As popular and profitable as this industry might look, as we depicted in the first article of this series, the BNPL providers are still into a regulatory grey area that needs to be addressed as early as possible. Moreover, there is a need for a better understanding of how these services work and how can they best fit into a regulated environment, as there are a couple of scenarios where consumers are not fully protected when applying for pay later services. Therefore, we describe the current regulatory context and the associated risks.
Regulations around the world
Although in several countries regulations in this field are well studied, the enforcements are still pending. So for the sake of offering accurate information about how regulation currently looks, here are the state of affairs in this matter in the three corners of the world: the UK, US, and Australia.
UK
At the beginning of 2021, the Financial Conduct Authority (FCA) stated that ‘billions of pounds were being lent in unregulated transactions’ and that more than 10% of consumers who had used a BNPL option were already overdue. To prevent having a large part of the population at financial risk, FCA’s former interim chief executive Christopher Woolard suggested that BNPL products should become subject to FCA credit rules, requiring providers to carry out a hard credit check and affordability test when customers opt to pay in instalments.
However, although there might be multiple types of BNPL products, those offered by the well-known players don’t require a credit agreement simply because it’s not a credit service, so they can be exempted from regulations for consumer credit lending. As instalments plans work, consumers can pay throughout no more than a year, in 12 or less instalments, and in many cases with no interest or other fees involved. So the article 60F(2) of the Regulated Activities Order (RAO) for credit agreements does not apply to BNPL services, for this reason, the FCA recommends bringing into regulatory scope those arrangements that currently fall outside it. The British government has said the legislation will be tabled as soon as parliamentary time allows, and it’s been said that it may take two or more years for the law to change.
Tighter restrictions on short-term credit are likely to have an impact on sales, which will be felt strongly by the merchants for whom BNPL has been a major driver of customer conversion. In any event, legal advisors believe an alignment with the regulated consumer credit sector is inevitable for BNPL.
US
Although most of the discussions regarding BNPL regulation revolve around the UK, there is a need for more discipline and transparency in this space in the US as well. According to a study by Credit Karma, 40% of US consumers who used BNPL have missed more than one payment, and 72% of those saw their credit score decline.
Fitting BNPL into the US regulations is relatively challenging since laws vary by state. Overall, BNPL schemes are regulated by federal and state laws under consumer credit regimes, depending on the different definitions of credit covered by those laws. The credit reporting system in the US is also leveraged for BNPL. Lenders may consult credit reporting bureaus to check the credit standing of the purchaser, which credit checks are subject to regulation under the US Fair Credit Reporting Act. In more general terms, credit checks, ‘as an indication of ability to repay, may serve as a proxy for an assessment of affordability, but they have not been recognized as such’. Moreover, the loan regulations in the country can’t be fully applied to BNPL providers, because they don’t make loans per se to consumers, but they facilitate and support the instalment plans, on behalf of the customer.
At the beginning of the year, some tensions occurred in California. The California Department for Business Oversight (DBO), a division of the state government that regulates financial services, has taken over several cases focused on BNPL services. BOD refused to grant Sezzle a Financing Law license to carry out its operations. As well, in March 2021, DBO accused Afterpay of collecting taxes from more than 640,000 Californians in transactions that were in fact ‘illegal loans’. As a result of the settlement, Afterpay, which had 5.6 million active users in the US as of June 30, 2020, was forced to return USD 900,000 to consumers and pay USD 90,000 in administrative fees.
Australia
Based on ASIC data, the number of transactions increased in the country from 1.9 million in June 2018 to 3.4 million in June 2019, representing a surge of 75%. What’s more, the number of BNPL accounts had climbed to 6.1 million by June 2019, representing 30% of the nation's adult population, yet 21% of BNPL users missed a payment in the last 12 months.
BNPL providers enjoyed a relaxed regime in Australia, as the provisions of the Australian National Consumer Credit Protection Act of 2009 do not apply to certain types of loans, including short-term interest-free credits. The industry has eventually adopted a self-regulatory approach. The Australian Finance Industry Association (AFIA) announced on the 1st of March 2021 that its Code of Practice for the BNPL sector has come into effect. According to their statement, ‘AFIA’s BNPL Code goes above and beyond the law in Australia, setting best practice standards for the sector and strengthening consumer protections. It does this while preserving customer choice to make purchases and payments in a way that suits their needs and preferences.’
BNPL providers that are compliant with this Code must carry out assessments before a customer can make a purchase and conduct additional checks to prevent consumers from stretching their arm further than their sleeve will reach. BNPL disputes under the code will be managed by the Australian Financial Complaints Authority, where a designated committee will have the power to publicly denounce companies that provide loans services outside the Code’s standards.
Europe
At the European level, several policymakers believe that BNPL providers (in particular Klarna) fall short of consumer ethics principles. Secretary-General of the Swedish Consumers' Association, the European consumer rights group BEUC, Austrian consumer organization Arbeiterkammer are a few entities that questioned the way BNPL companies meet their liabilities in terms of obligations against the law. The EU’s Consumer Credit Directive rules of which are currently under review by the Commission, and adoption of the consumer credit review is planned for the second quarter of 2021.
The risks
The need for more regulation occurred as a result of several risks observed on the consumer side. People are looking to better manage their cash flow, and some people don’t even qualify for a credit card, both categories choosing the next available option for shopping, which is BNPL. But some of them either go overboard and end up in debt, or they simply forget to pay because the instalment plans are hard to track.
Simon Taylor of 11:FS believes that Open Banking could be a good option to gain affordability insights, as well as effectively educating consumers more could contribute to a better understanding of the associated risks. Further to this premise, open baking can indeed help more than credit bureaus do. Open Banking data consist of the latest consumers’ financial information, which may allow a fast, frictionless and accurate credit check.
There are also risks on the merchant’s side, such as those depicted by Equifax:
Instalment payment options are attractive for both genuine and illegitimate parties, either consumers or merchants, because where’s an opportunity, there’s always a risk. For now, setting the reliability of those involved in the process it’s more like an experience curve.
With a stricter regime in place, providers will find it challenging to stand out from other instalment services that merchants already offer standalone, or via credit card issuers. For instance, banks, that are already regulated entities, could remove fees on low-balance cards and introduce their own interest-free cards, and further compete with BNPL providers. In the long term, both merchants and BNPL companies should rethink the way their business model fits into a more regulated environment.
This article serves as a summary and is for educational purposes only. It is not intended to offer legal advice.
About Anda Kania
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