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In a new Dear CEO letter to retail finance providers, the UK Financial Conduct Authority (FCA) has urged firms to adopt "effective prioritisation" measures ahead of a key deadline. However, some buy now, pay later (BNPL) firms will not receive the letter for now.

With the Consumer Duty regime set to come into force on July 31 this year, the FCA has to retail finance firms to highlight what it sees as key areas to focus on ahead of the deadline.

The FCA said there are three areas where firms should concentrate their efforts, namely “effective prioritisation”, “embedding substantive requirements” and “working with other firms”.

In terms of prioritisation, the FCA emphasised that working towards “reducing the risk of poor consumer outcomes” should be the highest priority of all firms while working towards the deadline.

Broadly speaking, this is the main goal of the Consumer Duty — a new set of guidelines that will introduce a more “outcomes-focused approach” to customer protection and raise standards of customer care.

Roma Pearson, director of consumer finance supervision, policy and competition at the FCA, urged firms to assess where they are likely to be furthest away from the outcomes requirements of the duty, and to prioritise these areas accordingly.

BNPL firms take note

Ultimately, the retail finance sector will include all BNPL firms, but as some of these firms are not yet regulated by the FCA, the July 31 deadline will not apply to them.

Speaking to VIXIO, an FCA spokesperson said that Consumer Duty requirements will only apply to all BNPL firms once the sector comes under FCA regulation, which is expected to take place in 2024.

However, as many BNPL firms, such as Klarna, PayPal and Payl8r, offer other regulated retail finance services, these firms have received the Dear CEO letter and are required to comply.

In the letter, the FCA has singled out BNPL as a particular cause for concern ahead of the Consumer Duty, due to the “unprecedented” cost of living crisis in which these products are currently being marketed.

“We are aware of a range of new business models and products in the retail finance market, including some new products being offered to customers for the purchase of essentials in the context of the rising cost of living,” said the FCA.

“We are increasingly seeing BNPL products being used in this context.”

As regulated firms seek to deploy new BNPL products or expand existing ones, the FCA said they must ensure they are lending responsibly and designing those products in a way that is suitable for the intended target market.

Such considerations, the FCA added, should be present throughout the design of the entire customer journey and in all interactions between firm and customer.

“Firms should be closely monitoring and aware if the product is being offered to individual customers on the edge of the target market, in these circumstances taking extra care and considering whether the product remains suitable,” said the FCA.

Key drivers of harm

In a section on “key drivers of harm”, the FCA urged BNPL firms to consider issues such as affordability; price and value; incentives and commissions; customer support and customer understanding.

Under the Consumer Duty, the FCA reminded firms that they are required to demonstrate that their lending, marketing and other business practices “avoid causing foreseeable harm”.

“We want retail finance providers to help deliver outcomes that ensure consumers do not become over-indebted by being given credit they cannot afford,” said the FCA.

“Under our rules, as supported by the duty, it is important that any lending product is affordable for the customer, and firms must have in place adequate systems and controls to make this assessment.”

To illustrate how BNPL firms can meet these requirements, the FCA included an example from its , published in July 2022.

It describes a typical BNPL firm that offers interest-free credit to customers over a period of 18 months, generating its core revenue from merchant commissions on each sale.

However, the firm also charges default fees when repayment terms are broken, and as the firm’s target market includes customers with low incomes and poor credit ratings, a high number of customers default.

The firm then earns “considerable revenue” from default fees, and creates a cost spiral for the customer.

“Under the duty, we would expect firms to consider whether elements of the pricing structure could cause foreseeable harm and be able to demonstrate that the overall costs that consumers are likely to pay, including potential default fees, are reasonable relative to the benefits,” said the FCA.

“We note that consumers might not give sufficient consideration to the risks and consequences of default when being offered such products, and this can increase the risk of them receiving unfair value.”

A reminder for every sector

BNPL firms are not the first to receive a Dear CEO letter from the FCA on the implementation of the Consumer Duty.

Last month, as covered by VIXIO, payment and e-money firms received a similar letter, with advice tailored to their sector.

Priorities for payment and e-money firms included strong customer authentication (SCA) solutions for vulnerable customers who do not own or use a mobile phone, or who do not have a mobile phone signal.

Other priorities included reducing the frequency and duration of account freezing due to suspected fraudulent activity, and introducing stricter rules on cross-selling to ensure that target markets are suitable as a product or service expands.

Over the past two to three weeks, most financial service firms have received tailored to their sector on the implementation of the Consumer Duty.