Alexandra Leonards explores what regulation might mean for the future of Buy Now Pay Later and looks at how the market has responded to the government’s decision to green-light new rules.

Last year saw the UK’s Buy Now, Pay Later (BNPL) market almost quadruple, driving its value up to £2.7 billion. Data from Klarna, one of the world’s fastest-growing alternative payments firms, found that instalment financing can increase average order value by up to 58 per cent, and boost conversion rates by 30 per cent.

But the apparently boundless growth and success of the payment-by-instalment method has come at a price for many of its five million British users. More than one in ten customers of a major bank who use the payment service in arrears, highlighting the need for government legislation to protect consumers.

The recent publication of the Financial Conduct Authority’s (FCA) Woolard Review, which calls for stricter boundaries on Buy Now Pay Later services, has finally prompted the government to take action to regulate providers. But what will this mean for BNPL companies and their retail partners?

Impact on retailers

Many questions have been raised about who will take responsibility for credit checks and whether retailers will need to be authorised for credit broking once formal regulation is rolled out.

The FCA says that it expects a consultation around these queries in due course, but that it’s too early to say what this will look like. But the authority has proposed a “proportionate regime” for retailers.

Now that the government has given the go-ahead, the FCA will work with the Treasury on amendments to existing legislation. Next the FCA has to develop a “proportionate regulatory framework” that addresses how credit information will be dealt with in the market.
Although it’s not been confirmed, the FCA recommends that partner retailers should be authorised for credit broking.

“A number of the harms set out [in the review] relate to the presentation of the BNPL offers which in most cases will be on a retailer’s website,” says the FCA. “It’s therefore important retailers are subject to appropriate high-level regulation to ensure they treat consumers fairly.”

But it points out that many larger retailers that already provide regulated credit and account for a significant number of retail transactions are already authorised.

“However, beyond these, the main BNPL providers partner with many hundreds of retailers, which vary in scale and sophistication,” it says. “It will therefore be important to ensure the regime applying to retailers is proportionate and options are available to them. Retailers could, for example, fall under the Appointed Representatives Regime rather than having to seek direct authorisation.”

The FCA predicts there may be some retailers that do not want the responsibility of being authorised and that they might withdraw from the market altogether.
“This is likely to be a positive measure that improves consumer protection,” says the FCA. “This will need to be considered in the round in any future implementation consultation the FCA undertakes.”

Because BNPL providers are also looking to expand beyond their online offering, there will also likely be regulation around the service in-store.

“BNPL providers and retail partners will also need to ensure in-store staff are not incentivised to encourage inappropriate use of BNPL products,” says the FCA.

The role of BNPL providers

The FCA says it’s too soon to say what the regulatory regime for BNPL providers will look like, but there are some clues in the authority’s review.

If recommendations in the review are carried out, BNPL providers would have responsibility as the principal for “ensuring compliance with the relevant rules.”

As it stands, most Buy Now, Pay Later companies complete a basic credit assessment by using a mixture of soft credit searches and previous payment history. But the FCA warns that this focuses on credit risk, rather than affordability.

“Many providers rely on lending once and seeing if they are repaid as a means of managing their risks, rather than a wider attempt to consider affordability,” the authority says. “Most providers apply limits to the amount of credit they’ll extend in the first instance and won’t allow consumers to continue using their product if missed payments are outstanding.”

But this doesn’t stop customers looking for credit from alternative providers.

According to the review, one major UK bank found that of 677,000 personal current account customers who made a payment to two of the big BNPL providers in November last year, 10 per cent exceeded their overdraft allowance in the same month.

Once legislation is brought forward, it’s likely there will be enforcement of proper affordability checks before credit is given to consumers.

The FCA has also recommended a scheme focussed on how lenders treat customers that do get into financial trouble.

Market response to regulation

Reactions to the government’s commitment to enforce regulation have been fairly mixed.

“As a fully licensed bank, Klarna is very comfortable operating in a regulated environment and wholeheartedly supports the regulation of the Buy Now, Pay Later sector in the UK,” says Alex Marsh, head of Klarna UK. “We agree that regulation has not kept pace with new products and changes in consumer behaviour and it is now essential that regulation is modern, proportionate and fit for purpose, reflecting both the digital nature of transactions and evolving consumer preferences.”

Earlier this month, Damian Kassabgi, Clearpay’s executive vice president for public policy, told fashion publication Drapers that although the approval of regulation came at an appropriate time for the market, new rules must be “proportionate.”

“Changes in the types of credit information available and new analytical tools could mean prescriptive rules become unnecessarily rigid, requiring frequent updating or putting barriers to innovation or access to credit,” he said.

While managing director of Laybuy, Gary Rohloff, told the fashion publication that there needs to be a balance between protecting consumers and ensuring BNPL “retains the innovation and simplicity that consumers value.”

But Howard Rees, principal consultant at Capco, says that FinTechs have repeatedly shown that highly regulated industries can still deliver streamlined and accessible customer experiences.

“If the current crop of BNPL providers can’t develop solutions that are both compliant with incoming regulation and still delight customers, there will be new FinTechs that will,” he warns.

Rees says the UK is a leading FinTech hub and that this wouldn’t be possible without a “market and regulator that supports innovation.”

Some have said that introduction of red tape could put some retailers off extending the service to customers.

Responding to the possibility of scaring away retail business, the FCA says: “It remains a decision for retailers whether they choose to continue to offer these products, but given the potential risk of harm the report considers that it is important that this these risks are addressed as a matter of urgency by bringing BNPL into regulation.”

There isn’t much clarity about when the new regulation will come into force. But Christopher Woolard, chair of the review, says that he hopes the legislation is rolled out in a matter of months rather than years. In the meantime, retailers are encouraged to put in place proper credit checks and join credit agencies.

Only time will tell the regulator's approach, but what is certain is that Buy Now, Pay Later will likely look very different when regulation is finally enforced.

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