BNPL Regulation in the UK - Marking out the tramlines

Preparations for the incoming new regulation of Buy Now Pay Later ("BNPL") credit products reached a new milestone this February with the publication of the Treasury’s ("HMT") consultation of the draft legislation. The proposals to regulate BNPL were first announced in February 2021 followed by further consideration and consultation over the subsequent 18 months or so.

This latest consultation paper confirms much of what has been shared by the government and the FCA to date but also helpfully move the story forward in terms of definitively ruling out some types of peripheral BNPL (e.g. excluding traditional merchants, i.e. providers of goods and services, from the regime). It also puts forward a broad structure for the expected approach to authorisation that the FCA will administer (see below).
 

What are the key messages?

• In earlier publications, HMT signalled that some consideration was being given to regulating online as well as ‘bricks and mortar’ merchants offering short-term interest free credit agreements. HMT has now clarified that it intends to limit the scope of the expansion of the regulatory perimeter to firms that provide BNPL products to consumers and small businesses. It was also confirmed that other previously mooted products for inclusion such as trade credit, invoice financing, employer-employee lending (i.e. season ticket loans) and repayments relating to insurance contracts, will be out of scope.
• There is an expectation that there will be a mandated form of standardised credit agreement (or potentially minimum standard) to be implemented by BNPL lenders.
• It was confirmed that unauthorised merchants that offer BNPL as a payment option will be required to abide by the same Financial Promotions Regime administrated by the FCA as regulated BNPL providers.
• The consultation paper also highlights the potential that the Consumer Credit Act (“CCA”) may be adapted to accommodate some of the unique features of BNPL (e.g. standards relating to Arrears and Forbearance and approach to assessing creditworthiness of customers).
   

What will the Authorisation process look like?

From the consultation paper, an understanding of what might will be required to become authorised to offer BNPL products is now emerging. In short, the FCA will deploy a two-stage process to ensure sufficient time is available to establish the new regulatory framework as well as allow those needing authorisation to prepare to become regulated.

The stages are:

• Initial registration will be required under a Temporary Permissions Regime ("TPR"). Firms will need to pre-register with the FCA prior to ‘Regulation Day’ with basic information submitted to the FCA along with a non-refundable registration fee; and
• Following this, firms registered will progressively be invited to apply for full authorisation through FCA designated ‘Landing Slots’ (i.e. a calendar range where they are expected to submit a full authorisation application).

This approach mirrors recent arrangements implemented to manage the FCA’s authorisation workload resulting from Brexit.

It is important to note that the paper clarifies that TPR registration will close on ‘Regulation Day’ and any firms that have not registered to enter TPR will be in breach of the regulatory perimeter. Withdrawals from the TPR after ‘Regulation Day’ will be permitted although registration fees will not be refunded. Unfortunately the specific timelines attached to the introduction of the regime, when exactly ‘Regulation Day’ will occur; and the length of the TPR, remain unknown.

Upon submission of full applications in the second stage, the regulator will review whether applicant firms can meet the FCA's Threshold Conditions, including if there is a sufficient level of 'mind and management' present in the UK. This may pose challenges to future applicants who are headquartered overseas or service multiple locations from overseas hubs. Whilst these models are accepted means of doing business, there is an expectation that there is a local management team in place able to oversee the UK operation with appropriate understanding of local regulatory standards.

Minimum standards will also apply in relation how support functions are organised, outsourcing arrangements, record keeping and regulatory reporting.
 

Are you prepared?

Whilst much of the detail requirements of the new regime are yet to be published, there are several themes which will inevitably form a crucial part of both the assessment of authorisation applications as well as maintaining regulatory compliance thereafter. In our view, likely themes will include:

• Consumer Duty: Given the strong concerns raised in relation to risks of consumer detriment as a result of BNPL activity; the upcoming introduction of the Consumer Duty requirements (which will be well embedded by the time BNPL regulation goes live) will invariably be high on the list of lenses through which the FCA will examine applications for authorisation. BNPL firms will need to demonstrate how they integrate their in-depth understanding of their customers alongside ensuring they have appropriate customer support mechanisms, product governance and their pricing is matched to customers’ needs and is fair and transparent.
• Financial Promotions: Whilst HMT and the FCA have voiced concerns about the promotion of BNPL services in their own right; the regulator has also independently been taking steps to enhance the overall standards applicable to financial promotions. These include introducing stronger rules on the approval of financial promotions on behalf on non-regulated firms; clamp downs on marketing of high risk investments to retail consumers; and a marked step up in the frequency of FCA intervention to remove inappropriate financial promotions.
• Arrears and Forbearance: The FCA has clear expectations about how customers should be treated when experiencing financial difficulties and how regulated firms should approach such cases to ensure that treatment is fair and transparent to the consumer. Particular attention will likely be paid to how BNPL firms identify and treat vulnerable customers, especially in the context of the (generally low) value of individual credit agreements made and/or where multiple agreements are tied to single customers.
• AML and Financial Crime Prevention: Regulatory standards in relation to these topics are distinct and necessitate specific documentation as well as systems and controls to be in place. The same general standards are expected to apply to BNPL firms which may for some require a significant uplift relative to current arrangements. This may require some gap analysis ahead of authorisation applications to understand required changes; and
• Governance and Risk Management: Becoming regulated for the first time often results in a need to elevate both governance and risk management arrangements to meet FCA expectations. This may include reviewing and better documenting internal governance such as committee terms of reference, reporting lines and job descriptions of senior management. It often also results in a shift in the documented approach to the identification, monitoring and management of risks; especially ensuring that those of interest to the FCA are appropriately defined and integrated into day-to-day practice.