Impending Regulatory Changes to the Buy-Now-Pay-Later Sector - Action to Take Now

BNPL firms offer consumers short-term loans at the point of purchase, with either little or no fees or interest. This is usually done by way of either credit, which is repaid over a period of time, or invoicing payments, which sees consumers making repayments in instalments (usually 3 or 4). The main source of BNPL firms’ revenue is via merchant fees, which can be between 3 and 6% of the purchase price.

A driver for change

BNPL firms have significantly changed the payments landscape in recent years, especially during the pandemic, due to their ability to meet the growing needs of customers by offering a digital experience with interest-free instalments. Research has shown that the Gen Z demographic has shied away from high-interest credit cards, leaving a space for the BNPL industry to enter the market. BNPL firms also help merchants by increasing revenue, enhancing customer loyalty, and increasing their customer base. Online conversion rates are often the highest, and shopping baskets higher in value, where BNPL is used in the transaction[1].

UK BNPL lending during 2020 was estimated at £2.7bn, which means that the BNPL market was by then already larger than the UK payday loan sector was at its prime in 2013[2]. It has even been estimated that the global BNPL industry will grow to USD $900 billion by 2026[3].

However, this model, like any other platform model, has both its challenges and risks.

Current position: very limited regulatory oversight

As in many areas of law, regulation can often take time to catch up with real world developments. This is especially so in the ever-changing FinTech space. Currently, only certain BNPL products are regulated by the FCA under consumer credit regulation, with many BNPL credit agreements relying on the exemption found in Article 60F(2) of the Regulated Activities Order (RAO) which provides that certain BNPL arrangements are exempt from regulation “because they are interest and charge free, and are repayable in no more than a year through 12 or fewer instalments”[4]. It is important to note that, in many (but not all) cases, the lack of interest and charges made by the BNPL firm is true unless and until a customer misses a payment.

This exemption has enabled a multitude of players to enter a market which has little to no FCA oversight.

Where credit is classified as unregulated, lenders do not need to: (i) perform credit checks or share data with credit bureaus; (ii) provide pre-contractual information disclosures; (iii) comply with advertising rules on financial promotions; or (iv) assess whether the applicant can afford the credit (unlike where the credit is regulated). Furthermore, consumers are unable to claim redress or make complaints to the financial services ombudsman. The benefit of this to merchants and BNPL firms is clear but potentially damaging to the more vulnerable members of society.

Whilst one BNPL provider sought to support the service by stating: “there is clearly a greater risk of consumer harm from spending on credit cards”[5], it is important to note that, in 2021 in the UK, 19.5% of active credit cards had BNPL transactions charged to them[6] and there are further concerns where bank overdrafts and borrowing from friends and family are used to make repayments. The concerns with BNPL therefore centre around: (i) consumers’ ability to pay for BNPL instalments where such instalments are charged to a credit card; this is because, whilst there is a headline BNPL interest rate of 0%, the reality is that the instalments charged to the credit card, where not paid monthly, will attract credit card rates of interest (which can be circa 20%); and (ii) the lack of consumer protection; an example being the possibility for ‘stacking’ – where a consumer uses multiple BNPL providers, none of which carry out in-depth credit checks, which allows a credit spiral causing the consumer to get into unmanageable debt.

Future regulation of BNPL?

The current economic climate of a cost-of-living crisis, rising inflation and interest rates and talk of wider recessionary pressures, has the potential to create an environment that makes BNPL more attractive to consumers. For this reason, in September 2020, the FCA’s Board commissioned a review of the unsecured credit market and the extent to which further regulation may be required. The result was the Woolard Review, which found that there was an urgent need to regulate all BNPL products[7].

Most recently, on 20 June this year, the government set out its plans for the strengthening of regulation of interest-free BNPL products and other forms of unsecured short-term interest-free credit when they are provided by third-party lenders, which pose similar risks to consumers[8]. Significantly, the plans outline that those providers which offer BNPL products will:

1. be required to carry out credit checks to ensure that loans are affordable for consumers;
2. need to ensure that any BNPL advertisements are fair, clear and not misleading;
3. need to be approved by the FCA; and
4. consumers will also be able to take a complaint to the Financial Ombudsman Service.

The government will allow exemptions for specific agreements where there is limited risk of potential consumer detriment, and where regulation would otherwise adversely impact day-to-day business activities.

The government has assessed that it will need to publish and consult on draft legislation to ensure that it is achieving the policy objectives intended. Following this, the government will proceed to lay the final legislation, the draft of which is expected to be published around the end of the year. Following full consultation, the government aims to lay secondary legislation in mid-2023 which will confirm the scope and framework of the new regulatory regime[9].

Whilst the lack of any concrete regulation to date has allowed the BNPL industry to flourish, there will inevitably be a transitional period and BNPL firms will therefore soon become acutely acutely aware of the complexities which arise from being in a market governed by multiple different regulatory regimes and ways of working.

Action for BNPL firms to take now

Despite this lack of immediate regulation, BNPL firms should use this time to acclimatise to the impending regulatory requirements which will be imposed upon them. Furthermore, all BNPL firms should be aware that there are existing obligations on them to comply with consumer protection legislation, which includes the Consumer Rights Act 2015 (CRA) for contracts entered into from 1 October 2015 and the Unfair Terms in Consumer Contracts Regulations 1999 for contracts entered into between 1 July 1995 and 30 September 2015.

The FCA has powers to enforce the consumer protection legislation and it has been proactive in doing so, with certain BNPL providers agreeing to change the terms in their consumer contracts to make them fairer and easier for consumers to understand.

In preparation for more stringent regulation, BNPL firms should be reviewing their consumer contracts against the requirements of the consumer protection legislation to ensure that the spirit of fairness is reflected.

For example, the CRA imposes the following requirements:

1. contract terms must be fair (taking into account the nature of the subject matter and contract and by reference to all the circumstances existing when the term was agreed (Section 62 CRA):
   1. the CRA provides a list of consumer contract terms which may be regarded as unfair (although, ultimately, only a court can determine this);
   2. where consumers exercise their right to cancel an online sales contract, the related loan agreement is terminated in accordance with regulation 38(1) of the Consumer Contracts (Information, Cancellation and Additional Charges) Regulations 2013; and
   3. BNPL firms must therefore ensure that:
      1. any terms setting out what happens if a consumer cancels the contract for purchases funded by the BNPL loan are fair and clear, so consumers should not be required to continue paying instalments or be charged late payment fees for not paying instalments after the loan agreement has been terminated. Where a retailer has delayed in informing the BNPL firm of a cancelled agreement, the terms should provide when and how a refund of any monies taken will be effected; and
      2. any right of set-off terms do not prevent the consumer from being able to offset money which may be owed to them by the BNPL firm against instalments. 
2. contract terms must be transparent (expressed in plain and intelligible language (Section 68 CRA)):
   1. to the extent that any charges are imposed for late payments, this should be made clear to the consumer in the BNPL firm’s terms; and
   2. any continuous payment authority terms (where a consumer gives card details and consents to the BNPL firm taking money from their account) should be transparent. Accordingly, when drafting these terms, BNPL firms should make it clear how consumers may cancel this authority and detail how this will affect any outstanding payments which will become due. 

International platform but localised regulatory approach

Starting a business in FinTech has challenges, not least for BNPL firms with the range of local rules and the changes expected in them. Consequently, such cross-border complexities present a significant challenge to the BNPL players, but the market has the potential to create huge opportunities. BNPL firms should be looking at the opportunities to scale their businesses globally while at the same time ensuring a localised regulatory approach.

Contact Nick Purnell (Partner) or Georgia Harris (Associate) for further advice.