Payments View - January 2024

Welcome back to Payments View after what we hope has been a good start to 2024. This edition includes updates on:

• the Digital Pound and Euro proposals
• Extension of the Special Resolution Regime for "Small Banks"
• FCA push back on the Complaints Commissioner's report on oversight of Premier FX
• Revisions to the PSRs Specific Directions on the Card-acquiring Market
• AML changes: DAML exemptions and high risk third countries
• Our very first Credit Corner on the FCA's work in the motor finance market and BNPL
• Reminder: Consumer Duty a current focus for the FCA

Also another quick reminder that Payments Reviewer, our new cross-border regulatory diligence tool, is open for test access - if you'd like us to get this sorted for you, please let us know.

As always, don't hesitate to reach out to us if you would like to discuss any of the developments in this edition.

Digital Currencies Update: Digital Pound response and ECB  Digital Euro project

As you might remember, in February last year the BoE and HMT sought feedback on a proposed 'digital pound' with a view to informing a future decision on the viability of a UK CBDC - our briefing on the details can be found here. Following feedback from a scarcely believable 50,000 respondents, a response has been published which confirms that no final decision has been made to pursue a digital pound. It does, however, argue that the design of a digital pound as proposed remains appropriate.

The response makes great efforts to assuage the concerns raised in the press around users' privacy and control - confirming that neither the BoE nor the government would have access to users' personal data with commitments to introduce primary legislation with a vote in both Houses of Parliament before launching a digital pound.

The response also makes commitments on maintaining access to cash as well as setting out the proposed key design principles (incl. being reliable and secure, supporting innovation, being interoperable, adaptable and scalable, inclusive and attractive, and energy efficient). We also know that the plan is for:

• the BoE to run the core ledger and private sector firms to provide digital wallets for users,
• the digital pound to be used for making retail payments,
• a limited amount of digital pound (£10,000-£20,000) available per user initially,
• no interest to be paid,
• making the digital pound available to non-UK residents on the same basis as UK residents, and
• for seamless exchangeable with other forms of money (including cash and bank deposits)

This all still looks very much like central bank issued e-money, so not particularly innovative as Fintech products go, but this looks deliberate. Governments and regulators around the world have already demonstrated that they aren't prepared to allow large scale private initiatives such as Libra to take off so this initial stage should be seen as more of a defensive move to establish a UK CBDC ahead of commercial alternatives.

The response also confirms that the project has moved into Phase 2 (Design) with this lasting until 2025/26 ahead of any Build phase, with a firm decision on launch expected around the same time.

For Europe, the ECB has opened vendor applications for various related services for a potential digital euro with these contracts together totalling more than 1 billion euros in value. Whilst no final decision on a rollout of the digital euro has been made (similar to the position in respect of the digital pound) the ECB has begun the preparation phase and has now issued calls for applications for framework agreements for various aspects of any build.

In an indication of timing, these agreements would run for four years from early 2025 - aligned with, if not ahead of, the UK's most likely timetable. 

Extension of the Special Resolution Regime for "Small Banks"

It's nearly a year since HSBC bought the UK arm of Silicon Valley Bank for £1 over the course of a very eventful weekend This was seen as a victory for the UK's special resolution regime ("SRR") as the private sector purchase meant the potential economic fallout from SVB UK's failure was largely avoided and customer banking services were not interrupted.

HMT is now consulting on enhancements to the SRR to specifically address small banks which fail and are placed in resolution (and which were not covered in quite as much detail when the SRR was drafted). At their core, the enhancements are focused on using the existing depositor protection arrangements to meet any recapitalisation costs, which would previously have been borne by taxpayers.

What is the SRR?

Whilst the intricacies of the SRR would no doubt top the list of everyone's chosen Mastermind subject, for those in need of a refresher the regime was implemented post-2008 and designed to avoid the concept of a bank being deemed "Too Big To Fail". To do so it aims to ensure that any failure can be managed in an orderly manner by providing the BoE with various "stabilisation options" to steady a failing firm, including:

• Bail-in for the largest and most complex banks, with them being required to hold Minimum Requirements for own funds and Eligible Liabilities ("MREL"). The MREL would be used to recapitalise the bank if it fails.
• Transfer (all or part) of the bank to a private sector purchaser, asset management vehicle or a temporary BoE Bridge Bank.

For the purposes of HMT's consultation, "small banks" are those which are not required to hold MREL. The main risk of Small Banks that the consultation identifies is that if a credible buyer is not forthcoming, then the bank would need to be transferred to a Bridge Bank and the costs to recapitalise would be borne by taxpayers with HMT the only available source of funds. Therefore, HMT is proposing enhancements to the SRR that should reduce the likelihood of these costs needing to be met by the taxpayer.

What is changing?

HMT is proposing a new mechanism to allow the BoE to use funds provided by the banking sector to cover costs associated with a resolution by building on existing depositor protection arrangements. Such funds would be provided by the FSCS as needed in the event of a failure and subsequently funded by a levy on the banking sector. In HMT's opinion this would enable the BoE to use its resolution tools to mitigate the risk that taxpayer funds would be needed to cover the costs of a small bank failure.

The consultation notes that the new mechanism could be implemented with 'minimal disruption' to the existing SRR and avoid new upfront costs for firms. HMT also discusses alternative options, such as requiring small banks to hold MREL but raises concerns that small banks would likely need to meet MREL requirements with equity leading to disproportionate costs and harm being caused to competition in the UK banking market.

HMT is requesting feedback until 7 March 2024. HMT will then issue a consultation response and look to legislate when parliamentary time allows.

If you would like to discuss this consultation please do let us know. We commented on the changes to the Depositor Protection Scheme in April last year and the PRA is still considering whether further amends are needed to its rules following the failure of SVB on how FSCS protection works in practice.

FCA pushes back on Complaints Commissioner's report on oversight of Premier FX

Readers will remember the case of Premier FX ("PFX"), a payment institution which collapsed in 2018 with a significant shortfall in customer funds. The liquidators eventually distributed 9p for every £1 of lost customer funds, with the remaining shortfall made up by the bank providing the firm's safeguarding accounts following FCA enforcement action.

The Premier FX Liquidation Committee (a group of PFX customers) complained to the FCA in 2020 about the way it had regulated PFX which was eventually escalated to the Complaints Commissioner for review.

The Complaints Commissioner noted that the complaint raises serious concerns about the actions and inactions of the FCA in connection with PFX, noting that:

"Whilst the bank voluntarily agreed to repay PFX customers, the FCA must nevertheless be held to the same high standards it applies to the firms it regulates, and it must take responsibility for the role it played in these events, that is the failure to appropriately authorise and supervise PFX and the issues around the Register, with a recognition of the impact of this on innocent consumers who followed all the FCA advice available to them at the time but still fell victim to these financial crimes and suffered grave consequences."

The Commissioner found it reasonable for the FCA to make an ex gratia payment award to the complainants in recognition of its significant failures to act (amounting to 4% simple interest on the capital recovered over the c.4 year period it took for capital to be returned to customers).

Of particular interest to the payments industry will be the Commissioner's recommendations that the FCA make changes to the FS Register to:

• Make it more accessible for users and engage with the Commissioner on a satisfactory method for doing so, after the FCA rejected the Commissioner's preliminary recommendation that the register contain hyperlinks to the Handbook glossary.
• Inform consumers that they should contact the FSCS or FOS if they are unsure what protection applies to them after reviewing the FS Register. 

The FCA has accepted many of the Commissioner's recommendations but declines to make an ex gratia payment award to the complainants (on the basis that the Commissioner cannot require the FCA to do so). The Commissioner had this to say about the FCA's position:

"De facto, compensatory payments on an ex gratia basis due to supervisory or regulatory failings on the part of the FCA (and possibly the other Regulators) will never be available to complainants despite the FCA saying there are exceptional circumstances where it might be', and I am afraid this case has proved to be no exception. If this is not precisely the case, where the FCA concedes it should make a de facto compensatory payment, for its supervisory or regulatory failures, then it is difficult to envisage a case when it will in fact ever do so."

In relation to making changes to the FS Register:

• The FCA continues to disagree that hyperlinks to the Handbook glossary should be added to the Register, but says it will consider what further changes it can make to the Register by the end of this month.
• The FCA has made changes to the Register and its website to direct consumers to the FOS and FSCS, as well as continuing to direct consumers to speak to the firm in question if they are unsure about the protection that applies to them. 

Revisions to the PSRs Specific Directions on the Card-acquiring Market

Last year the PSR's remedies to improve the credit-acquiring market for merchants (and ultimately consumers) who have an annual card turnover of below £50 million came into force. We summarised the remedies in the October 2022 edition of Payments View. The PSR is now proposing the following amendments:

• Amending the list of directed legal entities. Following internal restructurings and transfers of the 'relevant business', the list of directed legal entities no longer represents the providers which account for 95% of retailer transactions in the UK. The PSR summarises the changes to the list under para. 3.3 of the consultation.
• Introducing a new mechanism which updates the list of directed entities automatically when a provider transfers its 'relevant business'. To avoid the need to manually update the list of directed entities, the PSR would like to have a mechanism in place which manages this on an ongoing basis. The provisions require a transferor to provide advance notice of the transfer to the PSR and for the transferor and transferee to confirm when the transfer has taken place.
• Including Checkout Ltd as one of the directed legal entities. The PSR based its list of directed entities on its review of the market in 2021. More recent market evidence shows that based on its share of card transactions acquired at UK outlets, Checkout Ltd has a market share at least as large as the smallest currently directed acquirer and so the consultation states that it should be included in the list.

The PSR is accepting comments on the proposed revisions until 9 February 2024.

AML changes: DAML exemptions and high risk third countries

Whilst perhaps more relevant for your MLROs, we thought it would be helpful to flag that the Home Office has published guidance discussing the changes to the money laundering reporting obligations in POCA following their amendment by the Economic Crime and Corporate Transparency Act 2023 ("ECCT Act"). The EECT Act's changes reflect a desire to "maintain the wider effectiveness of the suspicious activity reports regime" and include:

• providing a DAML exemption for the whole AML regulated sector when firms end a relationship with a customer and pay away property with a value below £1,000 (subject of course to other CDD obligations having been fulfilled);
• clarifying the handling of mixed assets where only part of the assets are suspected to be criminal proceeds; and
• raising the threshold amount of criminal property below which certain firms (including EMIs and APIs) can carry out a transaction without submitting a DAML suspicious activity report from £250 to £1,000 for acts in operation of an account.

Separately, and effective as of now, the list of 'high risk third countries' in schedule 3ZA of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 is no more. Reference is instead made just to the respective FATF lists and firms will need to update policies and processes to reflect this.

And finally from Europe, a political agreement has been reached on the proposed AML Regulation and MLD6. The legislative texts (drafts of which have not yet been published) will now be finalised before the agreement is formally adopted by the Council and the Parliament.

Credit Corner: FCA's work in the motor finance market

As part of our first real focus on consumer credit matters, we wanted to dive into the FCA's recently announced work in the motor finance market following increased complaints and compensation claims arising from discretionary commission arrangements ("DCAs").

The FCA banned DCAs in January 2021 and at the time did not require retrospective action in relation to arrangements that were already in place before the ban was introduced. However now - following adverse decisions against lenders - DCAs that were entered into and paid long before 2021 are attracting scrutiny. 

This move appears to have been triggered by two recent findings by the Financial Ombudsman Service ("FOS") in favour of complainants, which the FCA views as likely to prompt a significant increase in the number of complaints from consumers. There are also a number of County Court claims than have been upheld, which indicates some tension between firms and consumers on whether there have breaches of legal and regulatory requirements.

The FCA has announced that it will use its powers under section 166 of the Financial Services and Markets Act 2000 ("FSMA") to review historical motor finance commission arrangements and sales across several firms. The FCA will assess practices within motor finance firms arising from the incentives potentially created by DCAs and the effect on customers. Should the FCA reach a finding of misconduct, it will seek to identify how customers can receive adequate settlements by potentially using its powers under FSMA to set up an industry-wide consumer redress scheme or applying to the Financial Markets Test Case Scheme.

Whilst it carries out its review, the FCA is implementing a number of amendments to the complaints handling process in relation to DCA complaints:

• Pausing the 8-week deadline for motor finance firms to provide a final response to DCA related customer complaints. This pause will last for 37 weeks and applies to complaints received by firms between 17 November 2023 to 25 September 2024.
• Extending the time customers have to refer DCA complaints to the Financial Ombudsman from 6 to 15 months. This applies to complaints where a final response was sent between 12 July 2023 to 10 January 2024, or between 11 January 2024 to 20 November 2024.

The FCA is taking these steps to prevent disorderly, inconsistent and inefficient outcomes while it assesses the issue and determines the best way forward.

Credit Corner: BNPL - Here we go again!

And finally for Credit Corner, you'd be forgiven for feeling like you've travelled back in time as the FCA calls for regulation of BNPL. This comes as part of Nikhil Rathi's speech to the Imperial College Business School and very much suggests that the previously shelved (dropped?) HMT plans might have been picked back up - albeit this time with the further overlay of the consumer duty and suggestions from Mr Rathi that BNPL companies should monitor consumers' social media activity and spending patterns "to offer the optimal repayment scheme".

We'll be following how this one develops, but see it as unlikely to find traction before the (much speculated about) General Election.

Reminder: Consumer Duty a current focus for the FCA

Whilst it might now feel 'so last year', we thought we'd end this edition of Payments View with a quick note on the Consumer Duty - particularly as we know that the FCA, true to its word, has sent around questionnaires to a large number of payments firms checking in on the Duty's implementation.

Key refresher points we'd personally look to would be the FCA's speech covered in our November edition on what the 'next steps' will be for firms (e.g. both the implementation for closed products and the annual board report), the December webinar on the FCA's supervision and enforcement approach, and reflecting back on your firm's historic response to the 10 questions.

As ever, we'd be very happy to have a quick chat to discuss any points around the Duty, its ongoing application.

News Flash

• The FCA have given a speech on the future regulation of consumer-facing technologies - specifically on the risks, opportunities and questions that 'hyper-digitised, super-personalised' data raises.
• The PSR has published a '2023 in review' which includes a helpful guide to key events and consultations over the coming months.
• The BoE have given a speech on the ongoing enhancements to the RTGS and how further technical changes can drive innovation. The BoE intends to publish a discussion paper in February 2024 to seek industry views on whether it has identified the right priorities.
• Apple have taken steps to broaden access for PSPs to NFC payment capabilities on their devices, without being required to operate through Apple Pay or Apple Wallet.
• Unlike in Europe where political agreement is (broadly) behind proposals for a CBDC (in some form or another), in the US Donald Trump has made clear that he would "never allow the creation of a central bank digital currency".