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Fund safeguarding

Introduction

The document provides a comprehensive guide on cards issuing and safeguarding, detailing Electronic Money Institutions’ (EMIs) approaches to managing e-money ledgers, safeguarding methods, and the intricacies of card payment systems. It covers various models for issuing cards, such as against e-money or card processor ledgers, and the settlement-only BIN sponsorship. The text emphasizes the importance of safeguarding customer funds, managing financial operations, and adhering to regulatory standards, offering insights into the challenges and best practices in the financial sector.

Three primary methods of safeguarding

Segregated Funds (Most Popular)

Upon issuing e-money, EMIs are required to deposit an equivalent fiat amount with a recognized credit institution. This amount, known as “relevant funds,” must be segregated from both the EMI’s operational funds and the customer’s corporate funds. The hosting bank must be informed that these funds are safeguarded, ensuring they are stored in designated accounts. Additionally, with regulatory approval, these funds may be placed in low-risk investment accounts.

Guarantee Method

Here, the customer’s funds are secured by a guarantee, either from the customer themselves or a credit institution acting on their behalf. This guarantee must exceed the total value of e-money issued at any time. Should the issued e-money surpass the guarantee’s value, the shortfall must be covered by another safeguarding method (either segregated funds or insurance). While this method eases financial operations for the EMI, it risks inaccuracies in tracking the volume of e-money issued and the requisite size of the guarantee.

Insurance Method

In this approach, the funds to be safeguarded are covered by an insurance policy held by the EMI. The institution must ensure it holds an equivalent fiat amount to the e-money issued. The EMI can activate the insurance policy to claim the fiat amount from the customer.

It’s important to note that banking and financial operations are highly dynamic, making it challenging to accurately match the amount of e-money issued with guarantees or insurance. Consequently, the segregated funds method is the most commonly adopted approach.

For EMIs operating across multiple jurisdictions, safeguarded funds cannot be pooled across entities. Each customer must be associated with a specific EMI entity, which then segregates those funds in safeguarded accounts accessible only to the local EMI.

Funds safeguarded for e-money issuance are considered relevant funds until the e-money is redeemed, at which point they are deemed spent. The primary goal of safeguarding is to protect the end-user’s money.

A significant challenge in safeguarding is determining the precise moment when funds transition from being relevant to spent.

Beyond safeguarding customer funds, EMIs must also protect their operational funds in specially designated safeguarding accounts with a banking partner. These accounts must be explicitly marked as safeguarded, ensuring exclusive access by the beneficiary institution.

This stipulation means an EMI operating in multiple countries cannot use pooled accounts for safeguarding. Each entity must segregate and safeguard its funds locally.

Example:

Consider FINTEX XYZ, with headquarters in London, UK, and an operational entity in Amsterdam, NL.

The London branch, holding a UK-issued EMI license, is required to safeguard the UK entity’s funds separately.

Similarly, the Amsterdam branch, with a NL-issued EMI license, must safeguard its funds independently from the UK entity’s funds.

Case Study

Three entities are involved:

  • EMI: Typically a bank or fintech with an e-money license.
  • Business Customer: A corporate client of the EMI, offering financial services to end-users without obtaining an EMI license.
  • End-User: The business customer’s client, who uses a payment vehicle (e.g., card, wallet) provided by the EMI to access their funds.

When a business customer offers a debit card solution, and an end-user deposits £3000 into their account, the EMI must issue £3000 of e-money and safeguard an equivalent fiat amount in a designated account. This account is distinct from both the customer’s corporate funds and the EMI’s operational funds.

The EMI has a 24-hour window to initiate the safeguarding process. If, for instance, the end-user spends £1000 of the £3000 pre-funded, that £1000 is considered spent. The EMI uses the equivalent amount for settlement, continuing to safeguard the remaining £2000.

Financial Infrastructure Overview

The core of financial infrastructure for issuing electronic money (e-money) centers around an efficient ledger system. Electronic Money Institutions (EMIs) operate under stringent regulations, including safeguarding requirements, though certain ledger types are exempt:

  • Settlement intermediaries.
  • Pre-funding ledgers.
  • Collateral ledgers.
  • Virtual ledgers backed by a physical account.

Banking as a Service (BaaS) and Fund Management

Funds received in exchange for e-money are crucial, with cash transactions recognized instantly and other forms, like bank transfers or card payments, acknowledged when credited to the EMI’s account. Refunds and reversals are treated as new transactions, becoming relevant once processed.

For EMIs serving customers through third-party processors, pre-funding accounts can mitigate the impact of settlement delays, typically a day (T+1) with payment processors.

Spent Funds and Transaction Processing

Funds become ‘spent’ when payment instructions are irrevocably sent to banking partners or payment schemes. Transactions that are reversed or returned are seen as new inflows, with e-money reissued upon settlement. Failed payments, due to technical or security issues, keep funds in a ‘relevant’ status until successful processing.

Funds in Processing: Various Stages

  • Firewall Stage: Funds collected but pending due to AML or sanctions screenings. No e-money issuance or safeguarding applies.
  • Manual Return Stage: Funds awaiting return to the sender without e-money issuance or safeguarding requirements.
  • Awaiting Settlement Stage: Funds recognized but not yet settled. These are excluded from safeguarding but included in reporting.

Inter-Ledger Fund Movements

EMIs manage transfers between safeguarded and non-safeguarded ledgers, crucial for accurate safeguarding calculations. For example, a transfer from Company A to Company B within the same EMI adjusts each company’s safeguarding obligations accordingly.

Safeguarding Reporting and Negative Balances

Negative e-money ledger balances are reported as zero for safeguarding purposes. Funds directed to a negative balance ledger are excluded from safeguarding calculations, barring any amount that corrects the deficit.

For instance, if a ledger with a £100 negative balance receives £120, only the positive balance of £20 is considered for safeguarding. Yet, negative balances must be accurately reported to comply with regulatory standards.

Reconciliation Breaks and Service Disruptions

Reconciliation processes, conducted post-settlement, occasionally uncover discrepancies where expected funds were not received or where there were shortcomings in settlement, resulting in funds that were spent but not settled. Such disruptions and any subsequent adjustments made to address these discrepancies must be detailed within the reporting framework. These adjustments, vital for accurate safeguarding, must be considered in the planning and execution of safeguarding activities, ensuring all relevant transfers are accounted for.

Reporting Requirements

Operational Throughput – Daily Balance Report

  • Daily operational and transaction monitoring (Business As Usual – BAU)
  • Breakdown by currency and entity
  • Safeguarding account balances (Assets)
  • E-Money balances (Liabilities)
  • Card BIN Balances (Liabilities)
  • Funds in transfer (Assets)
  • Adjustments for safeguarding (addressing negative e-money balances and reconciliation discrepancies)
  • Totals of all liabilities and assets
  • Within the safeguarding period: total transactions sent and received

Operational Throughput – Monthly Balance Report

  • Comprehensive daily operational and transaction monitoring (BAU) for a calendar month
  • Breakdown by currency and entity, including customer balances (Liabilities)
  • All elements from the daily report are extended to a monthly overview

Customer Ledger Monitoring

  • Two-day rolling balance analysis by customer, product, and currency
  • Examination of balance changes (both in value and percentage)
  • E-money ledger balances overview
  • General Balance Monitoring
  • 24-hour monitoring of total funds received and sent, broken down by currency and corporate entity
  • E-Money issuance and redemption activities, including cross-ledger movements from e-money to non-e-money accounts
  • Funds held in transfer, detailed by currency and corporate entity
  • Negative Balance Monitoring
  • Two-day analysis of negative balances, highlighting current and previous day figures
  • Examination of the age of debt or negative balance, providing insights into the duration of outstanding balances
  • Ledger Balance and Transaction Reconciliation Report

Opening and closing ledger balances

  • Daily reconciliation efforts aimed at aligning balances and transactions accurately
  • Detailed intra-day ledger postings, ensuring comprehensive oversight of all ledger activities

This structured approach ensures that all aspects of financial monitoring, from daily operational oversight to detailed reconciliation and safeguarding adjustments, are meticulously reported and analyzed, supporting effective management and regulatory compliance.

Cards as a Service Overview

Card payments operate through either a Dual Message System or a Single Message System, facilitating transactions via distinct processing methods.

Dual Message System

This system initiates transactions with an AUTHORIZATION message, requesting confirmation from the card issuer (e.g., an Electronic Money Institution, EMI) on the availability of funds. Upon approval, the funds are earmarked for settlement, affecting the visible balance of the end-user but not the e-money ledger balance, thus maintaining safeguarding obligations. The subsequent message, CLEAR, instructs the release of funds for settlement, marking the funds as spent and ending the safeguarding obligation once processed beyond any firewall or holding stage.

Single Message System

In this streamlined approach, the AUTHORIZATION and CLEAR commands are combined into a single message. An approved authorization is treated as final, with e-money considered redeemed (spent) and the safeguarding obligation concluded at this point.

Handling of Reversals and Refunds

For reversals, refunds, or any credit transactions, e-money is reissued to the end-user’s account upon notification from the issuer processor.

Example: Financial Operations Impacting an End-User’s Balance

Consider an end-user with a £200 balance who withdraws £30 via an ATM, incurring a high transaction fee of £5 due to the costliness of ATM withdrawals. Additionally, a previous accidental double refund of £10 requires correction. The balance adjustment is as follows:

  • £30 for the withdrawal (redeemed e-money)
  • £5 transaction fee (revenue for the issuer)
  • £10 balance adjustment for the over-refunded amount

After these adjustments, the end-user’s balance is £155. Positive balance adjustments result in the issuance and crediting of e-money following issuer processor notification.

Common Card Events Impacting E-Money

E-Money Spent

  • Debits: Transactions like ATM withdrawals signify e-money spent.
  • Credits: Reversals of intended refunds, mistakenly debited again.
  • E-Money Redemption/Liquidation
  • Fees: Transaction fees, e.g., for foreign exchange, charged to the cardholder.
  • Negative balance adjustments: Corrections for errors like duplicate refunds.
  • Unload: Transfers from card balance to bank accounts instead of card transactions.

E-Money Creation

  • Load: Pre-funding by end-users resulting in immediate e-money issuance.
  • Credit: Refunds leading to e-money creation.
  • Debit Reversals: Reversed transactions initially intended as debits.
  • Positive balance adjustments and cashback credits.

Events Not Impacting E-Money

Costs absorbed by the EMI or issuer do not affect e-money balances:

  • Debits: Scheme fees, negative interchange fees, dispute-related chargeback reversals, and representments.
  • Credits: Credits for scheme fees, positive interchange, chargebacks, and representment reversals.

This categorization ensures clarity in transaction processing, highlighting the distinct ways in which card events can influence e-money balances and the issuer’s safeguarding obligations.

Cards as a Service Models

Electronic Money Institutions (EMIs) typically offer cards as a service through various models:

  • Cards Issued Against E-Money Ledgers
  • Cards Issued Against Card Processor Ledgers
  • Settlement-Only BIN Sponsorship
  • Cards Issued Against E-Money Ledgers

This model leverages Banking as a Service (BaaS), either in-house or through a third-party provider, to manage e-money ledgers. It applies the concept of ‘spent funds’ within the BaaS framework, utilizing it as the primary infrastructure for ledger management. This approach ensures that transactions are reflected in real-time, maintaining accurate safeguarding obligations.

Cards Issued Against Card Processor Ledgers

In scenarios lacking BaaS infrastructure, EMIs can utilize their card processors’ ledgers. Third-party processors like GPS, FIS, or Checkout.com update EMIs on card spending through APIs or file-based processes. These updates are critical for EMIs to perform accurate safeguarding calculations and to determine the status of funds. EMIs must maintain synchronized copies of these ledgers to reflect transactions within their e-money ledgers promptly.

Financial operations following card spending involve various accounts, including:

  • Pre-Funding Account
  • Safeguarding Account (for end-user balances)
  • Dispute Account
  • Revenue Account
  • Scheme Settlement Account

A common practice involves setting up an e-money settlement account as a counterpart to the banking scheme settlement account, facilitating automatic fund movements based on safeguarding calculations.

Settlement-Only BIN Sponsorship

In this model, EMIs do not issue e-money. Instead, the end-user balance management is delegated to the customer, utilizing either their infrastructure or a third party’s. The EMI’s role is limited to settling transactions with the schemes, requiring pre-funded scheme settlement accounts. This model simplifies the EMI’s operations by eliminating the need for direct e-money issuance and safeguarding.

Reporting Requirements

EMIs must maintain detailed records of transactions affecting e-money balances, including funds received, redeemed, and spent, within specific periods. This includes monitoring loads, balance adjustments, fees, refunds, and transaction reversals.

Negative Balance Management

Card scheme rules necessitate EMIs to honour transactions even if they result in negative balances. The management of such balances involves customer engagement to rectify the shortfall and ensuring sufficient pre-funding to cover potential liabilities. EMIs are prohibited from issuing negative e-money, requiring customers to address any negative balances through their liquidity.

Summary

This comprehensive framework for cards as a service encompasses various models, operational considerations, and financial management practices. EMIs must navigate these complexities to offer robust card services while maintaining compliance with regulatory requirements and safeguarding obligations.