Why Own Funds Matter
Regulatory capital for payment firms and electronic money institutions is one of the most frequently misunderstood areas of fintech finance. Founders often conflate safeguarding (protecting customer funds) with own funds (protecting the firm's solvency), treat the minimum capital requirement as a one-time box to tick at authorisation, or fail to model the variable element of the requirement as the business scales.
The consequences of falling below the own funds requirement are serious. Under both the Payment Services Regulations 2017 (PSRs) and the E-Money Regulations 2011 (EMRs), a firm that fails to maintain the minimum own funds requirement at all times is in breach of a fundamental regulatory obligation. The FCA expects firms to have early warning systems in place and to notify it proactively if a breach is imminent. Firms that discover breaches retrospectively, or fail to notify, face significantly worse supervisory outcomes.
Practical planning requires understanding three things: what counts as a qualifying own funds instrument, how to calculate the minimum requirement, and how to monitor and report it. This article covers all three.
Qualifying Own Funds Instruments
Not all capital is equal for regulatory purposes. Both the PSRs and EMRs require own funds to be composed of qualifying instruments, broadly aligned with the CRR (Capital Requirements Regulation) capital quality hierarchy. The three tiers relevant to payment firms and EMIs are:
- Common Equity Tier 1 (CET1): Paid-up ordinary share capital, share premium account, and retained earnings (including current-year profits where audited or verified by the firm's auditors). This is the highest-quality capital and there is no limit on how much of the requirement can be met with CET1. For most early-stage fintechs, CET1 will comprise substantially all of their own funds.
- Additional Tier 1 (AT1) instruments: Instruments that are perpetual, fully discretionary as to coupon, and loss-absorbent. For practical purposes, AT1 is rare in early-stage payment firms: the complexity and cost of issuing qualifying AT1 instruments is not proportionate for firms below £50m of regulatory capital.
- Tier 2 instruments: Subordinated debt with a minimum maturity of five years and specific contractual provisions (including principal write-down or conversion on breach of a capital trigger). Again, uncommon at early stage but relevant for larger or more complex institutions.
The FCA also permits certain deductions from own funds. Intangible assets, deferred tax assets (where these exceed the threshold), material holdings in other financial institutions, and losses for the current financial year are all deducted from CET1. For asset-light fintechs with significant capitalised development costs, the deduction for intangibles can be material and must be factored into the capital calculation.
Payment Institution Own Funds: Three Methods
Payment Institutions have a choice of three methods for calculating their variable own funds requirement. The choice is made at authorisation and can be changed subject to FCA approval. The three methods are defined in Schedule 3 of the PSRs 2017:
Method A: Fixed Overhead Requirement
Under Method A, the own funds requirement is 10% of the firm's fixed overheads from the preceding year. Fixed overheads include staff costs, rent, IT costs and other expenses that do not vary with payment volume. For a firm with £2m of annual fixed overheads, the Method A requirement is £200,000.
Method A is most advantageous for firms that process large payment volumes relative to their cost base: firms with a high transaction-to-overhead ratio. It is commonly used by firms that have scaled their volume significantly without proportionally increasing fixed costs.
Method B: Payment Volume Based
Method B calculates the requirement as a percentage of payment volume (the total value of payment transactions executed), using a tiered scale:
- 4.0% of the first €5m of payment volume per month
- 2.5% of the next €5m (€5m to €10m per month)
- 1.0% of the next €90m (€10m to €100m per month)
- 0.5% of the next €150m (€100m to €250m per month)
- 0.25% of everything above €250m per month
Method B is typically the most relevant for small Payment Institutions at low volume levels, where the percentages produce a modest absolute requirement. As volume grows, the tiered structure means the marginal capital requirement diminishes, but the absolute number grows substantially.
Method C: Liabilities to Payment Service Users
Method C is based on the firm's average outstanding liabilities to payment service users (the amounts owed to customers at any point). The requirement is calculated as a percentage of these liabilities using the same tiered scale as Method B. Method C is less commonly used and is most relevant for firms that hold significant customer balances for extended periods.
The Combined Requirement
The PI's own funds requirement is the higher of the fixed minimum and the variable calculation under the chosen method. The fixed minimum for a PI is €20,000 for account information services, €50,000 for money remittance, and €125,000 for all other payment services. Most PIs will find the fixed minimum binds at launch and the variable calculation becomes binding as volume grows.
EMI Own Funds Requirement
E-Money Institutions have a simpler own funds calculation than Payment Institutions, but the absolute amounts are typically larger because e-money issuance is the basis of the calculation rather than payment volume.
The EMI own funds requirement has two components:
- Fixed minimum: €350,000, regardless of size. This is the floor below which no EMI's own funds can fall.
- Variable component: 2% of the average outstanding e-money over the preceding six months (calculated as the average of the monthly figures). This is the binding constraint for any EMI with significant issuance.
The own funds requirement is the higher of these two figures. For an EMI with €10m of average outstanding e-money, the variable component is €200,000 and the fixed minimum of €350,000 binds. For an EMI with €25m of average outstanding e-money, the variable component is €500,000 and becomes the binding figure.
"The 2% EMI variable requirement sounds modest. At £50m of average outstanding e-money, it implies £1m of own funds committed to regulatory capital in addition to safeguarding. Build it into your funding model from day one."
Safeguarding vs Own Funds: A Critical Distinction
This is the most important conceptual distinction for founders of EMIs and PIs to understand. Safeguarding and own funds are entirely separate obligations and the assets in one cannot be used to meet the other.
Safeguarding protects customer funds: when customers send you money in exchange for e-money, or when you receive funds to execute a payment, those funds must be safeguarded (either by segregation in a dedicated account at an approved credit institution, or by an insurance policy or guarantee from an approved counterparty). The safeguarded funds belong beneficially to the customers; they are not the firm's assets.
Own funds protect the firm's solvency: they are the firm's equity, sitting on its own balance sheet, available to absorb losses and cover wind-down costs. They have nothing to do with customer money.
A common misunderstanding is that a large safeguarding pool makes a firm financially stronger. It does not. A firm can hold £100m of safeguarded customer funds and £200,000 of own funds. The safeguarded funds provide zero protection against the firm's operational losses or insolvency. It is the own funds that provide the solvency buffer. Mixing up these two concepts leads to dangerously optimistic capital planning.
Worked Calculations
Payment Institution Example
Consider a PI processing £8m of payment volume per month, with £1.8m of annual fixed overheads. The PI has chosen Method B. The calculation proceeds as follows:
E-Money Institution Example
An EMI has average outstanding e-money of £18m over the preceding six months (calculated as the average of the six monthly balances). The fixed minimum is €350,000 (approximately £300,000). The variable component is 2% of £18m, which equals £360,000. The binding requirement is £360,000 as it exceeds the fixed minimum. The EMI must hold at least £360,000 of qualifying own funds at all times.
If the EMI grows to £30m average outstanding e-money, the requirement increases to £600,000 with six months of operational history. The CFO must model this trajectory and ensure capital raises are timed to maintain headroom above the minimum, taking into account the six-month averaging period that creates a lag between growth and the measured requirement.
Reporting Regulatory Capital to the FCA
Both PIs and EMIs report their regulatory capital position to the FCA through the Gabriel (now RegData) regulatory reporting system. The relevant returns are:
- EMI001 / PI001: Annual own funds return, including the composition of own funds, the calculation of the minimum requirement, and the resulting surplus or deficit.
- EMI002 / PI002: Transaction volume data used to calculate the variable element.
- Ad hoc notifications: Where a firm's own funds fall below the minimum requirement, or where there is a reasonable likelihood they will do so within the next three months, the FCA must be notified promptly under SUP 15.3.
The CFO should maintain a monthly own funds calculation, compared against the current requirement and a 12-month rolling forecast. Headroom should be managed as a percentage of the minimum requirement rather than an absolute amount: for a growing firm, a £50,000 buffer that looked comfortable at launch may be entirely inadequate six months later as volume scales.
Key Takeaways
- Own funds must be held at all times, not just at the point of authorisation. The requirement grows as volume or issuance grows.
- PIs choose between Method A (10% of fixed overheads), Method B (tiered percentage of payment volume), or Method C (tiered percentage of liabilities to customers). The requirement is the higher of the chosen method and the fixed minimum.
- EMIs hold the higher of €350,000 and 2% of average outstanding e-money over the preceding six months.
- Qualifying own funds are predominantly CET1: paid-up share capital, share premium, and retained earnings. Standard convertible notes and directors' loans do not qualify.
- Safeguarding and own funds are entirely distinct: safeguarded customer funds cannot be counted toward regulatory capital under any circumstances.
- Intangible assets and current-year losses are deducted from CET1: fintechs with significant capitalised development costs must account for this deduction in their capital planning.
- Proactive FCA notification is required if own funds fall below the minimum, or are likely to do so within three months.
