The challenges of customer funds safeguarding for payment and electronic money institutions

Matthieu Blandineau
May 2023
min read

The regulation requires any electronic money institution (EMI) and payment institution (PI) to safeguard customer funds. There are three main methods to do so: logical safeguarding using ledgers to track customer funds, keeping these funds in a segregated account, and contracting insurance to cover these funds.

In this article, we explore precisely what challenges can PIs and EMIs face when using the segregated account method. These issues have been surfaced by the UK’s Financial Conduct Authority (FCA) and the Central Bank of Ireland in letters addressed to CEOs of PIs and EMIs under their supervision.

Three types of challenges are highlighted: mismanagement of the segregated accounts themselves, unfit tracking, reconciliation and monitoring of these accounts, and organisational issues. Let’s deep dive.

Mismanagement of the segregated accounts

When using the fund segregation method to safeguard customer funds, the segregated accounts are the core pieces of the mechanism. So managing them and the funds that are supposed to be held in these accounts is critical. Here is what can go wrong:

Delays in segregating customer funds following receipt

Regulators mandate a 24-hour delay within which PIs and EMIs must safeguard customer funds after receiving them.

Indeed, payments cannot be sent to or received directly from a safeguarding account, so in most cases, PIs and EMIs will use a settlement account to do so. And they, therefore, have to transfer money received on the settlement account to the safeguarding account within 24 hours.

Without adequate systems and processes, these money transfers between the settlement and safeguarding accounts can take too long.

Co-mingling of customer funds and non-customer funds in safeguarding accounts

Most PIs and EMIs won’t make the basic mistake of using their segregated accounts as corporate bank accounts. But there are many ways non-customer funds can end up in a safeguarding account.

Any fees applied to customer transactions or corresponding to the monthly or yearly subscription to your services should not be held nor taken from the safeguarding account. The collection and holding of these funds should happen elsewhere.

Similarly, if PIs and EMIs make money with card interchange, these funds should not touch the safeguarding account.

A more tricky case is when PIs and EMIs’ own partner banks charge fees to hold their safeguarding accounts and debit these fees directly from the said accounts. Even if the PI or EMI credits the safeguarding account with company money beforehand, this isn’t acceptable to the regulator.

Consumer fees and other charges inappropriately taken out of the safeguarding account leading to a potential shortfall of customer funds

As discussed above, these fees should not be present on PIs and EMIs’ safeguarding accounts in the first place and should, therefore, not be withdrawn from these accounts.

Tracking, reconciliation, and monitoring issues

PIs and EMIs cannot correctly manage their safeguarding accounts and processes if they don’t track their customers’ and companies’ flow of funds accurately. The regulators, therefore, pay close attention to how PIs and EMIs do so.

Failing to reconcile that the correct amounts are being segregated on a daily basis

Without accurately tracking and reconciling transactions adequately, PIs and EMIs cannot ensure they respect the 24-hour mandatory delay for safeguarding funds and avoid mingling customer and non-customer funds.

Bank accounts where customer funds are held being incorrectly designated and therefore customer funds not safeguarded correctly

This can seem like a basic thing to do or even an unnecessary one, especially when PIs/EMIs start and only manage a few accounts.

But first, it is so basic that not doing it demonstrates a serious lack in the concerned PIs and EMIs will to safeguard their customers’ funds appropriately.

Second, as these companies grow, launch new products and expand geographically, the number of managed accounts will grow, and unfit accounts labelling can lead to serious headaches.

An extreme example of this process done wrong – or not at all – is FTX.

Organisational issues

Company organisation is equally as important as its operations and procedures. Indeed, if said operations, processes and related monitoring aren’t properly implemented and overseen, they cannot be effective.

“Control over the safeguarding account resting outside of the firm, for example with a Group entity.“

If the PI or EMI has no control over its safeguarding account, it will not be able to manage it properly.

“Insufficient oversight of arrangements for managing the safeguarding of customers’ funds, for example a lack of policy documentation at the legal entity level (i.e., referable to the Central Bank authorised payment and e-money firm) and a lack of effective and regular monitoring and review of safeguarding.”

Similarly to the previous point, any safeguarding framework needs to be monitored, enforceable and effectively enforced to be of any use.

“Failure to evidence adequate consideration of the impact of operational changes, including material changes in the business strategy, on safeguarding arrangements.“

Doing the right things when it comes to safeguarding at a given point in time doesn’t ensure your safeguarding operations are future-proof, especially in the current banking context.

The PI or EMI can pivot and sunset products linked to the safeguarded funds. It can change banking partners for various reasons. It can stop operating in specific geographies.

Regulators expect precise planning regarding how the safeguarded funds and safeguarding procedures will be handled in such events.

“Maintain appropriate records to enable the firm or a third party such as an insolvency practitioner to identify the customer to which the funds it holds relate.“

The ultimate reason d’être of customer funds’ safeguarding is to protect them in the case of a PI or EMI’s insolvency. If such an event happens, the said PI or EMI must be able to precisely allocate the funds held in the safeguarding account to each customer.

In addition, the regulators don’t take PIs or EMIs’ word for it regarding how they manage safeguarding. You must demonstrate to the regulator that you follow an adequate safeguarding framework at all times.

The path to proper safeguarding

As we’ve covered, properly managing customer funds safeguarding isn’t an easy task. PIs and EMIs must set up the right teams, systems, and processes to do so.

Part of the challenge is to implement robust payment flows, bank reconciliations, and real-time account balances and payment statuses. Numeral can help with these topics.

If you are looking to improve your safeguarding operations, do not hesitate to contact us.

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