On 22 May 2023, Treasury announced the Government’s intention to regulate the Buy Now Pay Later (BNPL) industry under the proposed Option 2 as presented by Treasury in its BNPL consultation last November. Under this option, the services will be subject to limited regulation under the National Consumer Credit Protection Act 2009 (Cth) (Credit Act). Considerable ambiguity remains regarding the practices that will be required to satisfy the new requirements.
In a further development on 26 May 2023, ASIC announced a stop order on humm’s BNPL products over concerns about its target market determination for the products. The Australian Securities and Investments Commission (ASIC) previously indicated that the BNPL sector would be the first near-term cab off the rank to experience the regulator’s new product intervention power (aligned to the design and distribution obligations (DDO) regime) which allows ASIC to temporarily intervene in a range of ways including, when necessary, banning products when there is a risk of significant consumer detriment.
This article tracks the background to BNPL regulation and the questions that currently remain unanswered in the Government’s proposal to regulate the sector. It outlines what BNPL issuers and distributors can do now to prepare for heightened regulatory scrutiny and upcoming regulatory reform.
Background to BNPL regulation
The growth of digital platforms and blended shopping experiences has perpetuated the rapid growth of BNPL products. Due to the nature of these products, calls to regulate the BNPL industry have been building, primarily driven by concerns that consumers are not provided with the same protections that exist for consumer credit products under the Credit Act. While BNPL structures vary between providers, they are usually provided under the auspices of a definitional exclusion or licensing exemption.
Despite this, BNPL is not entirely unregulated. Since 2021, BNPL providers have been subject to DDO under the Corporations Act 2001 (Cth) by virtue of the broader credit definition under the Australian Securities and Investments Commission Act 2001 (Cth). This requires (among other things) providers to ensure BNPL products are distributed to an appropriately identified target market (ie, a consumer base with objectives, financial situations and needs that are consistent with the product’s attributes).
Acknowledging the need to manage evolving consumer risks, BNPL providers are also able to voluntarily subscribe to the Australian Financial Industry Association’s (AFIA) BNPL Code of Practice (BNPL Industry Code). The BNPL Industry Code was developed in conjunction with the BNPL industry and interested stakeholders. While this is not law and compliance is not enforceable by regulators, it indicates industry recognition of the need for consumer protection. Promontory’s independent review (report dated March 2023) on the BNPL Industry Code recommended a further strengthening of the code to improve protections for vulnerable customers.
Treasury’s proposals for regulatory reform
In line with the Government’s announcement to introduce BNPL regulation, Treasury released a consultation paper on 3 proposed regulatory options, with varying degrees of intervention (BNPL Consultation Paper).
Under Option 1, the existing BNPL Industry Code would be expanded to introduce more robust requirements for signatories and the requirement for providers to undertake an affordability test.
The key points of the proposed regulation included:
amending the Credit Act to impose specific obligations for BNPL providers to conduct an affordability test. Treasury suggested the test would be proportionate to the overall value of credit being provided. It was not proposed to include requirements to verify a customer’s financial situation or check if the provision of credit aligns with the person’s needs and objectives;
BNPL providers would not be required to hold an Australian credit licence; and
there would be further consultation between industry and government to strengthen the BNPL Industry Code to address issues such as disclosure, dispute resolution, fees, refund and chargeback processes, advertising and marketing, mitigating the risks associated with domestic violence, scams and financial abuse, and ensuring compliance controls are adequate.
The BNPL Consultation Paper also suggested that the BNPL Industry Code could be enforceable by the Australian Securities and Investments Commission (ASIC), subject to the industry body’s application and ASIC’s approval, and be made mandatory for all BNPL providers. The revised BNPL Industry Code would also supplement (but not override) the bespoke affordability checks that would be specified in the Credit Act.
Under Option 2, BNPL providers would be required to hold an Australian credit licence or be otherwise authorised. BNPL providers would need to comply with most general obligations of credit licensees, including complying with a reduced set of responsible lending-like obligations to confirm that BNPL credit is not unsuitable for a person (and scaled to the level of risk of the BNPL credit).
The key points of the proposed regulation included:
BNPL providers would be required to undertake a credit assessment that BNPL is not unsuitable for a consumer but may not need to verify financial documentation or check that BNPL credit aligns with the person’s needs and objectives;
BNPL providers would be prohibited from increasing spending limits without customer instructions;
participation in the existing credit reporting framework would remain voluntary, unless the BNPL provider is a big bank;
fee caps for charges relating to missed or late payments would be required, combined with additional warnings and disclosure requirements; and
merchants would not need to be an authorised credit representative of a BNPL provider.
The above legislative amendments would be supplemented by a strengthened BNPL Industry Code, with parts of the code being enforceable by ASIC (subject to ASIC’s approval).
Under Option 3, BNPL would be treated similarly to other credit products under the Credit Act and require BNPL providers to obtain an Australian credit licence and step fully into the regulatory regime for credit providers.
The key points of the proposed regulation included:
BNPL providers would need to either hold an Australian credit licence or be a credit representative of a credit licensee, subject to all relevant obligations under the Credit Act including responsible lending (ie, confirming that BNPL credit is not unsuitable for a person), compensation and dispute resolution arrangements;
a requirement that consumers be able to set their own spending limit and a prohibition on increasing this without permission;
fee caps for missed or late payments would be applied, combined with disclosure requirements; and
improved accessibility to the credit reporting regime by BNPL providers to share and receive credit information (eg, repayment history information and hardship information).
Option 3 also contemplated revisions to the BNPL Industry Code to address issues not considered in the scope of the Credit Act, such as industry standards, refund and chargeback processes and providing BNPL providers with information on identifying vulnerable customer situations (eg, domestic violence and financial abuse).
Government’s announcement - right-sizing BNPL regulation
The Government has announced its intention to implement Option 2 under the BNPL Consultation Paper. As above, this will broadly require BNPL providers to hold an Australian credit licence (or be otherwise authorised), comply with most general licensee obligations and a reduced set of responsible lending-like obligations. While this may be a welcome announcement for consumer protection advocates, it is not yet clear how the regulation will be structured and what steps will be required for the regulation to be implemented.
Unsurprisingly, responses by industry participants to the BNPL Consultation Paper broadly advocated for Option 1 (ie, least prescriptive regulation). These responses generally highlighted that technology focussed BNPL providers already have complex processes to identify whether a consumer is likely to default on their repayments (in order to manage credit risk), and that although these do not directly correlate to the responsible lending requirements under the Credit Act, they are more fit for purpose in the context of their own product risk profiles.
Also unsurprisingly, responses by regulators broadly advocated for Option 3 (ie, most prescriptive regulation). Notably, ASIC’s submission highlighted that “the harms identified in ASIC’s work on buy now pay later arrangements suggest the starting point for consumer protections should be the same as credit products with comparable harms.” That is, it appears ASIC considers products with the same purpose and function should be treated in the same way.
In light of the polarising responses, the Government has proposed to take the middle ground with Option 2. The Treasurer commented that the proposed responsible lending obligations would be “scalable and technology neutral”. Technological neutrality is already a pillar of regulatory application in Australia (as highlighted by ASIC), and therefore already applies in the Credit Act context. It is also unclear how the reference to scalable responsible lending obligations will be different to the existing obligations, which are already intended to be scaled based on the risk of consumer harm and the proposed credit product. Further, clarity is required as to whether ancillary BNPL services providers (eg, providers that enhance features or access to BNPL, but are not the lender) will be captured by regulation (as credit service providers are currently regulated under the Credit Act).
The discourse on practical implementation of BNPL regulation is already taking place in the United Kingdom, which indicates a shift towards developing proportionate and pragmatic regulation that strikes a balance between consumer protection and innovation in a manner that is commensurate with the risk profiles of specific products. It may be that Australia follows suit.
While the Government’s announcement appears to be focussed on broad based appeasement, it remains an anti-climax until detail on the proposal is provided to industry. As many providers in the Australian market have either reduced the scope of their BNPL product offering or exited the market entirely, the practical impact of any regulation in this space remains to be seen.
What BNPL providers should do to prepare for tougher regulation
There are a number of practical steps that BNPL product issuers and distributors can take to prepare for heightened regulatory scrutiny and regulation of the sector.
Current state assessment and uplift of product governance framework
BNPL issuers should conduct a post-implementation review of their implementation of DDO (which commenced on 5 October 2021) to confirm the embedment of the measures introduced to meet the requirements of the regime, as well as to test the design and operational effectiveness of those measures. This is because a considered implementation of DDO would likely alleviate many of the concerns that have been raised in relation to BNPL, including in ASIC’s reports ‘REP 600: Review of buy now pay later arrangements’ (REP 600) and ‘ REP 672: Buy now pay later: An industry update ’ (REP 672).
DDO focusses on consumer outcomes and harms rather than impose prescriptive compliance obligations and play an important role in promoting good consumer outcomes. A good product governance framework will incorporate customer-focussed principles which inform the implementation of the framework across the life cycle of a product.
Central to DDO is the requirement to identify in advance, in a target market determination, the class of retail clients for whom a product is appropriate and to direct distribution to that target market. In defining the target market, BNPL product issuers are required to identify the likely objectives, financial situation and needs of such consumers and to confirm that the features and attributes of the product are likely to be consistent with them. In addition, issuers must specify distribution conditions and restrictions that make it likely that consumers who acquire the product are in the target market.
BNPL issuers should consider whether they are undertaking a sufficiently robust critical assessment and testing of the target market. This involves drawing on information reasonably available about how consumers in the target market are using similar products and the actual consumer outcomes achieved. The assessment should consider whether there are cohorts of customers who are experiencing poor outcomes, such as those who are exhibiting signs of potentially problematic debt by missing payments regularly, are having trouble repaying debt or identify as having problems with gambling. Consideration should be given to the categories of potential vulnerability that are highlighted in ASIC’s REP 600 and REP 672.
An assessment template and associated guidance that requires product managers to consider and document all relevant considerations in assessing the target market would assist BNPL providers to demonstrate that they know their consumers and are issuing and distributing products that are appropriate for them.
There are a variety of measures available to BNPL issuers to minimise the risk of consumers acquiring products that are not appropriate for them. The application process allows issuers to collect relevant information about consumers to assist in identifying potential customer vulnerability. Eligibility criteria and credit rules may be better deployed to prevent the approval of applications where, for example, there is clear evidence of poor repayment history. These arrangements support the commercial imperative to limit losses from defaults.
There can be challenges in ascertaining whether consumers are experiencing certain types of problematic debt at the application stage. Open banking reforms will likely make relevant information more readily available. BNPL providers should seek active participation in the open banking reform agenda.
Ongoing monitoring and reviews of BNPL products should confirm whether they are meeting the needs of customers and whether adjustments to distribution practices are required to prevent consumer harm. Data on arrears, late payment fees, complaints, hardship cases and write-offs, among other data points, enable issuers to test and refine the value proposition of their products and associated distribution arrangements. Monitoring and reviews should drive continuous improvement in the product governance framework.
Gap analysis against Promontory’s recommendations for a strengthened BNPL Industry Code
The BNPL Industry Code is administered by AFIA. In October 2022, AFIA commissioned Promontory to undertake an independent review of the BNPL Code and Promontory released its report of the review on 31 March 2023.
The Promontory report found the overarching commitments contained in the BNPL Industry Code were sound, while identifying opportunities to strengthen consumer protections. The review makes 51 recommendations, including to relation to vulnerable customers, suitability assessments and credit checking. AFIA and the BNPL sector have indicated their support for all of these recommendations.
Subscribers to the BNPL Industry Code should seek to undertake a gap analysis against the recommendations in the Promontory report to identify early the implications for their product governance frameworks. Certain of these recommendations refer specifically to ASIC Regulatory Guide RG 271 - Internal Dispute Resolution and ASIC Regulatory Guide 267 - Oversight of the Australian Financial Complaints Authority and making the complaints process easier and more accessible. The recommendations also refer, for example, to the need to identify and recognise financial abuse (including through improving staff training and awareness) and providing protection to customers where debts arise from financial abuse, including through waivers and removing adverse information from credit reports. BNPL providers should consider the extent to which their current product governance arrangements are consistent with the recommendations in the report and otherwise the extent of any uplift required.
Those who are not currently subscribers to the BNPL Industry Code may nonetheless reflect on the commitments in the Code and Promontory’s recommendations, to ensure that they remain competitive relative to subscribers.
Prepare for tailored regulation
While the details of the Government’s proposed BNPL regulation are yet to be announced, there are a number of practical steps that BNPL providers can take now to prepare for the new regulation. BNPL providers can:
familiarise themselves with the credit licensing process, including the fee payable, supporting information and documents required and the likely adequacy of their professional indemnity insurance;
understand the obligations of a credit licensee. They could reflect on the internal arrangements that would need to be put in place to ensure those obligations are met. This would necessarily include the introduction of relevant policies, procedures, processes, systems and controls, and information and training for relevant staff;
consider the changes likely to be required, including to systems, to undertake a credit assessment that BNPL is not unsuitable for a consumer;
identify the changes that would need to be made to distribution arrangements, including marketing collateral, back-office operations and arrangements with third party distributors, to ensure spending limits are not increased without customer instructions, fee caps are applied to missed or late payments and additional warnings and disclosure requirements are met.
While the Government’s announcement indicates renewed motivation to enhance consumer protection in the BNPL industry, Australian regulators have consistently kept their focus on good consumer outcomes (including through ASIC’s current enforcement lens through DDO). Therefore, by taking product and governance steps that seek to improve consumer experiences, BNPL providers can ready themselves for future regulation in this space.
Should you have any questions in relation to how best to respond the regulatory develops affecting the BNPL sector, please reach out to our Financial Services Solution team.
Authors : Silvana Wood, Partner and Robert O’Grady, Lawyer