FCA introduces change to payment allocation rules

Some may not have spotted that, from 1 October 2021, the Financial Conduct Authority (FCA) has quietly introduced a change to the payment allocation rules in the Consumer Credit sourcebook (CONC). This, at last, enables running account credit providers to offer instalment or payment plans without seeking a waiver in relation to CONC 6.7.4R.

Appetite for short-term instalment plans 

There is consumer enthusiasm for short-term instalment plans.  As consumers increasingly adopt subscription models, paying for individual items in three or four instalments or payments has become more popular, with buy-now-pay-later (BNPL) lenders growing hugely in profile in recent years. Many BNPL lenders have benefitted from the increase in digital shopping driven by the pandemic as they are able to offer their instalment plan products at point of sale/digital checkout.  

However, the concept of short-term instalment plans is not new. Credit and store card issuers have been keen to introduce them in the UK for several years (and offer them successfully in other jurisdictions). Running account credit providers also have the technology to put their customers in control, enabling customers to allocate particular purchases to particular instalment plans. However, CONC 6.7.4R has, until now, limited card issuers' ability to capitalise on this technology in the UK. 

By contrast, BNPL providers do not currently have to comply with CONC – this is because they tend to offer one-off short-term loans that are not currently captured by FCA regulation. However, this is due to change in future. In October 2021, HM Treasury launched its much-anticipated consultation on regulating BNPL, following the government's announcement in February that it intended to regulate these products. 

Previous position 

How did CONC 6.7.4R restrict card issuers in offering instalment plans?  Before 1 October 2021, CONC 6.7.4R provided that, for credit cards and retail revolving credit, firms had to allocate customer repayments to balances at higher interest rates before those at lower interest rates.

This rule was designed to prevent card issuers from prolonging customers' debts (and increasing interest costs) by allocating repayments to the balances with the lower rates first.  However, insofar as customer might want to pay down a purchase at a promotional rate over a series of fixed payments, this rule meant that he or she might not be able to do so if the account had a balance accruing interest at a higher rate.

For example, a customer might have a retail balance of £100 accruing interest at a standard rate of 16.9% and also an instalment plan balance of £250 at 0%, which the customer wanted to pay off at £50 a month over 5 months. If the customer paid £60 to their card issuer in the first month (with the intention that £50 went to the instalment plan, and £10 towards the rest of the balance), the lender could not do this – CONC 6.7.4R dictated that the entire £60 would have to go entirely to pay off the retail balance, leaving the customer's instalment payment unpaid.

CONC 6.7.4(3)R did offer a caveat if there was a "fixed sum credit element" to a credit card or storecard product. The caveat allowed the high-to-low payment hierarchy to apply only to repayments beyond those required to satisfy the fixed instalments. Unfortunately, this did not permit credit card issuers to avoid the high-to-low rule when offering instalment plans, because, when drafting the rule, the FCA used the FCA Glossary's defined term when referring to the "fixed sum credit element". This meant that the caveat only covered standalone (and separately signed) credit agreements which were not running account agreements. Several lenders pointed out to the FCA that it was difficult to think of examples of agreements that could rely on the caveat as drafted, but the FCA remained immovable until this year.

Perhaps the FCA has shifted its stance in response to the increasing popularity among consumers of BNPL products (and the consequent perceived asymmetries in the market); it is also possible card issuers have been avidly lobbying behind the scenes. Whatever the reason, it is unclear why the FCA has made this change with so little publicity: it is an important change for both card issuers and fintech lenders alike.

What has changed?

The FCA has introduced a subsection (4) to CONC 6.7.4R that allows firms to avoid the high-to-low rule in relation to instalment plans subject to the following:

An instalment plan must not be offered unless, acting reasonably, the firm has concluded that this option is likely to be in the customer's best interests. Examples of where it would not be considered reasonable to conclude that an instalment plan is likely to be in the customer's best interests include: 

• where the cash rate is higher than other rates on the account and the customer has a cash balance or a recent history of carrying cash balances; and/or
• where a customer is likely to be worse off by taking out an instalment plan than if he/she didn't take out the instalment plan.

An instalment plan must not be offered unless the firm has taken reasonable steps to ensure that the customer is put in a position to make an informed decision regarding exercising this option.  Examples of reasonable steps include:

• providing the customer with information about the features, costs and implications of an instalment plan, which may include illustrative examples which allow the customer to compare costs; and
• explaining to the customer the implications of failing to make an instalment plan payment e.g. whether this will be reported to the credit reference agencies as a missed payment.

This guidance reflects some of the FCA's concerns around instalment plans being offered in the context of running account credit agreements. They have, in the past, suggested that customers might be missing out on better offers from other lenders, and have also expressed concerns that customers could end up paying more on a cash balance as a result of having an instalment plan, so these provisos are unlikely come as a surprise to running account credit lenders.

Osborne Clarke comment

What impact might this change have on the market?  The good news is we are likely to see an uptick in product innovation and competition as a result of this change and, in broad terms, this can only benefit consumers in the longer term. Not only could we see more fintechs offering point-of-sale lending app products, which combine credit lines with instalment plans, but we are also likely to see credit card issuers quickly broadening their instalment plan offerings.

Equally, however, these types of product do muddy the waters between the traditional "fixed sum" model and the "running account" model. Each of these categories of credit has different legal and regulatory requirements that apply not only in terms of credit agreement documentation and post-contractual notices but also in terms of conduct of business requirements. 

As running account credit providers start to compete more directly with BNPL lenders, HM Treasury and the FCA will need to consider where exactly the proposed "lighter touch" regime for BNPL should begin and end. This is an issue they will need to tackle sooner rather than later, and will be made all the more challenging by the lack of focus on much-needed reform of the Consumer Credit Act itself.