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Eddie Flanagan

Partner, Shakespeare Martineau

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The draft legislation proposed that consumer complaints about BNPL loans would be handled by the Financial Ombudsman Service

Debt or innovation? BNPL's explosive growth and regulation

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Debt or innovation? BNPL's explosive growth and regulation

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Eddie Flanagan delves into the challenges and implications of regulating the burgeoning Buy Now Pay Later sector

The Buy Now Pay Later (BNPL) sector has been under scrutiny since it exploded onto the UK’s financial scene, largely as a result of the pandemic. Although not a new phenomenon, BNPL increased in popularity during COVID which revolutionized the way that people work and shop.. Due to the ease of online shopping through the pandemic, this trend continued post COVID and has now become the norm. Figures show that the BNPL market has more than quadrupled in size since 2020 and it is expected to reach a record total of £30bn this year. This situation has been exacerbated by the cost of living crisis which has prompted even more people to turn to BNPL providers like Klarna to help manage their finances and spread-out payments and as a result, there has been a number of questions around how BNPL companies need to be regulated, and what this regulation should look like.

Just recently it was reported that Citizens Advice was urging ministers to regulate the sector, after figures showed that UK consumers spent £1.7bn a month online using such BNPL agreements. In many cases it has been suggested that BNPL has taken the place of payday loans for people wanting to spread their outgoings more manageably. And whilst the rates of interest are undoubtedly lower for BNPL loans, there are still fears around vulnerable customers chalking up uncontrollable levels of debt.

However, it is a balancing act between protecting the consumer and stimulating innovation in the sector.

The History: BNPL regulation

Regulating the BNPL sector has certainly been in the sights of the UK Government in recent years, and at the start of 2023 , it was looking increasingly likely. Following a two-year consultation process, the government released draft legislation as a Valentine’s gift, on February 14, granting the Financial Conduct Authority (FCA) the authority to regulate companies offering certain types of interest-free installment credit to consumers. This move was in response to the concerns highlighted in the Woolard Review, which pointed out that most BNPL firms and products were unregulated, depriving borrowers of the consumer protections required in regulated lending products. With this draft legislation, the government proposed that lenders providing BNPL products would need to be authorised by the FCA, thereby significantly expanding the FCA’s jurisdiction. Even after lengthy consultation, the Government has still not published its response and there is still no further movement on when or if this legislation will ever come to fruition, with the matter debated again before parliament on 7 February this year. Given the impending general election, the current state of play looks set to remain for the immediate future.

Data from Adobe Digital Insights, which monitors hundreds of millions of retail transactions monthly, shows that "buy now, pay later" agreements made up over £1 of every £7 spent online during the first quarter of 2024.

Kicked into the Long Grass

However, despite the evident demand for this legislation, reports emerged that the Treasury had decided to postpone its implementation. Sky News suggested in July 2023 that this decision might have been influenced by recent discussions with the BNPL industry, which warned that "a number of its biggest players could quit the UK market if subjected to 'heavy-handed' regulation." Since then, campaigners have continued to fight for more legislation and it remains to be seen if this issue will be picked up again post-General Election. Labour has made BNPL regulation a pledge in its election manifesto, creating a dividing line with the Conservative party, saying it will ‘bring forward long overdue consumer protection regulation in areas like buy now pay later.’ However, whilst it is of course very important to protect consumers from getting into huge amounts of debt, the legislation which was being discussed was not perfect.

The draft legislation proposed that consumer complaints about BNPL loans would be handled by the Financial Ombudsman Service (FOS). Recently it was reported that the FOS is already fielding hundreds of complaints about BNPL, and this number is rising, although this body is not officially responsible for fielding these complaints. However, there is debate about the practicality of this suggested arrangement. Some have raised concerns about how the FOS would manage a potential surge in consumer complaints. Additionally, the cost to providers for each complaint, which is significant, was not addressed in the legislation.

There are also fears that increased regulation in the BNPL sector would drive some providers away from the UK, leaving consumers with less choice and potentially a worse deal.

Existing regulation: enough for BNPL?

However, BNPL companies are not operating in a completely lawless environment and we are still seeing significant regulatory changes impacting how BNPL providers operate. Last summer (July 2023) we saw the FCA’s Consumer Duty rules come into force. This duty raises the standard to which firms and financial service providers, including BNPL firms, must act in regard to their customers. They must communicate openly, with full transparency and honesty about the services they provide.

In response to the FCA’s Consumer Duty rules, BNPL companies have started to reassess their customer communication strategies to ensure consumers are fully informed about the financial risks associated with accumulating credit. This is a beneficial move for both consumers and providers, as it offers greater protection for vulnerable customers against debt and safeguards providers from potential losses. Since this duty is outcomes-based, BNPL firms must be meticulous in making necessary changes to meet the required standards, or they risk facing significant fines and substantial reputational harm.

As with so many innovations, legislation and regulation can be slow to catch-up to the everyday realities. As mentioned, it remains to be seen if the draft BNPL regulations are revisited. However there is hope that the significant regulation for BNPL providers via the Consumer Duty should reduce the number of consumers falling into debt over the long term, benefiting both firms and consumers at a time when financial risks for both are increasing. So a question remains: is more regulation the answer? Or do we risk over-regulating the sector and creating new issues? What is clear is that while BNPL has been an effective and popular way for many consumers to obtain credit, it is not without risks, as the recent figures show more and more people are increasingly relying on BNPL to help make ends meet. There is no doubt that BNPL providers should comply with existing regulations and also consider introducing enhanced consumer protections, such as additional screening measures to assess consumers' credit risk. This would not only prevent vulnerable people from falling into debt but also benefit the providers, and the BNPL market as a whole.

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