Payments firms face stricter safeguarding standards

The Financial Conduct Authority has set out its stall to strengthen safeguarding rules for payments and e-money firms. Firms will need to engage with the consultation, which closes on 17 December, and then get ready for extensive changes to how they safeguard relevant funds. The first rule changes are likely to apply from Q3 2025, with more fundamental reform to follow.

Two-stage process

Payments and e-money firms are required to protect funds they receive in connection with making payments or issuing e-money. The current safeguarding requirements are set out in the Electronic Money Regulations and Payment Services Regulations. The FCA is concerned about poor compliance practices in the payments industry and so is seeking to tighten the rules.

In its consultation (CP24/20), the FCA proposes to reshape the safeguarding regime in two phases:

• First, interim rules will add to the existing safeguarding requirements under the EMRs and PSRs.
• Later, end state rules will later replace the relevant parts of the EMRs and PSRs with a CASS-style regime.

Interim rules

Under the interim state proposals, payments and e-money firms would have to:

• Allocate an individual senior manager with responsibility for overseeing safeguarding compliance
• Maintain adequate policies and procedures to ensure safeguarding compliance
• Maintain accurate records and accounts
• Perform internal and external reconciliations and investigate discrepancies
• Maintain resolution packs
• Have safeguarding compliance audited by an external auditor
• Submit a monthly safeguarding regulatory return to the FCA
• Exercise due skill, care and diligence in selecting and appointing third party custodians
• Consider the need for diversification of third parties with which payments firms hold safeguarded funds

Some of these new requirements already exist in regulatory guidance but will be rewritten into the FCA’s rulebook. Others are new, such as the requirement to assign a director as, effectively, a Safeguarding Compliance Officer.

Other proposals from the FCA include introducing additional conditions where firms intend to use insurance to safeguard relevant funds or invest those funds in secure liquid assets.

End state rules

In the longer term, the FCA is going to rewrite the safeguarding requirements. The relevant parts of the EMRs and PSRs will be repealed under the Government’s smarter regulatory framework programme. The FCA will replace them with more prescriptive rules aligned with its existing client asset regime for investment firms (CASS).

A central tenet to this future regime will be that payments and e-money firms hold customer money on trust. According to the FCA, this is the only viable option to provide adequate client protection. This will presumably draw a line under a long-running legal debate around the application of the current rules (see for example our briefing from earlier this year: Court confirms that UK payment firms do not (yet) hold customer money on trust).

As well as introducing the trust structure, the end state proposals would further increase the compliance burden on payments and e-money firms. For example, the final regime would update record-keeping and reconciliation requirements and specify in more detail how firms should handle and segregate customer funds.

Next steps

The deadline for responses to the consultation is 17 December 2024. 

The FCA plans to finalise the interim safeguarding rules in the first half of 2025. Payments firms would have to start reviewing their use of third parties for safeguarding purposes within three months. The other interim rules would apply six months after the rules are finalised, i.e. before the end of 2025.

The timing of the end-state rules is subject to the Government’s timetable for revoking the safeguarding requirements in the EMRs and PSRs. Once this happens, the FCA suggests giving payments firms a 12-month transition before switching to its new regime. This reflects the significant changes that firms will need to implement.