The regulation of Buy-Now Pay-Later moves one step closer

HM Treasury (HMT) has published its much-anticipated consultation on draft legislation to bring Buy-Now Pay-Later (BNPL) products into the FCA's regulatory perimeter. This change is still some time away given the need for the completion of the consultation process, parliamentary time to approve the legislation and the FCA's consultation on scheme rules. However, the FCA's existing regulatory regimes for retail products and the Consumer Duty should provide firms with an idea of regulatory expectations. The proposals as drafted should not result in merchants experiencing significant change.

This consultation represents another step in the process initiated in early 2021 in response to the recommendations of the Woolard Review which identified areas of potential consumer detriment in the fast growing BNPL market, including:

• Poor consumer understanding of products.
• A lack of affordability assessment.
• Inconsistent treatment of people in financial difficulty.
• The potential to create high levels of indebtedness with some people making multiple BNPL purchases.

The term 'BNPL' refers to a type of interest-free instalment credit which allows borrowers to split the cost of purchases into regular repayments not exceeding a 12-month period. These agreements are currently unregulated, under the legislative exemption in article 60F(2) of the Financial Services and Markets Act 2000 Regulated Activities Order 2001 (RAO).

The proposed legislation stays true to HMT's intent to regulate BNPL products in a proportionate way. HMT seeks to achieve this by approaching its design with two key parameters:

1. Scope — Ensuring the scope is defined as closely as possible to the types of credit agreement where there is potential for consumer detriment.
2. Regulatory requirements — Fine tuning regulatory requirements for BNPL agreements so that they are adapted to the business model and focused on those elements of lending practice that are most closely linked to the potential consumer detriment

Scope

HMT proposes the scope of regulation is limited to agreements offered by third-party lenders currently exempt from regulation under article 60F(2). To ensure the approach remains proportionate and doesn't inadvertently catch agreement types not linked to potential customer harm, the legislation sets out a number of exemptions. This means that agreements would become regulated where they are:

“Borrower-lender-supplier agreements for fixed-sum credit to individuals or relevant recipients of credit which are:

• interest-free, repayable in 12 or fewer instalments within 12 months or less;
• where the credit is provided by a person that is not the provider of goods or services which the credit agreement finances (i.e. third-party lenders); and
• not exempt as a result of falling within one of the defined exemptions”

Third-party lenders offering these agreements will need to be authorised and regulated by the FCA and will need to comply with the regulatory controls under the new regime. The legislation makes no distinction between in-person, online, or distance transactions in order to create a regime that is as clear as possible for consumers.

The legislation includes an anti-avoidance mechanism. This is to combat the risk that some firms may structure business to technically become the merchant in a transaction they are financing to avoid the regulation.

Exemptions

The Government will continue to provide regulatory exemptions for arrangements not considered to present a substantive risk of consumer detriment for:

• Agreements financing premiums under contracts of insurance.
• Agreements offered by registered social landlords to their tenants and leaseholders, and where there is third-party lender involvement.
• Employee-employer agreements e.g. season ticket loans.

Short-Term Interest-Free Credit (STIFC) is also out of scope of the regulation. STIFC is 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. The rationale for its exclusion is this form of credit has operated for many years without raising significant concerns of consumer detriment.

Arrangements where a third-party lender is not involved in the transaction, remain exempt under A60F(2) of the RAO. Examples of these arrangements are:

• Invoicing, where deferred payment is offered directly by a provider of goods or services to a consumer where it is interest free and repayable in a single instalment, or where a deposit is paid and the balance of the cost due is repayable in a single instalment.
• Trade credit, where suppliers provide flexibility to small businesses to defer payment for goods or services until the small business is paid by their customers.

The Government proposes the following regulatory requirements:

• Advertising and promotions — Financial promotions regime will apply to all BNPL. The current regime already applies to some scenarios in which BNPL agreements are offered. HMT proposes that when the regulation commences, unauthorised merchants will be required to have their financial promotions approved by an authorised person.
• Pre contractual information — Pre contractual disclosure will be FCA-rules based rather than mandated by the CCA so that it is more proportional to the level of risk.
• Credit agreement form and content — Current CCA requirements for the content of agreements will apply to newly regulated agreements.
• Creditworthiness assessment — FCA to develop tailored approach to applying its current creditworthiness rules to BNPL agreements.
• Arrears / default and forbearance — CCA requirements on the treatment of consumers in financial difficulty will apply to newly regulated agreements. Whilst not making any adaptations now, HMT recognises industry feedback on requests for tailoring to BNPL products and has suggested this may be considered as part of the broader CCA reform process.
• Section 75— Application of statutory protections in line with other regulated credit agreements.
• FOS and Redress — FOS jurisdiction will be expanded to cover newly regulated agreements.
• Distance marketing regulation (DMR) — The Government will disapply the DMR for unauthorised brokers where information is disclosed by authorised lenders in accordance with the FCA's rules on distance marketing for authorised persons.
• Credit broking — Merchants will be exempt from FCA regulation (as credit brokers) where they offer newly regulated agreements as a payment option. HMT believes capturing merchants under credit broking regulation would be disproportionate as it could result in increased costs for merchants leading them to cease offering BNPL products.
• Domestic premise suppliers (DPS) — Will be required to obtain FCA authorisation as a credit broker if they wish to offer newly regulated agreements from a third-party lender as a payment option. The rationale for this approach is the higher-risk of pressure selling where sales may routinely take place in their home.
• Small agreements — Disapply Section 17 of the CCA so that requirements apply to BNPL agreements under £50.
  

A temporary permission regime (TPR) will be put in place when the amending legislation is made (subject to parliamentary approval). This will allow sufficient time for the FCA to consult on and put in place rules for the new regulatory regime. It will allow firms to continue to operate until they are fully authorised and time to take the necessary steps to meet the requirements of the amended regulatory framework. Firms in the TPR will be temporarily authorised and will need to comply with the relevant FCA rules. This also gives the FCA the ability to supervise firms and if necessary, take enforcement action.

Prior to the final draft legislation being laid before parliament, the FCA will consult on proposed conduct and TPR rules for BNPL firms. In line with the FCA's recent approach to the authorisation of new sectors it is anticipated firms will be given a specific window in which they can register for the TPR which will close when the rules come into force. Any firm not registered for the TPR prior to regulation day, and which does not have the appropriate authorisation, will not be able to undertake the regulated activity.

Whilst the consultation makes no reference to the FCA's Consumer Duty requirements, BNPL firms would be wise to consider as early as possible the Duty's requirements and how they would meet them in the context of their business model. For example, under the Consumer Understanding outcome firms will need to consider what approach they will take to ensure their BNPL products are understood by customers and how to evidence this. BNPL firms will need to have a clear understanding of the target market for their products and ensure that the design of the product or service meets the needs, characteristics, and objectives of customers in the identified target market and their distribution strategy is appropriate.