Safeguarding by cash backed guarantee
- Posted on: 18 June 2021
- Written by: John Burns
Payment Services and E-money Institutions will be aware that they have (in theory) had the option to safeguard using the bank guarantee method since the implementation of the first Payment Services Directive (PSD1). The attraction of using the bank guarantee method is that, like the insurance method, it removes the requirement to segregate relevant funds. However, the reality has been somewhat different as providing such guarantees has been beyond the risk appetite of all banks, especially as the FCA have been insistent that there must not be any contingent guarantee (for example from a parent company). It effectively means the bank providing a guarantee in the event of the insolvency of a firm.
To get around this situation a number of clients have suggested placing an amount of cash in a safeguarding account which would be sufficient to cover their maximum relevant funds exposure. As the Payment Services Regulations require that the safeguarding account is used only for holding relevant funds, this would be in breach of the regulations and therefore not acceptable to the FCA.
However, we recently engaged with the FCA on behalf of a client on a combined approach. The firm has placed a deposit with their bank in support of a safeguarding guarantee being provided. The nature of the deposit means that in the event of insolvency of the firm the bank has a claim over the funds, to counter the amount paid out under the guarantee. There is, therefore, no risk to the bank in providing the guarantee and the claim over the deposit is not seen as a contingent guarantee. Because the guarantee element means that there is no requirement to segregate relevant funds this can simplify safeguarding processes for the firm.
GETTING A GUARANTEE
Having established a precedent, this is now a valid option for those firms that have the cash available and a bank which is willing to discuss the option.
In order to secure an approved bank guarantee the FCA will need to be convinced that the amount of the guarantee is sufficiently high to meet the expected level of relevant funds. This can be calculated using historical data and payment forecasts and the level must be reassessed on a regular basis. Because there is no liability making use of any credit lines the guarantee should be able to be continuous rather than having to be renewed on an annual basis, as happens with an insurance policy. This is, of course, dependent on the the agreement of the bank in question and the deposit remaining in place and sufficient to cover the level of relevant funds.