HM Treasury takes next steps on regulation of 'buy-now pay-later'

Back in February 2021, the government announced its intention to regulate interest-free "buy now, pay later" (BNPL) products, given the perceived risk of consumer harm highlighted in the Woolard Review. The much-anticipated HM Treasury consultation on regulating BNPL has now (21 October 2021) been launched and the government has asked for responses by 6 January 2022. 

What's the present situation with BNPL products?

As a starting point, firms have to be authorised by the UK Financial Conduct Authority (FCA) to provide regulated consumer credit. BNPL products are currently covered by an exemption which allows providers to remain unregulated where the borrower makes no more than 12 payments within 12 months or less, and no interest or other charges are payable.

Other types of business have been using this exemption for a long time. The main examples are invoicing (that is, letting a customer pay for goods and services after receiving them), and what the government is calling "short-term interest-free credit", which covers interest-free loans for things like sofas, white goods or season tickets, where the borrower has to repay in under a year.

What does the government want to change?

The Woolard Review identified areas where BNPL products could create a risk of consumer harm. These areas include how BNPL is promoted to consumers when they are shopping, the absence of creditworthiness checks, and consumers' lack of understanding about the product.

The government wants to start regulating BNPL in a way that is proportionate to the risks, and is looking for feedback on how to do it. The consultation focuses on two areas: which products should be brought into scope of regulation, and what rules should apply to those newly-regulated products?

Which products should be regulated?

The government is trying to come up with a definition that catches the BNPL products it wants to regulate, while not catching established types of business (especially invoicing) that don't have the same risks as BNPL. It's difficult to draw a line between BNPL and short-term interest-free credit owing to the similarities between the two business models. The consultation asks for views on this issue.

The consultation offers two ideas for the new definition:

•    catching interest-free credit agreements where there is a third-party lender involved in the transaction (and not arrangements directly between a merchant and a consumer); and

•    catching agreements where there is a pre-existing, overarching relationship between the lender and consumer (for example, a consumer opens an account with a lender), the lender agrees to finance one or more transactions, and repayments go towards specific agreements made as part of that relationship.

Under the first option, the definition is so wide it means all third-party BNPL lenders need to be authorised, and a large proportion of short-term interest-free credit would also be caught.

Under the second option, this definition has similarities to running-account credit, particularly since the recent changes to the payment allocation rules that allow more flexibility for providers to offer fixed instalment plans under a single agreement. This raises questions around how BNPL and running-account credit differ and how each product should be treated. The government is also concerned that providers could make small tweaks to their BNPL products to fall within a similar exemption to that currently relied on, but which applies to running-account credit.
Neither of these options is a perfect solution, and we expect a lot more discussion to come on this important question.

What rules should apply when BNPL is regulated?

The government acknowledges that BNPL products, being interest-free, are less risky than interest-bearing credit products. Making BNPL subject to all the rules that apply to mainstream regulated credit products would be disproportionate. This means changes may be needed to tailor the rules for BNPL.

The consultation covers the government's current thinking on many elements of credit regulation and whether or how these should apply to BNPL products. The key points are:

Merchants and credit broking

Currently, a merchant doesn't need to be regulated to introduce its customers to BNPL providers.
A crucial question in the industry post-Woolard Review was whether, as a result of BNPL becoming regulated, merchants offering BNPL would be credit broking. This is a regulated activity where a business introduces a customer to a lender with a view to the customer entering into a regulated credit agreement.

If merchants are credit broking they would need to apply for FCA authorisation and comply with FCA rules which apply to credit brokers. It's likely many merchants would simply stop offering BNPL to avoid this, or that BNPL lenders would need to appoint merchants as "appointed representatives" and take responsibility for their broking.
The government is proposing an exemption under the new BNPL regulation, meaning merchants offering BNPL payment options would generally not be regulated as credit brokers. This is particularly helpful for smaller businesses who wouldn't be in a position to become authorised.  

Advertising and promotions

The Woolard Review flagged concerns around how BNPL products are promoted to customers. For example, BNPL advertising often focuses on aspiration and taps into consumers' desire for a certain lifestyle. 

From a regulatory perspective, currently there is an exemption from the financial promotion rules for merchants who promote unregulated BNPL agreements offered by an authorised lender. This means merchants don't have to get their promotions approved by an authorised firm.

The government is considering changing the rules so that all promotions of BNPL agreements fall within the financial promotions regime. This would mean that in future merchants need to get their promotions approved by an authorised firm, such as their BNPL lender partner. This could be tricky in practice given the number of lenders and volume of promotions. 

The government also envisages that the FCA could supervise lenders' pre-contractual screens to make sure BNPL customers get clear information on negative consequences like arrears fees and debt collection. While this would be helpful, this is likely to prove time consuming in practice.

Key credit rules

The government has looked at key rules that apply to the regulated credit market and indicated whether they think the rules should apply to BNPL products, either "as is" or tailored in some way.

The two main sources of rules are the Consumer Credit Act 1974, and the FCA's Handbook rules (in particular the Consumer Credit sourcebook, known as CONC).

•  Pre-contractual information: The Consumer Credit Act contains detailed and prescriptive rules on what information has to be provided for regulated credit agreements. The FCA rules also cover pre-contract disclosure. The government thinks that applying the Consumer Credit Act rules to BNPL products would be disproportionate, especially as customers aren't charged interest and are unlikely to read through long disclosures online every time they make a purchase using BNPL. It should be enough to apply only the "lighter touch" FCA requirements (known as providing an "adequate explanation"), with any changes the FCA thinks are needed.

•  Form and content of credit agreements: The Consumer Credit Act and other regulations contain detailed rules on the form and content of regulated credit agreements. The government thinks applying these rules to BNPL products would be disproportionate. Instead, bespoke legislation for the BNPL sector is likely needed, and the consultation asks for views on what this could look like.

•  Improper execution: Where a regulated credit agreement is not in the right form, with the right content, and signed in the right way, there are serious consequences for the lender: a wrongly executed agreement is unenforceable by the lender without a court order. The government considers that these rules should apply to BNPL products. While this adds friction to transactions, as customers will need to consider and sign an agreement, this could create a helpful opportunity for customers to consider whether the BNPL product is right for them.

•  Creditworthiness assessments: Mandatory for regulated credit, creditworthiness assessments look at the credit risk to the lender plus whether the customer can afford to repay. These checks are not currently required for BNPL products. The government thinks these rules should apply to BNPL products, with any tailoring the FCA thinks is needed. The government also intends to work with credit reference agencies on how BNPL may be reported on consumers' credit files. This is currently an area of inconsistency which has attracted attention from industry bodies, and the FCA is also in the process of conducting its Credit Information Market Study, which BNPL considerations ought to form part of.

•  FCA rules on arrears, default and forbearance: There are currently no requirements on how BNPL providers should treat customers in financial difficulty or communicate with borrowers who have missed payments. While many BNPL providers have hardship policies to help customers who are struggling to repay, these are not consistent across providers. The government thinks that regulation of BNPL should include rules on how firms treat customers in financial difficulty. As in other areas, the existing FCA rules may need adapting to fit BNPL.

•  Consumer Credit Act rules on consumers in financial difficulty: The Consumer Credit Act contains rules on providing information about arrears, defaults and pre-enforcement. This gives customers a warning that they may need to take action in relation to a credit product, hopefully enabling them to resolve problems early. The government is considering applying these rules to BNPL, and is asking for views on how proportionate this would be.

•  Section 75 Consumer Credit Act protection: This rule protects customers, typically where they use a credit card to buy goods or services between £100 and £30,000, by allowing them to claim against the credit provider instead of the supplier. Under the new rules, this protection should apply to BNPL products too.
•  Small agreements: Some parts of the Consumer Credit Act and the FCA rules currently don't apply to "small agreements" (broadly speaking, credit of £50 or less). BNPL transactions tend to be relatively low in value, averaging between £65 and £75. The government therefore thinks the small agreement exemption should be changed, so no rules are switched off for BNPL agreements under £50.

•  Financial Ombudsman Service (FOS): The FOS is a service to help resolve disputes between financial services firms and consumers, as an alternative to the courts. The government thinks that customers should be able to complain to the FOS about BNPL lenders.

Osborne Clarke comment

Overall, the proposals from HM Treasury are sensible, proportionate and likely to be welcomed by BNPL lenders and merchants alike.

There are, however, areas where no clear proposals have been made and others where detail is light. This is likely to result in the need for further consultation from both HM Treasury and the FCA, and will have a negative knock-on effect on the timing for implementing these changes.

Areas that are likely to attract feedback include:

•   The distinction between BNPL and short-term interest free credit is not particularly clear. It appears to be what a customer wishes to spend their credit on which determines whether the agreement should be properly categorised as short-term interest free credit (white goods and big-ticket electronics) or BNPL (potentially anything else?) – more thinking is required on this point.

•  While opening up the FOS to BNPL customers is positive for customers, the consultation makes no mention of FOS fees. After the first 25 complaints, BNPL lenders would need to pay a per-case fee of £750, which may be entirely disproportionate to the value of the loan. Given the volume of merchants and transactions in the BNPL space, it's likely 25 complaints would be reached fairly quickly.

•  Not requiring merchants to be regulated to broker BNPL could create asymmetry in the market. Credit broking now typically only involves displaying a financial promotion with a link to the lender's website or portal, and this remains the case whether the underlying product is BNPL or a "fully" regulated product. This will be a concern for lenders who offer "fully" regulated products whose brokers do need to be regulated, whereas brokers of BNPL do not.

•    Extending the post-contractual notice and statement requirements to BNPL is likely to be disproportionate given the typical value of the loan, and may be hard to implement in practice given the relatively short duration of the agreements. Thought will be required to ensure that any post-contractual notice regime works in practice and doesn’t cause customer confusion.

•    The consultation mentions the concerns raised in the Woolard Review about the ease of access to BNPL and the risk of customers being able to use it in a way that pushes them into financial difficulties. While the consultation proposes bringing BNPL into the ambit of the FCA’s responsible lending rules, it stops short of giving any views on any aspects of BNPL product that it thinks may be problematic. For example, consumers can use their credit card to repay BNPL products – does HM Treasury think this may be problematic? This lack of views is emblematic of the significant lack of data that HM Treasury appears to have to support the "urgent" reforms demanded by Woolard, and it is now down to the industry to provide data which either supports or counters the concerns raised in the Woolard Review.