The Financial Conduct Authority‘s (FCA) recent Consumer Duty launch has brought the issue of governance to the fore. Now more than ever, organisations must prioritise protecting consumer assets.
It is unlikely that the importance of governance is going to be washed away anytime soon. According to John Burns, non-executive director at Cornerstone FS plc, the foreign exchange company, this is only the beginning.
Burns has over 40 years’ of experience in the payments industry, assisting banks and payment and e-money institutions manage their compliance and developing payments legislation and regulation in the UK and Europe.
This includes having been the Financial Service Authority’s technical specialist on payments with responsibility for the UK’s implementation of the Payment Services Directive and second e-money directive. Other experience includes positions with the Association for Payment Clearing Services, the Payments Council, Clydesdale Bank and Lloyds Banking Group.
He explains:
Improving governance in the financial services sector – why does it matter?
The FCA is adamant that there is a governance issue with the financial services sector. Particularly with payment services and e-money firms. From the regulator’s perspective, companies understate the importance of governance and risk management. They are unable – or unwilling – to take a step back to assess what proper governance should look like.
This matters because payment services and e-money firms are not covered by the Financial Services Compensation Scheme (FSCS). Consequently, failures are likely to cause losses to customers – which is something the regulator is desperate to avoid. As a result, the FCA has taken measures to address this issue.
The most recent of which is Consumer Duty. It is a set of rules which came into force on 31 July 2023, to ‘set higher and clearer standards of consumer protection across financial services and require firms to put their customers’ needs first’.
Another example is the recent evolution of the regulator’s resourcing of payment supervision. The FCA employs 50 people in a department called ‘Payments Markets Intervention’. In comparison, when I was working at the agency’s predecessor, the Financial Services Authority (FSA), between 2008 and 2013, payment supervision merely involved two people.
The message to financial services providers is clear: they should expect the FCA to inspect their governance, safeguarding, financial controls, etc. at any time. Therefore, they must implement better practices and also be able to provide evidence that they are doing things correctly.
Operational resilience requirements
One key aspect of improving governance relates to resilience. In March 2021, the FCA published PS21/3 Building operational resilience to strengthen operational resilience in the industry.
The policy statement outlines that, as of 31 March 2022, firms “must have identified their important business services, set impact tolerances for the maximum tolerable disruption and carried out mapping and testing to a level of sophistication necessary to do so”. Firms are also expected to “have identified any vulnerabilities in their operational resilience”.
These guidelines apply to the largest banks and insurers and to all payment and e-money companies, even the smallest. Indeed, payments is the end element of every type of financial transaction regardless of the identity of the customer – companies or individuals. There always needs to be a strong level of trust between these customers and the payment service providers. And arguably, good governance will facilitate said trust.
Having said that, in my opinion, many payment firms haven’t – yet – done enough with resilience. For example, implementing procedures to limit disruption, should they be unable to conduct some business services. Neither would they be able to provide evidence they have done the right things.
New insolvency regime
And this relates to insolvency as well. As mentioned, payment services and e-money are not covered by FSCS. Thus, firms are expected to safeguard the customers’ money i.e. segregating it (or covering it by an approved insurance policy or guarantee) so that in the event of insolvency, the administrator can’t access that money for anything other than to complete the transactions the customers have ordered or pay back the customers.
However, there are two issues with safeguarding. One, in the absence of direct state protection (as in FSCS), the process is entirely under the control of the firms themselves, who thus may or may not do it properly. For instance, many firms suffered liquidity problems during the pandemic. This affected their ability to pay for rent or wages, whilst having a pile of money available – customers’ money. They shouldn’t touch it, but there must have been a strong temptation to temporarily borrow from it.
When I was working in a bank, my first lending manager said something to me that really struck and stuck with me ever since: “There’s nothing so permanent as a temporary overdraft”. And that is the sort of situation firms may be dragged into.
Proper safeguarding
The second issue is when companies collapse, resulting in customers losing money in the process. Two notable examples of recent high-profile failures being Premier FX and Ipagoo LLP. These have particularly impacted the FCA as they were held responsible by the press. These reinforced the regulator’s goal to have firms safeguarding properly, but also and crucially, being able to prove it.
As a result, the Payment and Electronic Money Institution Insolvency Rules 2021 came into effect in November 2021. This legislation outlines the procedure for a Special Administration regime (pSAR) for payments and e-money firms, which was first introduced four months beforehand. The overarching aim is to enable speedier and more efficient return of customers’ money in the event of an insolvency, but this is dependent upon the firm keeping proper records to enable the administrator to identify the relevant funds.
Good governance has become a priority for the FCA recently, and the latest legislation and regulatory changes (Consumer Duty) reflect this. Financial services firms, especially payment services providers and e-money firms, need to be aware of governance, and take steps to improve operational resilience.
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