Buy-Now-Pay-Later – Getting ahead of the game

Regulatory landscape and timeline

In our last blog, we outlined the key proposals set out in the Treasury’s latest draft consultation paper in respect to the regulation of Buy-Now Pay-Later (BNPL) products. This consultation closed on 11 April 2023, and once the government has digested stakeholder feedback and published a consultation response, it aims to lay legislation before Parliament by the end of 2023 or early 2024. Following this, the FCA will begin consulting on its rules for this sector.

Whilst there is still some uncertainty over the exact date of when the FCA will commence its consultation and how long this consultation period will last, what is certain is that the FCA has already expressed that it is concerned with the increased risk of potential customer harm within this sector. The FCA’s concerns and the risk of customer harm are further exacerbated as a result of the increased use of BNPL agreements (across all age groups and income bands) and the continued impact of the current “Cost of Living Crisis” and rising rates of inflation, which has resulted in changes in customer behaviours and an increased reliance on these types of agreements to facilitate day-to-day spending.

In light of the above, and as the regulatory timeline moves closer, the question that remains is what should BNPL firms and new entrants into the market be considering, and what can they do now to get a head start?

In this blog, we offer practical considerations for firms looking towards obtaining authorisation in the near future, with the aim of helping them understand what it means from an FCA perspective and the route to authorisation. We also cover the key regulatory considerations applicable to firms seeking to obtain authorisation, and for firms that are already authorised (to enter into regulated credit agreements) but are currently offering an unregulated BNPL product. For unauthorised firms, the route to authorisation can be time consuming and complex, so getting that head start can help to make the journey smoother and far less daunting. For firms that are already authorised, actions will still be required to ensure robust processes and controls are in place in order to demonstrate adherence to regulatory requirements and to support the delivery of good customer outcomes, once these products become regulated.

What firms should be doing now?

There are a number of actions firms can and should start to take now to get ahead of a demanding timetable as we approach Regulation Day. In doing so, firms should start to consider the following:

1. What is your business model and proposition offering?

Firms should initially consider what their business model and offering of the BNPL product will look like. Depending on the business model, and subject to the final legislation, a firm may or may not need to apply for authorisation:

• Unauthorised firms that are offering BNPL agreements (which will now be brought into regulation) as a third-party lender will need to be authorised and regulated by the FCA.
• Authorised firms that are offering unregulated BNPL agreements would not need to re-apply for authorisation. However, as these agreements will be brought into the FCA perimeter, firms will need to ensure that they have a robust framework, processes and supporting controls in place (as outlined in section 3 below) to adhere to regulatory requirements and expectations for these products.
• Merchants which introduce their customers to BNPL agreements (which will now be brought into regulation) will be exempt from credit broking regulation.

2. Is authorisation required? If so, what is the route to authorisation?

The good news is that the Treasury has confirmed how firms currently operating in this space will transition towards regulation by confirming that it will introduce a Temporary Permissions Regime (TPR). The TPR will allow unauthorised BNPL firms to continue to operate until they are fully authorised (without this, an unauthorised firm would have to suspend operations until it had completed the FCA's authorisation process). However, unauthorised BNPL firms will need to consider their approach (both current and future state) well in advance of the TPR coming into operation. This is because, in order to enter the TPR, they will need to have:

• engaged in an activity which will become a regulated activity on the day regulation commences (known as “Regulation Day”);
• registered for the TPR prior to Regulation Day; and
• paid a non-refundable registration fee.

Based upon prior experience, including EU firms post-Brexit and the transfer of regulation for Consumer Credit firms from the Office of Fair Trading to the FCA, it is likely that the TPR will last for a period of up to two years. Following this period, authorisation on a more permanent basis will be required.

In undertaking an application for authorisation, firms will need to demonstrate how they will meet the FCA’s threshold conditions, how they will operate in line with the FCA’s Principles of Business and submit a strong detailed Regulatory Business Plan (RBP) in support of the authorisation application. The RBP will require firms to:

• consider and outline a number of key components of their business such as background to the business, strategy for growth and financial information (including fees/charges levied to customers;
• ensure that they have a robust compliance framework (taking into account the considerations outlined in section 3 below); and
• demonstrate sufficient processes, systems, controls and resources in place to manage and monitor adherence to regulatory requirements and to enable the delivery of good customer outcomes.

With this in mind, it is imperative that firms set themselves up for success, by assessing the nature and scale of resources needed to ensure a smooth pathway to authorisation including securing the right expertise from internal and external sources.

3. Does your firm have a framework and supporting processes and controls to enable compliance with regulatory requirements and enable the delivery of good customer outcomes?

Once it is decided what the firm's business model will look like, and if an application for authorisation is required, firms will need to take the time to understand whether and how the FCA’s existing Consumer Credit rules and regulatory requirements will apply to their business model and consider what this means for them. Whilst the Treasury’s Consultation Paper has outlined that the FCA will tailor its rules for the sector, how far it will go is as yet uncertain. Therefore, firms need to be prepared to be able to demonstrate adherence to existing rules, requirements and expectations already set out by the FCA (for example within the FCA’s Consumer Credit Sourcebook (CONC), Principles for Businesses (PRIN), Systems and Controls Sourcebook (SYSC) and the forthcoming Consumer Duty rules and requirements (including the FCA’s Finalised Guidance (FG22/5 – Final non-Handbook Guidance for firms on the Consumer Duty).

In order to determine the level of action required, firms should consider undertaking a detailed analysis of their existing processes, systems and controls against FCA requirements and expectations to identify and understand any gaps. This will enable the identification of mitigating actions required to rectify these gaps.

In undertaking this activity, firms should also consider if they have an adequate level of skills and capability in-house to undertake a robust gap analysis exercise as this is often a task that requires a considerable amount of time, effort and experience. This activity will require firms to focus on all applicable regulatory requirements and expectations and consider the end-to-end BNPL customer journey (including the delivery of good customer outcomes).

Some further key regulatory areas that firms should focus on include those set out below; please note, this is not intended to be an exhaustive list of considerations:

a) Consumer Duty:

The FCA has introduced a new outcomes-focused approach to regulation within retail financial services. The Consumer Duty rules apply from 31 July 2023 and will be in force by the time the FCA regulates BNPL providers. As such, BNPL firms will need to ensure that they have considered this and how it applies to their business model. This includes asking the following (non-exhaustive) questions:

• Has the firm clearly defined the target market for the product at a sufficiently granular level? This will include identifying the extent of potential vulnerability, as well as identifying groups of customers for whom the product may not be suitable.
• Has the firm performed a fair value assessment of the product? This will need to identify the benefits that the product provides to customers, the costs customers may be charged across the lifecycle of the product and an assessment as to whether the relationship between benefit and cost of the product represents fair value for the customer. This should also consider whether particular groups, including vulnerable customers, end up paying more for the product than other customers in the wider target market, and if this points to potential issues with the business model.
• Do the firm’s customer communications ensure and facilitate consumer understanding? Depending on the significance of the communication, this may involve external testing, e.g. testing of customer focus groups or through the use of specialist communications agencies.
• Does the firm have sufficient processes in place to provide adequate customer support, including for customers that present characteristics of vulnerability? Firms would also need to consider if they have sufficient processes in place to identify, manage and treat customers that display characteristics of vulnerability fairly and in accordance with regulatory requirements and expectations. This will require firms to consider its processes end-to-end across the product lifecycle including training, call waiting times, customer complaints, customers that require forbearance, etc.
  

b) Financial Promotions:

BNPL firms will need consider whether their financial promotions comply with existing FCA regulatory requirements and expectations (including those outlined, for example, in the FCA’s Consumer Credit Sourcebook and the expectations outlined by the FCA within their ‘Dear CEO’ letter in this area) and facilitate customer understanding of the BNPL product being provided. This will require firms to consider the content and clarity of financial promotions and whether these provide a sufficient balance of information, including:

• the benefits and drawbacks of the product;
• applicable fees/charges and interest; and
• whether the information provided enables the customer to understand that they are entering into a credit agreement.

c) Affordability and creditworthiness:

In addition to an appropriate creditworthiness check being undertaken for all new applications, BNPL firms may also need to consider the processes (including data inputs) it has in place to assess and verify a customer’s income and expenditure (I&E) in order to provide comfort that the customer is able to afford the credit being offered. This may also require BNPL firms to consider the availability and reliability of income data that is used to inform the affordability assessment and the robustness of its existing expenditure models in being able to capture changes in the macro-economic environment alongside key items that influence spending (e.g., household composition, income bands, geography etc).

d) Arrears management:

BNPL firms may also need to consider whether they have sufficient processes, policies and controls in place to pro-actively support and manage customers in financial difficulty and those requiring forbearance. This will include consideration of:

• The controls and monitoring in place to identify and pro-actively respond to early signs of financial difficulty (for example, before the customer falls into arrears);
• The robustness of the firm’s customer contact strategy for engaging with customers pro-actively across all appropriate communication channels, to provide support and to avoid causing foreseeable harm; and
• The appropriateness and availability of tailored forbearance options, including adequate processes for undertaking I&E assessments to understand the customer’s circumstances and affordability before applying forbearance measures.
  

e) Complaints Handling:

Firms should consider whether they have sufficient processes in place to identify, record, investigate and resolve customer complaints in accordance with regulatory requirements and to enable the delivery of good customer outcomes. This should also include processes to sufficiently oversee and monitor adherence to this process (e.g., first line quality assurance, outcomes testing, second line monitoring, MI and governance arrangements) alongside a robust root cause analysis process to identify and rectify any systemic failings and trends arising from complaint outcomes.

Next steps and how Deloitte can help

The highly anticipated move towards BNPL regulation has begun and firms should use the coming months to evaluate their proposition and act on the actions outlined in this blog. Time and focus should be applied to reviewing existing frameworks, processes and capabilities (including resources) to gain comfort that the firm will be able to demonstrate compliance with regulatory requirements and deliver good customer outcomes.

As part of this process, firms need to consider from the outset whether they have the right regulatory and legal support and the requisite experience to meet your plan of activities successfully. By taking proactive steps now to support their authorisation application and/or develop existing capabilities, firms can get ahead of the game and prevent challenges and potentially costly delays further down the line.