Does new regulation spell the beginning of the end for 'buy now, pay later' in the UK?

The government has been intending to bring interest-free "Buy-Now Pay-Later" (BNPL) products into the scope of regulation by the Financial Conduct Authority (FCA) since February 2021. It has consulted twice on its approach to regulation, in October 2021 and June 2022 (see our previous Insight).  

On 14 February 2023, HM Treasury published its latest consultation together with a draft statutory instrument: The Financial Services and Markets Act 2000 (Regulated Activities etc.) (Amendment) Order 2023. 

Changes to exemption

The government is proposing legislative changes to Article 60F(2) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 which broadly exempts any borrower-lender-supplier agreement for fixed-sum credit where:

• the number of repayments is not more than 12; 
• the repayments must be made over no more than 12 months; and 
• no interest or fees are charged for the credit.  

This exemption is currently relied upon by BNPL providers to stay outside the FCA regulatory perimeter, as they are able to offer either a one-off BNPL loan or a number of short-term fixed-sum loans which finance a series of separate purchases. This has the potential to create confusion for consumers, as taking out a series of exempt BNPL loans can look and feel much the same as a regulated "running account" app-based credit line, which enables customers to make a series of purchases up to a specified credit limit. 

The proposed changes mean that standalone BNPL lenders will need to become FCA-authorised as they will no longer be exempt. Retailers who provide exempt loans themselves or who introduce their customers to lenders will not be caught by regulation. However, retailers who have set up group companies to provide interest-free credit to their customers on an exempt basis will now find that their captive lenders need to apply for FCA authorisation, with all of the cost and operational burden that entails, including being within the jurisdiction of the Financial Ombudsman Service.

Unknown number of exempt lenders 

The problem for the government has been that an unquantifiable number of short-term interest-free credit products (which are not what we would think of as BNPL) also rely on the same exemption. For example, when borrowers spread the cost of their annual insurance premium over 12 months, and when employees are given season ticket loans by their employers, these are exempt loans, so repealing the exemption in its entirety is not an attractive option. Unfortunately, there is no way that the government can know or find out exactly how many exempt products are offered in the market.  

Following feedback received to last year's consultation, the government has come to a couple of sensible conclusions: that the exemption for several "low risk" types of product should be maintained;  and that regulation should not extend to agreements provided by merchants (who are the providers of the goods/services being financed) online or at a distance. 

How is the law changing?

The government is narrowing the Article 60F(2) exemption considerably by removing from its scope two types of borrower-lender-supplier agreement.  

Firstly, agreements that would otherwise fall within the exemption but where the lender and the supplier are not the same person (that is, where the credit is provided by a person that is not the provider of the goods or services being financed) will now be regulated.  

Secondly, agreements where the lender purchases products from the supplier and resells them to the consumer on finance will become regulated. This second limb is an "anti-avoidance" mechanism built into the draft order in response to industry concerns.

Which products will continue to be exempt?

The exemption available for higher value business lending to sole traders, small partnerships and unincorporated associations will not be affected, and the government also does not intend to affect firms' ability to offer invoicing and trade credit outside the scope of regulation. 

The draft order specifically aims to ensure that loans financing contracts of insurance and loans to employees will continue to qualify for the exemption.

The government is also proposing that credit offered by registered social landlords to tenants and leaseholders to finance the provision of goods and services can continue to qualify for the exemption, although it has asked for views on whether this "is appropriate and does not lead to potential consumer detriment". 

What rules will apply to retailers?

Retailers introducing customers to newly in-scope products will continue to be exempt from credit broking regulation. However this exemption will not apply to "domestic premises suppliers", in order to account for a perceived higher risk of pressure selling for vulnerable consumers where sales take place routinely inside the home. 

The government intends that unauthorised retailers will need to obtain approval of any marketing material from an authorised firm. In practice, it expects that third party lender partners will provide pre-approved material to retailers as part of the commercial arrangements between them. 

The government will disapply information disclosure rules that would otherwise apply to retailers in the Financial Services (Distance Marketing) Regulations 2004 so as to avoid duplication of information for consumers and disproportionate regulatory burden. 

Impact on the market 

It is important to note that the proposed changes are product-focused rather than lender-focused. This means that firms that are already regulated and which offer previously exempt products will also be affected. 

All affected lenders will now need to factor into the risk of incurring connected lender liability under section 75 Consumer Credit Act 1974 (CCA) where purchases have a cash price of more than £100 and less than £30,000. This may make some consumer purchases that are perceived as "high risk" less attractive to fund (for example plastic surgery treatments and new green technology), to the extent they are financed over a 12 month period without interest and charges. 

The full suite of legal and regulatory requirements will apply to every in-scope agreement, even where the amount of the loan is less than £50, subject to the following:  

• there will be no requirement to provide the standard form Pre-Contract Credit Information (instead, the FCA will consult on rules for dealing with pre-contract information), although the current plan is to apply all other CCA documentary requirements (including signatures, rights of withdrawal, provision of copy documents and post-contractual notices) without change; and
• there may be some tailoring of FCA rules relating to creditworthiness and affordability assessments.

The impact of all these changes is likely to mean that the choice of BNPL products available for consumers is reduced. Some currently exempt BNPL lenders may decide either to withdraw from the market entirely (rather than face the increased costs and operational burden of being an FCA regulated firm); or to obtain FCA authorisation for lending but ultimately decide that it is no longer a cost effective model to offer credit free of interest and charges to customers.

Transition period

The government will put in place a transition period from the point at which the legislation is made until the day on which regulation commences (regulation day). 

From regulation day, a "Temporary Permissions Regime" (TPR) will apply to firms that are newly caught.  Each firm will have to make an application for full authorisation while they are in the TPR.  Firms entering the TPR will be deemed authorised by the FCA and therefore will be expected to comply with all applicable FCA rules. The FCA will be able to supervise and take enforcement action where necessary.

Importantly, from regulation day onwards newly in-scope credit agreements will be regulated and therefore must comply with the CCA. Firms that exit the TPR, either due to refusal or withdrawal, will not be allowed to enter into new agreements which are caught by regulation as they will no longer be deemed authorised. 

Newly caught firms should be aware that the TPR is a transitional period for the purposes of getting FCA authorisation only – it does not allow firms to delay compliance. All firms will need to be fully CCA-compliant by regulation day, as any new credit agreements entered into after regulation day will be regulated credit agreements.

What happens next?

HM Treasury is seeking views from stakeholders by 11 April 2023. The government's ambition is to lay legislation during 2023. There will be a separate FCA consultation on proposed new FCA rules, to be published shortly after the government's response.

Osborne Clarke comment

The government has said that it aims to make changes that are proportionate and that strike the right balance between innovation, a level playing field for all credit providers and consumer protection. While the aim can be supported, there are concerns that, with these proposals, the government is achieving a level playing field at the expense of competition and innovation, which in turn may impact consumer choice and consumer outcomes. While the government has launched a review of the CCA more broadly, reforms are not expected to come into force for several years, so the potential impact of these changes to Article 60F(2) should not be underestimated.

In practice, BNPL providers should start deciding as soon as possible which is the lesser of two evils:

• sticking with the "series of fixed sum" agreements model, which will involve huge friction being introduced into customer journeys each time a customer makes a purchase including: an affordability check (with appropriate record keeping); provision of an adequate explanation on a screen that must be passed through by the customer and potentially complying with new, additional FCA rules on pre-contract disclosures; obtaining a signed credit agreement containing all the terms; providing a 14 day right of withdrawal; and providing a copy of the credit agreement; or
• restructuring their BNPL products to become regulated "running account" credit agreements, which will result in their merchants carrying on credit broking.

Our view is that the changes being proposed are likely to signal the end of BNPL as we know it, so the government needs to be comfortable with this outcome.

View the recordings from our Future of Financial Services Week, which included webinars on the rise in alternative payment methods (including BNPL)