On 14th February 2023, HM Treasury (“HMT”) opened a consultation on the government’s draft legislation to regulate certain types of currently exempt interest-free “Buy-Now Pay-Later” (“BNPL”) products. This follows an initial announcement in February 2021 of the intention to regulate, and the first consultation launched in October 2021, to gather stakeholder views on a proportionate regulatory approach.
The government’s proposed legislation will bring these products under the regulatory regime of the Financial Conduct Authority (“FCA”). It has been drafted partly in response to the Woolard review, which highlighted a need for urgent regulation of the burgeoning BNPL market to protect against consumer harm and unaffordable credit.
This latest consultation is open for responses until 11 April 2023.
12-payments-or-fewer exemption and anti-avoidance measures
This particular set of proposals represent the most substantive intended change and is the government’s means of bringing many BNPL providers into the scope of regulation.
Currently, many BNPL products take advantage of the statutory exemption relating to borrowers agreeing to make interest-free repayments within 12 months and in not more than 12 payments (Article 60F(2) The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the “RAO”)).
Under the proposed legislation, the scope of this ‘12-payments-or-fewer’ exemption is to be narrowed so that Borrower-Lender-Supplier products (such as BNPL propositions) offered by third party lenders (i.e. a lender who is not also the merchant) will be brought into the FCA’s regulatory scope.
In its June 2022 consultation response, the government set out concerns about BNPL lenders skirting regulation by structuring agreements in a way that they became the merchant themselves (i.e. purchasing the goods to be financed) prior to offering them on credit terms to the customer. This draft legislation therefore contains anti-avoidance measures to specifically prevent this type of arrangement being used to avoid regulation, and to try to make it clearer for customers what is, and what is not, a regulated product.
The government has recognised the potentially broad impact this change to the exemption will have, and the possibility of this inadvertently bringing in propositions it views as low risk to the regulatory perimeter. Based on this, the proposals also include new carve-outs for certain structures, including genuine ‘merchant as lender’ propositions, credit falling within the ‘business purposes’ exemption and insurance policy financing propositions. It also remains the case that trade credit to non-relevant recipients should remain outside the scope of regulation.
Given the complexities of the proposals, and the manner in which the carve-outs interact with each other, current providers in the market using the exemption under Article 60F(2) RAO should consider how the proposed changes to the perimeter will affect the status of their product going forward, and whether they may need to seek FCA authorisation in the future.
Changes to the financial promotions rules
In response to concerns around the lack of balance in advertising of BNPL products, the FCA has recently warned firms (whether FCA-authorised or not) that even though BNPL agreements are currently largely exempt from regulation, financial promotions in relation to these must nevertheless comply with regulatory requirements. Furthermore, current proposals in the draft legislation will create a specific statutory provision applying the regime to the activities of merchants making BNPL available as a potential payment option.
These proposed change to the financial promotion rules may present additional operational difficulties for merchants and the lenders they partner with, as unauthorised merchants will need to have financial promotions in relation to BNPL approved by an FCA authorised firm. The government is expecting that third-party lender partners will provide pre-approved materials to merchants as part of the arrangements between the parties, rather than merchants producing their own materials for sign-off. Whether or not lenders will be willing to accept such a burden, which will likely necessitate overseeing compliance with the provided materials, remains to be tested.
Therefore, a key question to be considering is whether the controls on marketing will seriously impact the way that BNPL offerings are promoted to customers, and lenders will very likely need to review their marketing processes to ensure both they and their contracted merchants remain within the scope of the regime.
Temporary Permission Regime and regulatory controls
In acknowledgement of the need for a transition period allowing firms sufficient time to make the required changes to their business models ahead of ‘regulation day’, the government proposes to put in place a Temporary Permission Regime (“TPR”) which will allow firms to continue to operate whilst they undergo the FCA authorisation process. The government has also confirmed that it will extend regulatory controls outside of the draft legislation, for example by expanding the jurisdiction of the Financial Ombudsman Service to cover these newly regulated BNLP products.
Outstanding points
A number of key elements remain unresolved. These include:
- How will the FCA's current rules on creditworthiness assessments be applied to BNPL products? The government has indicated some proportionate tailoring of these may be appropriate, but the FCA is yet to state its view.
- Whether changes are needed to the credit agreement form and content rules to apply these in a proportionate manner? The government has indicated the current rules will apply in full, but has invited comments on this.
- How the FCA will operate the proposed ‘temporary permissions regime’ for those entities that do need to become authorised? With the current delays with FCA applications, how the FCA deals with the burden of operating another registration regime will be a point of interest; and
- How the wider reforms to the Consumer Credit Act 1974, and the arrears elements in particular, will affect any newly authorised lenders going forward?
With a number of issues in need of resolution, it is likely that market participants will see some fluctuation in the proposed regime in the coming months.
Wider changes
In addition to the changes to BNPL regulation, the market for embedded finance providers is likely to be affected by the FCA’s incoming Consumer Duty regime. The FCA has recently issued a number of industry specific letters highlighting how the Consumer Duty regime may apply to various types of firm, with the letters being directed at mainstream lenders and payment service providers being of particular interest to participants in the embedded finance industry.
Whilst the letters do not contain any significant changes to the scope or understanding of the Consumer Duty regime, they do emphasise the importance the FCA is putting on these rules for consumer-facing providers and give insight into the types of area the firms should have regard to. Particular interesting FCA comments include:
- that even for firms that distribute their products purely online (as many BNPL providers do), having an online journey as the sole means for customers to contact the firm to resolve difficulties may not be sufficient; and
- having clarity in customer communications around fees and the split of responsibilities between entities within the transaction chain (e.g. between merchant and lender) is of significant importance.
BNPL providers should therefore be aware of these requirements when assessing how the proposal to bring them into the FCA’s remit may affect them more widely.
Our view
We are expecting to see significant changes to the market in the coming year and whilst these proposals may cause challenges for existing providers, there remains opportunities for both consumer solutions and trade credit offerings.
At the conclusion of the consultation period, the government will consider responses with a view to amending the draft legislation where required. Providers should follow these changes closely to see how the landscape develops further. The consultation response will provide an anticipated timeline for regulation, but the stated ambition is for legislation to be laid before Parliament during the course of this year.
CMS has leading specialists working within the consumer credit and embedded finance sectors on all aspects of law and regulation. Please get in touch if you have any questions or require further guidance on any of these proposals.
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