Buy Now Pay Later: Preparing For Regulation 

At a glance:

  • The Woolard Review on change and innovation in the unsecured consumer credit market (the review) has identified potential consumer harms in relation to unregulated Buy Now Pay Later (“BNPL”) products. In response, the Government has agreed to “take swift action” to bring them within the regulatory perimeter.  
  • Meeting the requirements of regulation is likely to be time and resource intensive, particularly for BNPL providers not already subject to FCA authorisation.
  • Firms should lose no time in preparing. Initial efforts need to focus on reviewing business plans and customer journeys against the FCA’s longstanding expectations regarding customer outcomes and the fair treatment of customers (including vulnerable customers and those in arrears), responsible lending, and the fairness of fees and charges. Firms should also start to put in place robust policies and processes to:
  • perform adequate creditworthiness assessments; and
  • ensure appropriate oversight of retail partners.

The growing popularity of BNPL

There has been significant growth in the unregulated BNPL market over the past few years. Though it amounts to just 1% of the total credit market, the value of transactions using BNPL almost quadrupled between January and December 2020 and is now at £2.7 billion, with 5 million people using these products since the beginning of the COVID-19 pandemic.

The review acknowledges that there are benefits to BNPL products. If repaid on time, BNPL products are cheaper than most other forms of credit and are a useful alternative to high cost borrowing for those who struggle to access mainstream credit. Nevertheless, it identifies significant potential consumer harms including:

  • A lack of consumer understanding: some consumers do not view BNPL products as credit (more closely associating them with payment technologies) or wrongly believe the product is regulated and comes with associated protections, including the ability to refer complaints to the Financial Ombudsman Service.
  • Business models: providers market themselves to retailers on the basis that consumers spend more when they use BNPL offers than they would paying by traditional methods. This may result in the customer journey being designed to drive sales, rather than good outcomes for consumers. Late payment charges can make up a significant proportion of some firms’ revenue.
  • Presentation of BNPL: BNPL may exploit behavioural biases, encouraging consumers to make impulsive decisions about taking out credit. BNPL is sometimes presented as the default payment method online and details of providers’ approaches to payments and defaults are often not clear, harming consumers’ ability to compare products.
  • Creditworthiness and indebtedness: most BNPL providers complete only a very basic credit assessment, usually through a combination of soft credit searches and previous repayment history. BNPL firms are not required to report payment history to Credit Reference Agencies (CRAs) and customers can get access to multiple BNPL offers, leading to concerns about increased consumer indebtedness.

Government response

In a letter to Christopher Woolard, John Glen MP, the Economic Secretary to the Treasury, agreed that “without intervention, this market could develop in a way that is not in the best interests of consumers or the wider credit sector”. Accordingly, the Government plans to “take swift action to bring these products into regulation before potential detriment is able to occur”.

The HM Treasury (HMT) is keen to provide adequate protection for consumers without damaging the overall utility of BNPL products and so is working with the FCA to assess the best options, on which a formal consultation will be launched, to achieve a balanced and proportionate approach to regulation.

Whilst a consultation may take a number of months, firms should be under no illusion as to the urgency with which HMT and the FCA intend to act. Furthermore, though the regulation is intended to be proportionate, meeting even basic requirements is likely to be time and resource intensive, particularly for firms not already authorised by the FCA. Firms will also need time to think through the implications of regulation on their customer journey to ensure they can meet their regulatory obligations whilst continuing to deliver a smooth customer experience.

Key steps firms need to take

In our view, firms should lose no time in preparing for the new regulation; we set out below some the key steps they can begin to take:

Review their business model and strategy

The assessment of firms’ business models is core to the FCA’s supervisory approach, and firms can expect it to scrutinise closely any apparent misalignment between profit incentives and the interests of consumers and the outcomes they are experiencing. In particular, we expect the FCA to be alert to the risk of harm in business models that prioritise commercial relationships and product sales over the treatment of customers or those where late payment fees account for a significant proportion of revenue.

Firms should review their business models to identify and address any drivers of customer harm, bearing in mind that the FCA’s supervisory strategy for firms will ultimately be informed by its understanding of the risks inherent in their business model.

Understand regulatory expectations regarding the treatment of customers

The FCA has set clear expectations regarding the outcomes it expects firms to achieve to ensure the fair treatment of customers. Understanding these expectations will help firms get on the front foot with regulation by allowing them to identify and rectify issues ahead of time.

The findings of the review indicate various potential concerns around the treatment of customers, from the initial presentation of the product on retailers’ websites through to the treatment of customers in arrears. Firms should conduct an end-to-end review of the customer journey and sales process against FCA’s expectations, paying particular attention to its desire to see an environment in which sales, disclosure and marketing help consumers to make good decisions, customers are offered good value products they can afford and are protected from harms including over-indebtedness.

Address the needs of vulnerable customers

The FCA attaches significant priority to the identification and fair treatment of vulnerable customers and expects firms to ensure that they receive outcomes as good as other customers. Firms should revisit their product design, customer service propositions and communications to ensure that they are able to identify and respond to the needs of vulnerable customers.

Given the economic conditions created by COVID-19, firms should be particularly alert to the risk of financial difficulty amongst consumers and ensure they have appropriate policies and procedures in place to deal with customers in arrears. This should include providing clear information about the help available and ensuring customers can access adequate support through what is a predominantly digital journey.

Establish proportionate creditworthiness assessments

One of the FCA’s current priorities is to ensure that consumers do not become over indebted. BNPL providers should begin to establish and implement clear and effective procedures to assess consumers’ creditworthiness, bearing in mind that this must assess affordability risk for the borrower, as well as credit risk to the firm.

The FCA has previously preferred not to take a prescriptive approach to creditworthiness and firms will face challenges in deciding what amounts to a reasonable and proportionate assessment. However, based on its expectations of the wider consumer credit sector, the FCA will expect firms to consider factors including the amount of the credit, its costs, the number and amount of repayments, and the potential adverse consequences of non-payment, including default charges.

Get access to credit information

The effectiveness of creditworthiness assessments depends on the availability of good quality credit information. The review recommends that once BNPL firms have been brought into regulation, the FCA should look at how credit information works in the sector. In the interim, firms should review the data-sharing arrangements they have in place with CRAs, if any, to gain access to credit information, particularly given the FCA’s concern that they do not have visibility of missed payments with other providers or consumers’ wider financial circumstances.

Put in place systems and controls to oversee retailers

Once exempt BNPL products are brought within the regulatory perimeter, retailers will need to be authorised as credit brokers. Some retailers, including those already offering consumer credit, will be directly authorised. However, the review states that the regime  needs to offer proportionate options, particularly for smaller retailers. One such option would be to become authorised representatives (ARs) of the BNPL provider.

Where retailers act as their ARs, BNPL providers would have responsibility for ensuring compliance with the relevant rules. Given that some BNPL providers have relationships with thousands of retailers, ensuring adequate oversight is likely to be a considerable undertaking and so they will need, urgently and comprehensively, to review the systems, controls and monitoring that must be put in place.