BNPL regulation

Author: Professor Brian Scott-Quinn.

Yes its unsecured credit but no, it's not regulated. But surely if it walks like a duck and quacks like a duck, it is a duck i.e. Credit. So what are we talking about and why now? Well of course it's Buy Now Pay Later (BNPL) credit. Klarna is the market leader but many other firms can provide such credit and it can now be integrated with a bank or other card issuer's debit card. It is currently unregulated but by 2026 it will come under similar regulation to other types of credit. It will give customers more protection and will, of course, have an impact on providers of such services. Even with regulation it will remain a large, and potentially worthwhile, market to be in. Customers of retailers, whether at the 'cash' desk of a physical retailer or on-line, increasingly expect to find an ability to accept their BNPL provider. But those providing BNPL services may have to consider upgrading the platform they use for this consumer financial service offering.

Unfortunately, BNPL has been promoted as a 'lifestyle choice' with users seldom giving enough thought to the fact that, like any other credit product, they are building up debt. And while BNPL lending is not registered on the files of a credit reference reporting agency such as Experian and therefore does not affect credit scores, this is only at the time the credit is taken out. If the customer defaults, the default will be reported.

There will be customers who use their credit cards to enable BNPL repayments. Others will use BNPL for everyday food shopping. Some will have multiple BNPL accounts. So it is not difficult for such customers to find that using 0% interest credit ends up costing a substantial amount in late payment fees, interest costs beyond a certain period of 0% and a black mark with credit referencing agencies.

The reason why this state of affairs exists is that BNPL lending has an exemption under Art. 60F(2) of the FSMA (Regulated Activities) Order 2001 (the "RAO"), provided:

1.       the agreements are borrower-lender-supplier agreements for fixed-sum credit;
2.       the number of payments made by borrowers is fewer that 12;
3.       those payments are made within a period of 12 months or less; and
4.       the credit is provided without interest or other charges.
   
   

As a result of this exemption BNPL providers in the UK are generally not regulated by the FCA, falling as they do within this RAO exemption. Despite this exemption, BNPL certainly passes the duck test as "a provision of credit". In our view it should have fallen under the Consumer Credit Act since such loans first started to be offered.

Despite that, the FCA already has the power to review the terms and conditions of consumer contracts for fairness and may act proactively to ensure that BNPL firms adopt high standards in their terms and conditions. However, they clearly had some misgivings about this lenient approach.

Concerns of the Treasury as well as the FCA included:

• Issues relating to how the product is promoted to consumers and presented as a payment option (rather than a credit option);
• Misunderstanding of the product by consumers, including the absence of information given to consumers about the features of the agreement;
• The absence of any requirements to undertake affordability and creditworthiness assessments;
• The potential to create high levels of indebtedness;
• Inconsistency of treatment of customers in financial difficulty; and
• Impacts on the wider credit market including little visibility of BNPL debts on an individual's credit file
  
  

In consequence of these concerns, in September 2020 the FCA Board asked Christopher Woolard to review this type of unsecured credit market and to report to them in early 2021. Woolard is a former board member of FCA and was the interim CEO until he took up a position with EY. His review was published in 2021.

The Woolard Review concluded that the FCA should have the power to regulate BNPL firms. In October 2024, the FCA issued a consultation document responding to feedback HM Treasury received to its previous consultation that ran between February and April 2023.The latest consultation covers the proposed new rules with a view to final legislation being laid before Parliament in "early 2025".As we're now racing through March, perhaps that will be "first half of 2025" realistically. Once the legislation is laid, the FCA will then finalise the rules so they can take effect in 2026. Not a fast process as it has been ongoing since 2020 but hopefully one which will protect customers but without damaging firms operating in this market.

The new rules will mean that:

• BNPL firms will need to be authorised by the FCA.
• Consumers will have access to clear information about BNPL agreements.
• Consumers will have key statutory rights and other protections.
• Consumers will be able to complain to the Financial Ombudsman Service.
  
  

The new name for BNPL will be 'a regulated deferred payment credit agreement'. The scope for this new form of regulated agreement will be limited to deferred payment credit (DPC) agreements offered by third party lenders and thus retailers who provide such credit will still be exempted.

Section 75 of the Consumer Credit Act 1974 protects consumers who use credit cards to buy goods and services that cost between £100 and £30,000. It gives consumers the right to claim money back from their credit provider if the supplier doesn't deliver as promised or breaches the contract. So at present, as BNPL is not defined as 'credit', there is no such right. Clearly, to the extent that this leads to customer re-imbursements, it will impose additional costs on BNPL providers as will other aspects of the new legislation.

It may therefore be necessary for some providers to make changes to their business model not just in respect of now being at risk of having to refund monies but also, and very importantly, their need now to assess 'affordability' before providing credit. Those who lend in breach of affordability criteria, may find that re-imbursing customers to whom they should not have lent in the first place may become a drag on profitability as well as the view taken by the FCA, of the firm.

Firms will need to have effective compliance functions in place in regard to matters such as financial promotions and unfair contract terms. There is, therefore, likely to be additional scrutiny in any authorisation process on how firms will try to ensure good outcomes for their customers and thereby comply with their Consumer Duty.

For firms in, or considering setting up in, the BNPL business a key requirement will be to ensure that the platform used to run their business can deliver the necessary compliance tools. Equally important as costs of running a BNPL business increase, will be the maximum degree of automation help keep down the cost of employing people to undertake the new workload.

Compliance

There are firms, like Madiston, that offer platforms that are designed to ensure that BNPL compliance tools are 'fit for purpose' and also minimise the need for human input and hence cost. Compliance can be achieved through 'smart' integration. Madiston uses profiles to determine what route for the customer journey is appropriate for the particular type of user. User profiles could be multiple variations of retailer, merchant or consumer. Depending on the profile of the user, different settings can then determine the journey route. This gives great flexibility to the BNPL provider and, importantly, enables compliance in operations.

With the new regulations on consumers coming in next year, requirements to undertake affordability and creditworthiness assessments mean that such checks are critical as well as ensuring that information given to consumers about the features of the agreement are available and must be read by them before proceeding further on their journey. Beyond this, providing automated reminders, triggered at the right time and providing consumers with meaningful information about their levels of commitment before, during and post-transaction will all be important from a consumer-protection compliance perspective.

In-built automated payment processing

A key decision for those choosing which BNPL system to employ is whether it offers automated payment processing. From our experience, payment processing is almost always thought of as a mandatory bought-in service from a specialist company. If bought in, this will dilute margins by giving away more funds to external providers. Alternatively, you could use a system that will enable you to do payment processing in-house such as is built-in to the Madiston platform.

With the great strides in Open Banking, direct Account to Account (A2A) payments are becoming more prevalent but, even using the old banking systems, automated compliant payments processing is available, with no added cost per transaction. A technology solution which includes automated, secure faster payments or A2A payments within their system to save the cost of an external provider is a critical need.

Automate the full BNPL lifecycle

Back-office processing is often neglected relative to the front office. But it is here that you will be able to reduce your costs and increase your reliability and hence achieve higher profits (or maintain existing profit margins). The back-office function can be costly unless your system works as an integral part of the team, carrying more than its share of the workload.

By automating as many processes as practical, not only do you ensure a consistent fair approach for all customers, but the software can carry the heavy load of managing the many, many variables that occur beyond the point of purchase. This means fewer people and thus less cost required to manage customer accounts.

Repayment reminders, allocation of payments and repayments, failed and penalty payments, interest and fee calculations, reconciliations, changes in instalment plans, incentives, notices of sums in arrears, debt recovery and more, can all be automated reducing the need for an army of operations staff. Showing regulators that all these processes are in place and reliably executed, will be the key to your organisation's future safe growth.

Corporate and regulatory reporting

Automated systems will provide evidence to regulators that processes are robust, controls are in place and reporting structures are quick and transparent. Audit trails and banking-level security such as dual approvals are all available on the Madiston platform.

Your management will want to monitor and measure the business coming through from each retailer or sponsor. The technology you select needs to be capable of analysing these partners as you wish them to be assessed – slicing and dicing the data as you need it presented. Having flexibility in your reporting capability, will enable you to provide proof to the regulators, and gather meaningful information for your management teams. All parties involved, including consumers and retailers, will also be looking for transaction data from their perspective. Providing detailed digital dashboards for everyone, must be part of any good system.

Conclusion

The new regulations relating to BNPL are based on regulation already present in other forms of credit - so fast, robust systems with POS BNPL technology running on the tracks of credit processing systems with in-built regulatory compliance will ensure that you are prepared for next year's new regulations. If you are considering adding Buy Now Pay Later to your existing services, or launching as a new provider, then talk to us. The Madiston Platform should be on your short list for BNPL technology.