Safeguarding Requirement

A safeguarding requirement is a legal obligation on non-bank payment firms, such as payment institutions and electronic money institutions, to protect the money they hold for customers. Because these firms are not banks, their customers' balances are not covered by deposit insurance. Instead, the law requires the firm to keep customer funds separate from its own, or to cover them with an insurance policy or bank guarantee, so that customers can be repaid if the firm fails.

The requirement is the legal rule; safeguarding is the practice of complying with it, usually through a designated safeguarding account at a bank. In the European Union it derives from PSD2 and the Electronic Money Directive, and in the United Kingdom from the Payment Services Regulations 2017 and the Electronic Money Regulations 2011. Similar obligations exist in other countries, sometimes under different names, such as the permissible investment rules for US money transmitters.

The requirement applies to firms that receive funds from or for customers in order to execute payments or issue e-money. In Europe and the UK this covers authorised electronic money institutions and payment institutions, and can apply to smaller registered firms that choose or are required to safeguard. Firms that never hold customer money, such as pure account information services, are not affected. Banks are outside these rules because depositors are protected by capital regulation and deposit guarantee schemes.

The law allows two main methods:

• Segregation. Customer funds are kept apart from the firm's own money and placed in a separate account at an authorised credit institution, or invested in secure, liquid, low-risk assets approved for the purpose. The account must be clearly designated as holding customer funds, and the firm must not use the money for its own purposes.
• Insurance or guarantee. The firm arranges an insurance policy or a comparable guarantee from an insurer or bank outside its group, covering an amount equal to the customer funds and payable into a segregated account if the firm becomes insolvent.

Some firms use a combination. Segregation is far more common in practice, because suitable insurance is expensive and limited in supply.

Where a firm holds funds that are only partly customer money, such as a payment for goods that includes the firm's fee, rules generally require the customer portion to be safeguarded. Firms must document which method they use, how they calculate the safeguarded amount and how they would return funds if they failed.

Funds must be protected promptly. For payment institutions, money received for a payment that has not been executed by the end of the business day after receipt must be safeguarded from that point. E-money funds must generally be safeguarded within a similar short period. Firms must reconcile their safeguarded balances against what they owe customers frequently, usually daily, and correct any shortfall at once. Records must show at all times which funds belong to which customers.

Common difficulties arise where money passes through several accounts, payment partners or currencies, or where card acquirers and other intermediaries hold funds for the firm. Firms need clear flow-of-funds documentation and reliable reconciliation to show that the requirement is met.

Safeguarding is a priority for supervisors because several payment and e-money firm failures have left customers waiting months or years for their money, often because records were incomplete or funds had been mixed with the firm's own. In the UK, the Financial Conduct Authority has strengthened its rules with more detailed record-keeping, regular reporting of safeguarded amounts, annual audits by an external auditor and resolution packs that help an administrator return funds quickly. Courts have also clarified how safeguarded funds are distributed in insolvency.

Firms that breach the requirement can face restrictions, fines or loss of authorisation, and directors may be held responsible. A firm's ability to show compliance is also tested during regulatory authorization and by banks that provide safeguarding accounts, which carry out their own due diligence.

Safeguarding protects customers from the firm's insolvency, not from fraud or poor investment decisions made by the customer. It differs from deposit insurance, which pays depositors up to a limit from a fund, and from the reserve rules for stablecoins, which require issuers to hold assets backing their tokens. Customer funds held under a safeguarding requirement are similar in purpose to safeguarded client funds in investment firms, which are governed by client money rules.