Her Majesty's Treasury ("HMT") has this week published a consultation paper ("CP") on the regulation of currently unregulated Buy Now Pay Later products ("BNPL"). In this Insight, Sushil Kuner, Principal Associate in our UK Financial Services Regulatory team, summarises the background to the CP, policy options proposed by HMT and next steps.
In the UK, regulated consumer credit agreements are subject to both the Consumer Credit Act 1974 ("the CCA") and the FCA's Principles for Businesses and Handbook Rules. While the CCA contains prescriptive requirements in terms of the form and content of regulated agreements as well as certain consumer rights and protections, the FCA rules govern the conduct of lenders and brokers of regulated credit agreements, for example, in respect of firms' financial promotions. Entering into a regulated credit agreement as a lender and broking of regulated credit agreements are also regulated activities for which FCA authorisation must first be obtained before such agreements can be entered into.
So what is a regulated credit agreement and why are some BNPL products currently unregulated?
Under the UK consumer credit regulatory framework, a regulated credit agreement is any agreement made between an individual or 'relevant recipient of credit' ("A") and any other person ("B") under which B provides A with credit of any amount, unless the agreement is an exempt agreement. The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 ("the RAO") sets out the conditions for a number of exempt agreements.
In particular, Article 60F(2) of the RAO sets out an exemption for short term interest free credit agreements. To benefit from this exemption, the following conditions must all be satisfied:
- the agreement is a borrower-lender-supplier agreement for fixed-sum credit;
- the number of payments to be made by the borrower is not more than 12;
- those payments are required to be made within a period of 12 months or less; and
- the credit is provided without interest or other charges.
This exemption was originally made available to ensure that standard invoicing did not fall within the definition of regulated credit and to cover circumstances where merchants offer their consumers direct payment deferral / instalment options. Over time, products and business models have evolved, including the rise of BNPL agreements which typically have all the hallmarks of exempt agreements under Article 60F(2) of the RAO. For example, at the point of sale with a merchant, consumers are typically able to enter into an agreement with a third party lender under which they may be allowed to:
- receive products on deferred payment terms whereby the consumer can receive their items without any upfront payment so that they can 'try before they buy'. Payment will typically be taken from their account a set time after the purchase date unless the item is returned by the customer before then; or
- pay for goods or services in several weekly instalments, with the first payment often being taken at the point of sale.
With both of these options, BNPL providers do not charge the consumer any interest or fees for these arrangements; instead, they typically earn revenue through their arrangements with merchants.
The Woolard Review
On 2 February 2021, the FCA published a report on change and innovation in the unsecured consumer credit sector following a Review by its former Interim Chief Executive, Christopher Woolard CBE ("the Woolard Review").
The Woolard Review recommended that currently unregulated BNPL products should be brought within the regulatory perimeter as a matter of urgency, highlighting that the use of BNPL products had almost quadrupled in 2020, and as at the date of the report, had a value of £2.7 billion with 5 million consumers using these products since the beginning of the coronavirus pandemic.
While the Woolard Review recognised that BNPL products have significant potential benefits for consumers, for example, providing a cost-free way to access credit easily for those who can afford to repay on time and the opportunity to 'try before you buy', it identified a number of potential harms including:
- a lack of understanding of BNPL offers among consumers with some consumers not viewing these options as 'credit' but instead likening them to payment technologies such as Apple Pay;
- consumers assuming BNPL products are regulated and that they are therefore protected with recourse to the Financial Ombudsman Service when they are not in fact;
- presentation of BNPL offers which may induce consumers to make impulsive decisions which may not be in their best interests;
- BNPL being presented as the default payment method online with details of each option not being clear enough upfront potentially causing confusion for consumers and making it difficult for them to make informed choices;
- lack of protection for vulnerable consumers, for example where they have mental health issues which can make it harder to manage money and control spending;
- the absence of any requirements to undertake affordability assessments and a focus of lenders instead on credit risk in an environment where basic checks are undertaken with Credit Reference Agencies and there is little visibility of BNPL debts on individual credit files;
- the ability of consumers to access multiple BNPL products from various providers, thereby potentially creating high levels of indebtedness; and
- inconsistent treatment of customers in financial difficulty.
Recognising the transformation in the use of the Article 60F(2) exemption and the issues identified in the Woolard Review, the Government committed to introduce 'balanced and proportionate' regulation of BNPL.
It is evident from the CP that HMT are acutely aware of the need to strike a balance to ensure that consumers are afforded appropriate protections without limiting the availability of what are, for many consumers, useful financial products.
To that end, HMT confirmed "this principle of proportionality will be achieved by:
- ensuring that the scope of the new regulations is defined as closely as possible to target those products where there is potential for consumer detriment; and
- calibrating the regulatory controls that are put in place for BNPL 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 in this market."
'Proportionate Regulatory Controls'
HMT have set out the following key policy changes to ensure a proportionate regulatory approach, making clear that the detail of the regulatory regime and the FCA rules that will apply will be developed by the FCA and subject to consultation. At the time of writing, we expect the FCA to publish their proposals in Q1 2022.
- A proportionate approach to credit broking regulation - Merchants offering currently unregulated BNPL products do not need to be authorised by the FCA. If the exemption in Article 60F(2) is amended such that some or all of these agreements become regulated, this position would change and merchants, on the basis of the current definition of 'credit broking' would need to be authorised by the FCA and subject to the full rules relevant to credit brokers. Given the high expected compliance costs for these businesses, the disproportionate impact on sole traders and micro businesses and the fact that this may lead to an unintended consequence of merchants ceasing to offer BNPL thereby limiting consumer choice, HMT is proposing that any regulation of BNPL be accompanied by an exemption so that the broking of BNPL credit by a merchant would not require the merchant to be subject to regulation as a credit broker.
- Advertising and promotions - While HMT recognises that there are some existing requirements on BNPL providers and merchants around advertising and promotions, for example, as set out by the UK Advertising Codes and which are monitored by the Advertising Standards Authority and the Committee of Advertising Practice, the CP makes clear that consumer protections could be strengthened further by the application of the FCA's Financial Promotions Regime ("FPR") to all forms of BNPL promotions. This would mean that any person communicating an invitation or inducement to enter into a BNPL credit agreement, whether they be a merchant or the BNPL provider, would need to be authorised by the FCA or the communication or financial promotion would need to be pre-approved by an FCA authorised person. Communications would also need to comply with the FCA's detailed financial promotion rules including the requirement to be 'fair clear and not misleading'.
- Pre-contractual information - Currently, all regulated consumer credit agreements need to comply with the prescriptive requirements of the CCA as to the form and content of pre-contractual information. This includes the provision of the Standard Consumer Credit Information form, commonly referred to as the 'SECCI'. Firms must also comply with FCA rules on the provision of pre-contract disclosure and adequate explanations. HMT consider that the full extent of the CCA pre-contract disclosures may not be appropriate for BNPL agreements on the basis that:
- "the risks of the product are lower given it is interest fee;
- the mandated information about the cost of the credit is not well suited to BNPL products given that they do not charge interest and tend to be of a significantly smaller size and duration than regulated consumer credit products; and
- a customer is likely to enter into a BNPL agreement online and with much greater frequency than a traditional credit product, and so there is a particularly high risk that the customer will not engage with long and detailed information disclosures."
As such, the government is proposing that a proportionate approach to the regulation of BNPL, would be to require compliance with the FCA's pre-contract disclosure rules only, which would still afford consumers of BNPL products adequate protection.
- Form and content of the credit agreement - The CCA, and its secondary legislation, prescribes the form and content of regulated consumer credit agreements. In line with the above, the government considers that these prescriptive requirements are inappropriate for BNPL agreements in their current form and that it may be necessary to develop bespoke legislation on the form and content requirements for BNPL.
- Improper Execution - Under the CCA, a regulated credit agreement is not properly executed unless a document in the prescribed form and containing the prescribed content is signed in the prescribed manner. The consequences of improperly executed credit agreements are that they become unenforceable without a court order. HMT considers that this provides strong incentives to lenders to provide the necessary information to consumers and would be a valuable feature of any BNPL regulatory framework.
- Creditworthiness assessments - At present, providers of unregulated BNPL agreements do need to undertake creditworthiness assessments, which are a key FCA requirement for regulated credit agreements. For regulated products, they must include an assessment of the borrower's affordability. As such, HMT anticipates that proportionate regulation of BNPL would include the extension of the FCA's current creditworthiness rules to BNPL products. The government has also indicated that it will work with the CRAs to see how data on BNPL products may be proportionately reported on consumers' credit files.
- Arrears, default and forbearance - Currently, there are no requirements on BNPL firms in respect of the treatment of customers in financial difficulty or how they should communicate with borrowers about missed payments. Given the potential consumer harms in this area, the government considers that it would be proportionate for regulation of BNPL to include some requirements on how firms treat customers in financial difficulty, similar perhaps to some of the FCA's rules on forbearance for current regulated credit agreements. The Government is also welcoming views on potentially extending the requirements in the CCA in relation to the provision of post-contractual information on arrears and defaults as well as information which lenders need to provide to consumers before taking certain action.
- Section 75 of the CCA - Section 75 of the CCA makes a creditor jointly and severally liable in certain circumstances for a supplier's breach of contract or misrepresentations for goods or services provided that the value of the goods or services purchased is between £100 and £30,000. While HMT recognises that some BNPL providers provide their own buyer protection schemes, it is currently of the view that a statutory protection could apply as part of the future regulatory framework of BNPL, in line with other regulated credit agreements.
- Small agreements - Some parts of the CCA do not currently apply to small agreements, i.e. those regulated credit agreements where the credit does not exceed £50. The Government is conscious that many BNPL agreements will be for less than £50 and therefore would be classed as 'small agreements'. Therefore, it is considering narrowing the current limitation such that the CCA requirements apply to BNPL agreements under £50.
- FOS and Redress - The government considers that proportionate regulation of BNPL should include the ability for consumers to access the FOS for issues concerning the conduct of lenders in order to secure greater protection for consumers and ensure that consumers have access to appropriate dispute resolution processes.
The government is seeking views on the CP to inform the approach to regulation of BNPL.
The consultation period is open until 11.59pm on 6 January 2022 and responses can be submitted by email or by post to:
Buy-Now Pay-Later Consultation
Personal Finances and Funds Team
1 Horse Guards Road
 Defined in Article 60L of the RAO as: "(a) a partnership consisting of two or three persons not all of whom are bodies corporate; or (b) an unincorporated body of persons which does not consist entirely of bodies corporate and is not a partnership."
 Defined as including "effecting an introduction of an individual or relevant recipient of credit who wishes to enter into a credit agreement to a person ("P") with a view to P entering into by way of business as lender a regulated credit agreement' under Article 36A of the RAO."