BNPL vs ‘Short-term lending’: what’s the difference?
Both ‘Buy Now Pay Later’ and ‘short-term interest free credit’ rely on the same exemption in Article 60F(2) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the ‘RAO’). There is no current definition of either product, nor is there a proposed definition in the consultation paper, but HMT does set out what it considers to be the key characteristics of each:
- ‘Buy Now Pay Later’ is usually offered by a third party lender as a way to pay for goods from a merchant. The consumer often has an account with the lender and enters into a credit agreement with them at the point of sale. The transaction is likely to be relatively low (averaging £65-£75) and over a very short term, of up to three or four months. BNPL also includes products where the entire payment is deferred for one month.
- ‘Short-term interest free credit’ arrangements are typically for higher value goods such as electronic items and furniture, as well as gym memberships and season tickets. Although they were originally offered by merchants themselves, in recent years third party lenders have become more prevalent. Borrowers usually repay over 12 months and don’t usually have an ongoing relationship or ‘account’ with the lender.
Interestingly this distinction wasn’t made in the Woolard review itself; it seems that HMT is trying to avoid over-regulation, which could otherwise drive many providers out of the market altogether.
Where should the regulatory perimeter be drawn?
HMT recognises that the BNPL/ short-term interest free credit distinction won’t always be clear and there will be some products which have features of both. It is also clear that the descriptions above do not lend themselves readily to a clear delineation since HMT recognises that these are merely ‘more likely’ attributes rather than required ones. The CP therefore sets out two options for where exactly the scope of regulation should fall. These are:
- Regulation of third party financing?
HMT considers regulating all short-term interest-free arrangements where a third party provides the credit. This would be a fairly radical change and would regulate the majority of point-of-sale finance providers but would have the benefit of being clear and relatively straightforward to implement and police (eg the exemption could simply be amended to apply only to agreements falling within section 11(1)(a) CCA). HMT also recognises that many of these finance providers already offer regulated products, meaning that the additional (implementation) burden of regulation may be fairly low.
It would however likely catch a number of ‘short-term interest-free credit’ arrangements that do not otherwise share the characteristics of BNPL that HMT is seeking to regulate so may mean regulating more lenders than is strictly needed in order to address the perceived harm. This goes against the ‘proportionate’ approach advocated by HMT.
- Regulation of pre-existing borrower/lender relationships?
Alternatively, HMT considers only regulating arrangements where there is a pre-existing relationship between the lender and a consumer (eg where the borrower opens an account with the lender and can enter into multiple separate fixed-sum credit agreements for different purchases).
HMT is concerned that this may lead to some BNPL providers changing their product proposition to fit within the exemption for running-account credit in Article 60F(3) RAO. There is some suggestion that HMT might also look at changing that provision to make sure that BNPL providers can’t continue to operate unregulated, resulting in consumer harm. Combined with the statement that BNPL also includes products where the entire payment is deferred for one month, this may spell trouble for charge card providers.
Clearly the scope of regulation will require careful thought on the part of HMT, including consideration of unintended knock-on consequences which could impact other sectors.
What does proportionate regulation look like?
HMT recognises that it wouldn’t be appropriate to regulate BNPL to the same extent as a standard interest-bearing loan under the Consumer Credit Act 1974 (‘CCA’). Instead, regulation should be proportionate to the risks of the product and a bespoke - or hybrid - regime should be created to deal with these products. HMT’s proposals nevertheless impact all elements of the customer journey:
- Broking: HMT propose that merchants should be exempt from needing credit broking permission where they offer regulated BNPL credit at point of sale for the finance of their own goods or services. This could be subject to some exceptions in higher-risk circumstances, such as business models involving merchants visiting consumers in their homes.
This is a welcome proposal; any other approach could well result in the majority of merchants refusing to offer BNPL as a payment option as a way to avoid regulation. This would likely reduce the size of the BNPL market, leading to a lack of choice for consumers.
Marketing: Although BNPL providers are subject to the Advertising Standards Authority codes (as well as the Consumer Protection from Unfair Trading Regulations), HMT is considering extending the financial promotions regime to all BNPL promotions, resulting in merchants needing approval from an authorised person before communicating any promotions (presumably ‘short-term interest free credit’ will remain excluded). It isn’t clear whether the detailed FCA rules in its Consumer Credit Sourcebook (CONC) will apply to these products or whether a bespoke financial promotions regime would be required.
Creditworthiness: HMT suggest that the current FCA rules for assessing affordability should be applied to BNPL agreements. They note that the FCA may decide to make changes to its current rules to tailor them to BNPL products, though we’d be surprised if there was a significantly lighter touch regime for BNPL, given the concerns raised by the Woolard review and the press coverage on this point. Similarly, HMT intends to work with Credit Reference Agencies to ensure that BNPL is reflected in consumer’s credit files and a consistent approach to reporting is in place across the industry.
- Pre-contract information: HMT express concerns that the current level of information communicated before sale is not prescribed and can vary significantly among BNPL providers. However, it also recognises that applying the full CCA pre-contract regime (requiring a prescribed pre-contract information document) would be disproportionate in light of the risks and structure of BNPL products. Instead, HMT suggest that the CCA itself could be disapplied, and BNPL lenders would simply be required to provide ‘adequate explanations’ under CONC. These requirements may be amended by the FCA to take into account the specific nature of BNPL agreements.
- Agreement documentation: Similarly, HMT consider that it would be disproportionate to apply the CCA agreements requirements to all BNPL products. Instead, it suggests that bespoke legislation should be developed which suits the features of the product.
Interestingly, it also suggests 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) should apply to BNPL agreements.
- Arrears: unlike regulated agreements, BNPL products aren’t subject to FCA rules on exercising appropriate forbearance for customers in arrears. Whilst HMT recognises that many existing BNPL providers do have hardship policies in place, these are inconsistent across the industry. It considers that a proportionate approach would be to apply the FCA’s rules on how firms treat customers in financial difficulties (again, the FCA may choose to amend these to ensure they are proportionate and appropriate for BNPL products).
- Statutory notices: regulated agreements are subject to an array of overlapping and complex notice requirements. This includes default notices, notices of sums in arrears, notices of default sums and termination notices. It isn’t clear whether HMT are in favour of applying these requirements to BNPL products – although they recognise that it would address the lack of consistent treatment of customers in financial difficulties, they would ‘welcome views on the proportionality’ of applying the regime.
Some of these CCA statutory notice requirements are notoriously difficult to interpret, with some also having draconian consequences for non-compliance (loss of interest as well as unenforceability). This has historically resulted in lenders investing a large amount of resources in trying to comply, or in correcting non-compliance. It is therefore surprising that HMT consider it to be ‘proportionate’ to require BNPL providers to comply, given that these products are inherently lower risk. However, given the short-term nature of BNPL, a number of these requirements may well be irrelevant in practice.
- Section 75: HMT propose to extend section 75 CCA to regulated BNPL agreements. Although some providers do offer their own protection schemes, this is inconsistent across the industry.
In reality, section 75 is unlikely to apply to the majority of BNPL agreements unless it is amended, given the £100 minimum transaction threshold in the CCA.
- ‘Small agreements’: the CCA currently carves out ‘small agreements’ (under £50) from a number of provisions. HMT suggest that in order for smaller BNPL agreements to be subject to a proportionate level of consumer protection provisions, the ‘small agreement’ exemption should be amended to exclude small BNPL agreements.
This is an interesting suggestion from HMT. Clearly a policy decision was previously taken that credit agreements of less than £50 posed a lower risk of detriment and therefore required fewer CCA protections. It is difficult to see why BNPL agreements (which are often interest-free) should be subject to greater protection than small interest-bearing agreements, or why this approach would be ‘proportionate’.
- FOS rights: Although some BNPL providers provide an independent complaints process, this can differ across providers and HMT is concerned that these processes are not ‘truly independent’. As a result, HMT recommends that BNPL consumers should be granted access to FOS to ensure greater consumer protection.
The current case fee for firms is £750 per complaint (from the 26th complaint). Considering that the average BNPL agreement is said by HMT to be for between £65 and £75, allowing FOS referrals may well be costly for BNPL providers (and, in some cases is arguably disproportionate). Firms may want to consider whether there are more proportionate ways to achieve consumer protection, such as automatically triggering a FOS or other independent review if complaints reach a specified proportion of the firm’s customer volumes.
In some ways, the consultation doesn’t provide much certainty on either the regulatory perimeter or what the regime could eventually look like. However, it is encouraging that HMT recognise that any regime should be ‘proportionate’ to the potential detriment and have suggested a bespoke regime be developed rather than applying the CCA in its entirety. However, a number of the proposals are likely to create difficulties for BNPL providers and will require careful tailoring to ensure that the market remains competitive and providers aren’t driven out by the burden of regulation.
If your business has views on the regulatory perimeter or the scope of regulation itself, responses to the consultation must be submitted before 6 January 2022. It isn’t clear when HMT proposes to implement legislative changes, but given the lack of certainty in the consultation, we suspect it’s unlikely that a new regime will be created before 2023.
Please get in touch with any of the listed contacts if you would like to discuss the potential impact for your business.
Authored by James Black and Elizabeth Greaves.