THE FUTURE OF EMIs

In this report:

• EMIs have been a boom sector – but is there trouble ahead?

• Five tips for being prepared

• E-money licence applications

• Legal perspective on developments affecting EMIs

• Our online panel discussion

The attraction for customers is clear. Accounts can be opened quickly, online and with the minimum amount of paperwork, offering flexibility and convenience. EMIs cannot provide loans or interest-accumulating accounts but have introduced a wide range of payment and other financial solutions to their customers, from quick and easy international money transfers to prepaid
payment cards.

The epicentre for activity in Europe has been London. It has gained a reputation for being one of the most attractive jurisdictions in which to set up an EMI, as a result of:

/ A relatively stable financial and legislative environment
/ A well-respected regulator in the FCA
/ A relatively mature payments sector
/ Its reputation as a hub for fintech innovators, with strong R&D investment and a workforce with leading tech and financial skills

As of 25 May, 235 EMIs have been set up in the UK compared with 244 in the rest of Europe combined. Total assets held by UK EMIs in 2019 amounted to around £14bn.

But there are clouds on the horizon. The prospect of tighter regulation around EMIs, along with the impact of Brexit, brings specific risks for EMIs in the UK.

FCA TIGHTENS ITS GRIP

EMIs operate in an environment of lighter regulation and supervision than more traditional FS providers. Authorised EMIs are subject to capital requirements: they must hold initial capital of €350,000 and must meet the FCA’s conduct of business rules and
safeguarding requirements.

‘Small EMI’ licenses are also available for EMIs with annual payment transactions of less than €3m, which operate exclusively within the UK. Around 30 of these have been issued so far.

But there are clear signs that as the EMI sector grows, the FCA and other regulators are stepping up their scrutiny of institutions and enforcement of regulations. E-money licences are increasingly being used by a wide variety of businesses, from global giants such as Airbnb and Google to startups. More and more money is at stake; the risk of consumers being confused by companies that to all intents and purposes look like a bank, but which don’t have a banking licence and which don’t offer the same level of protection as regulated banks, is increasing every year.

The collapse of Wirecard, which filed for insolvency in Germany in the summer of 2020, has also drawn regulators’ and governments’ attention to the sector. Wirecard announced in June that €1.9bn in cash was missing from its accounts; its former chief executive is under investigation and the scandal triggered an examination of Germany’s system of financial regulation after BaFin brushed aside early warnings of possible fraud.

In April 2020, the FCA’s 2020/21 Business Plan announced payment services as a priority area. Three months later, the FCA wrote an open letter to the CEOs of payment services firms and EMIs setting out the steps it expects them to take to meet their regulatory obligations in six areas:

1. Safeguarding customers’ funds – from December 2020 to January 2021, the UK Government ran a consultation that asked for views on the introduction of a new administration regime for payment providers and EMIs. The regime is intended to protect customers should an EMI fall into insolvency, given that EMIs are not part of the Financial Services Compensation Scheme.
2. Prudential risk management – the FCA said it expects firms to have acted to review and remediate this in light of additional guidance issued by the FCA.
3. Financial crime – the FCA will ‘continue to undertake targeted assessments and will take action against firms that fall short of our expectations’.
4. Customer communications and promotions – the FCA stressed that these should be clear, fair and not misleading.
5. Governance and oversight – the FCA identified inadequate governance and oversight as ‘a root cause of many … EMIs’ regulatory issues’.
6. Reporting and records management

Anecdotal evidence reinforces the view that the FCA is tightening its grip around EMIs: we have seen the FCA ask questions of EMI clients that would normally be asked of a bank. It’s clear that both regulation and enforcement will inevitably become more stringent in the coming years.

THE IMPACT OF BREXIT

UK financial institutions lost their right to serve European customers through their EEA passporting rights on 1 January 2021. It is thought that around half of the UK’s EMIs could be affected by Brexit, based on the number that appear on the European Banking Authority’s central register.

The full impact of Brexit is still unclear as the financial services sector did not form part of the trade agreement signed between the UK and the European Commission in December 2020. A draft UK-EU Memorandum of Understanding on financial services was agreed in March this year, but is limited and focuses mainly on the mechanism for future discussions on regulation and equivalence.

Given the FCA’s increasing interest in EMIs, it also seems unlikely that the sector will benefit from the government’s Taskforce on Innovation, Growth and Regulatory Reform (TIGRR), which will look at ways of reducing post-Brexit red tape.

Most EMIs were well prepared for the changes and have been taking steps to offset the risk of losing their passporting rights. A number of EMIs have already set up subsidiaries in the EU, or formed joint ventures with EU EMIs, to handle EU-based customers; those EMIs with relatively few EU customers have stopped offering services beyond the UK’s borders.

For those setting up subsidiaries outside the UK, Lithuania has proved the most popular option. It was already the second most popular location for EMIs in Europe, after the UK: it offers a fast and transparent application process for licensing EMIs (more than 100 licenses have been issued in the past two years) and has strong fintech credentials. Revolut, Curve and Yapily have all set up operations in Lithuania in recent months.

Next: our top tips for EMIs with plans to expand into other European countries.

Virtual accounts, real money

E-money firms do advertise themselves as providing “bank accounts” which is what their clients understand they have, but they are actually virtual accounts. Semantics aside, the big difference is that the compensation that covers all those safeguarded accounts held at EMIs is limited to £50,000 – and that is just the figure that compensates the e-money firm in case of failure of its banking partner. In other words, it covers the gross balance of all their clients’ monies that are in the safeguarded account at that time, even though the account could potentially contain millions! It’s critical to ensure that all funds that sit in the virtual bank accounts are captured by a virtual IBAN.

Proper auditing of safeguarded accounts, and of the governance structure supporting them, requires a level of skill and knowledge that very few auditors possess. We strongly recommend being thorough in your due diligence before appointing an auditor.

Planning for wind-down

And that brings us to the wind-down plan that is becoming a requirement of all new applicants (and incumbents). This takes the form of a document – again, not a simple one – whose purpose is to enable an orderly wind-down and to show that your firm can pay for it if and when necessary.

In the past, safeguarded monies have contributed to the costs of winding down. That was never the intent of the regulations which seek to ensure that clients’ regulated monies are protected and, in theory, returned to them quickly in the event of failure. History has shown this hasn’t worked, hence the new requirement.

If you have any questions please contact Nick Andrews on info@mpacgroup.co.uk or call +44 (0)20 3056 0956.

Prudential and risk management

The FCA now states that it intends to increase requirements on EMIs in relation to prudential and risk management. It intends to make the following requirements, from 2020’s temporary guidance, permanent:

• Liquidity and capital stress testing: the FCA expects EMIs to carry out liquidity and capital stress testing to assess their exposure to economic turmoil and ensure they have adequate liquidity and capital resources
• Capital requirements: EMIs should calculate capital requirements and resources on an ongoing basis and regularly report these to the FCA

• Intra-group risk: in order to reduce exposure to intra-group risk, and ensure firms have adequate resources to absorb losses, the FCA considers that firms should deduct intra-group receivables from their own funds. Additionally, EMIs should not include uncommitted intra-group liquidity facilities when assessing their liquidity
• Wind-down plans: as discussed earlier in this report, the FCA requires firms to have a wind-down plan that effectively manages their liquidity and resolution risks, incorporating scenarios in which the firm is both solvent and insolven

If you have any questions please contact Sam Robinson on sam.robinson@cms-cmno.com or call +44 (0)20 7524 6836.