Authorised Payment Institutions (APIs) and E-money Institutions (EMIs) are required to safeguard ‘relevant funds’ by virtue of the Payments Services Regulations 2017 (PSRs) or the E-Money Regulations 2011 (EMRs). Many foreign exchange (FX) companies are authorised as either an EMI or an API, with the payment service of ‘payment accounts’ within their permission. We are frequently asked whether funds received from a customer in exchange for currency which is to be transmitted back to that customer should be treated as ‘relevant funds’ - and are required to be safeguarded - or fall within the ‘principal to principal’ model set out in the final sentence of the Financial Conduct Authority (FCA) Approach Document.
‘Relevant funds’ are defined in the PSRs as:
“sums received from, or for the benefit of, a payment service user for the execution of a payment transaction and sums received from a payment service provider for the execution of a payment transaction on behalf of a payment service user” and in the EMRs as “funds that have been received in exchange for electronic money that has been issued”.
The FCA states at paragraph 10.25 of its Approach Document that, in its view:
“an institution that is carrying out a foreign exchange transaction independently from its payment services is not required by the PSRs 2017 or EMRs to safeguard funds received for the purpose of the foreign exchange transaction (see Q12 in PERG 15.2). Indeed, where an institution is using the segregation method of safeguarding (see below), the foreign exchange transaction funds will need to be kept separate from the payment service transaction funds as they are not relevant funds. Once the foreign exchange transaction has taken place, if the institution pays those funds on to a third party on behalf of its client, and this amounts to a payment service, the currency purchased in the foreign exchange transaction becomes relevant funds to be safeguarded as soon as it is received by the institution. To be clear, in our view, in making a payment of currency to its customer in settlement of a foreign exchange transaction, the FX provider will be acting as principal in purchasing the other currency from its customer. This does not constitute a payment service.”
What are 'relevant funds' under the E-Money Regulations 2011?
Where a firm is operating E-Money accounts and the funds in relation to an FX transaction, where the currency is to be paid to the E-money holder (a ‘first party’ transaction), are paid into the customer’s E-money account it is clear that in accepting those funds and crediting the account E-money has been issued. Therefore, those funds are 'relevant funds' and are required to be safeguarded.
However, if the firm was to carry out such a transaction without the funds flowing through the E-money account, this would be a ‘principal to principal’ transaction, and therefore not a payment service or E-money and the inclusion of such funds in a safeguarding account would constitute ‘co-mingling’ which would be in breach of the regulations and corrupt the safeguarding protection.
What are 'relevant funds' under the Payment Services Regulations 2017?
In considering this question, it is important to take into account a number of definitions in the PSRs, viz:
- Payment account - an account held in the name of one or more payment service users which is used for the execution of payment transactions;
- Payment service user - a person when making use of a payment service in the capacity of payer, payee, or both;
- Payment transaction - an act initiated by the payer or payee, or on behalf of the payer, of placing, transferring or withdrawing funds, irrespective of any underlying obligations between the payer and payee;
- Relevant funds -sums received from, or for the benefit of, a payment service user for the execution of a payment transaction and sums received from a payment service provider for the execution of a payment transaction on behalf of a payment service user. Where the funds are for an FX transaction you also need to refer to Q12 in PERG 15.2 of the FCA Handbook, referred to in the Approach Document, which says "Foreign exchange transactions may exist as part of, or independent from, payment services”.
Paragraph 10.20 in the Approach Document says “an institution that is carrying out a foreign exchange transaction independently from its payment services is not required by the PSRs or EMRs to safeguard funds received for the purpose of the foreign exchange transaction.”
The provision of payment accounts for customers is a payment service, as listed in Schedule 1(1) of the PSRs and requires FCA authorisation. Therefore, where the funds for a first party transaction are credited to a payment account in the customer’s name, that constitutes the provision of a payment service, and the FX transaction cannot be said to be “independent from the firm’s payment services”. The customer is also then the ‘payment service user’, which is defined as “payer, payee, or both.” The fact that the customer is also the ultimate payee of the currency involved does not, therefore, alter the fact that a payment service is being provided.
In light of the above, it is clear that, where an FX firm is authorised as a Payment Institution, with payment account permission, and is placing funds for first party FX transactions through the customer’s payment account, this constitutes the provision of a payment service, and such funds are therefore ‘relevant funds’ for the purposes of Regulation 21 of the PSRs and require to be safeguarded as such.
Where a firm undertakes first party FX transactions, without them going through a payment account, however, these would not be relevant funds, and the inclusion of such funds in a safeguarding account would constitute ‘co-mingling’ which would be in breach of the regulations and corrupt the safeguarding protection.
If you have questions relating to this or any other aspect of safeguarding then please do get in touch. You might, also, be interested in our Safeguarding Audit service.