The UK Government announces regulation of BNPL credit - what action should you be taking now?

It has been coming since the Woolard Review - the UK Government has consulted and now released its response on how it will regulate the Buy Now Pay Later (BNPL) sector. Consumer credit is already by far the largest sector that the FCA supervises in terms of the number of firms (around 40,000 firms), which will only increase when its remit extends to Buy Now Pay Later (BNPL).

Buy Now Pay Later - get ready for regulation!

BNPL is instalment credit that allows borrowers to split the cost of purchases into regular repayments, typically without paying interest. BNPL lenders usually derive revenue from merchant fees, which are usually a percentage of the purchase price.  The sector has exploded over recent years (it more than trebled in size in 2020 alone), with most large online retailers now offering some form of interest-free instalment credit, an option usually provided by a third-party lender. The lenders tend to be technology-driven (usually integrating with online retailers at the online check-out), with a number of the lenders being some of the fastest growing fintechs in recent years.The lenders currently operate under an exemption in article 60F(2) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, which exempts certain credit agreements that provide credit for up to 12 months where the borrower pays by way of up to 12 instalments. However, the exemption was initially intended to cover short-term invoice deferral and did not anticipate the sort of product offered by BNPL lenders. The Treasury will therefore be removing this exemption for BNPL lenders.

Why is BNPL becoming regulated?

BNPL has many advantages, such as it being a cost-free or low-cost way to access credit easily, it being an alternative to high-cost borrowing for borrowers that may struggle to access credit elsewhere, the simplicity of the product and the ability to track payments easily, often through customer-facing apps and dashboards.However, the Woolard Review described an “urgent need” to regulate BNPL credit due to potential for consumer detriment. The review highlighted a lack of consumer awareness of BNPL, with some consumers not seeing BNPL as credit, whereas others assumed that, as it is a financial service, it comes with the associated protections afforded to other financial services (such as regulated consumer credit). In particular, the Review highlighted the need to protect vulnerable customers, to have affordability assessments and to prevent high levels of indebtedness.The Review found that potential areas of consumer detriment arise from consumers making BNPL payments on a credit card, thus attracting credit card rates of interest where the card balance is not cleared monthly, and customers using multiple BNPL providers (none of which carry out in-depth credit checks) allowing the customer to spiral into unmanageable debt.The government responded by launching a consultation in October 2021 and it published its consultation response on 20 June 2022, in which it stated draft legislation will be published around the end of the year, secondary legislation will be introduced in around mid-2023 with an FCA consultation on its rules for BNPL credit to follow. The government is also considering a transitional regime for BNPL.

Will the regime only apply to third-party BNPL lenders or will retailers and merchants need to be regulated too?

The consultation initially attempted to distinguish between BNPL and another form of credit the consultation refers to as Short-Term Interest-Free Credit (STIFC):

• BNPL: “usually taken out online with consumers having an overarching relationship with a third-party lender, under which multiple low value agreements are made, with little transactional friction as a result.”

• STIFC: “frequently offered in-store, with consumers taking out a single, higher-value discrete agreement with the credit provider, who may be a third-party lender or the merchant itself. These are a more traditional form of credit, which has operated for many years without raising significant concerns.”

However, as can often be the issue in practice, there is difficulty in drawing the regulatory distinction between the technology-driven BNPL products and the more traditional STIFC models.It is proposed that the scope of regulation will include both BNPL options provided by third-party lenders (whether in store or at a distance) as well as BNPL that is provided at a distance (e.g. by telephone or online). It is not proposed to extend the regime to in-person in-store STIFC provided by merchants.However, the UK Government has not made a final decision on BNPL credit provided by merchants at a distance and so has asked for further responses on this by 1 August 2022. The government has requested details of the scale of the market (i.e. the number of merchants providing STIFC) and the way in which merchants administer and manage STIFC.Finally, in a decision that had to be made to avoid bringing thousands of retailers into the regulatory perimeter, the government has decided to exempt merchants that offer BNPL credit provided by third party lenders from FCA regulation as credit brokers. There will be limited exceptions to this, such as for domestic premise suppliers who will likely be subject to regulation for brokering BNPL agreements.

What about low value agreements?

It is worth noting that the small agreements provisions in section 17 of the Consumer Credit Act 1974 will be disapplied so that BNPL agreements of less than £50 will be regulated.

Will there be any exemptions or ways of structuring credit to fall outside of the new BNPL regime?

Whether there are ways of structuring credit to fall outside of the regime will depend on the precise wording of the legislation. However, the government is considering anti-avoidance measures, including whether it needs to prevent firms using the exemption in article 60F(3) for certain types of running account credit.The UK Government has proposed the following arrangements should be exempt from new regulation:

• Invoicing arrangements that allow for deferred payment.
• Interest-free agreements that finance contracts of insurance.
• Charge cards (such as some American Express cards).
• Trade credit.
• Employer/employee lending.

What will the regime look like?

The government has set out that the regime will be a bespoke regime for BNPL in many areas as certain aspects of the current consumer credit regime would not be appropriate for BNPL lending. The regime will also differ as the government concluded that BNPL products are inherently lower risk that interest-bearing credit products. As such, some of the rules will be more relaxed.For example, certain provisions of the Consumer Credit Act 1974 will be disapplied to BNPL to deliver a bespoke regime in respect of pre-contractual information and form and content requirements for BNPL agreements. However, the current provisions on improper execution will apply, which mean that documents that do not comply with the requirements are unenforceable without an order of the courts. The time periods for post-contractual information (such as notices of sums in arrears - NOSIAs) will also be amended to make these more suitable for BNPL agreements.The key aspects of regulation for BNPL will be:

• Advertising and promotions will become subject to the financial promotions regime. The crux of this is that BNPL lenders will have to ensure that financial promotions are fair, clear and not misleading and unauthorised merchants will need to ensure any financial promotions they communicate are approved by the authorised BNPL lender.
• A requirement to carry out adequate creditworthiness assessments and affordability checking.
• FCA rules being applied on arrears and default.
• Section 75 applying to BNPL agreements.
• The FOS jurisdiction being extended to BNPL.

What should BNPL lenders be doing now?

BNPL lenders should ensure they keep abreast of and engage early with the proposed regulation of the sector. The FCA has already asked BNPL lenders to follow the guidance in its 'Dear CEO' letter of 16 June 2022 and even took the step of sending the letter to some unauthorised firms in the BNPL sector that it does not yet regulate.In our recent experience assisting clients with FCA authorisation applications for sectors new to regulation, it has been clear that the FCA expects firms to engage with regulation early and that businesses that change their processes as early as possible (and before regulation was implemented) are more likely to find the application process smoother.The areas of focus highlighted in the recent 'Dear CEO' letter included ensuring that lenders are treating customers fairly (TCF), focussing on the treatment of vulnerable customers, showing forbearance to borrowers in financial difficulty, and that fees and charges imposed on customers must be fair.The FCA has also been encouraging BNPL providers to address potentially unfair and unclear contract terms in their BNPL agreements and to mitigate the associated risk of harm to consumers. Following the FCA's intervention, four providers of BNPL credit have voluntarily decided to amend their BNPL agreements, in particular in respect of cancellation, suspension, set-off and continuous payment authority terms.We encourage BNPL lenders to start reviewing their lending terms as well as their processes (such as affordability processes and credit checks, treatment of borrowers in financial difficulty and vulnerable customer policies) in order to meet the FCA's expectations. If BNPL lenders can demonstrate to the FCA that they have started to engage with FCA regulation as early as possible, this will assist in being able to demonstrate to the FCA during the application process that you are 'ready, willing and organised' for FCA regulation.

How we can help

In the Financial Services Regulation team at Freeths, we have experts that focus on consumer credit who have experience advising our BNPL clients on: the impact of the Woolard Review, their contract terms, use of continuous payment authorities and debt collection processes. We also have recent experience advising clients in sectors that are new to FCA regulation to become 'ready, willing and organised' for FCA regulation. We regularly advise clients in the regulated consumer credit industry on a range of compliance issues and so are able to assist clients in the BNPL sector in becoming authorised and on implementing the necessary systems, controls and documentation.The introduction of BNPL regulation, along with the other recent developments in consumer credit (which we have summarised here), means that the consumer finance sector is facing the biggest regulatory change since the transfer of regulation from the OFT to the FCA in 2014. It will take some time for all of the developments to materialise, for it to be clear how the new regime will be interpreted and for firms to become used to operating in the regulated sector. It is clear that the new regime will focus on consumer outcomes and ensuring consumers are given the right information at the right time to make well-informed decisions. Having acted for clients across the consumer finance sector, we can assist firms across the sector in interpreting and implementing the new regime.If you have any queries in relation to consumer finance, please contact Adam Edwards or Daniel Meyer.