Buy-Now Pay-Later: HM Treasury sets out the government's approach to regulating the market

Hogan Lovells

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Hot on the heels of the government's commitment to reform the Consumer Credit Act 1974, HM Treasury has published the response to its October 2021 consultation on the scope and form of a new regulatory regime for Buy-Now Pay-Later (BNPL) products. Whilst the scope of the regime is still being assessed by HMT it will be expanded to include some Short Term Interest Free Credit (STIFC).  Those products brought within the regime will be subject to a bespoke pre-contract and agreement regime with HMT aiming to create a ‘proportionate’ regime whilst retaining many of the existing CCA protections.  However, HMT makes it clear that this is an interim step with the regime being considered more generally as part of its broader CCA reform work.

BNPL regime as a blueprint for the "new look" CCA 1974?

The consultation response refers to the recent announcement of CCA 1974 reform (see this Engage article for more) but states that, given that this will be complex and lengthy, the government intends to progress BNPL regulation and 'use the understanding gained from this intervention in considering broader reform'. This means that existing CCA requirements are being retained in the new BNPL regime but HMT is still seeking to implement 'proportionate regulation' and 'a more flexible FCA rules-based regime'. However, providers will not be happy if BNPL regulation changes a second time when the CCA regime is reviewed.

Regulatory perimeter to be drawn wider: STIFC as well as BNPL

The government has decided that given changes in business models in the BNPL and STIFC markets that blur the distinction made in the consultation, the scope of regulation should be expanded beyond BNPL set out in the consultation paper.

It is therefore planning to bring STIFC provided by third-party lenders into regulation. It considers this proportionate given that it understands that most third-party providers are already authorised for the provision of regulated credit agreements, and often treat their unregulated lending in a similar manner to their regulated offering so the practical impact will be limited.

The government is also thinking about extending the scope of regulation to capture STIFC agreements which are provided directly by merchants online or at a distance (but not in-person in-store).  It believes that this area presents the same risks as BNPL agreements and STIFC agreements provided by a third-party lender and this will also ensure that agreements offered directly by large e-commerce merchants would be regulated. HMT is also concerned about the potential for BNPL providers to avoid regulation by structuring agreements so that they technically become the merchant in the transaction they are financing. However, it is approaching the extension of regulation to merchant-provided STIFC 'with more caution' as it currently has limited information on the nature and scale of this market. As a result it is looking for further stakeholder input to help it in finalising its approach in this area, with a deadline of 1 August 2022. 

HMT believes that anti-avoidance measures are needed…

Depending on the final position on scope and how much STIFC lending is brought within scope, the government will consider including anti-avoidance measures in legislation to mitigate the risk of BNPL lenders synthetically structuring transactions as STIFC provided directly by merchants online or at a distance in order to circumvent regulation.

The government also remains concerned about the potential for BNPL providers adopting a running-account model and using the exemption in article 60F(3) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO) to escape regulation. It is therefore going to consider whether a legislative change is needed in relation to this exemption so that BNPL providers cannot take advantage of it.

…but confirms that some key exemptions will not be affected 

However, the government confirms this won't affect use of the exemption by charge card providers. It also confirms that the following other arrangements will continue to be exempt from regulation:

  • Invoicing;
  • Interest-free agreements which finance contracts of insurance;
  • Trade credit; and
  • Employer/employee lending.

Regulatory controls: something old, something new

HMT reiterates the importance of proportionate regulatory controls for agreements that will be brought into regulation. However, to ensure an adequate level of consumer protection many existing CCA requirements will apply.

In terms of its final position on the specific consultation proposals impacting the customer journey:

  • Broking: Firms will welcome the government's confirmation that merchants should be exempt from needing credit broking permission where they enable regulated BNPL credit at point of sale for the finance of their own goods or services. This is subject to a limited exception for merchants visiting consumers in their homes, who will require FCA authorisation (reflecting the current regulatory treatment of these merchants, who are subject to the FCA's full permissions regime and cannot rely on the limited permission regime).
  • Marketing: HMT has confirmed that the financial promotions regime will be extended to all merchants offering BNPL and STIFC products as payment options. This means that merchants will need approval from an authorised person before communicating any promotions. The FCA will consult on its proposals for rules on financial promotions for BNPL and STIFC agreements in due course.
  • Creditworthiness: The current FCA rules for assessing affordability will be applied to agreements that are brought within regulation. It is left to the FCA to decide if the rules need to be tailored for these products. The government is engaging with the credit reference agencies as they develop their approach to reporting BNPL on credit files. Alongside this, the FCA is undertaking its cross-market Credit Information Market Study, which, amongst other issues, will consider the impact that the growth in different and new forms of credit could have on credit information, and technological changes in the credit information market such as Open Banking. An interim report on its findings is due this summer.
  • Pre-contract information: HMT's view remains that it would be proportionate to disapply CCA pre-contractual provisions and to rely on FCA rules for the agreements that will be brought into regulation. However, it acknowledges that for convenience third-party STIFC providers often treat their current exempt lending as though it were regulated so that they have only one set of processes. It therefore recognises the need to ensure that transitioning to a rules-based pre-contract approach would not impose excessive burdens on them. It will therefore consider how to ensure that agreements will be compliant and properly executed should a lender choose to apply the existing CCA requirements for currently-regulated agreements to agreements falling under the new regime. HMT has confirmed that the pre-contract information requirements in the CCA will form a key part of the forthcoming review of the Act.
  • Agreement documentation: HMT confirms its view that it would be disproportionate to apply the CCA agreements requirements to all BNPL and STIFC products that will fall under the new regime. Instead, bespoke secondary legislation will be made under the CCA following further engagement with stakeholders. There is also confirmation that the current CCA ‘improper execution’ provisions (which mean that an agreement is unenforceable without a court order if the pre-contract information or credit agreement is non-compliant) will apply to all in-scope BNPL and STIFC agreements. As with the approach to pre-contractual information, the government will consider how to ensure that agreements will be compliant and properly executed should a lender choose to apply the existing CCA requirements on form and content of agreements. Again, there is mention that consideration of the improper execution provisions for all credit agreements will form part of the work to reform the CCA.
  • Arrears and statutory notices: HMT describes 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 as 'vital consumer protections'. It confirms that the CCA requirements on the treatment of consumers in financial difficulty will apply to the BNPL and STIFC agreements that are brought into regulation.  HMT recognises that the current CCA requirements on post-contractual information may need to be tailored for BNPL and STIFC agreements 'given their sometimes very short-term nature'. The government will set out any tailored requirements when it publishes its draft regulations. The FCA will consult on its proposals for rules on arrears, default and forbearance for BNPL and STIFC agreements in due course.
  • Section 75: As consulted on, section 75 CCA will be extended to regulated BNPL agreements. There is no proposal to adjust the £100 minimum transaction threshold in the CCA, so section 75 is unlikely to apply to many BNPL agreements.
  • ‘Small agreements’: HMT confirms that in order to ensure 'consistency in consumer protection' across in-scope BNPL and STIFC agreements, the ‘small agreement’ (under £50) exemption will be amended to exclude small BNPL and STIFC agreements. However, it then goes on to point out that some BNPL providers provide interest-bearing, regulated agreements for less than £50 which would fall within the small agreements provisions. It thinks this discrepancy is unlikely to arise in practice, given that lenders are likely to adopt standardised systems and processes when their currently-exempt lending becomes regulated. It will monitor how lenders treat small agreements and adds this to the list of issues that it will consider as part of the broader CCA reform.
  • Financial Ombudsman Service (FOS) rights: HMT's recommendation that  BNPL consumers should be granted access to FOS to ensure greater consumer protection is being taken forward. HMT notes stakeholders' concerns around the potential disproportionality of the FOS case fee for BNPL agreements - the current FOS case fee is £750 compared to a typical BNPL transaction of around £50-100 – HMT will engage with FOS on this but ultimately it will be for FOS to decide the approach.

Next steps

As mentioned above, the government is thinking about extending the scope of regulation so that STIFC products provided directly by merchants online or at a distance are brought into the scope of regulation. However, it wants to hear stakeholders' views on this part of the market before reaching a final decision. Further information can be provided to by 1 August 2022.

Given the anticipated complexity of the implementing legislation for the new regulatory regime, the government is planning to publish and consult on draft regulations and a draft impact assessment 'around the end of the year'. Alongside the consultation, it will set out its final position on whether STIFC provided directly by merchants online or at a distance should be brought within the regulatory perimeter. 

Following the second consultation, the government aims to lay secondary legislation in mid-2023 confirming the scope and framework of the new regulatory regime. This will enable the FCA to consult on its approach for the new regime and undertake a cost-benefit analysis.

The government will continue to work closely with the FCA to enable it to develop its rules. The government will also further consider the transitional regime for bringing firms into regulation.

Whilst this does mean that regulation is still some way off, HMT flags the fact that the FCA has already taken steps under broader consumer protection legislation to mitigate risks of potential consumer detriment from the use of BNPL (four BNPL firms having agreed to change terms in their consumer contracts). Ahead of the new regime, the FCA will continue to monitor the BNPL market and assess whether there are further interventions that it could make under its existing powers.

Please get in touch with any of the listed contacts if you would like to discuss the potential impact for your business.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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