What is Buy Now Pay Later or BNPL?
BNPL firms provide consumers with short-term, point-of-purchase credit with either little or no fees or interest. This is usually done either through a loan that is repaid over a period of time, or through billing, where consumers pay back in installments (usually 3 or 4). The main source of income for BNPL firms is merchant fees, which can range from 3% to 6% of the purchase price.
A driver for change
BNPL companies have significantly changed the payments landscape in recent years, especially during the pandemic, due to their ability to meet the growing needs of customers by offering a digital experience with interest-free installments. Research has shown that the Gen Z demographic has shyed away from high-yield credit cards, leaving room for the BNPL industry to enter the market. BNPL firms also help merchants by increasing sales, strengthening customer loyalty and expanding their customer base. Online conversion rates are often highest and shopping carts more valuable when BNPL is used in the transaction.
UK BNPL lending in 2020 was estimated at £2.7bn, meaning the BNPL market was by then already larger than the UK payday lending sector was in its heyday in 2013. It has even been estimated that the global BNPL industry will grow to $900 billion by 2026.
However, this model, like any other platform model, has both its challenges and its risks.
Current position: very limited regulatory oversight
As in many areas of law, regulation can often take some time to keep up with developments in the real world. This is especially true in the ever-changing FinTech space. Currently only certain BNPL products are regulated by the FCA under the Consumer Credit Regulations, with many BNPL credit agreements based on the provisions of Article 60F(2) of the Regulated Activities Order (RAO), which provides that certain BNPL agreements are exempt from regulation “because they are interest and fee-free and can be repaid in 12 or fewer installments in a maximum of one year”. It is important to note that in many (but not all) cases, the lack of interest and fees charged by the BNPL firm is true if and until A customer misses a payment.
This exemption has allowed a variety of players to enter a market with little or no regulation by the FCA.
If loans are determined to be unregulated, lenders are not required to: (i) conduct credit checks or share data with credit reporting agencies; (ii) disclosure of pre-contractual information; (iii) comply with advertising rules for financial promotions; or (iv) assess whether the applicant can afford the loan (unlike where the loan is regulated). In addition, consumers cannot seek redress or lodge complaints with the Financial Services Ombudsman. The benefit to traders and BNPL firms is clear, but potentially detrimental to the more vulnerable members of society.
While a BNPL provider tried to support the service by stating: “There is clearly a greater risk of consumer harm from credit card spending”it is important to note that in 2021 in the UK 19.5% of active credit cards were charged with BNPL transactions and there are other concerns when bank overdrafts and loans from friends and family are used to make repayments. Concerns about BNPL therefore focus on: (i) the ability of consumers to pay for BNPL rates when those rates are charged to a credit card; This is because although there is a 0% BNPL prime interest rate, the reality is that if not paid monthly, installments debited from the credit card will incur credit card interest (which can be around 20%); and (ii) the lack of consumer protection; An example is the possibility of “stacking” – when a consumer uses multiple BNPL providers, none of which carry out in-depth credit checks, resulting in a credit spiral that leaves the consumer in unmanageable debt.
Future regulation of BNPL?
The current economic climate of a cost of living crisis, rising inflation and interest rates, and talk of broader recessionary pressures has the potential to create an environment that makes BNPL more attractive to consumers. For this reason, in September 2020, the FCA’s Board of Directors commissioned a review of the unsecured lending market and the extent to which further regulation may be needed. The result was the Woolard Review, which concluded that there was an urgent need to regulate all BNPL products.
Most recently, on June 20 this year, the government unveiled its plans for increased regulation of interest-free BNPL products and other forms of unsecured short-term interest-free credit when provided by third-party lenders, posing similar risks to consumers. Significantly, the plans provide that vendors offering BNPL products will:
- be obliged to carry out credit checks to ensure that credit is affordable for consumers;
- must ensure that all BNPL advertisements are fair, clear and not misleading;
- must be approved by the FCA; and
- Consumers can also lodge a complaint with the Financial Ombudsman Service.
The government will allow exceptions to certain agreements where the risk of potential consumer harm is limited and regulation would otherwise disrupt day-to-day business activities.
The government has found that it must publish and consult draft legislation to ensure it achieves intended policy goals. The government will then adopt final legislation, the draft of which is due to be published towards the end of the year. After extensive consultation, the government intends to enact secondary legislation in mid-2023 that will confirm the scope and framework of the new regulatory regime.
Whilst the lack of any concrete regulation has so far allowed the BNPL industry to thrive, there will inevitably be a transition period and BNPL firms will therefore soon become aware of the complexities of being in a market served by several different ones regulatory systems is regulated and working methods.
Actions BNPL firms need to take now
Despite this lack of immediate regulation, BNPL firms should use this time to get used to the upcoming regulatory requirements that will be imposed on them. In addition, all BNPL firms should be aware that they have existing obligations to comply with consumer protection laws, including the Consumer Rights Act 2015 (CRA) for contracts made on or after October 1, 2015 and the Unfair Terms in Consumer Contracts Act 1999 for contracts made between July 1, 1995 and September 30, 2015.
The FCA has the power to enforce consumer protection laws and has done so proactively, with certain BNPL providers agreeing to amend the terms in their consumer contracts to make them fairer and easier for consumers to understand.
In preparation for stricter regulation, BNPL firms should review their consumer contracts against the requirements of consumer protection laws to ensure a spirit of fairness is reflected.
For example, the CRA has the following requirements:
- Contract terms must be fair (taking into account the nature of the subject matter of the contract and the contract and with reference to all circumstances that existed when the term was agreed (§ 62 KRA):
- the CRA provides a list of consumer contract terms that may be considered unfair (although ultimately only a court can decide that);
- if consumers exercise their right to cancel an online sales contract, the associated loan agreement will be canceled in accordance with Regulation 38(1) of the Consumer Contracts (Information, Cancellation and Additional Charges) Regulations 2013; and
- BNPL firms must therefore ensure that:
- All of the terms that set out what happens when a consumer terminates the contract for purchases funded by the BNPL loan are fair and clear, so consumers should not be required to continue paying installments or incur late payment fees if they Do not pay installments after the loan agreement has ended. If a retailer is late in notifying the BNPL firm of a terminated agreement, the terms should state when and how a refund of monies raised will be effected; and
- any right to offsetting terms shall not prevent the Consumer from offsetting any monies owed to him by the BNPL Company against instalments.
- Contract terms must be transparent (expressed in plain and understandable language (Section 68 CRA)):
- To the extent that late payment fees are charged, this should be made clear to the consumer in the BNPL company’s terms and conditions; and
- All continuous payment authority conditions (where a consumer provides card details and the BNPL firm agrees to withdraw funds from their account) should be transparent. Accordingly, when drafting these Terms, BNPL Firms should make clear how consumers may revoke this power of attorney and detail how this will affect any outstanding payments that are due.
International platform but localized regulatory approach
Starting a FinTech company comes with challenges, not least for BNPL companies with the range of local regulations and the expected changes therein. Consequently, such cross-border complexities pose a significant challenge for BNPL players, but the market has the potential to create tremendous opportunities. BNPL firms should look for ways to scale their businesses globally while ensuring a localized regulatory approach.
Contact Nick Purnell (Partner) or Georgia Harris (Associate) for further advice.