Buy Now Pay Later – how does it work and is it regulated?

What is BNPL?

BNPL allows a customer (who could be a consumers or a business) to pay for goods or services purchased from a merchant on a deferred basis. This typically means that the purchasing customer pays for the goods or services over one or more instalments (for example, splitting the cost of a £500 phone into 5 instalments of £100).

The success to date of BNPL services can be explained by the incentives for both customers and merchants:

• customers are able to pay for goods and spread the cost over multiple instalments (often without paying any more than if they had paid for the goods or services immediately); and
• merchants can achieve higher sales by attracting customers who could not, or would not, purchase the goods or services by paying the full amount immediately.

How does BNPL operate?

There are many models for BNPL and it is not possible to summarise all models in this article. In general, BNPL models can be distinguished as follows:

• those models where the merchant itself provides the BNPL service to the customer and so assumes the credit risk (Merchant Model); and
• those models where the merchant works with a third party provider (BNPL provider) who provides the BNPL service to the customer and that BNPL provider assumes (at least some) of the credit risk (Partner Model).

The Merchant Model and the Partner Model operate differently and each is explored below.

How does the Merchant Model operate?

The Merchant Model is relatively straightforward. The merchant enters into an agreement (which may or may not be the same agreement as its terms of sale) with the customer under which the customer may pay for the goods in a number of instalments. Typically no interest is charged although interest is sometimes charged if the duration of the instalments is significant.

How does the Partner Model operate?

The Partner Model can be setup in different ways but ultimately it is the BNPL provider, and not the merchant, who is providing the BNPL solution to the customer. An example of how the Partner Model may operate is set out below:

1. A customer who wishes to purchase goods or services from the merchant will see “pay by instalments using [BNPL provider]” wording on the checkout page.
2. The customer will select this payment method (rather than paying immediately with a debit card for example) and will be taken to the BNPL provider’s site. Here, the customer will enter into an agreement with the BNPL provider under which the latter will pay for goods on instalment (perhaps up to a certain credit limit). The customer will typically provide their payment details to the BNPL provider. The BNPL provider may carry out a credit check on the customer.
3. The customer will return to the merchant webpage to complete their purchase. Typically the first instalment will be taken by the BNPL provider at this point.
4. The BNPL provider will then (either immediately after completion of the payment or within a certain period of time) pay the full amount of the purchase to the merchant but minus a discount (which represents the BNPL provider’s fees).
5. The BNPL provider will collect the remaining instalments directly from the customer.

There is often, although not always, a contract between the merchant and the BNPL provider. This will address the discount charged by the BNPL provider, whether the merchant should, at least in part, be liable for any instalment plans for which the customer fails to pay and any issues relating to regulatory compliance.

The Partner Model can be structured in other ways. For example, in some cases the deferred credit is provided by the merchant itself and then the merchant sells this claim (which it has against the customer) to the BNPL provider.

Regulatory issues for BNPL

The BNPL model presents a number of potential regulatory issues for merchants and BNPL providers to consider:

Consumer credit regime

As the BNPL models involve the provision of credit (as the customers are permitted to pay later than they otherwise would), there is a risk that these arrangements could fall within the scope of the UK’s consumer credit regime. Falling within the UK’s consumer credit regime means that (1) the person would require a regulatory authorisation from the FCA or PRA, (2) the person would have to comply with the consumer credit rules imposed by the FCA and (3) the requirements of the Consumer Credit Act 1974 would apply meaning that mandatory disclosures must be made and that the credit agreement must include prescribed wording.

The UK’s consumer credit regime is complex but in general the following two types of activity will fall within scope:

• entering into a credit agreement as lender where the borrower is an individual or ‘relevant recipient of credit’ (which, broadly speaking, is an unincorporated partnership or association) (regulated lending);
• effecting an introduction of a person seeking credit (the borrower) to a lender (this is what is commonly referred to as ‘credit broking’) (regulated broking).

For the Merchant Model, the risk is therefore that the merchant is carrying on regulated lending. For the Partner Model, the risk is that the BNPL provider is carrying on regulated lending and the merchant is carrying on regulated broking or regulated lending (depending upon how the arrangements are setup).

There is, however, an important exclusion which many BNPL arrangements rely upon in order to fall outside of the scope of the consumer credit regime. In summary, this exclusion (known as the 60F Exclusion) is likely to apply when:

1. the credit agreement is for a fixed sum of credit and which is made by the lender under pre-existing arrangements with the merchant;
2. the number of payments to be made by the borrower is not more than 12 and those payments are required to be made within a period of 12 months or less (beginning on the date of the agreement); and
3. the credit is provided without interest or other charges.

This exclusion will therefore be useful for BNPL arrangements where no interest is charged and there are 12 or fewer payments in as many months. The 60F Exclusion is likely to be substantively amended following a review by the UK Government – see below.

Money laundering regime

Even if a merchant or BNPL provider falls outside of the consumer credit regime (because the 60F Exclusion is relied upon or because the customer is not an individual or relevant recipient of credit), it is likely that the UK’s anti-money laundering regime would apply. The consequences of falling within this regime are that the person must (1) apply customer due diligence measures (for example, verifying the identity of the customer) and (2) be registered with the FCA (for the purposes of money laundering supervision).

The scope of the anti-money laundering regime is wide – it applies to any ‘lending’. Thus the availability of the 60F Exclusion under the consumer credit regime will not assist a person seeking to fall outside of the scope of the anti-money laundering regime. There are other reasons why a person may fall outside of the scope of the anti-money laundering regime; for example if the activity is carried on outside the UK but this will be of limited use for BNPL providers and merchants. Some BNPL arrangements are setup in such a way that they may constitute factoring which is another activity which would bring a person within the scope of the anti-money laundering regime.

For the Merchant Model, it is likely that the merchant would fall within scope. For the Partner Model, it is likely that the BNPL provider would fall within scope but the merchant may not depending upon how the arrangements are setup (because the broking of credit does not fall within the scope of the anti-money laundering regime).

Regulatory scrutiny and new regulation

Over the last couple of years, BNPL arrangements have become increasingly popular with both merchants and customers. There are many BNPL providers catering for a wide variety of requirements.

However, the widespread adoption of BNPL has led to increasing regulatory scrutiny. The broad concern of regulators is that BNPL is a form of credit which attracts all of the issues faced by other, more standard, forms of credit (for example, ensuring that the credit is affordable for borrowers). Whilst traditional lenders (such as credit card providers) are subject to these requirements, many BNPL arrangements are not given the reliance on the 60F Exclusion.

This concern was one of the reasons which led to the publication of the Woolard Review by the FCA. The conclusions and recommendations of the Woolard Review are as follows:

• customers have a tendency to not view BNPL as a form of credit (with the risks associated with credit) and affordability checks are often not carried out;
• the arrangements are designed with the purpose of increasing sales for merchants (which is not necessarily in the interests of customers); and
• the recommendation that BNPL products should be brought within the scope of the consumer credit regime (expressing a view that the 60F Exclusion was never intended to exempt these types of lending from regulation).

With these conclusions in mind, the Government intends to make legislative changes as soon as parliamentary time allows. As of the date of this article, no specific legislative proposals have been published but we expect that the scope of the 60F Exclusion will be narrowed.

Although it will be important to consider the specific legislative proposals of the Government, it is likely that merchants and BNPL providers will need to consider:

• whether the agreement with the customer falls within the scope of the consumer credit regime (taking into account the 60F Exclusion as amended);
• if so:
  • whether under the Merchant Model, the merchant would require a regulatory authorisation. The Woolard Review does hint that a more relaxed approach may be adopted for merchants but it will of course be important to understand the specific legislative proposal;
  • whether under the Merchant Model, the BNPL provider (as lender) and the merchant (as broker) would require a regulatory authorisation. It seems likely that the former will require a regulatory authorisation but again a more relaxed approach may be taken for merchants;
• if the BNPL provider or merchant does require a regulatory authorisation, whether any form of regulatory cover could be obtained. It may be, for example, that BNPL providers become authorised but that merchants become their Appointed Representatives (whereby the merchant relies on the regulatory authorisation of the BNPL provider);
• what changes will be required to the customer journey. For example, how affordability checks will be carried out and how any mandatory disclosures will be made. In addition, the agreement with the customer will likely need to be in the form prescribed by the Consumer Credit Act.

Conclusion

In a sense, the success of BNPL has become a victim of its own success – a relaxed regulatory environment will be tightened up with the aim of improving consumer protection. Merchants and BNPL providers will need to carefully consider their regulatory position once the Government publishes specific legislative proposals in respect of the regulation of BNPL.

Should you have any questions about the above, please do not hesitate to contact one of the members of the Bird & Bird global payments team.

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