BNPL Government sets out next steps

On 14 February 2023, HM Treasury published a consultation paper on the regulation of buy-now-pay-later (BNPL) products, together with implementing legislation in the form of a draft version of the Financial Services and Markets Act 2000 (Regulated Activities etc) (Amendment) Order 2023. This follows a June 2022 paper in which the Government set out a number of proposed changes to the regime (see our briefing here). The reform of BNPL regulation takes place the backdrop of a wider review of the UK consumer credit regime that was launched as part of the so-called Edinburgh Reforms (see our briefings here and here).

This consultation paper contains the Government's response to feedback received following the June 2022 paper. The Government's plan to bring BNPL within the scope of regulation has the following key features:

• the new regime will largely capture third party lending: merchants would be exempt from regulated lending in connection with agreements financing the goods and services they supply;
• merchants would be exempt from regulated credit broking where they offer newly regulated agreements provided by third party lenders as a payment option, but advertising and promotions of such agreements would fall within the financial promotions regime;
• certain existing regulatory exemptions will continue to be available (including business-to-business lending and transactions that do not involve a third-party lender);
•  existing requirements of the Consumer Credit Act 1974 (CCA) will be disapplied in respect of pre-contract disclosures (and replaced with FCA rules), but will continue to apply in respect of the contents of BNPL credit agreements;
• FOS jurisdiction would be expanded to cover newly regulated agreements; and
• the FCA will operate a temporary permissions regime for firms to transfer into the new regime before obtaining permission under Part 4A of the Financial Services and Markets Act 2000 (FSMA).

Our briefing below provides an extensive summary of the changes proposed in the Government's consultation. This is an area that has been rumbling for some time and is clearly one of the Government's focus areas. However many BNPL credit providers have already changed their business model and sought FCA authorisation to become a regulated lender, for those businesses these proposals will be more limited. Clearly there will be a significant impact on the market but firms are still looking to the wholesale reforms of the consumer credit market as the moment of the "big bang".

Background

The term "BNPL" refers to a type of interest-free instalment credit which allows borrowers to split the cost of purchases into regular repayments not exceeding a 12-month period. Such instalment lending is usually exempt from FCA regulation (and therefore the requirement to obtain FCA authorisation) under Article 60F(2) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO). The conditions set out in Article 60F(2) include:

• the agreement is a borrower-lender-supplier agreement for fixed-sum credit;
• the number of payments to be made by the borrower is not more than 12;
• those payments are required to be made within a period of 12 months or less; and
• the credit is provided without interest or other charge.

As a result of concerns raised in the Woolard Review (see our briefing here) and elsewhere in relation to BNPL, the Government announced its intentioring currently-exempt BNPL products into regulation in February 2021. It then launched a consultation in October 2021 followed by consultation response in June 2022.

In addition, there have been a number of FCA interventions in relation to BNPL products, including an August 2022 "Dear CEO" letter setting out concerns identified with BNPL financial promotions, as well as a June 2022 letter outlining expectations for BNPL firms in relation to providing their customers with appropriate care and support. In February 2022, the FCA used its powers under the Consumer Rights Act 2015 to direct four of the biggest BNPL lenders to make changes to potentially unfair and unclear terms in their contracts.

In the June 2022 consultation response, the Government distinguished between different types of agreements falling within the Article 60F(2) exemption, referred to in the various papers as "A60F(2) agreements". A60F(2) agreements encompassed BNPL agreements, but also captured other kinds of interest free lending, including short-term interest free credit (STIFC), as well as day-to-day business activities (e.g. invoicing). The Government distinguished between BNPL and STIFC as follows:

• BNPL - usually taken out online with consumers often having an overarching relationship with a third-party lender, under which multiple low value agreements are made; and
• STIFC - frequently offered in-store, with consumers taking out a single, higher-value discrete agreement with the credit provider, who may be a third-party lender or the merchant itself.

It was originally proposed that the scope of regulation should capture both BNPL and STIFC agreements, where provided by a third party lender or directly by a merchant online. The Government was minded to exclude agreements between a merchant and customer who are physically present simultaneously. In its February 2023 consultation, the Government decided that the scope of regulation will be limited to agreements that are offered by third party lenders.

Accordingly, third party lenders offering A60F(2) agreements will – unless an exemption applies under the new regime – need to be authorised and regulated by the FCA. The Government's rationale for continuing to exclude agreements provided by merchants in-person or at a distance is twofold: first, it would be disproportionate to capture small, independent merchants whose primary business does not constitute financial services; second, consumer detriment arising from the use of A60F(2) agreements has only emerged since the development of BNPL products, where a third party lender "takes on on credit risk and provides a frictionless means of accessing credit across multiple merchants".

A60F(3) lending

In the June 2022 consultation response, the Government set out the possibility of introducing changes to article 60F(3) RAO (known as the "charge card exemption"). It was concerned that BNPL providers would adopt a running account model and use the article 60F(3) exemption to circumvent regulation. However, it acknowledged in its February 2023 paper that the utility of article 60F(3) as an avoidance measure would be limited, given the condition in article 60F(3)(c) that the full outstanding payment be cleared in a single repayment. Further, certain products with features of running account agreements, such as credit limits, may in reality constitute numerous fixed-sum A60F(2) agreements and, under the new regime, be regulated accordingly.
The Government's view is, therefore, that agreements exempt under article 60F(3) RAO should continue to be unregulated. This is because firms are not able to replicate the risks and detrimental effects of A60F(2) agreements under the article 60F(3) exemption.

Business-to-Business lending

The business lending exemption under article 60C of the RAO will continue to apply to newly regulated agreements. The exemption applies to lending for more than £25,000 and wholly or predominantly for business purposes.

Anti-avoidance

Given the Government's decision for the scope of regulation to cover A60F(2) agreements offered by a third party lender, BNPL lenders could seek to avoid regulation by becoming the merchant under the arrangement with the borrower.

The proposed framework includes an anti-avoidance mechanism through the introduction of new provisions in the RAO. This is to prevent BNPL lenders from structuring agreements such that the lender purchases the goods from the original supplier and effectively becomes the merchant in the transaction it is financing. Consumers are unlikely to be aware of the transaction between the merchant and the lender. As a result, if such arrangements were to remain unregulated, consumers could be unaware that they were using an unregulated product.

Regulatory exemptions

In the consultation response, the Government proposes maintaining or introducing certain regulatory exemptions which do not pose a substantive risk of consumer detriment.
Where a third party lender is not present, an express amendment to the RAO is not needed (as these arrangements will remain exempt under article 60F(2) RAO). Such arrangements include invoicing and trade credit, provided the other conditions for A60F(2) agreements are met.
Where a third party lender is present, the Government decided that certain arrangements should be exempt via express legislative provision. These include: agreements financing contracts of insurance; agreements offered by registered social landlords to tenants and leaseholders; and employer/employee lending. The draft amendments to the RAO set out the conditions for such exemptions to apply.

Credit broking

The Government considers that it would be disproportionate to bring merchants offering newly regulated agreements as payment options within the regulatory perimeter. The proposal is that a new article 36FB RAO would exclude merchants from carrying out regulated credit broking. Without such exclusion, the risk is that merchants would cease to offer interest-free credit products.
The exclusion will not cover domestic premises suppliers carrying on credit broking activities. These will instead be required to obtain full FCA authorisation, in line with current regulatory treatment of domestic premises suppliers. This approach takes into account the higher risk of pressure selling where suppliers are present in vulnerable customers' homes.

Advertising and promotions

The Government has proposed amending the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 to apply the financial promotion restriction to unauthorised merchants offering newly regulated agreements as a method of payment.

Merchants would be required to obtain approval for promotion of newly agreements from an authorised person (which could, but does not have to, be their lender partner). In practice, the Government feels that is likely that third party lender partners will provide pre-approved materials to merchants as part of the overarching commercial arrangements between the lender and the merchant.

Pre-contractual requirements

The Government is proposing to disapply pre-contractual requirements under section 55 CCA in relation to newly regulated agreements. This would include the requirements of the Consumer Credit (Disclosure of Information) Regulations 2010, which are made under section 55. The corresponding sanction of unenforceability without a court order, provided for in section 55(2) CCA, would also not be applicable. Instead, firms would be required to comply with FCA rules on pre-contractual disclosure of information and subject to FCA enforcement powers. The FCA is expected to consult on proposed rules.

In addition, the Government intends to disapply the Financial Services (Distance Marketing) Regulations 2004 (DMRs) for merchants. Currently, the DMRs do not apply to contracts made by authorised firms where those contracts constitute/are part of a regulated activity carried on by that firm. This means that, without amendment, the DMRs would apply to unauthorised merchants, resulting in disproportionate regulatory burdens on merchants and a discrepancy between the disclosure requirements imposed on the BNPL lenders (who would have to comply with FCA rules) and their merchant partners (who would have to comply with the DMRs).

Some mainstream lenders, which offer both regulated and unregulated credit products, currently treat their exempt A60F(2) agreements as regulated credit agreements in order to simplify internal systems and processes. Such lenders may continue to take this approach, as the Government does not consider voluntary compliance with section 55 CCA to be automatically contrary to FCA rules on pre-contractual disclosures.

Small agreements

Given that BNPL is frequently used for agreements below £50, the Government has committed to disapplying the small agreements exemption in section 17 CCA for newly regulated agreements.

Transitional arrangements

The Government intends to introduce a temporary permissions regime (TPR) designed to enable firms to transfer into the new regulatory regime before seeking full authorisation. Such firms will be deemed authorised under Part 4A of FSMA by the FCA and so will be permitted to undertake credit-related regulated activities.

The FCA will also be able to supervise these firms and take enforcement action against them if necessary.

TPR details

Firms that are not currently authorised, and wish to carry out regulated activities in respect of BNPL agreements on or after regulation day (the day on which regulation commences), will need to register with the FCA before regulation day. Firms will only enter the TPR where they have: engaged prior to regulation day in an activity that will on regulation day become a regulated activity; registered for the TPR prior to regulation day; and paid a non-refundable registration fee.

Firms that already have permissions for regulated lending, servicing and credit broking (as appropriate) will not be required to register for the TPR, as they can continue to rely on the relevant existing permission.

Sequencing of TPR

The FCA is expected to set out the proposed window in which a firm can register for the TPR. The window will close on regulation day and any firm that has not registered for the TPR prior to regulation day, and which does not have the appropriate authorisation, will not be able to undertake the regulated activity on or after regulation day.

Treatment of agreements made post-regulation day

New agreements entered into or brokered by firms in the TPR will be regulated credit agreements, as they will have been made after regulation day. Exempt credit agreements that were made before regulation day will continue to be exempt, in line with the general approach to regulatory interventions.

Firms may enter into newly regulated credit agreements during the TPR but later exit the TPR without full FCA authorisation, either on a voluntary basis or because their application is refused. Firms that exit the TPR without full authorisation will be prohibited from entering into or brokering new agreements. However, it is proposed that they retain a temporary permission under article 60B(2) RAO to service existing agreements. The maximum duration of this temporary permission would be two years. Alternatively, firms can sell their loan book to an authorised third party and exit the TPR altogether.

Creditworthiness and credit files

The FCA will consult on tailoring FCA rules in respect of creditworthiness assessments to BNPL lenders.

The Government is also keen to ensure clear, consistent and timely credit reporting of newly regulated agreements. In November 2022, the FCA raised in its interim report on the Credit Information Market Study issues with regards to the recording of BNPL agreements on credit files.

Content of agreements

The Government considers it proportionate to apply to newly regulated agreements the CCA requirements for the content of agreements, as set out in the Consumer Credit (Agreements) Regulations 2010.

Arrears, default and forbearance

The July 2022 consultation response discussed the FCA's rules on the treatment of customers in default or arrears and the statutory requirements on provision of information to consumers in arrears and default. It proposed that the CCA requirements on the treatment of consumers in financial difficulty would apply to newly regulated agreements.
At this stage, the Government has ruled out making legislative changes to the CCA timings for sending out arrears and default notices. However, this position could be reviewed as part of the broader CCA reform.

Section 75 CCA

The Government considers that section 75 and its current monetary thresholds should apply unamended to newly regulated agreements. Section 75 will therefore not apply to claims relating to a single item with a price of less than £100 or more than £30,000.

FOS jurisdiction

Under the proposals, the FOS regime in relation to conduct of lenders would apply to regulated agreements (but it would be left to FOS to consider its case fees).

Next steps

The closing date for comments is 11 April 2023. The Government is expected to consider any amendments to draft legislation and will then publish a consultation response. Legislation will then be laid when Parliamentary time permits. The FCA is also expected to publish a consultation paper on proposed conduct rules, as well as rules in relation to the TPR.