Who is this blog for?
Senior executives in Line 1, risk and compliance teams of firms in or intending to enter the Buy Now Pay Later (BNPL) market.
On 14 February 2023, HM Treasury (HMT) released its draft legislation on Buy-Now-Pay-Later (BNPL), bringing this market one step closer to coming into the FCA’s regulatory perimeter.
At a glance
- HMT has published draft legislation to bring BNPL into the regulatory perimeter. The timeline for legislation to be laid before Parliament is uncertain and the FCA will still need to consult on detailed rules for this market. Rules are unlikely to be finalised until well into 2024.
- All BNPL agreements where credit is provided by third‑party lenders will be subject to the new regime with some exceptions such as those in relation to insurance premium finance. Merchant‑provided credit will remain outside the scope of the regime.
- Key proposals include: all advertising and promotions of BNPL agreements will be subject to the financial promotions regime and lenders will be subject to FCA tailored rules on creditworthiness assessments and reporting to credit rating agencies.
- Firms in the BNPL market should consider carrying out a detailed impact assessment of the proposals on their business models to help them decide their next steps. The new regime is likely to affect customer behaviour, levels of friction and ease of access to products, operational and compliance costs and regulatory risks.
Context: Buying now, but who ‘pays’ later?
On 14 February 2023, HMT released its draft legislation on Buy-Now-Pay-Later , bringing this market one step closer to coming into the FCA’s regulatory perimeter. The draft legislation follows on from HMT’s October 2021 consultation in response to previous concerns about the potential consumer harm from BNPL products, outlined in the Woolard Review. The timing for passing legislation is still uncertain, with HMT expressing an ambition to do so before the end of 2023. This blog explores the proposed regulatory scope and measures in the draft legislation and the potential business impact to BNPL providers. For more insight into the BNPL market and the customer harms that the new regulations try to mitigate read our previous blog “Buying now, but who ‘pays’ later?”.
What is BNPL?
BNPL offers shoppers the choice to pay for their goods in a series of instalments without being charged interest. Retailers offering these products benefit through an increase in sales from customers that would perhaps hesitate to purchase the goods if they had to do so outright, and firms offering BNPL are able to profit from a percentage of the sales they facilitate. For customers, BNPL has a number of benefits too. It can be an easy way to access credit and it is more cost effective than other available regulated credit options, being interest free.
While traditionally BNPL was associated with online fashion retailers, there are now firms offering this option for essentials such as grocery shopping, car repairs, homeware, and household electricals. There are also now Eat-Now-Pay-Later options that allow customers to order takeaways without paying the cost of the meal upfront. New data from the Centre for Financial Capability has shown that demand for BNPL has increased across all age groups.
What is the proposed scope of the new regulations?
HMT is proposing to regulate BNPL agreements (those that are interest free and under 12 months duration) where credit is provided by a third-party lender. The FCA will need to draft and tailor rules to ensure a proportionate application to these agreements but it is uncertain how far the FCA will go to tailor its approach to regulating the BNPL market. Merchant‑provided credit will remain outside the regulatory perimeter along with a few other exemptions including financing of insurance premiums by a third party.
Key HMT proposals
- All advertising and promotions of BNPL agreements will be subject to the financial promotions regime. Although many of these promotions already fall under the regime, it will bring unauthorised merchants into its remit, requiring them to have their promotions authorised. HMT does not anticipate that merchants will have each of their financial promotions individually approved by an authorised person. Instead, HMT’s view is that third-party lender partners will provide pre-approved materials to merchants as part of their overarching commercial arrangements with the merchant.
- The FCA will be tasked to tailor its rules on creditworthiness assessments to apply to BNPL in a proportionate manner. However, it is uncertain how the FCA will approach the task of tailoring rules for this market. In our view, even a tailored approach is likely to have a significant impact on business volumes and operational costs for firms due to the cliff effect of moving from no regulation to regulation and friction in the transactions.
- The CCA requirements relating to the treatment of customers in financial difficulty will apply to BNPL. Regulated firms are required to treat their customers fairly and with forbearance taking into consideration the individual circumstances of each borrower – this is also likely to increase the costs of supporting BNPL customers under the new regime.
- BNPL lenders will be required to undertake clear, consistent and timely credit reporting of BNPL contracts. This could act as a deterrent to customers taking out credit, since failing to meet payments can have long-term consequences for them.
- BNPL customers will have the right to make complaints to the Financial Ombudsman Service (FOS).
- Regulation and the required FCA authorisation are expected to bring BNPL into the scope of the Consumer Duty. This means BNPL lenders will need to consider how they will demonstrate that they are delivering good outcomes for their customers on an ongoing basis.
What does it mean for business models?
The regulation of BNPL will have an impact - both financial and operational - on firms’ business models. Firms will need to factor this impact into their decision making. Some firms will choose to seek authorisation under the new regime, whereas others may decide to withdraw. For those seeking authorisation it will be key to have a robust plan of action to ensure compliance with applicable rules and regulations. Below we describe some factors for firms to take into consideration when assessing the impact of moving into the regulated perimeter.
BNPL firms’ profitability is heavily dependent on merchant fees. Whereas customer journeys can currently be designed to drive sales, without consideration of whether a customer can afford the BNPL loan, in future firms will be required to undertake affordability checks. With the potential for more customers being declined, BNPL profitability may reduce as a result. In addition, with a potentially more rigorous application process to obtain BNPL and the risk of default damaging credit scores, fewer customers may choose this option. These forces in combination might drive BNPL lenders to change their pricing to remain profitable.
The right for customers to complain to the FOS may also lead to an increase in costs to firms. Firms will need to consider costs such as the FOS case fee, potential redress associated with complaints, and training and resource required for complaints‑handling activity.
Operationally, firms may need to upscale their resources which will lead to higher costs, as they develop new processes and train their staff to facilitate the transition into the new regime, as well as the new regulated environment. Firms may need to pay particular attention to the resourcing of their compliance teams. Firms will also need to consider how they will undertake due diligence on any merchants they partner with.
As the regulatory spotlight turns to this sector, firms in scope should focus on how they deliver good outcomes to their customers and how they evidence this as we expect BNPL firms to be subject to the Consumer Duty rules and guidance.
Transition: Temporary Permissions Regime (TPR)
To allow firms to transfer into the new regime and seek full FCA authorisation, HMT is proposing the introduction of a TPR. However, there are no significant details around the timings for this process yet.
For firms already providing credit that will be brought into scope, the TPR will allow them to continue operating whilst they apply for full permission. Firms wanting to undertake the newly regulated agreements will need to register for the TPR within a set window, providing the required information and paying a non-refundable registration fee. Firms in the TPR will be deemed authorised under part 4A of FSMA by the FCA and will need to comply with the relevant FCA rules.
The regulation will not be applied retrospectively. Firms that do not enter the TPR will be able to service agreements that were entered into prior to regulation day.
The consultation is open until 11 April 2023, following which HMT will publish its consultation response and draft legislation. HMT will then lay legislation when Parliamentary time allows, “with the ambition” that this will be during 2023. The FCA will publish a consultation on its proposed conduct rules, as well as rules for firms operating on a temporary permission, once HMT has published its consultation response.
Firms should consider responding to the consultation but also prepare to engage with the FCA when it publishes its detailed consultation. The FCA will be looking to tailor and apply the rules in a manner that mitigates the potential customer harms resulting from BNPL. It will be key for firms to engage fully with this discussion to ensure the regime results in a well calibrated set of rules that allow customers access to cost effective credit without incurring in material harm.