EU DGSD reform brings more “bank‑style” protection for client funds – what it means for firms and their bank partners

Client funds have always sat in a slightly awkward place in EU financial regulation. 

Sectoral rules for payment institutions (PSD 2), e-money institutions (EMD), investment firms (MiFID II) and crypto-asset service providers (MiCAR) require these firms to safeguard client funds that they receive or hold on behalf of their clients– typically by placing them in segregated accounts with a credit institution. The purpose of these sectoral rules is that client funds shall be insulated against claims of other creditors of the firm, in particular in the event of insolvency.

But when the credit institution fails, safeguarding alone does not protect clients. Rather, the question turns on whether these pooled client funds are also covered by a deposit guarantee scheme (DGS), such that clients can claim compensation after the regulator has determined that the credit institution appears to be unable to repay the deposits. 

Until recently, the response was: It depends. Not anymore. The recently enacted EU Crisis Management and Deposit Insurance (CMDI) package amends the Deposit Guarantee Scheme Directive (DGSD) and introduces a new, dedicated regime for “client funds deposits” (new Article 8b DGSD).

Below we unpack the proposal, with a practical lens on what this means firms and their banking partners. 

DGSD: explicit DGS coverage for “client funds deposits” (new Article 8b)

The problem the legislator is fixing

Until now, Member States have not treated “client funds” in bank accounts consistently under the relevant transposition of the DGSD. Approaches across the EEA have ranged from full coverage to no coverage, sometimes depending on which type of firm held the client funds in a bank account (“financial institutions” are excluded from deposit protection) and how “absolutely entitled” in DGSD Article 7(3) was read.

This has mattered because the dominant method of safeguarding for e-money institutions (including stablecoin issuers) (EMIs), payment institutions (PIs), crypto-asset service providers (CASPs) and investment firms in the EU is to deposit client funds with a credit institution – which protects clients against the firm’s insolvency but leaves but leaves them exposed if the bank becomes insolvent and the firm cannot retrieve the funds.

What Article 8b does – in one sentence

Article 8b requires Member States to ensure that “client funds deposits” are covered by DGSs, subject to clear conditions. It also applies the EUR 100,000 coverage level per underlying client, not per pooled account. 

Who and what is in scope?

The amending text introduces “client funds deposits” as funds that financial institutions deposit with a credit institution for the account of their clients in the course of their business. 
The recitals make the policy driver explicit: certain financial institutions (including EMIs, PIs, CASPs and investment firms) deposit funds received from their clients in bank accounts to comply with safeguarding obligations under their sectoral regimes – and DGSs should protect these deposits if clients are identified or identifiable.

The three gating conditions (Article 8b(1) DGSD)

DGS coverage becomes mandatory where all of the following apply:

1. Placed for eligible clients: the deposits are placed on behalf of, and for the account of, clients who are not excluded from DGSD protection.
2. Segregated safeguarding account: the deposits sit in segregated accounts in compliance with the relevant safeguarding requirements under EU sectoral law.
3. Identified or identifiable clients: clients must be identified or identifiable by the financial institution holding the account before the DGSD payout event.

Interestingly, Art. 8b(1) DGSD only requires the financial institution holding the account to have identified – or at least being able to identify – the client, rather than requiring identification of the client at bank level. The new rules, therefore, remove one driver for banks to identify clients as beneficiaries of client funds under current rules, potential requirements under the AMLD notwithstanding.

Operational consequences: coverage is per client, with no aggregation

Two points in Article 8b(2) DGSD are particularly important for product design and operational readiness:

• The standard DGSD coverage level (EUR 100,000) applies to each underlying client that meets the identification requirement.
• When calculating what is repayable to a given client, the DGS shall not aggregate that client’s own deposits held at the same credit institution (which is a carve‑out from the usual aggregation rule under the single customer view).

This is meant to address the fact that clients of financial institutions do not always know with which credit institution their financial institution has chosen to deposit their funds, and that credit institutions may not know the clients entitled to the sums held in the safeguarding accounts or record individual client data.

Who gets paid – the firm or the client?

Article 8b(3) gives Member States flexibility: DGSs must be able to repay either:

• the account holder “for the benefit of each client”, or
• the client directly.

This reflects the EBA’s earlier observation that implementation of the DGSD in Member States is split between “direct” and “indirect” payout models, and that both approaches raise different practical and contagion‑risk considerations. To avoid fragmentation under the new rules, the amended DGSD mandates the EBA to draw up draft Regulatory Technical Standards (RTS) to specify, among other things, the technical identification details and in which instances repayment should go to the account holder vs directly to the client, including safeguard against double payments.

“So what?” – quick takeaways for firms (and their banking partners)

Article 8b DGSD removes a significant obstacle for firms that want to offer clients deposit protection of client funds held in safeguarding accounts. It would, therefore, not be surprising if deposit protection for client funds became a market expectation in the EU – with implications, both, for firms and their banking partners. 

Which practical steps are likely to follow:

• More cross-border flexibility: The revised DGS removes an important barrier to holding client funds with banks in other Member States, since DGS protection no longer depends on the national transposition of the DGSD – which may also have implications for the availability and pricing of safeguarding accounts (see also “DGS contributions”).
   
• Data and records: Firms will need to demonstrate that each client is identified/identifiable, and anticipate more prescriptive EBA RTS on identification and payout routing, including mapping these requirements against existing KYC requirements.
   
• Client documentation: Firms need to consider whether disclosures (and operational terms) should explain how DGS coverage works for pooled accounts, including the new “no aggregation” rule.
   
• DGS contributions: The new regime may lead to higher DGS contributions for banks that have not yet reported client funds as covered deposits under current regulations.