Review of the UK Payment Services Regulations: Considerations for Firms

On January 13, 2023, HM Treasury published a review of the Payment Services Regulations 2017 (PSRs) and related Call for Evidence (the Consultation). Responses to the Consultation are due by Friday, April 7, 2023.

The PSRs are the main piece of legislation regulating payment services in the UK. Any material changes could have a significant effect on UK banks, e-money institutions, and payment institutions providing payment services (payment service providers or PSPs).

The government has not at this stage provided much detail on what it plans to change. The Consultation does however identify certain parts of the PSRs as potential targets for reform and provides some strong hints on the government’s thinking. The lack of detailed proposals in the review suggests that respondents may have a significant opportunity to call for specific changes to the PSRs and related standards.

We set out below a summary of the key areas of review highlighted in the Consultation and how these could affect PSPs.

THE CONSULTATION

1. Safeguarding

The obligation to safeguard customer funds is a key regulatory requirement for payment and e-money institutions, and monitoring and enforcement of compliance with the safeguarding requirements has been high on the Financial Conduct Authority’s (FCA) agenda in recent years.

The government’s stated view is that the statutory rules underpinning the safeguarding regime do not give sufficient clarity as to the status of customer funds, nor do they enable the swift return of customer funds in the event of an institution’s insolvency.

The Consultation suggests delegating to the FCA the development and delivery of an updated safeguarding regime that “would enable the safeguarding regime to benefit from greater regulatory agility by setting requirements in regulatory rules.” The government notes that the FCA has experience in this area including in relation to the client assets rules (CASS), which apply to certain other categories of regulated financial services firms. It invites the FCA to consult later this year on changes to the safeguarding regime.

What does this mean for PSPs?

Payment and e-money institutions will likely need to adapt their safeguarding procedures to any new requirements. This may create additional operational burdens. However, if the new rules and guidance are created in a manner that gives sufficient operational flexibility for the various settlement models used across the sector, some institutions could benefit from this rewriting of the requirements.

Firms should engage with the FCA on the development of new safeguarding requirements. This will be of particular interest to payment and e-money institutions with complex settlement arrangements and those that have found the existing requirements to be operationally challenging.

2. Strong Customer Authentication

All PSPs are required to apply strong customer authentication (SCA) in certain circumstances. SCA provides an additional layer of security that helps prevent fraud. However, there are concerns that the detailed and relatively prescriptive regulatory technical standards on SCA may exclude certain customers from accessing payment services, such as those without reliable mobile coverage, or hinder innovation in the payments sector. The government is seeking evidence on whether an “outcome-based approach” is more appropriate for the UK market.

What does this mean for PSPs?

PSPs may wish to consider their implementation of SCA, its impact on fraud rates, customer experience, and operational challenges and engage with the FCA on areas of the existing technical standards that may benefit from reform.

3. Settlement

The PSRs impose certain requirements in relation to the settlement of payments by PSPs for their customers. In some cases, PSPs are required to ensure that payments are settled to the receiving account by the end of the working day following the relevant payment instruction (generally known as “T+1” or “D+1”). The government is considering whether greater flexibility and a “risk-based approach” may lead to better outcomes. In particular, the government’s focus appears to be on whether firms should be allowed to delay payments where there are financial crime concerns such as a suspicion that a customer may be at risk of fraud.

What does this mean for PSPs?

This could assist firms in preventing financial crime and reducing customer harm. However, it may also introduce additional operational complexity when processing payments if settlements times vary. PSPs may risk assuming greater responsibility for customer losses if, for example, it is open to PSPs to delay payments to prevent fraud. A customer that suffers such losses may question why its PSP failed to do so in its case. On the other hand, delaying settlement in such circumstances could also create liability risks for a PSP if the customer were to suffer loss as a result of the delay and claim the PSP did not have a sufficient justification for this under the relevant rules.

PSPs should consider carefully the liability risks that may arise from any changes to the existing settlement requirements and whether any proposed exceptions or exemptions provide sufficient certainty for a PSP to make the relevant operational decisions within the timeframes required.

4. Information requirements including currency conversion

PSPs are generally subject to information requirements under the PSRs and, in certain cases, the EU Cross Border Payments Regulation (as retained in the UK post-Brexit). These include information on currency conversion charges.

The government is considering whether these requirements “can be enhanced to provide relevant information to consumers, and support a better, competitive market in payment services” and has requested feedback on this in the call for evidence. The relevant section of the Consultation focuses on currency exchange disclosures, which suggests this is likely to be a key area of review.

What does this mean for PSPs?

Changes to currency exchange disclosure requirements may create significant operational challenges for PSPs, particularly if these involve requirements to display live rates or the differences between an offered rate and a published benchmark rate. Firms that offer payment services that involve a currency exchange (i.e., where the settlement currency is different from the funding currency) should consider carefully the potential commercial and operational effects of any reforms in this area.

5. Termination practices

Under the PSRs, PSPs are generally permitted to terminate customer contracts by giving two months’ notice. The extent to which this provides adequate protection for customers has been called into question in the media following several high-profile cases where PSPs have allegedly terminated customer accounts due to the customer’s political views.

In the Consultation, the government emphasises the importance of free speech and states that “[a]s a minimum … a notice-period and fair and open communication with a customer must apply in situations which relate to termination on grounds other than suspected or actual criminal offences or when otherwise allowed by law.”

What does this mean for PSPs?

Freedom of expression is emerging as a growing priority for the government and regulators. Firms will need to consider whether their termination policies are compliant with regulatory requirements (including the UK Equality Act 2010). This will be of particular interest for firms that combine a platform service (such as a social media offering) with payment services. Firms will also need to consider how any proposed reforms could affect the manner in which they communicate with customers in relation to suspending or terminating services.

POTENTIAL UK AND EU DIVERGENCE

The EU is reviewing the second Payment Services Directive (PSD2), paving the way for a revised EU Directive (PSD3). See our recent Sidley Update for more information on PSD3.

The PSRs transpose PSD2 into UK law. The UK and EU payment services regulations are therefore broadly aligned. Forthcoming changes to both the PSRs and PSD2 may lead to divergence between the UK and EU regimes. This is of potential significance for UK PSPs because (among other things) the continued participation of UK PSPs in the Single Euro Payments Area (SEPA) is predicated on a certain degree of alignment between the UK and EU regimes, especially as regards execution requirements. The UK government acknowledges this issue in the Consultation while noting that continued participation in SEPA will be balanced against the need for the UK to chart its own course.

The government will continue to seek to understand and monitor the impacts of regulatory change in the UK and EU on SEPA participation, while recognising that the UK must be able to determine its own regulatory approach.

The Consultation also notes that one of the government’s key objectives in reviewing the PSRs is to achieve “agile and proportionate regulation, which facilitates the international competitiveness of the UK economy through growth and innovation in the UK.”

Taken together, these statements suggest the government may have an appetite for significant shifts away from EU standards in certain areas, although it is likely to be selective and iterative rather than break with the EU regime wholesale.

PSPs that operate in both the EU and UK should monitor in tandem the proposed reforms to the PSRs and the passage of PSD3 through the EU legislative process, and should consider the impact of changes and divergence.

WHAT SHOULD FIRMS DO NEXT?

PSPs operating in the UK should consider how the points discussed above may affect their businesses and, particularly, whether changes in the relevant areas could create opportunities or risks. Based on these considerations, firms may wish to respond to the call for evidence directly and/or through relevant trade associations.