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The UK government’s decision to veer away from its original regulatory plans may ensure the survival of many buy now, pay later (BNPL) products, but experts warn a compliance leap should be anticipated for third-party lenders.

In February, HM Treasury (HMT) published its latest consultation regarding BNPL.

Considering the government first announced a move towards regulation in October 2021, it has taken sometime.

VIXIO itself ran a story in January 2022 with the headline “UK BNPL Regulations In Place By Year End”; however, leadership changes and economic turmoil have since slowed progress.

The new legislative document that has just been released shows that since its first consultation, the government has narrowed the scope of the regulation.

“There are no huge surprises,” commented Katie Fry-Paul, associate at Taylor Wessing. “However, there have been some changes to the measures originally proposed. Originally, the government proposals could have extended to certain loans made by merchants using the same exemption as BNPL lenders.”

It is clear that the responses to the first consultation have caused this idea to be revisited, she told VIXIO. “The focus is now firmly on third-party lenders”.

This means that merchants will be excluded from the regulation of BNPL products, with the government stating that certain arrangements do not present a “substantial risk of consumer detriment”.

“These will remain unregulated,” said Matthew Dibb, legal director at Addleshaw Goddard. “Those include agreements financing contracts of insurance by way of monthly instalments, agreements offered by registered social landlords to tenants and leaseholders, likely to be low-income consumers, for repairs to buildings and employer/employee lending as part of employee benefits and assistance schemes, typically to finance season ticket loans.”

This contrasts with the prior position of the government.

For example, the government previously showed concern that merchant-led BNPL and short-term interest-free credit (STIFC) agreements offered online or at a distance "had the potential to present the same risks as BNPL and STIFC agreements provided by a third-party lender".

However, following consultations, the government has instead focused on agreements offered by third-party lenders through concern that the burden of regulation for merchants selling online may cause them to stop offering useful low-risk products, rather than become authorised.

“As a result, there will remain an area of unregulated BNPL/STIFC lending without the protections afforded by the new regime, with at least the possibility of consumer detriment in the future,” suggested Dibb.

He continued to point out that the risk that this exemption would be exploited has been considered. For example, a third-party BNPL lender might seek to avoid regulation by structuring agreements so that they technically become the merchant in the transaction they are financing, having purchased the goods from the original supplier.

To counter and mitigate this risk, the government has set out anti-avoidance measures in the final legislation that will seek to capture such structures.

This exemption will likely prove a relief for both BNPL providers and merchants.

“The costs and administrative burden of being regulated may have deterred merchants from partnering with lenders to promote BNPL products,” said Rachpal Thind, regulatory partner at Sidley Austin.

“That said, the lenders will need to invest significantly in new policies and procedures to address the various compliance requirements referenced in the government’s consultation, including credit worthiness assessments, pre-contractual information requirements and rules on dealing with customers in default.”

Thind pointed out that the government’s intention is that such requirements should be proportionate. “But, it will be interesting to see what impact this will have on the cost of BNPL credit going forward."

The government has also confirmed in the consultation that Section 75 of the Consumer Credit Act 1974 (CCA) liability will extend to BNPL providers.

That will mean that if a consumer buys something under a regulated BNPL arrangement and is dissatisfied with the quality of its purchase, the consumer can seek reimbursement from its lender.

“This could significantly affect BNPL lenders’ existing business models and create a major new source of potential liability," Thind said.

The compliance leap

Before they get authorisation, BNPL providers will have to enter into a Temporary Permissions Regime (TPR) that will be managed by the UK’s Financial Conduct Authority (FCA).

Similar systems have been set up in light of Brexit for EU firms and for crypto providers due to the introduction of money laundering laws.

According to Simon Deane-Johns, consultant solicitor at Keystone Law, this is an area to which people should be paying attention.

“The regime is different to earlier types of transition arrangements, but is also being applied to the proposed crypto-asset regime,” he noted.

“Any currently unregulated firm that wants to offer regulated BNPL will need to register for the TPR and wait to be called forward to apply for authorisation.”

But, he added, they will not just be able to carry on as they were before because the FCA will expect the firm to comply with all the regulation relevant to consumer lending, as well as credit broking if they are broking BNPL in visits to customers’ homes.

“If you are currently a provider of unregulated BNPL, then there will likely be a big gap between your current policies and procedures and what you’ll need to fully comply with consumer credit regulation,” he said. “The timing is yet to be clarified but this will be a steep learning curve."

According to Dibb: "At present, most BNPL firms and the products they offer are unregulated and not subject to the regulatory controls and consumer protections afforded to consumers in the regulated market.”

The proposed new regulation is therefore a sea change for the BNPL market, he said. “Firms will need to expediently consider the regulatory, commercial, and legal impact arising from these proposed changes.”

For example, it will require newly regulated lenders in this space to ensure they conduct adequate credit checks prior to lending and that they tailor their agreements to the more prescriptive CCA requirements on substance and form.

In addition, firms will need to ensure that all financial promotions of their products both by themselves or through merchant-led credit brokering are "clear, fair and not misleading" to consumers.

As Dibb pointed out, this will also include consideration of how BNPL firms can and should be complying with the upcoming Consumer Duty, ensuring they deliver good outcomes for BNPL retail customers.

Ch, ch, ch changes

Experts we spoke to were divided on how impactful this legislation will be on the BNPL sector’s future.

"I expect that these changes could still make BNPL less appealing,” argued Deane-Johns. “We're yet to see the exact planning around credit checks, but the introduction of those and the other regulatory hurdles will likely sober people up from the earlier BNPL euphoria."

Meanwhile, Chris Kneen, UK and Ireland managing director at Provenir, told VIXIO that BNPL is here to stay.

“The take up and adoption of these solutions has grown exponentially. There are advantages to regulation being introduced that are aimed at the consumer, but there will be a little bit more friction in customer experience that stems from regulation,” he said.

BNPL created an Amazon-like experience, with a quick, efficient interaction, Kneen suggested. “Because of the additional regulation, the amount of data needed to be utilised will be similar to a credit card, but will also drive best practice into the BNPL sector. We should see this as a good thing."

Additionally, although these regulations represent a change to business as usual, those engaged with BNPL have known for some time that eventually regulation will be in place.

Firms such as Klarna have even put on a public image of being pro-regulation.

“This isn’t the first that BNPL lenders have heard about this,” said Fry-Paul. “Lenders have been expecting to be brought into the regulatory perimeter since the Woolard review, so this has been a long time coming.”

Fry-Paul noted that it is to be expected that a number of BNPL firms have already put in certain measures that were considered likely to be extended to them.

“To the vast majority of lenders, this is a well-known, telegraphed direction of travel for responsible lending and the alignment of BNPL/STIFC with more traditional forms of financing is a natural consequence of the increased regulator focus on consumer protection,” said Dibb.

Going forward, HMT has said that it will publish a consultation response "in due course" following its conclusion and that it has the "ambition" to lay the legislation before parliament during 2023.

“That may seem a significant lead time,” noted Dibb, but it is “something currently regulated firms will be all too familiar with through the Consumer Duty implementation requirements".

“For firms seeking FCA authorisation, it is never too soon to start planning their application and ensuring their processes are set up for such approval."