Earlier this month, the governor of the Bank of England made it clear that customers of electronic money (e-money) firms are less protected against a corporate collapse than customers of a bank. But how much riskier is e-money?
Bank money and e-money
To help avoid bank runs, UK bank deposits are protected by government insurance—called the Financial Services Compensation Scheme, or ‘FSCS’—up to a maximum of £85,000 per institution.
FSCS protections were beefed up after the financial crisis: before 2008, they covered only the first £2,000 of savings, followed by 90 percent of the next £33,000. This partial coverage was blamed for the 2007 run on UK bank Northern Rock, the first such panic in the UK for over a century.
Northern Rock bank run, 2007
But customer money handed over to a UK e-money institution (EMI) or an authorised payments institution (API) is looked after by an entirely different legal regime.
According to the Financial Conduct Authority, which regulates APIs and EMIs, clients’ e-money is protected through an internal process known as safeguarding.
e-money is looked after by an entirely different legal regime
“APIs and EMIs must either keep your money separate from their own money, or protect it with an insurance policy or comparable guarantee,” the FCA says on its website.
The FCA goes on to clarify that, unlike insured bank deposits, money placed at an EMI or API is at risk if a firm enters insolvency.
“It could take longer to be refunded than if your money was in a bank, and some costs are likely to be deducted by the administrator or liquidator of the insolvent company. For that reason, you may not get all your money back,” the FCA says.
If you’re a UK consumer, you can tell if the financial institution you’re dealing with is a bank (and therefore covered by FSCS) or an EMI by checking the FCA register.
“We must ensure that users fully understand the difference in protection”
However, many media articles comparing banks and EMIs routinely lump the two categories together and fail to highlight that they do not protect customer money in the same way.
For example, Revolut and Monzo are two widely used UK fintechs (financial technology firms), offering similar, mobile-based financial products and services, but only one—the latter—is a bank.
“We must ensure that users fully understand the difference in protection, and I suspect at the moment that is not widely the case,” Bank of England governor Bailey said earlier this month.
How much is at risk?
Despite the recent media noise about the fast-growing fintech sector, e-money is still a drop in the ocean when compared to traditional bank deposits.
e-money is still a drop in the ocean
In its July Payments Landscape Review, the FCA estimated the total volume of e-money in circulation as £10bn.
The volume of FSCS-insured deposits at UK banks at the end of last year was £1.1trn—over a hundred times more.
In theory, with the rapid rise of digital, mobile payments technology, e-money has the potential to grow its market share further.
What happens if things go wrong?
If your UK bank goes bust, the FSCS says it aims to repay deposits (up to the £85,000 insured limit) within seven days.
But if your EMI or API goes bust, you face a much longer wait, plus the erosion of some of your savings.
“You will have to contact the liquidator or administrator,” the FCA says on its website.
“This is because the administrator will be responsible for distributing any funds to customers.”
There is a recent case demonstrating how much of clients’ money might be at risk in the case of the insolvency of an EMI.
The administrator of a failed EMI called Supercapital, which provided FX and international payments services, deducted 10.48 percent of clients’ e-money balances to cover the costs of administration, while clients had to wait several months to get the remaining 89.52 percent of their funds back.
The administrator, Kevin Goldfarb of Griffins, told New Money Review he hopes to return more money to clients later.
“We will make a further distribution at a later date, but that is subject to recovering debit balances and duplicated payments and will almost certainly involve some element of legal action and so at this stage we can’t accurately estimate how much more will be paid,” Goldfarb said.
How robust is safeguarding?
Following this summer’s collapse of German payments firm Wirecard, which had a knock-on effect on a number of UK EMIs, the FCA has tightened its safeguarding rules.
Under the new rules, the FCA said, e-money and payment firms will have to undertake a number of extra steps to ensure that customer funds are kept separate from those of the service provider.
In particular, the FCA said, firms should be able to identify what relevant client funds the firm holds, ‘at any time and without delay’.
But insolvency specialists say these principles only go so far in practice, given that when client money arrives at—or departs from—an EMI, there is an unavoidable period of time when client and company funds are mingled together.
“These fine principles occasionally fall by the wayside”
And, according to Griffins’ Kevin Goldfarb, the practice of ‘sweeping’ client money regularly into a separate, segregated safeguarding account doesn’t solve the problem, particularly since it risks being neglected at a failing firm.
“In 2008 I know that various organisations were sweeping their accounts every half an hour to make sure that certain funds were not left with certain institutions any longer than they needed to be,” Goldfarb said during a recent webinar on safeguarding, organised by consultancy FSCOM.
“But when things go wrong, these fine principles occasionally fall by the wayside, and the sweeping [of funds into a safeguarding account], which is meant to happen every few hours, doesn’t happen for days,” Goldfarb said.
Uneven global rules
Another question mark over the robustness of the safeguarding regime comes from the unevenness of global insolvency rules.
From the end of December, with Brexit, UK EMIs and payment firms will have the ability to place safeguarded funds with banks anywhere in the world. Currently, they may only deploy these funds with authorised European Economic Area (EEA) banks.
“Does that create the potential for more problems? The answer has to be yes”
National financial regulators have already shown sensitivity in response to the types of cross-border risk that can arise in a corporate insolvency.
According to Alex Jay, a partner at law firm Gowlings, who also worked on the Supercapital case, EMIs’ future ability to deploy safeguarded funds worldwide will expose customers’ funds to further risk.
“You won’t have the same degree of harmonisation of insolvency processes,” said Jay.
“It will depend on a jurisdiction by jurisdiction approach. Does that create the potential for more problems? The answer has to be yes. It’s going to significantly widen the potential for more complicated cross-border issues.”
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