Author: James Borley, Director of Payment Services
The UK’s payments sector has matured considerably since the introduction of regulation in 2009. What began as a niche segment of historic remittance firms, and challenger firms facilitating online transactions and wallets, has evolved into a critical component of the financial services ecosystem. Today, millions of consumers and businesses rely on Electronic Money Institutions (EMIs) and Payment Institutions (PIs) for day-to-day financial activities, from salary payments and foreign exchange to merchant acquiring, international remittances and holiday spending.
Yet one notable distinction remains between payments firms and banks: customer funds held by EMIs and PIs do not benefit from protection under the Financial Services Compensation Scheme (FSCS).
Instead, customers rely upon safeguarding.
Historically, legislators have viewed safeguarding as an appropriate alternative to deposit protection. However, as payment firms increasingly perform functions that consumers perceive as ‘bank-like’, an important policy question emerges: if the Payment Services Regulations 2017 (PSRs) and Electronic Money Regulations 2011 (EMRs) are eventually absorbed into the Financial Services and Markets Act 2000 (FSMA) framework, as has been touted in recent times, should access to some form of compensation scheme follow?
The answer is not straightforward.
Why the Question Is Becoming More Relevant
The distinction between banks and EMIs remains clear from a legal perspective.
Banks take deposits and invest them and/or lend against them. EMIs issue electronic money and are required to safeguard customer funds. The regulatory frameworks were intentionally designed to reflect these differing risk profiles.
However, from a customer’s perspective, the distinction is often less obvious.
Consumers increasingly receive salaries into EMI accounts, maintain significant balances in digital wallets, and use payment accounts as their primary financial relationship. Many customers assume that funds held with a regulated financial institution enjoy the same protection regardless of the underlying authorisation category.
The Financial Conduct Authority (FCA) has long sought to address this through disclosure requirements (necessitating a targeted ‘Dear CEO’ letter to EMIs in 2021), but disclosure alone may not fully bridge the gap between legal reality and consumer expectation.
As the UK continues its post-Brexit redesign of financial services legislation, the prospect of bringing the PSRs and EMRs more fully within the FSMA architecture inevitably raises questions regarding the future of customer protection.
The Case for Extending FSCS Protection
The most obvious argument is consumer confidence and understanding.
Deposit protection schemes (at its core, what the FSCS is) exist not merely to compensate consumers after failures, but to promote trust in the financial system. Consumers are generally unconcerned with the technical distinctions between deposits, electronic money and safeguarded funds. They are concerned with whether they can access their money when they need it.
While safeguarding is designed to protect customer funds in the event of a firm’s insolvency, it is not exactly equivalent to FSCS protection.
The insolvency of several payment firms in recent years has demonstrated that even where safeguarding arrangements ultimately prove effective, customers may experience prolonged delays in accessing their funds. In some cases, the costs of the insolvency process itself have reduced the amount available for distribution.
An FSCS-backed regime, or similar, could potentially provide greater certainty and faster customer outcomes.
It might also remove a competitive distortion whereby firms offering functionally similar services operate under significantly different customer protection regimes and, consequently, different levels of customer understanding.
The Counterargument: Solving the Wrong Problem
Equally compelling arguments exist on the other side.
The fundamental purpose of safeguarding is different from deposit insurance.
Safeguarding is intended to prevent all customer funds from becoming part of the firm’s insolvency estate in the first place. If safeguarding functions correctly, customers should receive their funds back in their entirety, without requiring potentially capped compensation from an external scheme.
In theory, therefore, extending FSCS protection to EMIs risks addressing symptoms rather than causes.
If regulatory concern centres on delays in returning customer funds following insolvency, policymakers may be better served by strengthening safeguarding requirements, improving resolution planning, and enhancing insolvency procedures rather than introducing a compensation mechanism designed for an entirely different business model. This has been the thrust of the FCA’s recent changes to the safeguarding regime, as set out in PS25/12.
There is also a moral hazard consideration.
Deposit guarantee schemes inevitably weaken the incentive for consumers to assess the financial soundness of providers. While this may be acceptable in the banking sector, policymakers may question whether similar protections should be extended to firms that do not undertake deposit-taking activities.
If FSCS Protection Were Extended, At What Level?
Another interesting policy question concerns coverage levels.
The current FSCS deposit protection limit of £120,000 reflects the needs of bank customers, many of whom maintain substantial savings balances.
EMI customers typically behave differently. Most electronic money products are designed primarily as transactional accounts rather than savings vehicles, and often as secondary to a primary ‘current account’ held with a bank. Average balances held by EMI customers are often significantly lower than those seen in traditional banking relationships. Would applying the full banking limit to EMIs represent proportionate regulation?
A strong argument exists that it would not. If the objective is consumer protection, policymakers should first examine actual customer behaviour rather than simply importing banking rules into the payments sector.
A compensation limit of £10,000, £20,000 or £30,000 may provide meaningful protection for the overwhelming majority of EMI customers while significantly reducing the funding burden imposed upon the industry.
Indeed, a lower compensation threshold may align more closely with the operational purpose of many payment products, as noted above.
The challenge, of course, lies in identifying that appropriate level. Too low, and consumers may remain exposed to material losses. Too high, and firms may face disproportionate funding obligations relative to the underlying risks.
The Funding Question
No discussion of FSCS protection can avoid the issue of cost. Ultimately, compensation schemes are funded by industry participants, with different sectors having strong views about the ‘appropriateness’ of their contribution.
Extending FSCS coverage to hundreds of payment firms would require difficult decisions regarding:
- Levy allocation;
- Risk weighting;
- Cross-subsidisation between sectors;
- Prudential treatment; and
- Ongoing supervisory expectations.
Many smaller fintechs already operate within tight margins, especially at the start-up/scale-up stage. A significant increase in regulatory levies could create further barriers to entry (payments firms already cite low FCA Authorisation approval rates) and undermine competition, the very objective that much of the UK’s payments framework was originally designed to encourage.
There is also the perpetual question of fairness. Should banks effectively subsidise compensation for payment firms (as they largely do for other sectors)? Or should the payments sector fund its own protection mechanism?
The latter may be more politically and economically sustainable.
A Bespoke Compensation Scheme?
Rather than extending traditional FSCS protection wholesale, HM Treasury may wish to consider a bespoke protection regime tailored specifically to payments firms, as part of its work to update the PSRs and EMRs.
Such a scheme could reflect the unique characteristics of safeguarded funds.
For example, protection might:
- Apply only where safeguarding arrangements have failed;
- Cover insolvency-related shortfalls rather than all losses;
- Operate with lower compensation limits;
- Be funded exclusively by payment and e-money firms; and
- Sit alongside, rather than replace, existing safeguarding requirements.
This would preserve the core safeguarding model while addressing public policy concerns regarding customer outcomes following firm failures.
Importantly, it would also acknowledge that EMI customers face different risks from bank depositors.
Regulation should reflect those differences rather than assuming that identical outcomes require identical frameworks.
Could Enhanced Safeguarding Be the Better Solution?
There is a further possibility.
Rather than creating any compensation scheme at all, regulators could continue strengthening safeguarding requirements. Indeed, this has been signposted in PS25/12, with the ‘interim rules’ introduced on 7 May 2026 hoping to move the dial in terms of both firm behaviour and customer outcomes. But should that not be the case, the FCA may look to go further with ‘end-state rules’.
As has been well-publicised, recent years have seen increasing supervisory attention focused on safeguarding audits, reconciliation processes, insolvency planning, and customer fund protection. One can expect a future framework incorporating:
- Mandatory resolution planning for larger EMIs;
- Pre-positioned insolvency arrangements;
- Faster payout mechanisms;
- Enhanced capital requirements linked to safeguarding risks; and
- Greater regulatory intervention powers where safeguarding weaknesses emerge.
Such measures may achieve many of the benefits associated with compensation schemes without introducing the complexity and cost of an entirely new levy-funded regime.
Conclusion
The debate regarding FSCS protection for payment firms is ultimately a debate about legislative frameworks as well as regulatory maturity.
When safeguarding requirements were originally conceived, EMIs did not yet exist and then proceeded to occupy a relatively narrow corner of the financial services market. Today, many have become integral to the everyday financial lives of consumers and businesses.
As the UK continues to modernise its payments framework and consider the long-term integration of payments regulation into FSMA, HM Treasury (in consultation with the FCA) will need to consider whether safeguarding alone will remain sufficient.
There is a credible case for introducing some form of compensation protection. Equally, there is a credible case for preserving the existing safeguarding model while strengthening its effectiveness.
If reform beyond PS25/12 does occur, however, policymakers should resist the temptation simply to import the banking framework wholesale. The risks, business models and customer behaviours associated with payment firms are fundamentally different from those of deposit-taking institutions.
The most effective solution may therefore be neither traditional FSCS protection nor the status quo, but a bespoke customer protection regime designed specifically for the realities and quirks of the modern payments sector.
How Complyport Can Help
Complyport supports EMIs, Payment Institutions and fintech firms in managing evolving FCA requirements and strengthening their regulatory frameworks. Our specialist services include:
- FCA authorisation and regulatory applications;
- Safeguarding framework reviews and gap analyses;
- Governance and SM&CR support;
- Prudential risk management and wind-down planning;
- Consumer Duty implementation and oversight;
- Regulatory reporting and compliance monitoring; and
- Ongoing compliance advisory and outsourced compliance services.
If you would like to discuss your firm’s safeguarding arrangements or broader regulatory obligations, contact Complyport and book a meeting with one of our Subject Matter Experts.
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