Woolard Review looks at the risks posed by product innovation in the unsecured credit market

The Financial Conduct Authority (FCA) has published (2 February 2021) its review by former interim chief executive, Christopher Woolard CBE, into change and innovation in the unsecured credit market. The FCA's board asked Mr Woolard in September 2020 to conduct the review, which has concentrated on how regulation can better support the unsecured lending market.

His report, the Woolard Review, does not actually make any changes to FCA regulation, but, instead, sets out a series of 26 high-level recommendations for the UK financial watchdog and government.

Its publication comes as fintechs have been increasingly dominant in the unsecured credit market. Offering seamless customer journeys, quick access to funds and an entirely online experience, many customers value the convenience and speed offered by fintechs. However, the report highlights concerns over the risk posed to consumers by some of the recent innovations in the unsecured market.

Buy-now pay-later finance

One of the more innovative products offered by fintechs is what the FCA calls buy-now pay-later (BNPL) finance. Available at the point of sale online and approved at the click of a button, BNPL finance typically allows a shopper, free of charge, to spread the cost of paying for an online purchase over a few weeks or months.

The BNPL finance provider is able to offer the finance for free because the retailer pays for the benefit of the uplift in sales volume. Popular participants in the market include Openpay, Klarna, Laybuy, Clearpay, and PayPal. Importantly, BNPL finance is currently exempt from FCA regulation where it is payable in no more than 12 repayments and no interest or charges are payable by the borrower (under article 60F(2) Financial Services and Markets Act (Regulated Activities Order) 2001).

The Woolard Review has raised concerns that consumers are at risk of suffering harm in various ways when they use BNPL finance and recommends that it is brought within the scope of FCA regulation as a matter of urgency. It argues that the exemption from regulation was "never intended for this kind of product".

Chief among the risks it has identified is that shoppers often do not view BNPL as credit, but nonetheless believe that they are protected in the same way as they would be if they were using a regulated service. Additionally, the review highlights that:

• Consumers have the potential to get themselves into debt very quickly with these types of products (because they offer quick and seamless access to credit), which could have knock on risks for shoppers with vulnerabilities.
• Affordability checks are often inadequate and focus on credit-risk rather than affordability.
• There is a risk that a strong relationship between the lender and the retailer could harm the consumer (by aiming to drive sales without properly considering whether the shopper can afford to borrow).
• BNPL finance is often presented as the default payment method online, and there is no way for shoppers to compare like with like.

The review does not attempt to propose how BNPL finance will be defined by HM Treasury when it is brought into the regulatory regime. There is clearly a risk, in doing so, that the Treasury may unwittingly bring into the regulatory perimeter a great deal of exempt finance that the FCA has no interest in regulating. It will, therefore, be important for the entire market to look carefully at how the new perimeter is crafted.

It is important to note that when the law changes, retailers will also be impacted, as by 'introducing' their customers to regulated credit, they will be carrying on regulated credit broking activity.

Employer salary advance schemes

Compared to BNPL finance, employer salary advance schemes (ESAS) products are in their relative infancy, but fintech activity means that these are also becoming more widespread. As their name suggests, these schemes allow employees to access earned income before their contractual pay date (in return for a fixed fee). This is often of major benefit for those whose earnings fluctuate during a month. Money which has been advanced is taken automatically from the employee's next pay cheque as part of the payroll process – so there's nothing to "repay". The structure of ESAS products means that, typically, they are not classified as credit products.

However, the Woolard Review does raise some concerns that ESAS products could cause consumer harm. For example, employees could be left short of money at the end of the month; and repeat use of ESAS products is comparatively expensive. Furthermore, an employer may know that an employee is in financial difficulty, and may therefore have a conflict of interest, as the ESAS product may exacerbate those difficulties (by leaving a longer gap between paydays for a period).

While the review does not consider that it would be appropriate to bring ESAS within the scope of FCA regulation, it does recommend that the UK regulator closely monitors ESAS market developments and guard against risk (although it's not clear how the FCA can do this if ESAS providers are not regulated). More importantly, the review recommends that the FCA, working with government, encourages ESAS providers and "major employers" to draw up a code of best practice. Those major employers should also be encouraged only to deal with ESAS providers adhering to the code.

The recommendation for a code of best practice should be welcomed. It will give the ESAS market an opportunity to demonstrate that it is capable of delivering consistent and fair outcomes to employees without the need for the FCA to bring it within the scope of its formal regulation. Further, given its relatively small size, it should allow for an opportunity to build solid foundations on which other players can enter the market.

Customer journeys

It feels like we've been here before, and that's because we have.

The FCA has long been concerned with how firms communicate with consumers. It was back in October 2016 when the FCA released its "Smarter Consumer Communications" feedback statement, which covered things like examples of innovative communication, what good disclosure looks like, digital communication and vulnerability. Given the fact that a lot of lending is now undertaken entirely online, it's timely that the Woolard Review has taken the opportunity to build on its 2016 work.

Specifically, the review recommends that FCA has in place guidance for 'digital design' in the consumer credit sector that focuses on good consumer outcomes, ensuring consumers are informed and remain in control of their decision-making. Additionally, the FCA should consider updating its disclosure requirements to make them more suitable for a digital age.

What's next?

Firms should keep an eye out for the consultation paper on bringing BNPL products within the scope of FCA regulation, and contribute their responses.

We will also shortly be publishing further Insights covering the other main themes of the Woolard Review.