It’s not a duck. The impact of the FCA’s failed appeal in the Ipagoo case

Avid watchers of FCA court cases may have noticed that on 9 March the FCA lost its appeal against the decision of the High Court in the case of Ipagoo LLP that the Electronic Money Regulations 2011 (the ”EMRs”) do not imply a statutory trust over funds received from e-money holders. In the case, the FCA had argued that “relevant funds” are subject to a statutory trust pursuant to the EMRs, thus providing wider protection for customers in the event of insolvency.  This was, as far as I can see, largely on the basis of the “Duck Test” – if it walks like a duck and quacks like a duck, its highly likely to be a duck. Alas, The High Court disagreed and on 9 March the Court of Appeal unanimously confirmed that decision.

What does this mean?

While this may seem to be an obscure academic matter, of interest only to legal anoraks such as myself, it is actually really important and will have real-world implications for the protection of customers’ funds by safeguarding and for the FCA’s supervision of this area, which is already high on its priority list. The point of the FCA’s case was that if, as they asserted, a statutory trust was created, then even if an Electronic Money Institution (‘EMI’) failed to properly segregate funds received in return for e-money issued (“relevant funds”) in the event of insolvency, the statutory trust would allow the funds to be traced and placed in the asset pool for distribution to e-money holders, thus providing protection from other creditors of the firm. Unfortunately for e-money holders (and payment service users by wider implication) the three Appeal Court judges unanimously agreed with the High Court decision and dismissed the FCA’s appeal, holding that no such statutory trust is created by the EMRs.

The effect of this is that, if in an insolvency, an EMI or Payment Institution (PI) has failed to follow the requirements of the EMRs or Payment Services Regulations (PSRs) to the letter, funds received from customers for e-money or payment services will be available to other creditors and e-money holders or payment service users would have to rank as unsecured creditors, meaning that those customers would be highly unlikely to get their money back.

Wind down plans

The FCA, through its recent requirements for wind down plans for PIs and EMIs, is very focused on ensuring that firms are in a position to spot problems early enough to enable them to wind down while still solvent. This is so that customers’ money can be repaid and this decision can only serve to reinforce the regulator’s concerns about insolvent failure of PIs and EMIs. We have seen the FCA asking to see a number wind down plans and pushing back hard if the plans do not meet their expectations. So, as we can expect continued focus on wind down plans and their effectiveness, I’d suggest firms keep theirs under constant review to make sure that they can justify the triggers and resource requirements identified to be able to show to the FCA that they could wind down successfully and return customers’ funds if required.

Safeguarding requirements

What it also means is that as an EMI or PI, you should ensure that you are complying with the letter of the law regarding safeguarding requirements as well as being able to evidence that this is the case. All EMIs are already required by the FCA to have an annual safeguarding audit done and the FCA may start asking to see the audit reports more often given the implications of the Appeal Court decision.

Payment Institutions which are able to take advantage of the Small Companies Exemption in the Companies Act 2006 are not required to undertake such an audit, but unless you have had your safeguarding processes independently audited, how will you be able to show to the FCA that you are compliant?  As a reminder, safeguarding is a threshold condition for authorisation and the FCA said it in their recently published Strategy:

“We will use breaches of threshold conditions to stop or restrict the activities of a broader range of problematic firms, even if they don’t pose a risk to consumers or markets."

Not safeguarding properly would definitely be seen as a risk to consumers, so the FCA is likely to move quickly to enforcement action.

As always, it is much better for a firm to be ahead of the game and identity and address any issues before the FCA does. This Appeal Court decision and the FCA’s likely response reinforces that point with regards to safeguarding.