Electronic money, payment services and insolvency | Latham & Watkins LLP

Consumers and service providers should take note of some of the increased risks in the event of an electronic money institution’s insolvency.

Technology is rapidly changing the way customers and businesses interact with financial systems. Fintech companies are a driving force behind the disruption of traditional banking and payment services, with regulatory innovation close behind.

In the 12 months to June 2021, electronic money institutions (EMIs) in the UK processed more than £500 billion in transactions, according to data from the Financial Conduct Authority (FCA). In 2019, UK EMIs held £10 billion in client funds, according to UK government estimates. By 2025, more than seven out of 10 smartphone owners will be users of P2P mobile payments. As the top source country for remittances, the UK saw a 30% growth in its digital remittance market in 2021. According to Statista, this market is expected to reach over $4.6 billion in by 2025. These trends are fueling the UK’s ambition to become a global leader in payments innovation.

Changes in the payment services landscape

In 2017, the Bank of England accelerated payment service innovation by extending the real-time gross settlement (RTGS) service to non-bank payment service providers (PSPs). This measure opened up direct access to UK sterling payment systems that settle in sterling central bank money, including Faster Payments, BACS, CHAPS (Clearing House Automated Payment System), LINK (the largest UK ATM network) and Visa. The change was part of a wider strategy to open up access to UK payment systems to allow new entrants such as fintech payment companies to compete on equal footing with banks in square. This decision has encouraged the implementation of new technologies that have been developed to meet the demands of consumers and financial intermediaries for faster, simpler, cheaper and more flexible means of payment.

Another significant regulatory change in the payments and banking space is open banking, in which the UK was an early pioneer. Open banking allows third-party payment services and financial service providers to access consumer banking information such as transactions and payment history. Consumers can decide if they want to share their payment history from their primary bank account to a third-party payment app on their smartphone.

Regulatory framework

New payment technology requires stringent regulation. The UK legislation that underpins the scheme is based on the second European Electronic Money Directive (2EMD) and the revised Payment Services Directive (PSD2). The Electronic Money Regulations 2011 (EMR) implemented 2EMD and the Payment Services Regulations 2017 (PSR) implemented PSD2, under which the FCA is the competent authority. In addition to removing market barriers, the EMRs also introduced conduct requirements for all e-money issuers, as well as licensing, registration and prudential standards for EMIs.

Electronic money is defined in the EMR as monetary value represented by a claim on the issuer which is stored electronically, including magnetically, and issued upon receipt of funds to effect a payment transaction, and which is accepted by persons other than the issuer electronic money. An EMI is an institution authorized to issue electronic money and is often engaged in the business of providing payment services. From a consumer’s perspective, an EMI may seem indistinguishable from a bank. The main difference is the inability of an EMI to on-lend consumer funds. It is important to note that an IME is not covered by the Financial Services Compensation Scheme.

EMIs are less regulated than banks and therefore safeguard requirements and rules related to insolvency in EMIs are essential for the protection of EMI customers. An EMI must protect the funds received in exchange for electronic money (relevant funds). The funds concerned must be segregated from all other funds held by the EMI and either placed in a separate account held by the EMI with an approved credit institution or invested in safe, liquid and low-risk assets. In the latter case, the EMI must place these assets in a separate account with an approved depository, and no one other than the EMI may have an interest in the funds or assets concerned. In addition, an EMI must ensure that the relevant funds are covered by an insurance policy with an approved insurer, or a comparable guarantee from an approved insurer or credit institution.

In the event of IME’s insolvency, the claims of e-money holders shall be paid from the pool of assets in priority over all other creditors. Until all such claims have been paid, no right of set-off or security shall be enforceable against the pool of assets (except to the extent that the right of set-off relates to costs and expenses relating to the account management). Furthermore, the claims of e-money holders should not be diluted by the costs of insolvency proceedings (except for the costs of distributing the asset pool).

Ipagoo: An unlimited pool of assets?

The nature of the statutory “super priority” accorded to claims by e-money holders and the capacity in which the relevant funds were held were examined in the recent Court of Appeal decision in Ipagoo[1].

Ipagoo was authorized and supervised by the FCA to issue e-money and provide payment services, and was the first non-bank institution to directly access CHAPS. Ipagoo entered administration in July 2019. At that time, it held sums that had been paid by e-money holders in exchange for e-money and the administrators quickly realized that it was not possible to establish whether the relevant funds had been safeguarded as required. by the RME. The administrators asked two questions in seeking directions from the court as to the distribution of assets in the administration under the EMRs:

  • Do EMRs create a statutory trust over the asset pool for the benefit of e-money holders?
  • Are the affected funds, which should have been protected but were not, part of the asset pool?

At first instance, the court held that the DMEs did not create a legal trust over protected funds. The court, however, concluded that the asset pool should nevertheless be deemed to hold an amount equivalent to all relevant funds that should have been safeguarded, even if the funds that should have been safeguarded were not part of the actual asset pool. . The FCA appealed the decision and the administrators cross-appealed to present the argument on behalf of non-e-money unsecured creditors, whose position was affected by the expansion of the scope of the asset pool. by the court. The Court of Appeal dismissed both the appeal and the cross-appeal, agreeing with the lower court’s view that:

  • EMRs did not impose a statutory trust with respect to funds received from e-money holders;
  • a statutory trust should not be imposed to meet the requirements of EU directives (2EMD or PSD); and
  • the asset pool should include funds that have not been properly safeguarded.

The court held that the relationship between an EMI and its customers was purely contractual: the customers have a claim against the EMI represented by the electronic money it issued, but no right of ownership over the funds concerned which the EMI holds for them.

The implications of Ipagoo

While it is helpful that the decision has removed any doubts about the legal basis on which an EMI holds assets, it raises difficult compliance issues if the legal consequences of not properly ring-fencing assets in the event of insolvency are no different from the position they had been so. Ordinary unsecured creditors (which may include payment intermediaries) would appear to take an increased credit risk on an EMI if it is in serious non-compliance of the type found by the court in Ipagoo. Given the exponential growth of the EMI market and its anticipated future expansion, this increased risk is no small change for any consumer or service provider to ignore.

Endnotes


[1] Ipagoo LLP (in administration) [2022] EWCA Civil 302.


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Elaine R. Knight