E-money firms: does the safeguarding requirement give rise to a trust?

E-money institutions (EMIs) are required by the Electronic Money Regulations 2011 (EMRs) to safeguard sums paid by customers in exchange for e-money¹. A recent High Court judgment addresses the question of whether those sums are held on trust in circumstances where there has been a failure to safeguard. The judgment gives rise to a tension with temporary guidance and proposals issued by the FCA, which EMIs will need to grapple with. It will also be relevant to insolvency office holders tasked with distributing the assets of an insolvent EMI.

Ipagoo LLP (Electronic Money Regulations 2011 and Insolvency Act 1986)² concerned an EMI, Ipagoo, which had entered insolvency without having safeguarded customer funds as required by the EMRs. The Court had to determine the question of whether the customer funds received by Ipagoo were, by virtue of the EMRs, held on trust for Ipagoo’s customers, with the result that they would be returned in priority to the claims of other creditors in the insolvent estate.

The case has many similarities to Lehman Brothers International (Europe) (In Administration) (Lehman)³, in which the Supreme Court had to construe Chapter 7 of the Client Assets Sourcebook (CASS 7) in order to determine whether a statutory trust arose on a firm's receipt of client money. In both cases the FCA (or its predecessor, the FSA) intervened to argue in favour of greater protection for the clients of the insolvent firm.

Safeguarding requirement

Unlike banks (where funds held on deposit represent a debt owed by the bank to its customer), EMIs are required to take steps to safeguard "relevant funds", ie sums paid by customers to the EMI in exchange for e-money (Relevant Funds). The rules are set out in the EMRs and the FCA has recently emphasised their importance in light of the Covid-19 pandemic through additional guidance for payment and e-money firms on safeguarding.

Under the EMRs, EMIs are required to safeguard Relevant Funds in one of two ways. Relevant Funds must either be:

• segregated by placing them in a designated separate bank account or investing them in secure, liquid, low risk assets held in a separate account with a custodian; or
• covered by an insurance policy the proceeds of which, in the event of insolvency, are paid into a segregated bank account.

In addition, the EMRs provide that, following an insolvency event, the claims of customers are to be paid from the “asset pool” in priority to all other creditors. The asset pool is defined as those funds, investments or insurance proceeds held pursuant to the two safeguarding options. However, unlike CASS 7 the EMRs do not expressly provide that safeguarded funds are held on trust.

Ipagoo judgment

In Ipagoo the judge was referred to the recent decision in Re Supercapital Ltd⁴, which concerned the Payment Services Regulations 2017 (PSRs), where it was held that the safeguarding provisions of PSRs do create a statutory trust. Notwithstanding the similarities between the EMR and PSR safeguarding regimes, the judge declined to adopt the reasoning of the Court in Re Supercapital Ltd on the basis that the Court in that case had not had the benefit of hearing submissions to the contrary on this point.

The judge also distinguished the Lehman decision, in which the Court held that a trust arose upon the firm’s receipt of client money, on the basis that, unlike the EMRs, CASS 7 expressly provided for client money to be held on trust.

CASS 7 also did not make any further provision for the treatment of the client money held on trust. The EMRs, in contrast, provide that in the event of insolvency the claims of customers are to be paid from the asset pool in priority to all other creditors. Although the EMRs only refer to distributions from the asset pool, the judge held that they would override the usual priority rules for the distribution of all assets from an insolvent estate, including in respect of assets outside the asset pool. This was on the basis that the judge considered it necessary to do so in order to give proper effect to the Electronic Money Directive.

This was key to the judge’s reasoning, since in his view the imposition of a trust would at best duplicate this arrangement and at worst conflict with it. Since the judge found there to be nothing else about the EMRs which pointed unequivocally to a trust being created, he held that the Relevant Funds were not held on trust.

Although the Relevant Funds were not in fact segregated or held on trust, the judge’s conclusion meant that it would be necessary to treat the asset pool as including a sum equal to all Relevant Funds which ought to have been safeguarded. Accordingly, the customers of Ipagoo would have their funds returned in priority to other creditors in any event.

For insolvency office holders the consequence is therefore that, when they are tasked with distributing the assets of an insolvent EMI, they must consider before distributing the assets whether the EMI received Relevant Funds which should have been, but were not, safeguarded. If so, a sum equal to those Relevant Funds assets must be added to the asset pool and distributed in priority to any other distributions.

FCA temporary guidance and proposed changes to approach

As noted above, in July 2020 the FCA released additional temporary guidance to EMIs to strengthen their arrangements for safeguarding customers’ funds. In that temporary guidance the FCA stated its view that:

“[the EMRs] implicitly give e-money holders and payment service users a beneficial interest in the funds or assets held by the firm in the safeguarding account. Accordingly, we consider that a firm holds these funds on trust for its customers.”

Consistent with that view, the FCA’s temporary guidance provides an example form of acknowledgment letter for EMIs to send to the banks with whom they hold safeguarding accounts, stating: “we hold all [money/assets] standing to the credit of the Safeguarding Account in our capacity as trustee under the laws applicable to us.”

Further, in January 2021 the FCA consulted⁵ on its proposal to make this temporary guidance permanent and incorporate it into the FCA’s Payment Services and E-Money Approach Document. The Ipagoo judgment, which was handed down on 30 July 2021, postdates the closure of the consultation although the FCA has not yet published any Policy Statement in respect of it.

Accordingly, as matters stand, the FCA’s temporary guidance and its proposal to make it permanent are inconsistent with the law as set out in the Ipagoo judgment. This creates something of a quandary for EMIs, for whom it will be unclear whether, for example, they should seek an acknowledgment of trust from the bank with which customer funds are held.

The Ipagoo judgment makes clear that the FCA has until after the Court’s summer vacation period to decide whether to appeal the decision. If the FCA does not appeal, it will be interesting to see whether its Policy Statement following the consultation will alter its position (and guidance) regarding whether safeguarded funds are held on trust.

¹ Similar obligations are imposed on payment institutions by the Payment Services Regulations 2017.
² [2021] EWHC 2163 (Ch)
³ [2012] 3 All ER 1
⁴ [2020] EWHC 1685 (Ch)
⁵ In CP21/3.