Payment Firm Insolvency and Client Funds: What the FCA's Safeguarding Rules Actually Protect

One of the most important — and most misunderstood — aspects of holding funds at a payment firm rather than a bank is the nature of the protection in insolvency. The answer is nuanced: safeguarding, when properly implemented, provides meaningful protection for client funds. But safeguarding is not identical to FSCS protection, it is dependent on the quality of the EMI's compliance with safeguarding obligations, and there are circumstances in which safeguarding fails to fully protect all client funds. Businesses holding material funds at payment firms need to understand precisely what protection they have.

The FSCS Does Not Cover EMI Balances

The first and most important point: the Financial Services Compensation Scheme (FSCS) does not cover electronic money held at an EMI. FSCS covers deposits at PRA-authorised credit institutions (banks) up to £85,000 per eligible depositor. E-money at an EMI is not a deposit in the legal sense — it is a claim against the EMI's obligation to redeem e-money at par value. The protection mechanism is safeguarding, not FSCS.

This distinction matters practically. Where a bank fails, FSCS can make payments to depositors relatively quickly and up to the protected limit, with any excess claim ranking as an unsecured creditor in the bank's insolvency. For an EMI failure, there is no FSCS backstop — the client is entirely dependent on the safeguarding regime having been properly implemented.

How Safeguarding Protects Client Funds

Regulation 21 of the Electronic Money Regulations 2011 requires EMIs to safeguard client funds using the segregation method or insurance method (in practice, the segregation method is universal). Under the segregation method, the EMI holds client funds in designated safeguarding accounts at eligible credit institutions, separate from the EMI's own funds. These accounts are legally distinct from the EMI's operational accounts and are not available to the EMI's general creditors in insolvency.

In an insolvency, the safeguarded funds should be ring-fenced and returned to clients in priority over the EMI's unsecured creditors. The insolvency practitioner is required to identify and preserve the safeguarded funds and to return them to clients as quickly as practicable. The Insolvency (England and Wales) Rules 2016 and specific guidance from the Insolvency Service provide the mechanism for this priority return.

When Safeguarding Fails: The Real Risks

Safeguarding Shortfalls

The most significant risk is that the EMI has not properly maintained its safeguarding obligations — there is a shortfall between the relevant funds outstanding and the amount actually held in the safeguarding account. This can arise from: timing differences that were never reconciled; the EMI using client funds for its own operational expenses; or systematic errors in the reconciliation process. Where a shortfall exists at the point of insolvency, clients will suffer a proportionate loss — the safeguarded funds will be distributed pro rata among all clients rather than in full to each.

Safeguarding Account Provider Failure

The safeguarding account is held at a credit institution. If that credit institution fails, the safeguarding account — as a client account separate from the EMI's own assets — should itself be protected by FSCS up to the applicable limit (£85,000 per eligible depositor). However, for large safeguarding balances, the FSCS limit may not cover the full amount, and the credit institution's failure would create a recovery process of its own.

Mixed or Commingled Funds

Where an EMI has commingled client funds with its own operating funds — either deliberately or through poor controls — identifying the protected funds in insolvency becomes complex and time-consuming. This is why the FCA places such emphasis on the quality of daily reconciliation and the clarity of safeguarding account designation. Poor reconciliation can turn a theoretically sound safeguarding structure into a disputed pool of funds in insolvency.

The Special Administration Regime

The Investment Bank Special Administration Regulations 2011 were extended to payment institutions and EMIs through the Payment and Electronic Money Institution Insolvency Regulations 2021. This means that where an EMI fails, a special administrator can be appointed with the primary objective of ensuring client funds are returned as quickly as possible. The special administration regime gives priority to client fund return over other insolvency objectives, and the special administrator has specific powers to identify and preserve safeguarded funds.

The introduction of the special administration regime represented a significant improvement in the protection available to clients of failed payment firms. The PayBreak failure in 2018 and subsequent cases highlighted the inadequacy of general insolvency procedures for returning e-money balances promptly, which led to the 2021 legislation.

Practical Advice for Businesses

For businesses holding substantial funds at a payment firm: always ask for evidence of the firm's safeguarding arrangements (the safeguarding account acknowledgment letter and evidence of daily reconciliation); do not hold more funds at any single payment firm than you can afford to have inaccessible for several weeks in the event of the firm's insolvency; maintain accounts at multiple payment providers; and review the FCA's register to confirm the firm remains authorised and has not received supervisory restrictions. The safeguarding regime provides real protection when properly implemented — but the key phrase is "when properly implemented."