm, including the return of all customer funds
- Realistic triggers to start a solvent wind-down
- The need for any counterparties (e.g., merchants) to find alternative providers
- Realistic triggers to seek advice on entering an insolvency process
The FCA expects firms’ wind-down plans to be proportionate to the size and nature of the firm and states that firms should review their wind-down plans at least annually, and when there is a change to a firm’s operations which may materially change the way in which it can wind down.
This is an area of particular focus for the FCA, and a full consultation on changes to the FCA’s Approach Document is scheduled for later in 2020/21. Therefore, firms should prepare for additional permanent measures which build on this temporary guidance.
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