On 14 February 2023, HM Treasury (HMT) released its final consultation and response to its earlier (second) consultation, together with a draft statutory instrument on the proposed legislation that would bring firms offering currently unregulated buy-now-pay-later products (BNPL) or short-term interest-free credit products (STIFC), within the financial services regulatory perimeter.

Having been on the cards for several years, this announcement now sets the contours of the framework for the regulation of a sector of the market which continues to grow and grow.

One of the key questions which firms across the BNPL sector, including the multitude of merchants who partner with BNPL/STIFC providers to support the purchase of their goods and services are now asking themselves is: what does this all mean for me? This briefing note seeks to answer that question, and to identify the features of this new framework. HMT has been clear that it wishes to create a proportionate regulatory framework, recognising the particular use cases to which BNPL is applied. Of course, how far this will be achieved in practice will depend not only on the way in which lenders and merchants can adjust their arrangements and systems to meet the tailored provisions of the Consumer Credit Act 1974 (CCA), but also how the FCA calibrates the wider rules and guidance with which firms will need to comply.

Changes and impacts 1: Who's in and who's out?

HMT have confirmed that this new regulatory framework will cover BNPL or STIFC agreements that are offered by third party lenders only. The draft legislation provided by HMT seeks to amend Article 60(F) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO), which would, if the proposed changes take place, regulate agreements where they are borrower-lender-supplier agreements for a fixed sum credit provided to individuals or relevant recipients of credit which are: (i) interest-free, and repayable in 12 or fewer instalments within 12 months or less; (ii) where the credit is provided by a person that is not the provider of goods or services which the credit agreement finances (i.e., a third-party lender); and (iii) does not fall under one of the existing or new 'exempt agreements' provisions mentioned below.

This represents a substantial divergence from the current regulation in place for BNPL/STIFC lenders. Currently, where such BNPL/STIFC agreements meet the requirements of Article 60(F)(2) RAO, the lender need not be authorised by the FCA to enter into the agreement. The impact of changing the regulatory regime in accordance with that set out in the draft statutory instrument will mean that third party lenders who offer BNPL or STIFC products will be required to be authorised by the Financial Conduct Authority (the FCA) and will be required to comply with many more provisions of the Consumer Credit Act 1974, as well as the FCA's regulatory regime as further explored in section 2.

For merchants who provide BNPL/STIFC themselves, this consultation will provide some welcome relief. It was already clear that 'in-person' transactions between customers and merchants who provide their own BNPL/STIFC would not be in-scope of the new regulatory regime. In this latest consultation, HMT has confirmed that it will not include merchants who provide BNPL/STIFC online, or otherwise at a distance, either. This does not mean that such lenders are outside the scope of regulation entirely, however as other aspects of the wider legal and regulatory framework will continue to be relevant, including anti-money laundering legislation, the financial promotion restriction and consumer protection law, including the Consumer Rights Act 2015.

HMT have additionally included an anti-avoidance mechanism in a new paragraph 7A(b) in Article 60F RAO as set out in the draft statutory instrument to ensure that third party lenders who finance purchases from a merchant where the merchant has an arrangement with the third party lender to sell the goods to the lender at the point when the agreement is taken out, will be in scope of the Article 60(F) reforms and fall within the new regulatory perimeter.

There are, however, a number of new provisions which serve to 'exempt' particular types of credit agreements from falling within scope of the new framework for BNPL/STIFC.

Some of the key new provisions are those which will exempt credit agreements which meet the current Article 60F(2) requirements and which finance premiums for contracts of insurance.

For credit broking arrangements, the draft statutory instrument inserts a new Article 36FB into RAO so that merchants who introduce their customers to credit agreements which will otherwise be brought into regulation as a result of the changes, will be exempt. However, domestic premises suppliers will fall within the scope of regulation if they wish to offer newly regulated agreements from a third party lender as a payment option. The draft statutory instrument defines a "domestic premises supplier" as one that sells goods, offers or agrees to sell goods, or offers or contracts to supply services, to individuals while the supplier or the supplier's representative is physically present in the customer's home.

HMT had already indicated that it did not intend that the new regulatory framework for BNPL/STIFC should cover 'trade credit'. The intention to limit the scope of application to third party lenders is seen by HMT as consistent with this position, since most 'trade credit' in these terms would be provided by the merchant, rather than a third party lender. Clearly, where such credit is provided to an individual or 'relevant recipient of credit' the provisions of (present and future) Article 60F(2), RAO will need to be complied with, unless other 'exempt agreements' provisions apply to the relevant credit agreement (for example those at Article 60C, RAO – concerned with business lending for amounts exceeding £25,000).

Finally, it's worth noting that the draft statutory instrument does not amend Article 60F(3) RAO which provides an exemption for certain types of interest-free running account credit. The Government is of the view that changes to this exclusion are not required as lenders would not be able to replicate the effect of Article 60F(2) lending under the Article 60F(3) exemption, though clearly there will be close scrutiny of this.

Changes and impacts 2: Authorisation

a) Lenders

Third party providers of BNPL or STIFC who are not currently authorised, will now need to become directly authorised by the FCA to enter into regulated credit agreements as lender; and to exercise (or have the right to exercise, the lender's rights and duties under such an agreement).

The consultation states that current credit permissions will cover the activity that is being brought into the scope of regulation, and so authorised firms who have the above permissions will not need to seek a variation of permission. However, currently unregulated agreements will become regulated after 'regulation day' (which is discussed further below) and firms will need to administer them as such.

b) Merchants

Generally, where a business introduces an individual or relevant recipient of credit to a lender for the purpose of entering into either a regulated credit agreement or certain types of 'exempt' credit agreement, this is deemed to be credit broking, which is a regulated activity.

Under the existing framework, merchants need not be authorised to introduce customers to a lender for the purpose of the lender entering into, with that customer, a credit agreement which is 'exempt' pursuant to provisions at Article 60F(2), RAO.

HMT, however, has noted that it would be disproportionate, and could increase the costs on retailers and potentially lead them to stop offering relevant credit products, to require such a retailer to become authorised by the FCA to introduce customers to lenders providing (newly regulated) BNPL or STIFC credit products. It has been confirmed that such merchants will continue to fall outside the scope of regulation. It is also worth noting that merchants who act as 'domestic premises suppliers', and introduce customers to lenders providing BNPL or STIFC will not benefit from this continued 'carve out' and will be required to obtain FCA authorisation.

Clearly, where a merchant makes other forms of regulated credit (e.g. interest-bearing) available at point of sale, this may (as now) require authorisation for credit broking.

c) Temporary permissions regime

For those firms that will have to become authorised, HMT is proposing the creation of a temporary permissions regime (the TPR), in which firms can continue to operate ahead of authorisation by the FCA, provided they register in a window which will likely be set by the FCA. Currently, the intention is that firms will only be TPR-eligible if they (a) engage in an activity, which will become a regulated activity on regulation day; (b) register for the TPR prior to regulation day; and (c) pay a non-refundable registration fee. Should a firm not register by the time set out by the FCA, it will not be able to continue with the newly regulated activity on or after 'regulation day'. 'Regulation day' is the day regulation commences and which firms in the TPR will be deemed to have Part 4A permission (until their temporary permission is approved, refused, withdrawn or if the firms misses its slot). It is important to note that during the TPR, the FCA will be able to supervise firms and take enforcement action against them and so it will be important that unregulated firms prepare themselves accordingly.

Changes and impacts 3: The tailored application of the CCA to BNPL

HMT, in its consultation provides that the pre-contractual requirements set out in section 55, CCA will be dis-applied for new credit agreements that fall within the scope of regulation as a result of the proposed changes. The practical effect of this would mean that newly regulated BNPL or STIFC agreements would not need to comply with the Consumer Credit (Disclosure of Information) Regulations 2010 (CDIR), and instead third party lenders of BNPL or STIFC products would be required to comply with the relevant FCA rules on pre-contractual disclosures for credit agreements. The FCA will consult on the tailoring of these rules following this consultation to align any pre-contractual information disclosures arising from the newly regulated credit agreements with that set out in CONC.

Importantly for authorised lenders providing BNPL alongside other (currently) regulated products, HMT has clarified that lenders who currently provide pre-contractual information for other products in line with the requirements set out in the CCA, can, if they wish, provide information in a comparable format for BNPL or STIFC agreements which are newly regulated as a result of the reforms, provided, such information is fair, clear and not misleading and does not breach the FCA's rules on providing pre-contractual information for such products.

Although the CDIR requirements would not apply for pre-contractual information disclosures, newly regulated agreements under the reforms would be required to comply with requirements for regulated credit agreements in the Consumer Credit (Agreements) Regulations 2010 (the CCAR). The Government is of the view that having a prescriptive framework on the form and content for newly regulated agreements would strengthen consumer protection by ensuring that consumers are given the information they need to make effective decisions on whether to take out such an agreement, and to understand their ongoing obligations under the agreements. Clearly there will be challenges to the operation of these requirements, and newly authorised lenders will wish to take particular care to ensure that all of the various elements to compliance with the CCA, and the CCAR in this respect are observed. This is likely to have some significant implications for customer journeys and point of sale processes.

HMT is further proposing that the small agreements provision in section 17 of the CCA be dis-applied for newly regulated agreements. This is because many of the BNPL or STIFC products that are offered by third party lenders are for sums less than £50 which would allow lenders to rely on section 17 of the CCA to circumvent certain CCA requirements targeted at protecting consumers. The Government believe that consumer protection should be consistent across all BNPL or STIFC agreements, regardless of the sum of credit extended to the consumer.

Further, the provisions on post contractual notices under the CCA will apply to BNPL or STIFC agreements. The requirements (which oblige lenders to send notices of sums in arrears in accordance to specific form and content requirements at a specific time frame after the consumer has gone into arrears) have been critiqued as requiring revisions to the legislative framework for these agreements given the short-term nature of such agreements, however, the Government is of the view that no legislative change is needed at this stage and such considerations may be revisited during the wider CCA reforms.

It is important to remember that as a result of the new regulatory regime for BNPL or STIFC agreements, consumers are afforded protections granted by the CCA that go beyond those mentioned in detail in the consultation. This includes section 75 of the CCA which provides for a consumer to raise a claim against the lender if they use a point of sale loan to buy goods or services. HMT has confirmed that the monetary thresholds will not be amended for newly regulated agreements meaning that section 75 will continue to not apply to claims relating to a single item to which the supplier of goods and services has attached a cash price of less than £100, or more than £30,000. Outside of these thresholds where a consumer of a BNPL or STIFC agreement provided by a third party lender uses the funds to purchase goods or services, they will be able to raise a claim against the third party lender.

Additionally, under section 140A and 140B of the CCA the court may make an order if it determines the relationship between the lender and consumer is unfair as a result of any terms of the underlying agreement, or any action done by the creditor which may allude to an unfair relationship being present which is detrimental to the consumer. Third party lenders who are caught under the proposed reforms when offering BNPL or STIFC products must ensure that their agreements are fair and not detrimental to the consumer in order to avoid terms being deemed unenforceable on account of fairness at a later date. Terms that may be unfair, include but are not limited to, unbalanced terms that are heavily in favour of the lender, terms which give the lender wide discretion at the consumers detriment to exercise obligations under the agreement, or terms which provide for the lender to vary the agreement unilaterally without the consumers input or consent.

Of course, lenders will find themselves subject to wider FCA rules, too (some of which are explored further in this piece) and the prospect of individual accountability for senior managers of BNPL firms which will be a significant new development.

Changes and impacts 4: Financial promotions

The regulatory regime in relation to financial promotions is set out in the Financial Services and Markets Act 2000 (FSMA), the FSMA (Regulated Activities) Order 2001 and the FSMA (Financial Promotion) Order 2005. Under these regulations, unauthorised individuals are prohibited from communicating an "invitation or inducement" to engage in investment activity unless certain criteria are met. However, under this existing regime, an unauthorised merchant that offers the newly regulated agreements of a (newly authorised) third-party lender as a method of payment would not be subject to the general restriction on financial promotion.

In this consultation, HMT has confirmed its intention that unauthorised merchants offering BNPL as a payment option will no longer be able to rely on this existing provision in the future. Instead, they will be required to have financial promotions approved by an authorised person (the person in question could, but does not have to, be their lender partner). In practice, rather than requiring merchants' financial promotions to each be individually approved, the intention is that third-party lender partners will be able to provide merchants with pre-approved materials. Clearly, however, given the ambit of the financial promotion restriction which can include 'real time' communications and the consequent challenges concerned with any 'approval', this will be an area that merits close attention from both lenders and merchants to ensure that approval arrangements are not only compliant on paper but in practice. For newly authorised lenders, there will be a requirement (in light of other reforms to the financial promotions regime in the UK) to obtain a specific permission to approve financial promotions for third party merchants. Lenders should not underestimate the scale of the arrangements, systems and controls (particularly from a governance perspective) which will be required to meet FCA rules in this regard.

Changes and impacts 5: Affordability

The existing FCA rules regarding affordability are set out in the Consumer Credit sourcebook and apply to regulated consumer credit agreements. The consultation has confirmed that it will be up to the FCA to set out the approach on creditworthiness assessments for BNPL agreements. In this consultation, HMT note that the FCA will decide how the current rules should be 'tailored' for these products, indicating that there may be some modification of these rules for BNPL lenders, details of which we can expect to emerge in due course.

One of the perceived concerns with BNPL products is the risk that consumers accumulate unmanageable debt and so the creditworthiness rules are likely to be seen as an important barrier from this occurring. How these rules will work with a business model which has a customer offering based on speed and seamless integration remains to be seen, and it will be important for lenders to follow closely the FCA's response on this as part of its consultation, as it will potentially reflect one of the bigger operational challenges arising from this reform.

Changes and impacts 6: The FOS

As part of the consultation, it was confirmed that customers will be able to complain to the Financial Ombudsman Service (the FOS) about these types of agreements, if required. In previous consultations stakeholders highlighted concerns about the £750 FOS case fee, which it was argued is disproportionate to the amount of the typical BNPL transaction which is relatively small in nature. For lenders who have raised this concern and for whom the FOS jurisdiction will have potentially fundamental business model implications, HMT's response is unlikely to give much comfort – specific case fees are for the FOS to determine, and the outcome of FOS decisions (particularly in view of the associated rules in the Dispute Resolution sourcebook) will be of equal, or greater significance. That said, HMT has committed to raise the issue of case fees with FOS, whilst accepting that they remain at the discretion of the FOS.

The ability for customers to complain to the FOS – and where necessary, receive redress – is an important consumer protection for borrowers. What this means for BNPL lenders however, is that, in due course, they will have to familiarise themselves with the FOS' framework and approach, as well as ensure that their complaints policies and procedures reflects customers' rights to complain in this way.

Changes and impacts 7: Data, information sharing and credit reporting

HMT has further confirmed its intention that there should be 'clear, consistent and timely' credit reporting of the newly regulated agreements, and that this should be across the three main credit agencies. One criticism of BNPL is the lack of visibility on the loans on credit files, which impacts on other lenders when they are making assessments of whether to lend to a customer or not. Whilst the detail of what this looks like remains to be seen, the consultation has confirmed that BNPL lenders will be expected to report these transactions. In time, other lenders will have sight of these loans.

Changes and impacts 8: Customer journeys and the UX

Many BNPL providers will now be working through the impacts of this reform together with advisers to understand the impacts on customer journeys and the need to develop new systems, for example around affordability (accommodating both 'affordability risk' and 'credit risk').

Firms beginning this work would be well served by reviewing the totality of the new regulatory requirements to which they will be subject. In particular, the FCA's new 'Consumer Duty' marks a fundamental change in the regulation of products such as consumer credit, with new expectations around the role of friction in digital customer journeys. There is important read across to BNPL products for many aspects of the Consumer Duty, and customer engagement with the product, the ease with which they can take it up, and their ability to understand potential risks (a principal one here being non-payment risk and its consequences for the borrower) is a key focus.

These new requirements for BNPL are likely to have a major impact on the ways in which lenders construct customer journeys around point of sale which could affect the way that consumers engage with the product, when presented with other payment options.

The message here for lenders and merchants is that the development of new systems to accommodate not only the legal requirements of the CCA (as 'tailored' to BNPL) but also the FCA rules and guidance to which the product will be subject should begin now. The requirement that all BNPL providers meet applicable legal and regulatory requirements on 'regulation day' rather than at point of authorisation means that there may, in fact be a lot of work to do in short order. As set out below, the details of the transitional period are not yet known.

Changes and impacts 9: The Consumer Credit Market

Clearly, the reforms bringing BNPL and STIFC agreements provided by third party lenders into scope of the financial services regulatory regime will result in major changes to the provision and use of these products by lenders and consumers. Some lenders may exit the market when faced with stringent authorisation requirements and compliance frameworks, potentially impacting competition in the sector, customer choice and overall credit provision in the UK.

New affordability assessments applicable to BNPL and STIFC agreements could also reduce the penetration of these products. The 'Woolard Review', published in February 2021 whilst raising the concern around potential affordability risks, did also acknowledge that the BNPL sector can be viewed as a credible alternative to 'pay day loans' and clearly HMT is seeking to design a regime which appropriately mitigates potential customer harms from use by those who cannot afford repayments, but does not inadvertently result in other detriment.

Given recent research concerning the continued uptake of BNPL and STFIC, including amongst older borrowers, the regulation of BNPL will undoubtedly become a key strategic priority and challenge for the FCA. As the regulator responds to the cost of living crisis with new guidance for currently regulated lenders surrounding forbearance, the fair treatment of borrowers and of course the new Consumer Duty, the wider consumer credit market in the UK is likely to move through a number of structural adjustments in the coming two years.

Changes and impacts 10: Timeline to the new regime

The consultation will remain open for 8 weeks, and close at 11:59pm on 11 April 2023. While further dates have not been provided, once feedback has been considered and any amendments made, a consultation response setting out the key milestones for the BNPL reforms will be published. Following this, the FCA will publish a consultation on its proposed rules for firms which provide agreements that the legislation will bring into regulation. The current aim is for legislation to ultimately be laid later this year.

Once the amending legislation is made, a transitional period will begin, during which firms will be able to familiarise themselves with the new regime and make any necessary changes ahead of the final date on which the regulations will come into effect ('regulation day'). On regulation day, a TPR for which firms will have to register will be put in place (the details of which will be set out in full in the FCA's consultation on its proposed conduct rules).

Clearly, this is a major reform with far reaching consequences from both a legal, regulatory and commercial perspective for market participants. We will continue to monitor developments closely as further details emerge.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.