Management of the e-money float

Part

ELM Electronic Money

Chapter

Management of the e-money float

Printed on: 07/11/2024

Rulebook at: 27/08/2007

ELM 3

Management of the e-money float

ELM 3.1

Application

01/12/2004

ELM 3.1.1

The effect of ELM 1.1.1 R to ELM 1.1.3 R is that this chapter:

(1) applies to an ELMI other than a lead regulated firm;
(2) does not apply to:

(a) an incoming EEA firm; or
(b) an incoming Treaty firm.

27/04/2002

ELM 3.2

Purpose

01/12/2004

ELM 3.2.1

The purpose of this chapter is to apply to ELMIs prudent limits on their investments aimed at helping to ensure that their financial liabilities related to outstanding e-money are backed at all times by sufficiently liquid low risk assets.

27/04/2002

ELM 3.2.2

This involves addressing credit risk, market risk, foreign exchange risk, large exposure risk and liquidity risk.

27/04/2002

ELM 3.2.3

In addition, threshold condition 4 says that 'The resources of the [firm] must, in the opinion of the [FSA], be adequate in relation to the regulated activities that he seeks to carry on, or carries on'. Principle 4 also requires all firms 'to maintain adequate financial resources'.

27/04/2002

ELM 3.2.4

Credit risk is incurred whenever a firm is exposed to loss if another party fails to perform its financial obligations to the firm. This includes issuer risk, which could potentially result in a firm losing the full price of its investments, since default by the issuer could result in their value falling to nil.

27/04/2002

ELM 3.2.5

Liquidity is the ability of a firm to meet its liabilities at the time they fall due. Adequate liquidity is vital to the continuing viability of a firm and to maintaining the stability of the financial system as a whole. If consumers could not rely on being able to redeem their e-money in full in a timely fashion, they would lose confidence in the sector.

27/04/2002

ELM 3.2.6

The purpose of the liquidity requirements of this chapter is to help to enable a firm to be able to do the following in particular:

(1) to meet maturing obligations in the normal course of business (business liquidity);
(2) to maintain an additional cushion of liquidity to cope with unexpected events such as the failure of a significant counterparty or debtor (contingent liquidity); and
(3) to survive in a wider market-generated crisis (market liquidity).

27/04/2002

ELM 3.2.7

Where the firm's exposure to its counterparty is large, it risks a large loss should the counterparty default. Such a loss may be enough on its own to threaten the solvency of the firm and its ability to redeem e-money when required to do so. The purpose of the large exposure requirements is to help to ensure that a firm manages and diversifies its exposures to counterparties relating to its e-money float within suitable limits related to its capital resources.

27/04/2002

ELM 3.2.8

The purpose of the foreign exchange risk requirements in this chapter is to help to ensure that the e-money float is not put at risk by foreign exchange exposures.

27/04/2002

ELM 3.2.9

This chapter implements article 5 of the E-Money Directive. Although article 2 of the E-Money Directive disapplies the large exposures section of the Banking Consolidation Directive, article 5(2) reapplies it in part.

27/04/2002

ELM 3.3

Asset-liability management

01/12/2004

ELM 3.3.1

A firm must, at all times, have qualifying liquid assets of a value no less than the amount of its e-money outstandings at that time.

27/04/2002

ELM 3.3.2

For the purpose of ELM 3.3.1 R, a firm's qualifying liquid assets must be valued at the lower of:

(1) cost;
(2) the amount that can reasonably be realised in money from that investment (within the time specified in ELM 3.3.11 R (2) or less) by redemption, realisation, sale, exchange or other disposal of that asset.

27/04/2002

ELM 3.3.3

Where an asset is marketable the value attributed to it under ELM 3.3.2 R (2) should normally be the quoted market price, except where there is reason to suggest that it could not realise the asset held in the quantity actually held at that price. If there is reason to suggest that the asset could not be realised at that price, the value attributed to it under ELM 3.3.2 R (2) should be the price at which it can be realised.

27/04/2002

ELM 3.3.4

In determining the value attributed to assets, the firm should take into account any difficulty it might have in realising value from any concentration of assets.

27/04/2002

Liquid assets

ELM 3.3.5

A qualifying liquid asset is an investment fulfilling all the following criteria:

(1) it is unsubordinated;
(2) it ranks at least equally with the unsubordinated, non-preferred and unsecured obligations of the person who owes the obligation under the qualifying liquid asset in question;
(3) it is:

(a) a zero weighted asset; or
(b) a deposit that is repayable on demand and is held with a Zone A credit institution; or
(c) a qualifying debt security; and

(4) either:

(a) it has a residual maturity of one year or less; or
(b) (in the case of an investment on which a floating rate of interest is payable) the interest rate will be redetermined no later than one year from the time in question.

27/04/2002

ELM 3.3.6

The total amount of investments that fall into (b) or (c) of ELM 3.3.5 R (3) that are included as qualifying liquid assets in the calculation in ELM 3.3.1 R must not exceed an amount equal to 20 times the firm's own funds at the time in question.

27/04/2002

ELM 3.3.7

ELM 3.3.6 R only applies to qualifying liquid assets held to comply with ELM 3.3.1 R. It does not prohibit holding qualifying liquid assets that fall into (b) and (c) of ELM 3.3.5 R (3) in excess of 20 times the firm's own funds. Instead, it requires that the firm should have sufficient zero weighted assets or own funds to ensure that the firm complies with the limit in ELM 3.3.6 R.

27/04/2002

ELM 3.3.8

A zero weighted asset is any of the following:

(1) cash;
(2) a security issued by and representing a claim on (or that is fully, directly and unconditionally guaranteed by):

(a) a central government or central bank of a Zone A country; or
(b) the European Communities; or
(c) the European Central Bank;

but only if it is sufficiently liquid.

27/04/2002

ELM 3.3.9

A qualifying debt security means a debenture or government and public security (other than a zero weighted asset) that:

(1) is sufficiently liquid;
(2) is not issued by a controller of the firm or by a person in the same group as the firm; and
(3) satisfies the condition in ELM 3.3.10 R.

27/04/2002

ELM 3.3.10

The condition referred to in ELM 3.3.9 R is that either:

(1) the security is issued by and represents a claim on (or it is fully, directly and unconditionally guaranteed by):

(a) a multilateral development bank; or
(b) the regional or local government of a Zone A country; or
(c) a Zone A credit institution, but only if the security does not form part of its regulatory capital resources; or
(d) an ISD investment firm or recognised third country investment firm, but only if the shares of that person are listed on a recognised investment exchange or designated investment exchange; or

(2) the security:

(a) is listed on a recognised investment exchange or designated investment exchange; and
(b) is subject to a degree of default risk that, by virtue of the solvency of the issuer or guarantor (as the case may be) is no greater than what would be within the range of what is normal for a security falling into ELM 3.3.10 R (1).

27/04/2002

Test for liquidity

ELM 3.3.11

Investments held by a firm are only sufficiently liquid if they satisfy all of the following requirements:

(1) the firm is without delay able to get quotations for the sale or purchase of the investments complying with the following conditions:

(a) the prices are for transactions that would fall into ELM 3.3.11 R (2) and ELM 3.3.11 R (3); and
(b) the firm gets the prices from persons who are not associates of the firm, who are independent of the firm and who are willing and able to buy and purchase those investments at the prices they quote;

(2) it is reasonable to conclude that, except in exceptional circumstances, the firm will be able to find a buyer for the investments and complete the sale, for money, within a time that is within the range of (or that is quicker than) what is normal for a sale falling into (5);
(3) it is reasonable to conclude that, except in exceptional circumstances, the price that the firm will be able to obtain for the sale of the investments will not be materially affected by either the speed of the sale or the amount of the investments sold;
(4) they are regularly traded;
(5) taking into account all other factors such as the volume of trading and the number of persons who frequently trade in them, their liquidity is at least as great as would be within the range of what is normal for government and public securities (being traded on the main market for those government and public securities) of the central government of a Zone A country that are widely and continuously traded in large volumes; and
(6) the firm can buy or sell the investments in a market in which:

(a) there is a timetable for the settlement of sales of those investments; and
(b) it is general market practice in that market to follow that timetable;

so that the settlement timetable for purchases of those investments is generally not a matter for negotiation.

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ELM 3.3.12

ELM 3.3.11 R (1) does not apply to a security listed on a recognised investment exchange or designated investment exchange.

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Establishment of the e-money float

ELM 3.3.13

A firm must choose which particular qualifying liquid assets to treat as the e-money float for the purposes of ELM. The firm must do so on a consistent basis. In particular, the firm must not treat a particular investment as part of its e-money float for the purposes of some of the rules in ELM and not for others.

27/04/2002

ELM 3.4

Foreign exchange risk

01/12/2004

ELM 3.4.1

A firm must, at all times, have sufficient own funds to ensure that its FX exposure does not exceed its absolute FX exposure limit.

27/04/2002

ELM 3.4.2

A firm must, at all times, have sufficient own funds to ensure that its FX exposure does not exceed its FX exposure limit on more than:

(1) one day in any one week period; or
(2) two days in any one month period; or
(3) five days in any one year period;

ending on the day in question.

27/04/2002

Calculation of FX exposure

ELM 3.4.3

A firm's FX exposure is its net FX open position multiplied by 8%.

27/04/2002

ELM 3.4.4

A firm's net FX open position is calculated as follows:

(1) only take into account an asset, liability or other position that:

(a) is denominated in, or gives rise to a position in, a foreign currency; and
(b) forms part of its e-money outstandings or e-money float;

(2) items forming part of its e-money float must be valued in accordance with ELM 3.3.2 R;
(3) for each foreign currency:

(a) sum the long and short positions;
(b) calculate the net long or short position for that currency;

(4) convert each net position, long and short, into the firm's base currency at prevailing spot rates;
(5) sum all short positions and sum all long positions;
(6) the largest figure from (5) is the firm's net FX open position.

27/04/2002

ELM 3.4.5

For the purposes of determining the currency in which a position is denominated, a firm must apply the following principles:

(1) where the price of an investment is quoted in only one currency, a position in that investment must be treated as denominated in that currency;
(2) where the price of an investment is quoted in more than one currency, a position in that investment must be treated as denominated in the currency in which the firm accounts for the investment.

27/04/2002

FX exposure limits

ELM 3.4.6

A firm's absolute FX exposure limit is, at any time, the amount by which, at that time, the firm's own funds exceed 2.5% of its e-money outstandings. If there is no such excess, the firm's absolute FX exposure limit is zero.

27/04/2002

ELM 3.4.7

A firm's FX exposure limit is, at any time, the amount by which, at that time, the firm's own funds exceed 3% of its e-money outstandings. If there is no such excess, the firm's FX exposure limit is zero.

27/04/2002

ELM 3.4.8

The effect of ELM 3.4.1 R and ELM 3.4.2 R is that a firm should not generally have any FX exposure unless its own funds exceed 3% of its e-money outstandings.

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ELM 3.4.9

If a firm's own funds are 2.5% or less of its e-money outstandings, the firm should not have any FX exposure.

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ELM 3.4.10

If the firm's own funds are between 2.5% and 3% of its e-money outstandings, it should not in general have any FX exposure, but may occasionally have an FX exposure as long as it does so no more frequently than set out in ELM 3.4.2 R. The FX exposure must not exceed the amount by which its own funds exceed 2.5% of its e-money outstandings.

27/04/2002

ELM 3.4.11

If the firm's own funds exceed 3% of its e-money outstandings, it may have an FX exposure of up to the amount of that excess. It may exceed that limit by up to ?% of its e-money outstandings, but only if it does so occasionally, in accordance with ELM 3.4.2 R.

27/04/2002

ELM 3.4.12

The limits in ELM 3.4.2 R are cumulative. Therefore, for example, if a firm exceeds its FX exposure limit more than once in a one week period, the firm will breach ELM 3.4.2 R even though it is within the limits in ELM 3.4.2 R (2) and (3).

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ELM 3.5

Large exposure risk

01/12/2004

Large exposure limits

ELM 3.5.1

A firm must not at any time have any large e-money float exposure that exceeds 25% of its own funds.

27/04/2002

ELM 3.5.2

The total of a firm's large e-money float exposures must not at any time exceed 800% of its own funds.

27/04/2002

General rules for calculation of exposures

ELM 3.5.3

(1) A firm has an e-money float exposure to a person if the firm is exposed to the risk of incurring losses:

(a) in connection with an item that forms part of the firm's e-money float and that involves an obligation of that person; or
(b) if the firm realises an asset or off-balance sheet position that relates to an investment forming part of the firm's e-money float issued by that person or that otherwise involves an obligation of that person; or
(c) if the risk:

(i) relates to an investment forming part of the firm's e-money float; and
(ii) is wholly or mainly attributable to the risk that the person fails to meet or cannot meet an obligation or to the condition or prospects of that person (including its financial soundness).

(2) The amount of a firm's e-money float exposure in (1) is the maximum loss that the firm might suffer.
(3) An individual item gives rise to an individual e-money float exposure.
(4) The total e-money float exposure to a person is the sum of all such individual e-money float exposures.

27/04/2002

ELM 3.5.4

When calculating the amount of an e-money float exposure for the purpose of ELM, a firm must include accrued interest and dividends due.

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ELM 3.5.5

A firm's e-money float exposures relate to the exposures that it has in connection with its e-money float.

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Exclusions

ELM 3.5.6

A firm must not take account of the following e-money float exposures for the purposes of the definition of large e-money float exposure:

(1) a claim or other asset required to be deducted at stages C or F set out in ELM 2.4.2 R;
(2) a bill endorsement on a bill already endorsed by another firm;
(3) an e-money float exposure under a zero weighted asset;
(4) an e-money float exposure that is secured by collateral held by the firm in the form of:

(a) zero weighted assets; or
(b) a deposit of money with or certificates of deposit issued by the firm;

(but see ELM 3.5.16 R);
(5) an e-money float exposure with a residual maturity of one year or less to a full credit institution (including a deposit that is a qualifying liquid asset under ELM 3.3.5 R (3)(b)), but only if that e-money float exposure does not form part of that credit institution's regulatory capital resources.

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Calculation of large e-money float exposure

ELM 3.5.7

Each of the following is a large e-money float exposure of a firm:

(1) (if the total of the firm's e-money float exposures to a person equals or exceeds 10% of the firm's own funds) all the firm's e-money float exposures to that person; and
(2) (if the total of the firm's e-money float exposures to each member of a group of closely related counterparties equals or exceeds 10% of the firm's own funds) all the firm's e-money float exposures to each member of that group of closely related counterparties.

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ELM 3.5.8

A person, together with each person who is closely related to that person, is a group of closely related counterparties.

27/04/2002

ELM 3.5.9

In ELM 3.5.8 R, persons are closely related if:

(1) the financial soundness of one of them is, or is likely to be, significantly affected by the financial soundness of the others; or
(2) it would be prudent to regard them as representing the same risk, because the same factors are likely to affect the financial soundness of them all or for some other reason.

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ELM 3.5.10

In ELM 3.5.8 R, persons are also closely related if there are close links between them within the meaning of paragraph (2) of the definition of that term.

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ELM 3.5.11

(1) ELM 3.5.10 R does not apply with respect to particular e-money float exposures if the firm:

(a) has taken all steps that are reasonably required to prove that the persons in question are not closely related as defined in ELM 3.5.9 R; and
(b) makes and retains a record of the steps taken under (1)(a).

(2) A firm must retain the record in (1) for the period of three years after the firm ceases to take advantage of the disapplication of ELM 3.5.10 R by (1) (including where the firm ceases to have that e-money float exposure).

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ELM 3.5.12

The persons who are closely related to each other under ELM 3.5.9 R and each person who is linked with any of them under ELM 3.5.10 R are all closely related to each other for the purposes of ELM 3.5.8 R.

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Treatment of guarantees and collateral

ELM 3.5.13

To the extent that an e-money float exposure is directly and unconditionally guaranteed by a third party, a firm may, for the purposes of the rules in this section, treat that part of the e-money float exposure as having been incurred to the guarantor.

27/04/2002

ELM 3.5.14

If an e-money float exposure is secured by collateral in the form of securities issued by a third party, a firm may, for the purposes of the rules in ELM 3.5, treat that e-money float exposure as having been incurred to that third party, as long as ELM 3.5.15 R, ELM 3.5.16 R and ELM 3.5.17 R allow this.

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ELM 3.5.15

A firm may not recognise the benefits of collateral or a guarantee for the purpose of ELM 3.5.6 R unless ELM 3.5.6 R specifically permits this.

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ELM 3.5.16

A firm may not recognise the benefits of collateral for the purpose of this section, unless:

(1) the firm has an unconditional right to apply the collateral to discharge (or to use the proceeds of realising the collateral to discharge) the liability forming the e-money float exposure;
(2) the collateral arrangements are:

(a) legally well-founded in all relevant jurisdictions; and
(b) enforceable in the default, liquidation, bankruptcy or other similar circumstance of the person who provides the collateral, the person to whom the firm has the e-money float exposure and the firm; and

(3) the firm has obtained legal opinions from suitably experienced external lawyers confirming that the requirements of (1) and (2) are satisfied and has taken such other steps as are reasonable to confirm that they are satisfied.

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ELM 3.5.17

A firm may not recognise the benefits of collateral under ELM 3.5.14 R unless:

(1) the securities referred to in ELM 3.5.14 R are not issued by:

(a) the firm;
(b) another member of its group;
(c) the person to whom the firm has the e-money float exposure in question; or
(d) (in a case in which the question is whether the firm has a large e-money float exposure under ELM 3.5.7 R (2)) any member of that group of closely related counterparties;

(2) the securities are listed on a recognised investment exchange or designated investment exchange;
(3) the mark to market value of the securities is at least 200% of the amount of the e-money float exposure concerned, except that:

(a) the percentage figure is 250% rather 200% in the case of shares;
(b) the percentage figure is 150% rather than 200% in the case of debentures issued by a full credit institution if those debentures do not form part of its regulatory capital resources; and
(c) the percentage figure is 150% rather than 200% in the case of debentures or government and public securities issued by regional or local authorities of an EEA State or by a multilateral development bank; and

(4) the securities issued by any credit institution do not form part of its regulatory capital resources.

01/01/2007

ELM 3.5.18

A firm must make the choices set out in this section on a consistent basis. In particular, the firm must not:

(1) treat a guaranteed e-money float exposure as being one to the guarantor for the purposes of some of the rules in ELM and as being to the principal debtor for others; or
(2) treat a secured e-money float exposure as being one to the person who is the debtor under the security that is held as collateral for the purposes of some of the rules in ELM and as being to the debtor under the secured obligation for others.

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ELM 3.5.19

ELM 3.5.17 R does not apply to ELM 3.5.6 R.

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ELM 3.5.20

[Deleted]

01/01/2007

Notifying the FSA of reportable large exposures

ELM 3.5.21

A firm must notify the FSA if:

(1) it proposes to enter into a transaction or transactions that would result in it having a reportable large exposure; or
(2) it has a reportable large exposure not already notified under (1).

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ELM 3.5.22

The reporting requirement in ELM 3.5.21 R applies to the total e-money float exposure, that is, it includes e-money float exposures that are exempt from the limits set in ELM 3.5.1 R and ELM 3.5.2 R as well as those that are not.

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Factors to consider when deciding whether to incur an exposure

ELM 3.5.23

When considering the acceptability of a particular e-money float exposure, the FSA expects a firm to consider:

(1) the standing of the counterparty;
(2) the nature of the firm's relationship with the counterparty;
(3) the nature and extent of security taken against the e-money float exposure;
(4) the maturity of the e-money float exposure; and
(5) the firm's expertise in the type of transaction.

27/04/2002

ELM 3.6

Liquidity and interest rate risk

01/12/2004

ELM 3.6.1

A firm must maintain adequate liquidity, taking into account the nature and scale of its business, so that it is able to meet its obligations as they fall due.

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ELM 3.6.2

A firm should be able to meet its obligations as they fall due. It should hold sufficient liquidity to ensure it can be considered to be conducting its business in a prudent manner. This includes holding adequate liquidity to meet:

(1) its e-money outstandings; and
(2) requirements to make other payments such as cash flows in respect of off-balance sheet instruments and other expenses.

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ELM 3.6.3

A firm can meet such obligations in a number of ways:

(1) by holding sufficiently immediately available cash (including bank deposits) or marketable assets; this is the primary method to be used to meet e-money obligations;
(2) by securing an appropriate matching future profile of cash flows from maturing assets and liabilities; and
(3) by borrowing; this is subject to the firm's ability to raise funds and the cost at which they can be raised, which depends upon its standing in the market and on the general liquidity situation at the time.

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ELM 3.6.4

There are no specific rules about holding capital against interest rate risk as this risk is addressed by two other parts of ELM. These are the prohibition on paying interest in ELM 4.3.7 R and the limitations on the residual maturity of qualifying liquid assets and on the period within which the interest rate on them must be redetermined in ELM 3.3.5 R (4).

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ELM 3.7

Derivatives

01/12/2004

ELM 3.7.1

A firm must not be a party to or have a position in a derivative or quasi derivative contract unless ELM 3.7.2 R allows this.

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ELM 3.7.2

A firm may be a party to a derivative or quasi derivative contract if:

(1) the sole purpose (ignoring any other purposes which together are insignificant) of becoming a party to it is hedging market risks arising from:

(a) issuing e-money; or
(b) the e-money float;

(2) so far as reasonably possible, being a party to that derivative or quasi derivative contract achieves the permitted purpose described in ELM 3.7.2 R (1);
(3) the derivative or quasi derivative contract is sufficiently liquid; and
(4) either:

(a) the derivative or quasi derivative contract is an exchange rate contract relating to a foreign currency with an original maturity of 14 days or less; or
(b) the derivative or quasi derivative contract:

(i) is an interest rate or foreign exchange related contract;
(ii) is regularly traded on a recognised investment exchange or designated investment exchange; and
(iii) is subject to daily margin requirements under the rules of that exchange.

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