And the ‘EMI’ goes to…

Posted on: 20 November 2023

Written by: James Borley

Whilst much of the focus of the recent joint statement from the Prudential Regulation Authority (PRA), the Financial Conduct Authority (FCA) and the Bank of England (BoE) on the ‘Cross-authority roadmap on innovation in payments’ was on the treatment of stablecoins, there was one specific area that caught my attention...

In its Dear CEO letter to UK banks, on the innovative uses of deposits, e-money and stablecoins, the PRA set out its thoughts on how e-money issued by banks, as opposed to electronic money institutions (EMIs), might be treated in the future.

The PRA has stated that “e-money has been in existence for over a decade.” Indeed, while the legislation creating EMIs was implemented in 2011, the issuance of e-money has been a specific regulated activity permissible for credit institutions (‘banks’) since 2006, as contained within the legislation of the day (Directive 2006/48/EC (BCD)). However, since the introduction of the Electronic Money Regulations in 2011, EMIs have sought to compete with the banks in the ‘current account’ market, with the key functionality of an EMI e-money account competing with the traditional current account offered by the banks.

There are, of course, certain key differences between these types of accounts which lend (no pun intended) themselves to different legislative/regulatory treatment. Not least, is what is ‘done’ with the money, with only a bank being able to accept funds as a ‘deposit’ which it can then use to lend against. In contrast, funds exchanged for ‘e-money’ cannot be lent against, but are subject to safeguarding requirements. This highlights another key difference: the treatment of customer funds in the event of the firm’s insolvency. The FCA has long highlighted the potential for consumer ‘misunderstanding’ of the protections in place for account holders, specifically that Financial Services Compensation Scheme cover does not apply to funds held as e-money.

Now it seems that the PRA has also voiced similar concerns in relation to retail customers, stating:

 “Retail holders of e-money or regulated stablecoins might mistakenly assume that they have exactly the same protections as retail depositors.”

This might, in the PRA’s opinion, give rise to contagion risk and, in particular, a loss of confidence in the safety of funds held as deposits;

“especially if deposit-takers were to offer multiple forms of digital money or money-like instruments.”

So, the cunning plan to mitigate the risk of contagion is to establish a separate legal entity from the existing bank, which would be separately authorised to issue e-money (or regulated stablecoins) to retail customers, using separate branding to mitigate confusion risk. Where a bank has already issued e-money to retail customers, it is required to;

 “engage with the PRA on how they intend to mitigate the risk of contagion and restructure their activities as soon as practicable. The PRA recognises such deposit-takers may need time to adjust and will adopt a proportionate approach to implementation.”

Now that seems a bit of an understatement, given that the FCA is the competent authority for authorising firms seeking permission to issue e-money. I can’t recall the FCA saying anything on this topic yet.

This all leads to lots of questions. For example, will the application/assessment process be the same as for new start-ups (with a corresponding risk tolerance), or will there be some sort of ‘grandfathering’? I can’t see how the latter would work, given that, by definition, a separate entity needs to be created and separately evidence that it fulfils all the conditions of authorisation. It would mean separate governance structures and very likely many separate role holders. Stop me if you’ve heard this before, but there seem to be shades of the Ringfencing exercise in 2017 and, when banking institutions were required to separate retail banking services from the rest of their business.

In principle though, this is not that much of a stretch. As part of Brexit planning, many EEA credit institutions passporting under the Banking Consolidation Directive (BCD), were contemplating how they might effectively continue to operate in the UK, assuming the expiry of the Temporary Permission Regime. The traditional view was to replicate the licence profile in the home Member State, or the profile of the passported activities, which would necessitate the creation and authorisation of a new credit institution in the UK. However, one option we were suggesting to clients was to consider the type of business actually envisaged in the UK and whether an e-money licence might nevertheless be sufficient for their purposes.

Notwithstanding questions on the authorisations process itself, and assuming the authorisation requirements in regulation 6 of the Electronic Money Regulations 2011 apply as currently drafted, there is one key element that is hugely ironic. Effectively, an erstwhile bank will now (as an EMI) be required to safeguard “electronic money holders’ funds in accordance with regulation 20”. Regulation 21(2)(a) then goes on to say that, typically, these funds are allowed to be “held in a separate account that it holds with an authorised credit institution”. But, crucially, regulation 21(7) says “authorised credit institution” means a person authorised for the purposes of the 2000 Act to accept deposits or otherwise authorised as a credit institution in accordance with Article 6 of the banking consolidation directive other than a person in the same group as the electronic money institution [my emphasis]”. So, it leads me to ask the following question, if you can’t use the bank from whence you came, or any other in the group, then who is going to provide you with such an account on a proportionate, objective and non-discriminatory basis? So there, you can see the potential issue that got my attention.

This might well all be moot anyway, given the review of the Payment Services Regulations currently underway. I would hope that the lawmakers will have been in discussions with the PRA, FCA and BoE before the PRA published these directions. Regardless, should you need to consider making an application for authorisation as an EMI, please do get in touch with us. Cosegic has successfully supported dozens of EMI applications since 2011, and we’d be delighted to start a conversation with you.

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James B

James Borley

James, our Managing Director for Payment Services, is a highly qualified financial services expert and a familiar name to many in the payments and e-money community.

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