Clifford Chance

There has been a renewed focus on the payments sector and its regulation. COVID-19 and its impact on spending habits and the Wirecard scandal are two of the contributing factors. But what’s next? We explore five themes likely to drive regulatory change for payments, as well as shape the enforcement policies of global regulators over the next 12 months. In part four we look at safeguarding and prudential risk management.

Safeguarding

Robust safeguarding arrangements are integral to ensuring that funds are returned to customers in the event of an insolvency of a payment services or an e-money firm. The COVID-19 pandemic and the collapse of Wirecard in 2020 have brought payments firms’ prudential risk management and safeguarding arrangements into the spotlight as a key supervisory priority for 2021.

In the UK, the Financial Conduct Authority (FCA) had already been focusing on safeguarding rules for payment institutions. The FCA carried out a review of non-bank payment service providers’ compliance with safeguarding requirements in early 2019, resulting in a Dear CEO letter that required all electronic money institutions and authorised payment institutions to review their safeguarding arrangements. However, the COVID-19 pandemic led the FCA to look at this with renewed focus, quickly introducing new Guidance in July 2020 to strengthen payment firms’ prudential risk management and arrangements for safeguarding customers’ funds in light of the exceptional circumstances of the pandemic.

We expect that the status of safeguarded funds will continue to attract attention. The FCA considers that firms hold safeguarded funds on trust for their customers, even though this is neither expressly stated in the Second Payment Services Directive nor in the UK Payment Services Regulation 2017. The FCA cited the ruling in Supercapital (in administration) [2020] EWHC 1685 (Ch) where the judge stated that the Payment Services Regulation 2017 creates a statutory trust. It is possible that this view may be subject to further challenge in subsequent court cases.

Regulatory scrutiny of the prudential risk management of payment and electronic money institutions is also likely to continue during 2021.

UK

In the UK, the need for strong risk management and governance arrangements can be seen from the results of the FCA’s Covid-19 financial resiliency surveys (published on 7 January 2021), which found financial resilience concerns in some members of the payments and e-money sector. As part of satisfying the FCA that there are robust governance arrangements, firms are required to have a wind-down plan to manage their liquidity and resolution risks. Alongside this, the UK is expected to introduce a new “special administration regime” for payment institutions and e-money issuers to enhance the protection for customers if a payment or electronic money institution enters into insolvency. An HM Treasury consultation on the proposed regime published on 3 December 2020 notes that, in six recent insolvencies involving payment and electronic money institutions, five firms have not returned funds to customers.

Singapore

In Singapore, the MAS currently has the power to impose safeguarding requirements on major payment institutions in respect of certain payment services, which include merchant acquisition services. In view of the changing payment token landscape and to allow the regulator to act swiftly in this space when needed, there are also legislative proposals to extend 'the MAS' s power to impose user protection measures on certain digital payment token service providers, and these measures may include anti-commingling measures, ring-fencing measures and maintaining customers’ assets in a prescribed manner.

Japan

In Japan, the Japanese Financial Services Agency (JFSA) introduced a robust mechanism for safeguarding customer money kept by FTSPs when the FTSP regulatory framework was established in 2010. The June 2020 reform of the Payment Services Act will make the current single licence regime more flexible by creating three categories of FTSP licence and requiring different safeguarding measures to be taken by FTSPs, depending on the maximum limit of the payment reflecting a principle of regulating based on risk. Other parallel legislative changes are also designed to reduce customer risk in the case of insolvency of FTSPs. The amended regulations will be implemented in spring 2021.