ELM 3.2 Purpose

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.

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

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'.

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.

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.

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. (1)

   to meet maturing obligations in the normal course of business (business liquidity);

2. (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. (3)

   to survive in a wider market-generated crisis (market liquidity).

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.

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.

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.