Key takeaways
- Prefunding means placing money with a payout partner in advance so it can pay recipients immediately.
- Prefunded balances are often large, spread across many partners and currencies, and invisible to the firm until reconciled.
- Sizing prefunding too low delays payouts; sizing it too high ties up liquidity and adds partner risk.
- Prefunded amounts must be reconciled daily against confirmed payouts, and may affect how much the firm can count toward customer-money requirements.
What prefunding is
A cross-border payments company rarely holds bank accounts in every destination country. Instead it uses payout partners, local banks or payment companies that pay recipients in local currency. Many partners require the sender's company to deposit money with them in advance, so they can pay out instantly without waiting for funds to arrive. That deposit is prefunding.
Prefunding makes payments fast, but it shifts risk and cost to the sender's company. The money sits with the partner, in the partner's country, often in a currency the company does not otherwise hold. If the partner fails, the money may be difficult to recover.
Sizing prefund balances
Treasury must decide how much to place with each partner. Too little, and payouts stop when the balance runs out, usually at the busiest time. Too much, and liquidity is tied up abroad, earning little and exposed to the partner. The usual approach is to set a target balance for each partner based on expected daily payouts and how long it takes to top up, with a minimum that triggers a top-up and a maximum that triggers a return.
Worked example
A remittance company prefunds a payout partner in the Philippines. Expected payouts are around PHP 28 million a day, and a top-up takes one business day. Treasury sets a target of PHP 60 million, a top-up trigger at PHP 35 million and a maximum of PHP 80 million.
On Monday morning the reconciled balance is PHP 41.2 million. During the day the partner confirms payouts of PHP 30.4 million, leaving PHP 10.8 million, well below the trigger. Treasury had already sent a top-up of PHP 50 million at the trigger point, which arrives Tuesday, bringing the balance to PHP 60.8 million. Without the trigger, Tuesday's payouts would have stopped by mid-morning.
| Line | Amount (PHP millions) |
|---|---|
| Opening reconciled balance (Monday) | 41.2 |
| Payouts confirmed by partner (Monday) | (30.4) |
| Closing balance (Monday) | 10.8 |
| Top-up received (Tuesday) | 50.0 |
| Opening balance (Tuesday) | 60.8 |
Reconciliation and regulation
Each day, the prefund balance must be reconciled: opening balance, plus top-ups, less payouts confirmed by the partner, should equal the partner's statement. Every payout the partner confirms must also match a payment instruction the company sent, so that no recipient is paid twice or not at all. Differences usually come from payouts rejected and returned by the partner, fees deducted from the balance, or currency conversion.
Prefunding also matters for regulation. In the US, money advanced to paying agents for paying out transmissions can count toward permissible investments within the rules, and appears in the MSB call report. In the UK, whether prefunded amounts remain relevant funds depends on the flow and the firm's safeguarding analysis. Either way, the balance must be known and reconciled. Safeheld reconciles partner statements against instructions and payouts daily and tracks each prefund balance against its targets. See cash positioning.
Frequently asked questions
What is prefunding in payments?
Placing money with a payout partner in advance so it can pay recipients immediately.
How should prefund balances be sized?
From expected daily payouts and top-up time, with a target, a top-up trigger and a maximum for each partner.
What causes prefunding reconciliation breaks?
Returned payouts, fees deducted by the partner and currency conversion are the most common causes.
Does prefunding affect customer-money requirements?
It can. In the US it may count toward permissible investments within the rules; in the UK it depends on the flow and safeguarding analysis.
References
- FCA Handbook, CASS 15.8 Records, accounts and reconciliations
- Massachusetts General Laws c.169B §9: permissible investments
- Bank of Canada, Retail payment supervision
About Safeheld
Safeheld reconciles client money every day, resolves every difference and prepares every regulatory return for sign-off, for regulated firms in the United States, the United Kingdom, the European Union, Canada, Australia, Singapore and Hong Kong. To discuss your operations, contact us at safeheld.com/contact.
This article is for general information and does not constitute legal or regulatory advice.