The Insolvency Challenge
The entire purpose of safeguarding is to protect customer funds if a payment institution or EMI becomes insolvent. In theory, safeguarded funds should be clearly identifiable, separable from the firm's general assets, and returnable to customers ahead of other creditors. In practice, the legal position has proven more complex than the regulatory framework suggests.
The Payment Services Regulations 2017 (PSR 2017) and Electronic Money Regulations 2011 (EMR 2011) require firms to safeguard relevant funds by either segregating them in designated accounts or covering them with insurance. However, neither set of regulations explicitly creates a statutory trust over the funds. This gap has created significant uncertainty about the legal status of safeguarded funds in insolvency proceedings.
The Ipagoo Decision
The landmark case in this area is the Court of Appeal's decision in *Re Ipagoo LLP* [2022], which concerned an FCA-authorised EMI that entered administration. The case addressed a fundamental question: do safeguarded funds held under EMR 2011 constitute trust property, and if so, what happens when there is a shortfall?
The Court of Appeal held that the safeguarding provisions in EMR 2011 do create a statutory trust over the funds. This was welcome confirmation that customer funds are not simply part of the firm's general estate. However, the judgment also raised difficult questions about how shortfalls should be dealt with — specifically, whether customers should share ratably in the available funds or whether some customers might have priority based on when their funds were received.
The Ipagoo decision applies directly to EMIs under EMR 2011. The position for payment institutions under PSR 2017 is analogous but has not been tested at appellate level. Most practitioners assume the same trust analysis would apply, but this remains legally uncertain.
Current Limitations of the Safeguarding Regime
Several practical limitations reduce the effectiveness of safeguarding as an insolvency protection mechanism:
Shortfall risk. If a firm has not maintained adequate safeguarding — due to reconciliation failures, commingling of funds, or delayed segregation — there will be a shortfall between what customers are owed and what is actually held in safeguarding accounts. In this scenario, not all customers can be made whole, and the distribution of available funds becomes contentious.
Distribution costs. The insolvency process itself consumes funds. Administrators and their lawyers charge fees from the estate, and if the only significant assets are safeguarded funds, there is tension between the costs of administration and the amounts available for distribution to customers.
Identification challenges. If a firm's records are inadequate, it may be difficult to identify which funds belong to which customers. This was a practical problem in Ipagoo and has been a recurring issue in other payment firm insolvencies.
Time delays. Even where safeguarded funds are identifiable and sufficient, the insolvency process takes time. Customers may wait months or years to recover their funds, during which they have no access to their money.
No FSCS coverage. Unlike bank deposits, funds held with payment institutions and EMIs are not covered by the Financial Services Compensation Scheme (FSCS). This means there is no safety net if safeguarding fails — customers bear the full loss of any shortfall.
FCA's Proposed Reforms
Recognising these limitations, the FCA has consulted on reforms to strengthen the safeguarding regime. The key proposal is the introduction of a statutory trust over safeguarded funds, which would:
Provide legal certainty. A statutory trust would remove the uncertainty about whether safeguarding creates trust obligations. The trust would be established by regulation, not by inference from the safeguarding provisions.
Clarify priority. The statutory trust would make clear that safeguarded funds rank ahead of the firm's general creditors in insolvency, and would establish rules for dealing with shortfalls.
Address distribution. The proposed reforms would include provisions for distributing funds to customers in an orderly manner, potentially without requiring full insolvency proceedings.
Reduce administration costs. By providing a clear legal framework, the statutory trust should reduce the time and cost of identifying and returning customer funds.
The FCA's consultation also considers whether additional requirements should be imposed on firms to reduce the risk of shortfalls occurring in the first place, such as more frequent reconciliation, independent auditing of safeguarding arrangements, and enhanced reporting requirements.
Wind-Down Planning
The FCA requires all authorised payment institutions and EMIs to maintain credible wind-down plans. Safeguarding must be a central element of these plans. A credible wind-down plan should address:
Fund identification. How will the firm identify all safeguarded funds across all accounts and currencies in a wind-down scenario? This requires up-to-date records of all safeguarding accounts, acknowledgement letters, and customer entitlements.
Final reconciliation. The wind-down plan should describe how a final reconciliation will be performed to establish the total amount owed to customers and compare this against available safeguarded funds.
Customer communication. How will customers be informed about the wind-down, their fund balances, and the process for recovering their money? The plan should include template communications and contact mechanisms.
Distribution mechanism. The plan should describe the practical process for returning funds to customers, including how identity verification will be managed, how disputes will be handled, and what happens to unclaimed funds.
Regulatory notification. The plan must include procedures for notifying the FCA of the firm's intention to wind down, in accordance with Principle 11 (relations with regulators) and any specific notification requirements.
Practical Implications for Firms
Minimise shortfall risk. The single most important thing a firm can do to protect its customers in insolvency is to ensure that safeguarded funds always equal or exceed customer entitlements. This means robust reconciliation, prompt segregation, and accurate fee deduction.
Maintain impeccable records. In an insolvency, the ability to identify which funds belong to which customers depends entirely on the firm's records. Firms should maintain real-time customer ledgers that are reconciled daily against safeguarding account balances.
Review banking arrangements. Ensure safeguarding account documentation is complete, including acknowledgement letters confirming that the bank has no right of set-off. Review whether the firm's safeguarding banks are themselves financially sound.
Test wind-down plans. A wind-down plan that has never been tested is unlikely to work in practice. Firms should conduct tabletop exercises to identify practical problems and refine their plans accordingly.
Monitor reform proposals. The FCA's proposed statutory trust regime will require significant operational changes. Firms should engage with the consultation process and begin planning for implementation.
The Customer Perspective
Customers of payment institutions and EMIs should understand that their funds do not benefit from FSCS protection. The safeguarding regime provides meaningful but imperfect protection. Customers concerned about the safety of their funds should consider: the firm's regulatory status (authorised vs registered), the firm's published financial statements, whether the firm has a credible wind-down plan, and the general reputation and track record of the firm.
Regulatory Outlook
The direction of reform is towards stronger protection for customer funds. The statutory trust proposal, if implemented, will represent the most significant change to the UK safeguarding regime since the introduction of the Payment Services Directive. Firms should prepare for: enhanced safeguarding requirements, more prescriptive reconciliation and reporting obligations, potential independent auditing requirements, and clearer insolvency distribution rules.
The reforms reflect a broader regulatory recognition that as payment institutions and EMIs handle increasing volumes of customer money, the protections around those funds must keep pace.
Frequently Asked Questions
No. Unlike bank deposits (which are covered up to £85,000 per person per institution), funds held with payment institutions and electronic money institutions are not covered by the Financial Services Compensation Scheme. Customer protection relies entirely on the safeguarding regime, which requires firms to segregate customer funds from their own money.
Safeguarded funds should be ring-fenced from the firm's general estate and returned to customers ahead of other creditors. However, the process can be slow and complex, particularly if there is a shortfall between what customers are owed and what is actually held in safeguarding accounts. The Court of Appeal's Ipagoo decision confirmed that safeguarded funds are held on trust for customers.
The FCA has proposed introducing a statutory trust over safeguarded funds, which would provide explicit legal certainty that customer funds are held on trust and rank ahead of general creditors in insolvency. This would replace the current implied trust analysis and include clear rules for dealing with shortfalls and fund distribution.
Yes. The FCA requires all authorised payment institutions and EMIs to maintain credible wind-down plans. These must address how safeguarded funds will be identified, reconciled and returned to customers, as well as customer communication, regulatory notification and the practical distribution mechanism.