A lot of followers and clients asked me about customer funds segregation requirements in FinTech and how it is related to the deposit protection schemes.

Let’s break it down. 💪

First of all: The very reason that clients’ funds’ segregation requirements exist for FinTech, payments, e-money, crypto, investments companies, and other non-banks is precise because those funds in most cases and in most countries are not protected by the deposit protection schemes.

🏦 Banks can take your money as a deposit and give it to another customer as a loan, which creates a liquidity and insolvency risk and the governments want these funds to be covered by the national deposit protection arrangements.

E-money, payments, investments, most FinTech, crypto, and other non-banking institutions are required to segregate clients’ funds and not use these funds for anything else other than to execute clients’ instructions with respect to payments, investments, or trading. It means they cannot just take clients’ money and give it as a loan to someone else or invest these funds into their next venture. So these funds are expected to be protected from the investment, liquidity, or insolvency risks by design, which is why they don’t need (by law) any deposit protection.

So which funds need to be segregated? – They are so-called “relevant funds”:

• Funds received in exchange to issue e-money instruments
• Funds received from clients or financial partners to execute payments or similar transactions
• Funds received by investment firms to execute clients’ investment transactions or orders

When do you need to segregate clients’ funds:

• Normally, as soon as you (or your agent or partner) receive these funds and unless you already have the following instructions to send these funds on behalf of the users elsewhere.
• In some cases, you may receive clients’ funds but you need some time to identify who is it for or perform some other reconciliations, currency conversions, or other checks. It may happen when a lot of deposits arrive at a bank account accompanied by special codes or reference numbers, and it takes some time to do the matching of these deposits. If this is the case, you must segregate the funds at the moment when you performed the matching, allocated, and credited the amount to the customer account.
• For e-money, sometimes there are exceptions: for example, FCA explicitly stated that funds paid in exchange for issuing e-money must be segregated no later than 5 days.

What are the edge cases and special rules around segregation arrangements? 🤔

• Your bank cannot charge you any fees from the segregated account (because you cannot deplete clients’ money). For example, if the bank wants to charge you their monthly fees or negative interest rate associated with the safeguarding account, they must do it from your operational account, not from the client account.
• These customer funds accounts must have appropriate names, for example, clients’ fund’s account, segregation account, safeguarding account, etc.
• Sometimes, you send funds from the client accounts and they bounce back (maybe due to incorrect instructions). In this case, there is a small fee charged by the refusing party. You may or may not decide to charge these fees back to the client but you need to have a process of detecting and reconciling these cases.
• What if you have unallocated funds, you know it’s for the clients but you don’t know which one. Unallocated funds are still clients’ funds and must be segregated.
• What about risk reserves? It is possible, especially when you serve merchants, that some of their funds are not available to your customers, and you keep them as a risk reserve to cover for eventual disputes, complaints, and chargebacks. Risk reserves are still clients’ funds and you must segregate them too (until you actually use a portion of these funds to settle claims or chargebacks, if that’s the case).
• Are prepaid accounts and reserve accounts with Visa, MasterCard, or other participants within card networks considered to be “segregated” accounts? Or in other words, do you still need to segregate clients’ money if you, for example, already have prepaid accounts and reserves or escrow accounts with card network partners? In most cases, those prepaid accounts within card networks won’t qualify as clients’ money accounts for you (they may be for Visa & Co) because they are technically not associated with your specific clients’ transactions.
• Can you invest clients’ funds or do they just sit and pay negative interest? Yes, you can invest clients’ funds, for example, into risk-free liquid assets (aka government bonds, treasury instruments, and some local government debt instruments, if they are sufficiently liquid).
• You must perform annual risk assessment, liquidity, and stress testing, which should include the risks of your dependency on specific partners and their potential failure to operate, your concentration risks, and your investment strategy analysis with respect to clients’ funds. For this purpose, it is recommended to exclude any net impact of the intra-group positions from your own funds’ calculations.

Would be great to hear from you about compliance topics or challenges that occupy your mind. 💭