At the core of electronic money institutions (EMIs) and payment institutions (PIs) regulatory obligations are the safeguarding of customer funds.
Customer funds are funds received and held by those institutions to provide payment services and issuance of e-money to their customers. These funds should be protected in such a way that the insolvency of those institutions does not result in losses for their customers.
Safeguarding has become a hot topic recently, with both the Financial Conduct Authority (FCA) and the Central Bank of Ireland addressing warning letters to the CEOs of their respective UK and Irish PIs and EMIs.
In this article, we describe what safeguarding means and how PIs and EMIs work with their banking partners to safeguard funds and comply with local regulations.
In order to meet regulatory requirements, payment institutions and electronic money institutions must implement effective safeguards for customer funds. Fund safeguarding involves the implementation of procedures, rules, and systems that are designed to protect customer funds from fraud, misappropriation, or an institution's bankruptcy.
It is a requirement in all European countries, as it helps financial institutions prevent and protect them from mismanagement when correctly implemented.
At the core of safeguarding is the account structure held at the bank, protecting customer funds. There are two main ways to safeguard funds: segregated accounts and insured master accounts.
A first option to safeguard funds is to segregate client account balances into separate accounts at regulated entities such as banks or other financial services providers. Typically the institutions would have one settlement account to process payments from, and a safeguarded account where funds need to be deposited in less than 24 hours after receiving them (depending on the regulation).
Not only are the deposits in the safeguarded account insured and protected from a potential default of the institution, segregation also provides better protection against fraud or misuse since each account balance is tracked separately and all fund movements are recorded. Reconciliations of money movements between accounts and their associated customer ledgers are a critical foundation for this audit trail to be usable by payment and compliance teams.
On the flip side, the additional risk control of having a safeguarded + settlement account setup introduces additional complexity in orchestrating the money movements between the two accounts. Payment teams need to fund daily the settlement account taking into account the expected cash inflows/outflows of the day, as well as the acceptable risk profile defined by the company’s risk organisation. Historically, payment teams had good visibility on the expected credit transfers and debit debits expected at the beginning of each day.
However, the introduction of instant payments and the growing complexity of pan-European banking footprints is creating additional orchestration complexity.
To conclude on this first method, account segregation is the best and most viable option for sophisticated treasuries with sufficient processes and tools to manage cash flow orchestrated and associated reconciliations. As this is the more “traditional” method of safeguarding, it is favoured by regulatory bodies over the insurance method.
For small to medium PIs and EMIs with less sophisticated treasuries and compliance teams, a more convenient option can be to safeguard funds in a master account covered by an insurance policy or some other comparable guarantee issued by an insurance company or a credit institution.
While this setup is much simpler to implement and available out of the box with many banking partners, it has several downsides It is more challenging from a regulatory approval and oversight perspective. The institution needs to develop robust ledgers and internal procedures to track user balances at all times. And prove the reliability of those processes to the regulator. The insurance policy also needs to have the flexibility to scale depending on the amount of customer deposits on the master account Insurance can be more expensive than the segregated account option making it a viable option to start but not an efficient one at scale for the regulated institution
Whichever safeguarding option your PI or EMI is choosing, robust payment flows, bank reconciliations, and real-time account balances will be the mandatory foundations to comply with stricter regulations.
Numeral aggregates all your bank accounts and reconciliations into a single platform, providing both payment and compliance teams with a unified control and view of their funds and balances. If improving the control and accuracy of your safeguarding operations is a priority, do not hesitate to contact us.