UK Government consultation on a new insolvency regime for UK-authorised payment institutions and electronic money institutions

The Consultation identifies a UK Government concern that the normal regime for dealing with company insolvencies (which is frequently an “administration” – see below) does not adequately address the particular nature of PI/EMIs - especially in relation to ensuring the rapid return to their customers of “customer funds”. These are amounts paid to PI/EMIs in connection with their services (e.g. payment amounts to be transferred by a PI or the purchase price of electronic money issued by an EMI) and should be held by PI/EMI ring-fenced from its other assets and so immune from any adverse effects of its insolvency. This type of holding is typically referred to as the customer funds being “safeguarded”.

Customer funds safeguarding is a key justification for PI/EMIs benefiting from a less onerous regulatory regime than that applied to banks. But the quid pro quo is that it really needs to be effective in an insolvency situation. This has become particularly important given that PI/EMIs are now providing an increasingly wide range of services (often with similarities to current account banking) and are operating at a scale where any failure they suffer may have real market significance.

Accordingly, a key purpose of the SAR proposal is to improve the effectiveness of safeguarding in a PI/EMI insolvency. There are two principal aspects to this:

(a) avoiding/minimising shortfalls in the safeguarded amounts available to be returned; and

(b) ensuring that those amounts which can be returned are returned quickly. To evidence the issue here, the Consultation identifies that, out of six recent

PI/EMI insolvency proceedings, only one has so far returned customer funds to the customers, despite three of them having started in 2018.

An “administration” is a type of UK insolvency procedure in which an insolvency official (usually a partner in a large firm of accountants) takes control of the affairs of the insolvent company and has power to manage the continuation of its trading with a view to either:

(1) its survival as a going concern (e.g. the company just needs a breathing space from cashflow difficulties); or 

(2) achieving a better return to creditors than would be yielded by an immediate cessation of trading followed by a liquidation – for example because the company’s assets can be realised most advantageously by a sale of all or part of its business as a going concern.

During a period of administration, a statutory moratorium is imposed on the enforcement of the rights of creditors against the company.

The proposal for a “special” administration under the SAR (a Special Administration) takes an ordinary administration as its starting point but then adds the additional provisions referred to below in order to improve the effectiveness of such an administration in a PI/EMI insolvency context. This mirrors an earlier similar approach taken by the UK Government to the insolvency of investment banks – an approach which is embodied in the 2011 Investment Bank Special Administration Regulations and which the Government considers has successfully addressed concerns it identified following the Lehman Brothers collapse.

The PI and EMI SAR Objectives

At the heart of the proposed SAR approach is a set of draft regulations (the Draft Regulations). The first point to note is that, if a PI/EMI is facing an insolvency situation, then the effective presumption is that a Special Administration will be implemented rather than any of other potentially available insolvency procedures such as winding-up or a normal administration – unless, that is, the Financial Conduct Authority (the FCA) agrees otherwise (which it is unlikely to do if it considers that a Special Administration will – as is intended – produce a better result for the PI/EMI’s customers).

The Draft Regulations identify three key objectives (the Objectives) which are required to be pursued by any Special Administrator:

1) Objective 1: to ensure the return of relevant funds [i.e. customer funds] as soon as is reasonably practicable;

2) Objective 2: to ensure timely engagement with payment system operators; and 

3) Objective 3: to rescue the PI/EMI institution as a going concern or wind it up in the best interests of the creditors.

It is intended that the FCA will be given a power to prioritise one of these Objectives over the others, but only where this is considered necessary in the public interest in order to preserve the stability of, and public confidence in, UK financial systems and markets. The Objective most likely to be prioritised for these purposes would be Objective 1.

After introducing the Objectives, the Consultation and the Draft Regulations then set out a number of specific provisions that will apply to a Special Administration and certain obligations which will be imposed upon the appointed administrator (the Special Administrator), in each case in order to facilitate more effective fulfilment of the Objectives. The most important of these are referred to below.

Special Administration as a triggering “insolvency event”

The wording of the Payment Services Regulations 2017 and the Electronic Money Regulations 2011 (together the Regulations) will be amended so that 'the entry of an institution into special administration' will be added as a “insolvency event”. This means that the consequences under the Regulations which flow from such an event occurring will be triggered as soon as a Special Administration commences. The Consultation notes that, where a PI/EMI has entered into contractual arrangements which define and refer to an “insolvency event”, that definition should also be amended to include a Special Administration. This may be of crucial importance to a contract such as a safeguarding guarantee or insurance policy (if one of these documents forms any part of a PI/EMIs safeguarding approach) which can only be called upon following the occurrence of an “insolvency event” as defined in the relevant contract.

Collecting in and preserving safeguarded funds and funds that ought to be safeguarded

The SAR creates a number of obligations imposed upon a Special Administrator in furtherance of this aspect of Objective 1. In particular:

• immediately following his/her appointment, the Special Administrator must carry out a reconciliation of the monies that actually are safeguarded by the PI/EMI relative to the monies that ought to be safeguarded (e.g. monies received in since the last reconciliation but not yet transferred to the specific safeguarding account) and then make such transfers between the PI/EMI’s other account(s) and its safeguarding account(s) as this reconciliation indicates should be made (and indeed would have been made but for the Special Administration intervening);
• separately from, and subsequent to, the above reconciliation process, the Special Administrator should perform a process referred to in the Consultation as “constitution of the asset pool”. This is essentially a process to maximise the safeguarded funds under the control of the Special Administrator that will be available to meet the PI/EMI’s obligations to return customer funds and it has two key elements:
  
  • undertaking what is described by the Consultation as “reasonable efforts to include any customer funds and assets identifiable in any other accounts held by the institution in the asset pool (e.g. relevant funds that were not properly segregated)”. The Regulations require the segregation of customer funds coming into a PI/EMI even before they are credited to the PI/EMI’s dedicated safeguarding account, so this process is designed to ensure that those funds get transferred into the safeguarding account from any other account of the PI/EMI so long as they can be “identified” as being incoming customer funds in that other account. It would seem that this process could also be applied to moneys transferred out of a PI/EMI’s safeguarding account but still identifiable as customer funds in another account of the PI/EMI; and
  • realising assets held for safeguarding purposes – e.g. liquid assets other than money and an available claim under an insurance policy or guarantee created for safeguarding purposes – and crediting the proceeds of the realisation to the safeguarding account.

Payments out of relevant funds to PI/EMI customers

Once the Special Administrator has collected in all relevant funds (using the above approaches where applicable), the Special Administrator shall move towards distributing those amounts to the customers, and the SAR contains some additional useful provisions. In particular:

• the Special Administrator is placed under a duty to identify customers of the PI/EMI who have an entitlement to customer funds and to value each such entitlement as at the point when the PI/EMI went into Special Administration;
• the Special Administrator can set two types of “bar dates” setting limits to claims of customers to relevant funds. These are dates by which a customer’s claim must be received by the Special Administrator if it is to be taken into account in an interim distribution of relevant funds (a ‘soft bar date’) or a final distribution of those funds (a final ‘hard bar date’). Any bar date sought to be applied will be required to be adequately notified to the potential claimants;
• if there is any shortfall in the relevant funds held by the PI/EMI relative to customer claims to those amounts, the SAR clarifies that the resultant loss will be shared between the customer claims on a pro-rata basis; and
• the costs of collecting all relevant funds for credit to the safeguarding account will be borne by the asset pool, but costs caused by the PI/EMI failing to comply with its safeguarding obligations are to be borne by the general estate.

Provisions related to possible business transfers 

In some circumstances, the best outcome for the customers of an insolvent financial services business may be for the whole of that business to be sold to a new provider operating in the same space which is willing to take over the customer relationships. The Government indicates in the Consultation that it is considering implementing a number of legal changes to make this type of solution easier to implement, in particular making it possible for an insolvent PI/EMI to:

• transfer assets (including customer funds) without customer consent and without transferring any liabilities other than those which relate to rights that are transferred; or 
• transfer to a business purchaser its contractual rights in respect of a network of agents/distributors without each of the relevant contracts needing to be novated.

Involvement of the FCA and its powers under Part 24 of the Financial Services and Markets Act 2000

The Government proposes that the FCA will be given rights to consent to, and participate in, Special Administrations and other insolvency proceedings related to PI/EMIs, in each case in a role of protecting the customer creditors and the market generally. This will be done by an expansion of the supervisory powers granted to the FCA under Part 24 of the Financial Services Act 2000 (FSMA).

Objective 2 –market infrastructure bodies and authorities

Objective 2 creates a specific obligation on a Special Administrator to ensure timely engagement with payment system operators and the Authorities (meaning the FCA, the Bank of England and the UK Government - for these purposes HM Treasury). Rule 24(1) of the Draft Regulations sets out what this Objective means by imposing an obligation on a Special Administrator to “work with:

(a) with a payment system operator to: (i) facilitate the operation of that operator’s rules or arrangements, (ii) resolve issues arising from the operation of those rules or arrangements, and (iii) facilitate the transfer, settlement or prompt cancellation of non-settled payments, and 

(b) the Authorities and the Payment Systems Regulator, to facilitate any actions they propose to take as a consequence of a special administration order being made in respect of the institution.”

However, for these purposes, the expression “work with” is given a rather specific meaning by Regulation 24(2) which defines it as being to:

(a) comply, as soon as reasonably practicable, with a written request from a payment system operator or from any of the Authorities and the Payment Systems Regulator for the provision of information or the production of documents … relating to the [PI/EMI]; and 

(b) allow a payment system operator or any of the Authorities and the Payment Systems Regulator, on reasonable request, access to the facilities, staff and premises of the institution for the purposes set out in [regulation 24(1)].

An important proviso to the “work with” obligation is stated to be that “no action needs to be taken [in accordance with Regulation 24(2) – the “work with” obligation] to the extent that, in the opinion of the administrator, such action would lead to a “material reduction in the value of the property of the [PI/EMI]”.
In the Consultation, an example is given of co-operation with a payment system operator in relation to stopping, or completing, “inflight payment transactions” – e.g. amounts due to be credited to customer accounts but which have not yet been received through the relevant load channel.

Continuity of supply

In order to ensure that a Special Administrator can continue to operate the business of a PI/EMI under its control, the Draft Regulations propose that existing suppliers of certain critical services should be restricted in their ability to terminate (or change their terms of supply related to) their services to a PI/EMI in Special Administration, provided that the supplier’s charges for services after the commencement of the Special Administration continue to be paid within 28 days of becoming due. For these purposes a relevant “supplier” is a person (including another group undertaking) making a supply of any of:

(a) services relating to the safeguarding of relevant funds; 
(b) computer hardware or software or other hardware used by the institution, 
(c) financial data, 
(d) infrastructure permitting electronic communication services, 
(e) data processing, 
(f) secure data networks provided by an accredited network provider, or 
(g) access to a relevant system by a sponsoring system participant

(the last two categories of supply relating to providers of services in connection with the Uncertificated Securities Regulations 2001).

Importantly, however, it is expressly stated that a supplier does not include a payment system operator.

Next steps

Any failure of any PI/EMI has the potential to damage confidence in the market, but a failure of a substantial entity where customers were left out of pocket for a considerable time would be particularly damaging. The proposals within the Consultation and the Draft Regulations to minimise this risk should therefore be considered a welcome development. To a degree, they are less radical than they may seem, since many of the actions required to be taken by the Special Administrator are steps that an ordinary administrator would have taken anyway. However, the SAR will bring welcome clarity in some key areas where uncertainty as to the correct approach might have caused delay and sometimes even led to the administrator needing to seek the guidance of the court.

The proposals for improving the ease with which business transfers can be effected out of a PI/EMI insolvency will be particularly valuable if they enable customer relationships to be transferred apparently seamlessly (from a customer perspective) to a new provider.

Any responses to the Consultation need to be submitted by 14 January 2021, so time is relatively short. The Consultation will be supplemented by draft rules for the SAR which are due to be circulated on 17 December 2020 and for which there is a later deadline for comments of 28 January 2021.