Payment providers and protection

Many ‘bank-like’ services are available that can offer different levels of payment connectivity outlined in chapter one, but they are not created equally.

Market demand for new services and products suited to the needs of firms serving consumers through digital-first offerings has seen the rise of new entrants in several guises. The introduction of both the Electronic Money and Payment Services regulations has promoted significant innovation and additional competition in the UK financial services market.

The line between bank and non-bank provision of financial services is becoming increasingly blurred due to the significant growth in the number and use of electronic money institutions.

To understand what this means, you must evaluate the types of providers and the protections they offer to you and your customers.

One option available to firms is using an Electronic Money Institution or EMI. EMIs were introduced to create more competition in the payments sector and, as a result, improved choice, convenience and value for customers.

They are regulated entities that offer e-money payment accounts that allow customers to accept and execute payments without the need for a bank account. As a result, they can facilitate transactions such as cash withdrawals from a payment account, credit transfers, direct debits, remittances, and foreign exchange services.

While they were seen as competitors to the incumbent banks to support newer firms in getting to market quicker, it is important to understand that EMIs also have several limitations that you must consider when setting your risk tolerances for your service.

Those limitations include:

• An EMI, ultimately, requires a partner bank to operate, potentially exposing you to two layers of risk appetite. That appetite, between who the EMI would like to service and who the bank agrees they can service, may not always align and can lead to service reliability and continuity issues.
  
• Funds held with an alternative (non-bank) service provider, such as an electronic money (e-money) or payment institution, do not qualify under the Financial Services Compensation Scheme (FSCS). When a customer transfers funds to one of those institutions, they do so on the premise of making a payment, so the funds are not considered a qualifying, protected ‘deposit’.
  
• EMIs must have safeguarding arrangements to protect the firm’s customer funds. There are two ways in which an EMI may safeguard relevant funds:
  • the segregation method where the EMI must place relevant funds in a separate account from the institution’s working capital and other funds and/or
  • insurance or comparable guarantee method

However, it may not be apparent what an EMIs approach to safeguarding is.

• These alternative providers cannot accrue or pay interest on these funds. They cannot use customer funds for their own business activities and must only hold funds for the purpose of processing payment transactions.

With the rise of these alternative bank-like providers, regulators are now examining the role of EMIs, with some firms forced to rebrand and remove the word ‘bank’ to avoid confusing and misleading businesses and consumers.

The UK Financial Conduct Authority (FCA) has raised industry specific concerns via a portfolio-wide “Dear CEO” letter on four separate occasions in the last four years. It highlighted safeguarding, prudential risk management, wind-down planning, anti-money laundering and fraud as specific priorities and set out its expectations on firms with specific “actions to take”.

It also warned that any payment firms not meeting the FCA's expectations should expect swift and assertive action.

Another potential option is using an Authorised Payment Institution (API). Credit card processors, payment account operators, remittance operators, foreign exchange businesses, and payment initiation businesses are all examples of APIs. They are broadly similar to an EMI but with one significant difference – they cannot issue e-money.

To be authorised as an API, firms must, among other requirements, have robust governance arrangements and internal procedures and control mechanisms and take adequate measures to safeguard payment service user funds.

While an EMI or API might seem like a good fit for your business today, it is worth considering whether it will still work in the medium to long term.

• How is your firm regulated – are you a bank, payments institution or an EMI?
• Where are your customer funds stored?
• What customer protections do you have in place?
• Do you partner with anyone to offer deposit protection such as FSCS?

As a regulated bank, ClearBank offers the flexible approach of EMIs to support innovative firms with additional layers of protection for you and your customers by design.

Protection is delivered through:

• Segregated accounts: ensuring your clients money is held separately and securely from the firms’ own funds.
• All ClearBank client funds are held securely at the Bank of England and are available to their customers 24/7x365.