Safeguarding Client Funds: A Guide for Payment Institutions

Safeguarding is one of the most operationally demanding obligations facing payment institutions and e-money firms — and one of the most actively supervised by the FCA, following a series of high-profile failures that left customers unable to recover funds held by insolvent payment businesses.

The safeguarding obligation exists to protect customers. Where a payment institution or e-money firm becomes insolvent, safeguarded funds sit outside the firm’s estate and are returned to customers in full before any other creditor claims are satisfied. Without adequate safeguarding, customers’ payment balances rank as unsecured claims in an insolvency — meaning they may recover little or nothing. The FCA’s safeguarding supervision programme reflects its assessment that failures in this area represent a direct risk to consumer harm at scale.

The Legal Basis for Safeguarding

The safeguarding obligation for payment institutions is set out in Regulation 23 of the Payment Services Regulations 2017. The equivalent obligation for e-money institutions is in Regulation 20 of the Electronic Money Regulations 2011. Both regulations require the firm to safeguard relevant funds — funds received from payment service users or exchanged for e-money, that the firm holds at the end of the business day on which they were received.

The safeguarding obligation applies to funds that have been received but not yet transmitted to the payment recipient (in the case of a payment institution) or exchanged for e-money that remains outstanding and unredeemed (in the case of an EMI). Once transmitted or redeemed, the obligation is discharged. The challenge for firms with high transaction volumes is ensuring that the identification, segregation and reconciliation processes are robust enough to maintain compliance in real time.

The Two Safeguarding Methods

Method 1 — Segregation into a designated account. The firm places the relevant funds in one or more accounts held at an eligible credit institution, in each case held separately from the firm’s own funds. The account must be designated as a safeguarding account in a way that makes clear it holds customer funds. Funds in the account cannot be used by the firm for its own purposes; they must be available to be returned to customers at any time.

Method 2 — Insurance or comparable guarantee. The firm obtains an insurance policy or bank guarantee from an eligible institution, covering the full amount of relevant funds held for customers at any given time. This method is less common in practice because the insurance or guarantee must dynamically cover a fluctuating balance — which requires either a facility with sufficient headroom to cover peak balances or a mechanism for adjusting coverage in real time.

Most payment institutions and EMIs use Method 1. The FCA’s preference is for firms to use the segregation method where possible, as it provides a clearer evidential basis for the ring-fencing of funds in an insolvency. Firms using Method 2 must ensure their insurance or guarantee documentation is robust and that the insurer or guarantor is an eligible institution meeting the EMR/PSR requirements.

Eligible Institutions for Safeguarding Accounts

A safeguarding account must be held at an eligible credit institution — a bank or building society authorised in the UK or in an EEA state, or a qualifying institution in another jurisdiction approved by the FCA. The firm must carry out due diligence on the credit institution to confirm it meets the eligibility criteria and should document its assessment.

The FCA expects firms to consider the financial stability of the institution holding their safeguarding account as part of their operational risk assessment. A safeguarding account held at an institution in financial difficulty does not adequately protect customers — the purpose of safeguarding is to ensure funds are recoverable in an insolvency, including the firm’s own insolvency, not simply that they are held in a separate account.

Where a firm holds safeguarding accounts at multiple institutions — as is common for firms with large safeguarding balances or multiple currency operations — each account must meet the eligible institution requirements independently. The firm must be able to identify at any time the full balance of relevant funds across all safeguarding accounts and demonstrate that the aggregate balance equals the amount required to be safeguarded.

Acknowledgement Letters

One of the most commonly cited safeguarding deficiencies in FCA supervision is the absence of adequate acknowledgement letters. Where a firm holds safeguarding funds in an account at a credit institution, it must obtain a letter from that institution acknowledging that: the account holds relevant funds belonging to payment service users or e-money holders; the institution has no right to set off or claim a security interest over those funds; and the funds are held on trust for the payment service users or e-money holders.

The acknowledgement letter serves a critical function in insolvency: it establishes the trust relationship that allows the insolvency practitioner to identify and return safeguarded funds to customers without those funds being available to other creditors. A safeguarding account without a compliant acknowledgement letter may not achieve the ring-fencing that the safeguarding obligation requires.

Acknowledgement letters must be obtained before the safeguarding account is used, reviewed periodically for continued accuracy, and updated where the safeguarding arrangements change. Firms that have held safeguarding accounts for some years without reviewing their acknowledgement letters should treat a review as a compliance priority.

Daily Reconciliation

Firms must carry out a daily reconciliation of the amount of relevant funds required to be safeguarded against the amount actually held in their safeguarding accounts. The reconciliation must be completed by the end of the business day following the day to which it relates. Where a shortfall is identified — the safeguarding account balance is less than the amount required to be safeguarded — the firm must top up the account immediately from its own funds.

The reconciliation process requires the firm to have a clear methodology for calculating the amount of relevant funds at each point in the day. This calculation is straightforward for firms with simple payment flows but becomes complex for firms with high transaction volumes, multiple currencies, and settlement cycles that span more than one business day. The FCA expects firms to have documented their reconciliation methodology and to apply it consistently.

Deficiencies in reconciliation — including late reconciliation, incomplete reconciliation, or the use of estimates rather than actual balances — are among the most common findings in the FCA’s safeguarding supervision. Firms should treat their safeguarding reconciliation as an operational control of equivalent importance to their financial reporting.

The Annual Safeguarding Audit

The FCA expects payment institutions and e-money firms to commission an annual external audit of their safeguarding arrangements. The audit should assess whether the firm’s safeguarding processes comply with the regulatory requirements, whether the daily reconciliation methodology is adequate and consistently applied, and whether the acknowledgement letters and eligible institution documentation are in order.

The FCA’s supervisory approach to safeguarding has moved toward requiring firms to share their annual safeguarding audit reports with the FCA as part of regular supervisory engagement. Firms that cannot produce a current audit report, or whose report identifies material deficiencies that have not been remediated, face heightened supervisory scrutiny. The FCA has in recent years imposed requirements on payment firms requiring them to remediate identified safeguarding failures within specified timeframes.

FCA Safeguarding Reform

The FCA published proposals for significant reform of the safeguarding regime in 2023, following its review of safeguarding practices across the payment sector. The proposed changes — which remain subject to consultation and finalisation — would introduce more prescriptive requirements for the segregation method, tighten the eligible institution criteria, strengthen the reconciliation and audit requirements, and introduce a new wind-down planning obligation for payment firms holding material safeguarding balances.

Firms should monitor the progress of the FCA’s safeguarding reform proposals and assess their current arrangements against the proposed new requirements. Those that meet the existing requirements comfortably are likely to be well-positioned for the new regime; those with existing weaknesses should treat remediation as urgent.

The Finance Function’s Role

Safeguarding sits at the intersection of compliance and finance. The daily reconciliation is an operational finance task; the methodology and controls framework is a compliance responsibility; and board oversight of safeguarding adequacy is a governance matter. In practice the CFO or Finance Director at most payment institutions owns the safeguarding operation day-to-day, with the compliance function providing oversight of the regulatory requirements and the internal audit function providing independent assurance.

At firms with complex safeguarding operations — multiple currencies, high transaction volumes, dynamic safeguarding balances — this division of responsibility requires close coordination between the finance and compliance functions. The SMCR accountability mapping for safeguarding should be clear: the senior manager responsible for the safeguarding function carries personal accountability for its adequacy.

Key References

• Payment Services Regulations 2017, Regulation 23 — Safeguarding
• Electronic Money Regulations 2011
• FCA — Safeguarding requirements for payment and e-money firms