UK moves to reform consumer credit law and regulate buy now, pay later

The government has announced (16 June 2022) that it intends to reform the Consumer Credit Act 1974 (CCA), with the long-awaited project expected to take place over an extended timeframe and more details on its approach anticipated later in the year.  

HM Treasury has also set out, in its consultation response (20 June 2022), more specific plans to bring exempt interest-free lending within the scope of regulation, following a much-anticipated consultation.  

What will be regulated?

The regulatory perimeter will be extended to capture not only currently exempt interest-free buy-now-pay-later (BNPL) products but also currently exempt short-term interest-free credit (STIFC) products that are provided by third-party lenders.  

While exempt BNPL products and STIFC products rely on the same exemption under article 60F(2) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO), the government drew a distinction between them in its initial consultation and suggested that BNPL should be regulated while STIFC should not. It defined the two products as follows:

• BNPL: credit usually taken out online with the consumer having an overarching relationship with a third-party lender, under which multiple low-value agreements are made with little transactional friction as a result.
• STIFC: typically offered in-store, with the consumer taking out a one-off, higher-value agreement with the credit provider, who may be a third-party lender or the merchant.  The credit may also be used to finance subscriptions such as gym memberships or to purchase season tickets.

However, respondents to the consultation pointed out that both types of product are rapidly changing and adapting to changes in consumer behaviour in the market, and that the lines between the two product types are increasingly blurred. 

Drawing STIFC into the regulatory perimeter at the same time as BNPL means that the government will not have to draw what it now realises is a tricky distinction between the two. Instead, any lender offering either STIFC or BNPL will need to be authorised by the UK Financial Conduct Authority (FCA), and will be required to comply with certain aspects of the regulatory regime, including carrying out affordability checks to ensure loans are affordable for consumers.

The government approach

HM Treasury noted that many respondents to its consultation made the case for broader reform of the regulatory controls provided by the CCA that apply to all regulated credit agreements. Some respondents considered that a tailored approach to BNPL could be a test case for wider reform of CCA requirements. 

However, others felt that the existing CCA requirements should be applied in full to BNPL with reform coming later, or that the government should undertake broader reform in parallel.  Shortly before publishing its consultation response, HM Treasury announced that it intends to reform the CCA more broadly.

Arguably, this has softened the landing for HM Treasury's proposals to "tailor the application of" the CCA to BNPL and STIFC.  Some respondents will see this as HM Treasury deciding to apply a watered-down regime to BNPL lenders even though they directly compete with fully regulated credit card lenders, which gives them an unfair advantage. Many respondents argued strongly against this. However, there remain industry concerns about the potential impact of applying the full consumer credit legal and regulatory regime to BNPL and STIFC on competition and innovation. The government believes this tailored approach strikes the right balance between consumer protection and a proportionate burden on firms. 

The new regime

The main aspects of the regulatory regime for the newly in-scope products will include the following areas: 

• Credit broking. Merchants offering newly regulated BNPL and STIFC products as a payment option at point of sale will be exempt from FCA regulation as credit brokers. The government's view is that there is minimal risk of brokers pushing consumers towards BNPL and STIFC products unsuitable for their needs since, unlike most regulated products, merchants do not receive a commission for brokering BNPL and STIFC agreements, and instead pay a fee to the lender to provide the credit.  
• Financial promotions. Advertising and promotions of BNPL and STIFC agreements will fall within the UK financial promotions regime. In practice, this means merchants will be required to obtain approval for promotions of these products from an authorised firm – this could, but does not have to, be their BNPL or STIFC lender partner.
• Pre-contractual information. The CCA pre-contractual obligations (including the requirement to provide information in a standard form PCCI document) will be disapplied for the newly-regulated products; instead a more flexible regime based on the FCA rules will apply.
• Form and content of the credit agreement. The requirements on form and content of agreements will be prescribed in legislation, albeit with a tailored approach for BNPL and STIFC agreements given the lower risk involved.  It is therefore highly likely that BNPL and STIFC providers will need not only to 'repaper' their existing client relationships but also review and revise their customer journeys.
• Improper execution provisions. The improper execution provisions under section 61 of the CCA will apply to BNPL and STIFC agreements that are brought into regulation.
• Creditworthiness and credit files. The FCA's rules on creditworthiness assessments will apply, with tailoring as the FCA sees fit. The government is working with the credit reference agencies as they develop their approach to reporting BNPL on credit files – this may prove challenging in practice given the nature of BNPL products, particularly their short duration. The FCA is also carrying out work on its Credit Information Market Study, with an interim report on findings expected this summer.
• Arrears, default and forbearance. The FCA rules on the treatment of consumers in financial difficulty will apply to the BNPL and STIFC agreements brought into the scope of regulation. 
• Section 75 CCA protection. Consumers financing purchases using BNPL or STIFC will have section 75 CCA protection.  This means that they will have a like claim against their lender if they have a claim against the supplier of the financed goods in misrepresentation or breach of contract. While some BNPL transactions will fall outside the current monetary threshold for section 75, and some business models may break the debtor-creditor-supplier relationship meaning section 75 will not apply, this will be an important increase in consumer protection and a corresponding increase in potential cost for lenders. 
• Post contractual notices.  The CCA post-contractual notice requirements will also apply to both BNPL and STIFC providers in their as yet unreformed state. It is widely accepted that these requirements (which include sending notices of sums in arrears in accordance with stringent form and content requirements at very specific times after a customer goes into arrears) are in need of reform.  

The consequences for lenders who make unintended errors in this area can often be disproportionate and it is widely expected that these laws will be reformed. However, the government nonetheless will be applying these requirements to BNPL and STIFC, while recognising that the current requirements may need to be tailored for BNPL and STIFC agreements, given their sometimes very short-term nature.

While lenders who do not charge interest do not suffer the same financial losses where things go wrong in this area, the fact that these post-contractual notice requirements will apply means that lenders will either have to build new manual processes around these requirements or look to move their books onto automated platforms that are built to comply.

• Small agreements. The government intends to disapply section 17 CCA on small agreements (not exceeding £50) for the newly-regulated products. This mitigates a potential discrepancy whereby lenders offering interest-bearing credit not exceeding £50 would not be subject to CCA requirements on the form and content of agreements or FCA rules on creditworthiness assessments in relation to those small agreements, whereas lenders offering BNPL or STIFC agreements below £50 would be subject to these requirements.
• Financial Ombudsman Service jurisdiction. Financial Ombudsman Service (FOS) jurisdiction will apply to the newly regulated agreements. Regarding concerns around the current £750 FOS case fee being high compared to the typical BNPL transaction (around £50-£100), the government has indicated that this is a matter for FOS to consider.  

Outside the perimeter

Currently, the intention is that STIFC offered in person by merchants will not be caught in the scope of regulation. The government does not consider these transactions to carry the same level of risk as agreements provided online. Their reasoning is that there is greater friction present during in-person transactions and this reduces the likelihood that consumers accumulate debt across multiple agreements. Consumers are also less likely to make impromptu purchases using credit in person as reviewing the documentation in person is, in theory, more time consuming. 

This is a surprising conclusion, given it is well established that generally there is an increased risk of mis-selling in face-to-face channels.  Furthermore, face-to-face channels will usually involve an online acquisition process in any event (with the customer being asked to use a tablet to agree to the credit), so it may not be the case that reviewing the documentation in person is more time consuming. It seems to us that the HM Treasury needed to draw a line somewhere around what is caught and what is not caught, but certainly this one is open to challenge.

The government is considering extending the scope of regulation so that it captures STIFC provided directly by merchants online or at a distance, a move which could prove challenging for a number of existing business models where the merchant offering the credit is not currently FCA authorised. 

HM Treasury acknowledges that it does not at this stage understand the scale of the merchant-offered STIFC market and has invited further stakeholder engagement so that it can look at the scale and operation of the merchant-offered STIFC market fully, with a deadline for responses of 1 August 2022.

The regime will allow for exemptions where there is a limited risk of potential consumer detriment, and where regulation would adversely affect day-to-day business. These exemptions will cover:

• Invoicing.
• Interest-free agreements which finance contracts of insurance.
• Charge cards.
• Trade credit.
• Employer/employee lending.

What next?

The government is seeking views on extending the scope of regulation to capture STIFC products provided directly by merchants online or at a distance. It intends to publish draft legislation to enact the BNPL reforms towards the end of this year, along with a further consultation paper. 

The aim is then to lay secondary legislation in mid-2023, confirming the scope and framework of the new regime. Following this, the FCA will consult on its approach for the new regime. This projected timeline suggests it is unlikely the new rules will be in force before early 2024.

Osborne Clarke comment

HM Treasury's starting point in this consultation has been to look at product types and decide whether or not to bring them into the regulatory perimeter. This approach has inherent risks. The exemption in article 60F(2) of the RAO does not define products, it defines characteristics of products. This is an important difference. By effectively removing the exemption as it stands and replacing it with new product-based exemptions, in our view, HM Treasury risks unintentionally putting a break on fintech innovation.  

To date, only cursory attention appears to have been paid by HM Treasury to other reasons that unauthorised firms commonly rely on the article 60F(2) exemption.  The consultation response does not reflect a rigorous level of research into the extent to which unauthorised third parties (who are not primarily lending businesses) will be caught. 

For example, we are particularly concerned about innovative platforms and payment services providers that rely on the exemption to enable efficient payment flows, and the importance of this exemption to continued innovation in the fintech space.  The drafting of replacement exemptions is therefore key to the success of this change and we remain of the view that exemptions based on product characteristics (or even outcomes) rather than product types are more likely to stand the test of time.

We agree that HM Treasury needs to conduct further research into the volume and type of merchants which rely on the exemption to offer finance online or at a distance. We would expect this to be a market of some significant size comprised of non-financial services firms who are often unsophisticated and may be difficult to regulate. The practical issues and the potential for unintended consequences of regulating these kinds of firm should not be underestimated.

In terms of what the consultation response has to say about BNPL, there is no doubt that these changes will result in a significant increase in operational costs for BNPL providers. Once BNPL firms are regulated, we would therefore expect to see free-at-the-point-of-use BNPL to become less common as firms try to retain their margins by charging consumers fees and interest.  

While BNPL products are not yet within the regulatory perimeter and the changes may be some way down the line, in a sign of what is to come, the FCA is already messaging its expectations around BNPL providers' treatment of customers. For example, a recent FCA Dear CEO letter (16 June 2022), which reminded lenders of regulatory expectations as consumers face the cost-of-living crisis, was also sent to unauthorised BNPL providers to encourage them to give customers "an appropriate level of care and support". The regulator has also worked with four BNPL firms to change their terms and conditions due to concerns about potential risk of harm to consumers as a result of how some of the terms were drafted. 

The FCA is not the only regulator scrutinising BNPL providers – the Advertising Standards Authority has issued guidance and has continued to make rulings on specific BNPL advertisements.

In terms of the wider CCA review project, a consultation on the direction of the reform is expected to be published by the end of the year and is likely to coincide with the publication of draft legislation to enact BNPL reforms – these will need to work together to ensure a consistent direction of travel.

One question already being asked by stakeholders is whether the decision to exempt merchants offering newly regulated point of sale lending products from the scope of regulated credit broking activity increases the likelihood of further changes being made to the perimeter of credit broking as part of the wider CCA reform project.  Where the line is drawn between the online promotion of credit products and credit broking activity is often unclear, with subtle considerations such as whether the consumer wants to apply for credit playing a role.  There is certainly an argument to be made that any risks in this area could be covered by the financial promotions regime rather than the RAO.

The government intends to move much of the CCA from statute, which, it acknowledges, has proved to be inflexible and unnecessarily complex (often to the detriment of consumers and particularly over the pandemic and as lending becomes increasingly digital) to sit in the FCA handbook as rules, enabling the FCA to respond quickly to emerging developments.  

While legislation will initially be required to enact the BNPL reforms, we ultimately expect the new BNPL regime to be moved into FCA rules as part of the wider reform process.