PSD3 - Called to Account

As one of the aims of The Payment Services Directive (PSD), (from the very first European Commission proposal for “A New Legal Framework for Payment Services in the Internal Market”), was always to enable non-bank payment services providers to compete with banks, the FCA’s insistence that payment institutions can only hold funds in a payment account if they are allocated to a specific future dated payment, often comes as a surprise to payment institutions (and applicants for payment institution authorisation) looking to offer payment accounts to customers in the UK.

This article will look at why the FCA has taken this position and what implications it has while we look towards PSD3.

The FCA’s position

In support of this restriction, the FCA point to Regulation 33 in the Payment services Regulations (PSRs), implementing Article 18(2) in the 2^nd Payment Services Directive, which says:

“Any payment account held by an authorised payment institution or a small payment institution must be used only in relation to payment transactions.”

The FCA then expand on this at Question 5 in the Handbook at PERG 15, saying:

“Our view is that this means that a payment institution cannot hold funds for a payment service user unless accompanied by a payment order for onward transfer (whether to be executed immediately or on a future date). Funds cannot be held indefinitely. They should not be held for longer than is necessary for operational and technical reasons.

The fact that a payment account operated by a payment institution can only be used for payment transactions distinguishes it from a deposit.”

However, this view is in direct contradiction of the European Banking Authority’s stated position on the same article in response to a European Banking Authority (EBA) Single Rule Book Question (2018_4221 Ability of a payment account operated by a payment institution to hold a credit balance in readiness for future payment transactions | European Banking Authority (europa.eu), which reads:

“A payment institution may hold clients’ funds on payment accounts for the purpose of providing payment services, including the execution of not yet specified future payment transactions, in accordance with the framework contract for setting up the referred payment account.”

The final answer was published on 12 March 2021 so, after Brexit, but this does mean that the FCA’s position is much more restrictive on the activities of payment institutions than the EU.

E-Money Institutions

The FCA’s position effectively means that any firm which wants to be able to hold customer funds in a payment account (as many do, particularly in the FX space), has to apply for authorisation as an E-Money Institution (EMI). However, this leads to certain headaches. Even apart from the larger minimum capital requirement (€350,000 vs €125,000), there is the practical issue of meeting the definition of E-money:

“Electronically (including magnetically) stored monetary value as represented by a claim on the electronic money issuer which—

(a) is issued on receipt of funds for the purpose of making payment transactions;

(b) is accepted by a person other than the electronic money issuer”

Conceptually this means that E-money is something different from the underlying funds; something which is “issued” by the EMI and accepted by a person other than the issuer. Where the firm issues payment cards, this can be fairly simple to prove, as every merchant who accepts payment by the card is accepting the E-money. However, if there is no payment card, then a faster payment of Bacs payment to a payee does not constitute acceptance of the E-money as it has to be redeemed for fiat currency before entering the banking system.

This can be addressed by having the functionality to transfer between accounts of different customers within the EMI’s own platform, so that the recipient customer is “accepting “ the E-money, but this can sometimes look like form over substance (although it should be noted that there is no restriction on EMIs making credit transfers from their customers’ accounts through the banking system).

The EBA’s view

In its recommendations to the European Commission on what should be in PSD3, the EBA suggests that there is merit in merging the E-Money Directive and PSD, stating “The two types of accounts are very similar, if not identical, in nature since they have the same elements and serve the same purpose, namely, to execute payment transactions…   …Therefore, taking into account the principle ‘same activity, same risk, same rules’, there is merit in merging these two terms.”

They also say that “provisions, such as those under Article 83 (Payment transactions to a payment account) and 89 (Payment service providers’ liability for non-execution, defective or late execution of payment transactions) of PSD2 do not seem to apply”, which is not a view that the FCA has ever taken.

The EBA’s view seems to be ignoring one of the primary functions of E-money according to 2^nd E-Money Directive (2EMD), that of acting as a store of value and therefore the ability to hold funds on an ongoing basis in an E-money account. This, from my memory of the negotiations for the 2EMD, was one of the reasons behind the higher minimum capital requirements for EMIs compared with APIs.

2EMD allows for Member States to implement a prescription period after which unclaimed E-Money may no longer be redeemed (as indeed the UK did), however, PSD2 had no such provision. This has led to some Payment Institutions (PIs) having large amounts of unclaimed funds which they are required to continue to safeguard ad infinitum, with no ability to write off the unclaimed funds. If PIs are able to hold funds in payment accounts without payment instructions, this seems likely to exacerbate this problem.

The emergence of cryptocurrencies further complicates the situation, with the question of whether and when “stablecoins” fall within the E-money perimeter and, in the interests of clarity, the EBA proposes that E-money and “scriptural money” (which to be honest is a very rarely used term, merely meaning an electronic record of the funds held) both be replaced by the word “funds” in PSD3. As indicated above, this appears to ignore (or obviate) the concept mentioned above of E-money being something different from the underlying funds.

One other point which the EBA mentions is that, in its view, “electronic money has very cash-like characteristics, such as anonymity”. While this may be the case for prepaid cards purchased in newsagents and the like, much of the E-money growth in the UK is from so-called “neobanks” (a term which I dislike, because they are definitely not banks), where the offering of payment current accounts does not involve anonymity. It may be better to have some specific provisions to address that section of the market, rather than tarring the whole E-money sector with the same brush.

In summary then...

At the moment there are lots of unknowns about how this will all unravel, but what we do know is that the FCA and HM Treasury have been considering combining the EMRs and PSRs, presaged by the combination of the guidance into one Approach Document. The EBA’s recommendations to the European Commission for PSD3 to merge PSD and EMD seems along the same lines, but it raises some very interesting points for consideration on the question of payment accounts/E-money accounts. So much so,  that clarity of the intent and meaning of the legislation would be welcomed by market participants and customers alike. Fudging the issues again would just add to confusion for firms, the FCA, and customers.

It will be very interesting to see the choices the Commission and the FCA/HM Treasury make and the extent of UK divergence from the EU. Brexit was always likely to reduce the single market advantages previously available to firms wanting to come into Europe from the rest of the world, and if the UK and EU take markedly different approaches to this important question, this reduction will accelerate.