Electronic Money Institutions – are they safe and how are they regulated ?

Overview.

These days, an Electronic Money Institution (‘EMI’) can provide many of the same services as a traditional bank – including the ability to issue debit cards, open current accounts with unique IBAN numbers and make and receive payments in multiple currencies.

For those of us in the Isle of Man, the Channel Islands or similar jurisdictions, EMIs provide a valuable and increasingly popular alternative to traditional banks for many clients whose options to open a bank account have become extremely limited especially in higher risk sectors such as eGaming.  

Understanding how EMIs are regulated and the risks and protections associated with them is key if you are considering using one yourself or recommending one to your client. This topic is not well understood and this short article is aimed at clearing some of the mist.

What is an EMI, how does it work ?

Under UK law, an EMI is an “Electronic Money Institution” which is authorised to issue and redeem electronic money which can also be used to make payments.

Just like a traditional bank, EMIs open unique IBAN multi-currency accounts for their customers which can be used for payments and some can also issue debit cards. 

EMIs operate their business via institutional relationships with their authorised banking and custodial partners who provide the payment ‘rails’ via the various global payments systems.  (SEPA, FPS, FEDWIRE etc)

Unlike traditional banks, EMIs are not ‘deposit takers’ therefore they cannot lend money but they enjoy a low overhead and can usually offer lower transaction costs and excellent forex margins to their customers. 

Their tech based infractures also allows them (well the good ones), to offer account opening times, ease and speed of use and also customer service which the traditional banks seem unable to compete with. 

How are EMIs regulated in the UK ?

UK based EMIs are subject to strict licensing, regulation and oversight by the UK Financial Conduct Authority.

UK law requires EMIs to comply with a number of rules including The Electronic Money Regulations 2011 (‘EMR’) and also guidance included PERG3A document contained within the FCA handbook as well as their further guidance here.  

As EMIs are not banks, building societies or credit unions, the money held by them for customers is not protected by the UK Financial Services Compensation Scheme, however, there are robust requirements in place to protect customers via an obligation for EMIs to “safeguard relevant funds”.

Safeguarding – technical aspects.

Detailed requirements for safeguarding by EMIs are contained within Regulations 20-22 of the EMR. 

In summary, EMIs are required protect customers funds and  they can do this, either by:- 

(i) Segregating the relevant funds (regulation 21) – by holding them as secure, liquid, low-risk assets – in a clearly designated account with an authorised credit institution or authorised custodian so that in the event of an insolvency customers claims are paid in priority to other creditors. This is similar to a trust arrangement.

or

(ii) Insuring the relevant funds (regulation 22) via a guarantee from an authorised insurer in the event of insolvency.

You can read more about the technical legal aspects of safeguarding in the Simmons & Simmons article here. 

Safeguarding – practical aspects.

The FCA issued some helpful ‘additional guidance for payment and e-money firms’’ on its expectations in relation to safeguarding by Payments and EMoney Institutions in July 2020. 

As you will see from the FCA document, the requirements imposed on EMIs include:-

• Not less than daily reconciliations of customers’ funds. 
• A fully documented reconciliation process with accompanying rationale.
• FCA Notification requirements for material reconciliation discrepancies
• FCA Notification requirements for instances of non compliance.
• Requirement for EMI ‘safeguarding’ accounts to be clearly named and identified as such.
• A requirement to obtain acknowledgement letters from relevant banks, custodians etc that ‘safeguarding’ accounts are segregated, non recourse, no right of set of accounts.
• A requirement for EMIs to carefully review and document solvency / suitability of their authorised counterparties on an ongoing basis.
• The compulsory annual audit of the EMIs compliance with safeguarding requirements by an independent firm to provide an opinion on the following matters:-

1. whether the firm has maintained organisational arrangements adequate to enable it to meet the FCA’s expectations of its compliance with the safeguarding provisions of the EMRs/PSRs (as set out in chapter 10 of our Approach Document), throughout the audit period, and 
2. whether the firm met those expectations as at the audit period end date

Conclusion.

EMIs provide a useful, flexible, cost efficient and increasingly popular alternative to traditional banks for personal and corporate customers to hold money and make payments.

As well as lower fees, quicker account opening, they are also capable of offering a better user experience through avoidance of legacy systems and better tech and dare I say it, a clearer customer focus.

For higher risk customers, including those based in places like the Isle of Man, the Channel Islands, EMIs are a valuable alternative to traditional banks.

While account holders are not protected by the Financial Services Compensation Scheme, there are robust safeguarding requirements which have been put in place to protect customers and the requirement of authorisation and oversight by the FCA should also provide some comfort.

However, risks remain and therefore, it is recommended that potential customers undertake their own due diligence in respect of any payment or EMI before opening an account in order to satisfy themselves that the organisation is credible, well capitalised and operates safeguarding policies which are appropriate and effective.