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Supercapital – What happens when a payment (or e-money institution) becomes insolvent?

[fa icon="calendar"] 02-Oct-2020 09:10:01 / by Colin Sloan

Colin Sloan

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Safeguarding is an area that raises many points of debate and contention within the industry. And having assisted dozens of payment and e-money institutions with their safeguarding compliance, I have always been struck by the fact that the requirements have never been subject to any judicial ruling. That was until the High Court judgement[1] in June this year on the insolvency of the payment institution Supercapital.

This case and subsequent judgement offers a real-life example of a payment institution that became insolvent, and the extent to which the safeguarding requirement protected customer funds. For that reason, Alison Donnelly and I hosted a webinar with Kevin Goldfarb from Griffins Insolvency Practitioners and Alex Jay from Gowlings WLG, who respectively acted as an administrator and solicitor in the case of the insolvency.

Supercapital offered foreign exchange and cross-border payment services to clients including foreign exchange brokers, banks and wealth managers. The firm held approximately £12.6 million, which was calculated to leave a shortfall of approximately £585,000 owing to clients, excluding the costs of the work of the administrators.

In this post, I want to consider two key lessons from the subsequent High Court judgement that approved the distribution plan of the administrators.

 

  1. Payment and e-money institutions hold client funds on trust

When the FCA issued their temporary guidance consultation in May there was a lot of discussion as to whether the funds held by payment and e-money institutions was held in trust and there was surprise at the FCA’s assertion that it was.

 The safeguarding provisions of the Payment Services Regulations 2017 (PSRs) and Electronic Money Regulations 2011 (EMRs) make no reference to a trust. Concern voiced in the consultation responses to the FCA centered around potential hesitancy from safeguarding providers in acknowledging a trust over the relevant funds.

The Supercapital judgement however removes all doubt. Judge Agnello noted that a trust is created regardless of whether the word itself is used in the respective regulations.

“There are in my judgment, many similarities as between the PSRs and CASS 7, save that CASS 7 makes an express declaration of trust. That in in itself of course is not determinative, merely an indication that many of the provisions set out in the PSRs are those one would expect to see in the event that a statutory trust is created.”[2]

In terms of the practical implications of this, it provides some comfort to clients in the event that funds are not properly safeguarded according to the regulatory requirements. Were the payment or e-money institution to become insolvent, there would be the potential for a claim over the firm’s other assets where a sufficient sum is not retained in the safeguarding account.

The existence of a trust also raises the question of what acknowledgement the payment or e-money institution should receive from their safeguarding credit institution of the trust.

In their Feedback Statement following their consultation on the proposed new guidance, the FCA said that “the acknowledgement by the credit institution or custodian of the fact that the payments services firm is holding the money or assets on trust, and that there are no rights of set-off, is fundamental to protecting consumers if a payments or e-money firm becomes insolvent.”

Payment and e-money institutions should therefore undertake a review of letters and terms and conditions held with safeguarding credit institutions to ensure sufficient acknowledgement from the bank that the payment or e-money institution holds the funds on trust.

 

  1. The consequence of client money being held outside the safeguarding account

While there is some comfort to clients in knowing that the payment or e-money institution is a trustee of the relevant funds, this does not negate from the necessity of the institution having robust safeguarding policies and procedures. As discussed, in Supercapital’s case, there was a shortfall of £585K pertaining to clients, which was largely due to duplicate payments having been made which were not recovered. These duplicate payments were caused by human error, and the shortfall would have been easily spotted if the firm had carried out daily reconciliations of the safeguarding account.

Furthermore, the firm had some funds sitting in non-safeguarding accounts with other payment service providers. £126K of these funds were subject to a fee reduction by one of the providers, which the administrators considered uneconomical to contest.

Both of these instances demonstrate, that even though the payment or e-money institution holds the relevant funds on trust, significant detriment to clients can ensue from how the firm in practice handles client money and the robustness of its safeguarding procedures. If the duplicate payments had not been made, and if the £126K was held in Supercapital’s safeguarding account, clients would have been able to recoup a higher proportion of their funds.

 

Conclusion

In recent years, we have undertaken a number of safeguarding audits for clients, and have witnessed some clients devoting significant resource to getting it right (or as close as possible). However, our sad reflection is that there are plenty of payment and e-money institutions that have not seriously reviewed their fund flows and safeguarding processes in any great detail. Much therefore is welcome in the Supercapital judgement, as the confirmation of the trusteeship could aid the recovery of client money in the event that the payment or e-money institution has failed to comply with the safeguarding requirement.

That said, the FCA’s recent Finalised Guidance[3] was published after the Supercapital judgement. And rather than relaxing the guidance in light of the confirmation of trusteeship, the standards have been heightened further. It is safe to assume, therefore, that FCA does not see this judgement as an excuse for standards to slip, and that robust safeguarding arrangements are as important as ever.

 

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[1] Supercapital Ltd, Re Insolvency Act 1986 [2020] EWHC 1685 (Ch) (29 June 2020)

[2] CASS refers to the Client Asset Sourcebook of the FCA handbook, which contains the rules applicable for investment firms to protect client money and assets.

[3] Coronavirus and safeguarding customers’ funds: additional guidance for payment and e-money firms, 9 July 2020

 

This post contains a general summary of advice and is not a complete or definitive statement of the law. Specific advice should be obtained where appropriate.

 

Topics: Payment services, E-money sector, safeguarding

Colin Sloan

Written by Colin Sloan