E-money regulation: wind-down plans are falling short

The FCA has published the results of its coronavirus financial resilience survey¹ revealing that up to 4,000 financial services firms are at a ‘heightened risk of failure’ because of the pandemic. The sector breakdown also reveals that payments and e-money institutions reported the lowest levels of liquidity.

It is in this context that the FCA has turned the regulatory spotlight on the payments and e-money sector. Firms are increasingly providing a wider range of services and reaching a scale where a failure could have severe consequences in the wider markets. Approximately £17 billion is believed to be held by payments and e-money institutions. The failure of any payment or e-money firm where consumers were left out of pocket has potential to both cause market harm and be damaging to individual customers.

Three-tiered approach in payments and e-money regulation

The regulator has adopted a three-way approach to support the sector with a more robust regulatory framework.

1. Safeguarding

There is now a requirement for annual safeguarding audits over customer funds. My colleague Paul Staples has written guidance on this in Safeguarding audits for payment and e-money firms.

2. Wind-down planning

Payments and e-money institutions are required to have a wind-down plan in place to assist with an orderly wind-down. In December, I set out guidance on this requirement with tips for wind-down planning in How PSPs can meet FCA requirements for a wind-down plan.

3. Special administration regime

A new insolvency regime for the payment and e-money sector is being introduced. The rules of the regime have been published² by HM Treasury and were subject to consultation until 28 January.

Wind-down planning for payments and e-money institutions

In its financial resilience report published in January, the FCA recognises that its role "isn’t to prevent firms failing. But where they do, we work to ensure this happens in an orderly way. By getting early visibility of potential financial distress in firms we can intervene faster so that risks are managed, and consumers are adequately protected."³

All payment firms have had to have a wind-down plan in place since July 2020. But, according to the FCA, the sector has a way to go in satisfying the regulator that they would be prepared for an orderly wind-down. There are significant concerns that poor planning would raise costs, eroding customer funds in any wind-down scenario.

FCA considers many wind-down plans inadequate

The FCA requested access to, and has reviewed, wind-down plans from payments and e-money institutions. In a recent webinar⁴ the key message from the FCA was that many of these are falling short of expectations. Of a sample of 14 wind-down plans, not a single one was judged to meet expected standards. As an example, the following omissions were noted:

• Eight of the 14 plans failed to identify how the repatriation of customer funds would be achieved in a way that a third party would understand. Firms must provide information that would help an insolvency practitioner identity customer funds and return them as a priority.
• Six of the 14 plans did not mention third-party providers at all – a key weakness. Of the eight that did, not one identified which ones they would need to work with to have an orderly wind-down. The FCA believes that this lack of detail could lead to higher than expected costs in a wind-down scenario, reducing the funds available to return to consumers.
• Only five of the 14 plans considered the funding that would be needed in a wind-down. Many failed to consider redundancy payments, IT maintenance costs, IP costs and staffing costs, and were often imprecise about the timing of these costs.
• Only one of the 14 firms fully specified how it would maintain its IT and cyber position. Eight did not provide any information on IT or cyber controls despite its critical role in returning funds to consumers.
• Many plans did not consider the potential wind-down of a product or a subsidiary.
• Firms had included triggers for a solvent wind-down, but only one wind-down plan included triggers for an insolvent wind-down, or considered when external advice, for example from an insolvency practitioner, would become necessary.
• Some payment and e-money firms have yet to start work on a wind-down plan, even though guidance in July 2020 made it clear that this was a condition of authorisation. The FCA views this as unacceptable and needing priority action.

Taking action on common omissions

Our team has reviewed and advised on a number of wind-down plans across the sector and the FCA's comments resonate with what we see in the wider market. Payment and e-money institutions should take time ensure their wind-down plans address where plans are likely to fall short.

Management information should be at an appropriate level of granularity, with regularly tested thresholds which can give management real-time insight into the health of the business.

By considering early warning indicators that would trigger a wind-down, firms can recognise the point where an orderly wind-down could be achieved. This will help avoid an insolvent scenario where consumers are likely to be further out of pocket. These indicators can also improve a firm’s ability to implement recovery options and spot areas where a new approach could improve existing operations or financial processes. 

Special administration regime to speed return of funds

The FCA has become aware that existing insolvency processes for payments and e-money institutions are ‘sub-optimal’ from the consumer's perspective. When armed with only standard insolvency rules, the large number of creditors in these cases has meant that insolvency practitioners have had difficulties efficiently winding down firms, and returning money to consumers and other creditors. Administration cases involving payments and e-money firms have taken years to resolve, with consumers receiving reduced monies after the cost of distribution. As an example, the FCA highlights that in six recent cases of payments and e-money institutions in insolvency proceedings (of which three started in 2018), only one has so far returned funds to customers².

Therefore the FCA is introducing a bespoke special administration regime for payments and e-money institutions (pSAR). The pSAR will give IPs an expanded toolkit, which will allow an IP to prioritise the return of client assets.

Key features of the pSAR

• An explicit objective for the special administrator to return customer funds as soon as reasonably practicable
• A bar date for client claims to be submitted to speed up the distribution process
• A mechanism to facilitate the transfer of customer funds to a solvent institution
• A post-administration reconciliation to top-up or drawdown funds to or from the safeguarding process
• Provisions for continuity of supply to minimise disruption
• Rules for treatment of shortfalls in the institutions’ safeguarding accounts
• Rules for allocation of costs
• An explicit objective on the special administrator for timely engagement with payment systems and authorities

Time to prepare is now

The FCA's focus on payments and e-money regulation is clearly not going to go away and compliance requirements for firms are only going to increase. Management should take the time now to prepare for this.

For more information on wind-down planning, contact Chris Laverty, or information on safeguarding, contact Paul Staples .

References

1 The coronavirus (Covid-19) financial resilience survey data, FCA, 7 January 2021

2 Insolvency changes for payment and electronic money institutions: consultation, HM Treasury December 2020

3 FCA publishes coronavirus financial resilience survey data, FCA press release, 7 January 2021

4 Payments & E-Money: safeguarding & wind-down webinar for compliance consultants, FCA, 21 January 2021