BNPL, Credit Innovation and the Woolard Report

Some key takeaways for Fintech strategists from the FCA-comissioned Woolard report, a policy material with the potential to influence upcoming regulatory stances on BNPL and credit innovation. 

The final report of the FCA-commissioned review of change and innovation in the unsecured credit market (“The Woolard Review”) has the potential to influence upcoming policy discussions about credit innovation well beyond the borders of the United Kingdom. Chistopher Woolard´s 68-pages report makes 25 recommendations, some of which are of particular interest for fintech firms invested in Buy-Now-Pay-Later (BNPL) products and in general for firms which business models are adjacent to consumer credit or point-of-sale finance. While a careful read of the report is highly advisable for fintech CEOs and their policy and legal teams, here are some aspects of the report that can become of critical importance for future policy discussions and regulatory initiatives in and outside of the Anglo-Saxon context:

1. BNPL is consumer credit and will be regulated as such: This is not an entirely novel idea of the Woolard report. But this commonsense notion that seems to be well established in the British policy discussion does not seem to be that widely accepted everywhere. My perception is that fintech product teams and fintech strategists seem to think of BNPL as a type of product that can be designed to appear sufficiently different from credit as to be able to skirt most of its regulation. However, a good read of the Woolard report suggests no sensible policy discussion on BNPL will contemplate a significantly different regulatory framework from the one applicable to consumer credit products and point-of-sale finance. In that sense, the right way to address this challenge is not to assume that BNPL will be subject to a radically new regulatory framework but instead to advocate for an update of consumer credit regulation that addresses the novel characteristics of BNPL and the differences between the latter and more traditional brick-and-mortar point of sale offerings. Numerals 3 and 15 below propose some areas on which to focus this advocacy.

2.  0% APR claims or very short instalment plans may not be enough to avoid regulatory oversight: One of the most salient recommendations of the report pertains to “Unregulated BNPL products”. This term refers to certain credit products that are typically excluded from the scope of credit law by virtue of their short tenor or interest-free nature. The report highlights the fact that even non-interest-bearing products can be potentially harmful for consumers that perceive them as mere payment methods a-la Google Pay instead of the complex financing solutions that some of them actually are. After listing some of the potential harms that even 0% BNPL schemes may bring about, including the potential conflicts of interest that I elaborate upon in numeral 9 below,  the report makes the clear suggestion that even these typically exempted products should fall under the scope of oversight of regulatory bodies. I think it is safe to assume that the policy discussions elsewhere will reach a similar conclusion, so the policy teams of fintech firms should prepare for honest and intense discussions about the right regulation to address the consumer risks that are brought about by 0% BNPL or other typically “unregulated” products.

 

3. Rent-your-tech-products remain out of the radar, but caution is advised: Despite the fact that the report spends a few pages elaborating on the need to bring certain novel products into the scope of regulation, there is no express mention of Rent-your-tech offerings. This may be explained by the fact that these products seem to be much less pervasive in the UK than in Germany, for example, where Grover appears to have become a real alternative to Klarna or more traditional point-of-sale financing, securing partnerships with major tech retailers like Saturn. While this omission seems to be good news for firms like Fat Llama and Grover, the renewed emphasis on consumer protection outcomes that is proposed in the report shows that policy makers will not be blind to how similar their products are to credit and/or leasing in terms of the risks they bring about for consumers, including overindebtedness. It is certainly too soon to tell how the regulation for these products will look like, but it is unwise for rent-your-tech firms to simply assume that their products are not going to be under the scope of credit law or leasing regulation. Perhaps the right path to take is to prepare for that policy discussion in advance and proactively set a position on how a tailor-made regulatory framework that accounts for the nuances of rent-your-tech could look like. Close monitoring of the policy discussions in order to determine the right timing for such a proposal is a good idea, but nothing speaks against starting to draft that whitepaper/position paper right now.

 

4. Affordability assessments will remain critical, but be ready for discussions around forbearance and hardship policies: While the report continues to emphasize the importance of ensuring that unsecured credit customers are able to afford the products they are offered (which is not a standard that all BNPL firms seem to meet) it goes beyond affordability and suggests that future regulation should take a good look at standardizing the forbearance practices of market incumbents. That policy stance could translate into a set of rules that give much less latitude to lenders when it comes to (a) deciding which customers are eligible for forbearance, (b) what type of support should be given to borrowers whose financial situation has changed so dramatically as to make them unable to pay their dues under the credit agreement and (c) what circumstances should trigger this special treatment. When it comes to affordability, it is critical that fintech firms insist on a technology neutral and outcome-based regulatory framework that gives enough room for designing truly online/mobile user experiences. On this particular point, it is important that policy teams insist on the lessons learned from Australia, where the Securities and Investment commission (ASIC) practically ruled out online lending by setting an overly rigid set of rules governing the minimum documentation that online lenders need to revise in the course of their affordability assessments.  Finally, when it comes to forbearance, it would be wise for consumer lenders to proactively propose a standard set of hardship policies as a self-regulatory initiative. There is a good chance that such an initiative would put them in a better position for a future policy discussion. 

5. “Credit Scoring” practices (Including AI automated decisions) will be under renewed scrutiny: Given the emphasis on affordability, it is important that lenders take an honest look at how they are making credit decisions, especially in their most innovative products. Practices such as lending small amounts to every first applicant without a proper affordability test as a means to evaluate the applicant’s willingness and capability to repay need to be urgently discontinued, for example. This might also be the case for statistical models powered by AI that make automated decisions without incorporating robust affordability features. In general, a takeaway from the Woolard report seems to be that automated credit decisions that are made without careful regard to customers’ ability to repay increase the risk of over-indebtedness and are therefore undesirable from a public policy standpoint. In my view, this discussion about affordability and innovative credit decisions has not taken place vibrantly enough in the boardrooms of lenders and BNPL providers.

 

6.  Relending may be subject to further limits: Many lenders, specially BNPL firms, tend to be extremely lax in their relending practices, issuing repeat loans to customers without much regard for the risk of overindebtedness. This risk is particularly high in jurisdictions where BNPL firms are not obliged to report loan delinquency or customers in arrears to information databases, which leaves the door open for individuals in financial trouble to obtain further credit from other inadvertent BNPL firms. A good read of the Woolard report suggests that BNPL firms should expect affordability-based limits  similar to the ones adopted by the polish legislator (hopefully less draconian) to apply to their relending practices in the near future. At the risk of sounding repetitive, my suggestion here would be that the industry itself takes the initiative with a self-regulatory proposal that is sensible enough to inform the upcoming policy discussions.

 

7. Open Banking Data may play an even more important role in the future: While the privacy community tends to see a lot of tensions between the ideals of open banking and the privacy of account-holders, the Woolard report suggests that policy makers and regulators should look at open-banking data as a tool for alternative lenders (specially online-first lenders) for carrying out adequate creditworthiness assessments and affordability tests. Fintech firms should welcome a renewed regulatory commitment to remove “barriers to widespread use of Open banking data” and should continue to stress the importance of  banks’ compliance with the open banking rules enshrined in relevant legal materials such as PSD2. On this particular point, my intuition is that some strategic litigation or proactive regulatory whistleblowing might be needed to ensure that banks -finally- comply with open-banking rules.

 

8. High-cost credit might be a necessary evil to secure increased access to credit: Instead of attempting to root out high-cost offerings from the credit market, the report suggests that regulatory interventions might see better outcomes by focusing “on actions to generate a more dynamic market around alternatives to high-cost credit and ensuring those consumers who are improving their creditworthiness can evidence this and be rewarded with more options and lower prices.”.  What this means in practice is that regulation might shift away from the goal of diminishing the supply of high-cost credit and instead focus on increasing the menu of substitute products. For lenders, this means that high-cost credit does not necessarily need to disappear from their product range, but it may face more intense lower-cost competition incentivized by legislative action or regulatory interventions in the future.

 

9. Who is your client? The retailer or the consumer? Regulators and policy makers are no longer blind to the fact that the classic conflict of interest that applies to more traditional point-of-sale finance is potentially amplified in the case of modern BNPL firms, especially those who offer low-cost or 0% products bundled with acquiring services which main source of revenue are fees charged to retailers. In that sense, lenders should expect increased regulatory scrutiny to the arrangements that they make with retailers and should reconsider any claims and commitments that could result in irresponsible lending. A common example of these arrangements are contractual stipulations wherein the lender is bound by the retailer to maintain a minimum lead-to-sale conversion rate that forces it to relax its creditworthiness assessments and issue loans to consumers who might not afford to repay them. Ultimately, this point circles back to the issue of affordability and forbearance, so it is critical for fintech executives and compliance teams to have honest discussions with their sales teams and account managers to determine whether their commercial arrangements with merchants/retailers stand in the way of responsible lending practices.

 

10. One-click-BNPL claims should be used with caution:  Every fintech strategist that I have ever met tends to fantasize with a certain mythological animal that we can call “the one-click-loan”. Twisto, a Czech BNPL provider, presents its product as a “market leading 1-click BNPL solution”, for example. While these claims have tremendous resonance with investors, the Woolard report tends to suggest that they may be incompatible with sustainable lending principles and potentially subject to increased regulatory scrutiny. It would be very wise for BNPL execs to consider the possibility of moving away from these claims in favor of more nuanced convenience USPs. In my mind, this can be done without relinquishing their commitment to creating frictionless (and even paper-less) user experiences. As policy-makers start to take a look at the potential consumer risks related to BNPL, diligent investors should also read between lines and start shying away from investing in ventures whose claims may be perceived by regulators and policy-makers as overt confessions of irresponsible lending.

 
11. Expect your low-and-grow/ credit history building claims to be tested in the near future: Many lenders tend to justify their high-cost offerings by suggesting that these products allow individuals who are not eligible for lower-cost (prime or near-prime) products to have some access to credit that allows them to rebuild or improve their credit histories. The Woolard report tends to suggest that policy-makers are already aware of the fact that these so-called low-and-grow claims are not always honest. Therefore, fintech firms should be ready for regulatory interventions that make them unable to make use of this “credit-history-building” claims to attract new customers if they are unable to prove that they are effective in helping customers to transition to cheaper forms of credit.

 

12. The credit information industry is in desperate need of renovation and innovation: Credit information is one of the spaces that remains mostly untouched by fintech challengers. Somewhat paradoxically, the Woolard report seems to suggest that this is an industry ripe for innovation and disruption due to the legacy infrastructures of Credit Reference Agencies and Traditional Lenders.  Here is a direct quote from Woolard that refers to the difficulties that CRAs and lenders experienced while trying to comply with temporary COVID-19 forbearance rules: “Reference Agencies (CRAs) were unable to quickly provide a consistent approach to reporting short-term forbearance that has no long-term negative impact on credit files. This raises wider questions about the ability of the credit information market to operate at pace and deliver change in the interests of firms and consumers.”. Observed from any angle, this sounds like a great opportunity and a great problem for a fintech founder to address.

 

13. Good news: Price caps for consumer credit might finally become product-specific: This sounds rather obvious: Sufficiently different credit products should have sufficiently different pricing caps. The Spanish case, however, shows that this is not widely shared wisdom. In fact, the outdated usury legislation in Spain has resulted in a Supreme Tribunal doctrine according to which all consumer credit offerings are de-facto under the same pricing cap. In a line of decisions dating back decades (some of which I have been very critical of in this piece) the Supreme Tribunal simply overlooks the fact that subprime and near-prime credit should be subject to differentiated pricing caps and makes an even more deleterious mistake: It applies this one-size-fits-all formula rather inconsistently, leaving lenders in uncertainty about what the all-encompassing cap for consumer credit actually is. The legal uncertainty in Spain has put lenders and consumers at the mercy of unscrupulous litigators who are replacing the sorely needed policy discussion to update the usury law with cheap lawsuits at scale. Some of them tend do it with extremely vulgar showmanship, presenting themselves as consumer protection heroes, like the individual in this video:

 

The good news is that more sophisticated policy materials such as the Woolard report tend to see the utmost care that needs to be exercised while regulating credit pricing in order to strike a proper balance between consumer protection and access to credit. Here is Woolard on the matter: “Regulation of credit often raises questions around balancing consumer protection against limiting access to credit. This is particularly true of pricing interventions. Careful and complex analysis is vital to understand the impact of any intervention on consumers who may lose access as a result. This will vary between different products. (…) In this context, looking to set a price cap across the whole of consumer credit, which some European nations do, would present significant challenges to assessing the impact on access. To apply across all credit without having a major impact on access, it would need to be set so high as to have little impact on most products. Alternatively, it could be set in a way that did create a low cap (for example, as done in the Netherlands) but the potential effects of this on access and business models would need significant consideration. For example, credit card penetration is about four times lower in the Netherlands than the UK".

 

14. Digital design guidelines for consumer credit products may be on their way and they will accelerate change in legal and compliance functions: Regulatory interventions that reflect directly on UX design are not a new thing. However, the recent experience in Sweden suggests that policy-makers are willing to take this to the next level by regulating specific elements of website design: In particular, the Swedish E-Commerce Payments Bill prevents online retail platforms from presenting credit options before debit options. The report points out that “As a result, BNPL offer(s) can’t be presented as the ‘first choice’ ahead of the lowest cost direct payment option”. The Woolard report seems to suggest that this trend should materialize in a set of digital design guidelines for consumer credit products that fosters transparency and prevents undesirable outcomes such as consumer over indebtedness. In preparation for this type of regulatory intervention, fintech firms and lenders should evaluate the readiness of their legal and compliance functions to adopt compliance-by-design methodologies. The notion of compliance assurance as the role of some in-house policeman who checks for compliance every so often is rapidly becoming obsolete. A unified second line of defense where product counsels work in tight coordination with compliance officers seems like the only way to adapt to the credit regulation of the future. Compliance-as-a-service offerings can be bundled with BNPL solutions and offered to potential clients in order to ensure that they are able to comply.

 

15. Be ready to resist the preposterous idea of putting online retailers (your clients) in the scope of credit brokerage regulation: Some policy-makers seem to have adopted the idea that online retailers who offer BNPL payment options to their customers need to be regulated in the same way as credit brokers, which could potentially create an obligation for retailers to obtain a regulatory authorization/license. To be fair, this is probably a good idea in the context of more traditional point-of-sale finance, where the staff of brick-and-mortar retailers typically takes a preponderant role in offering (and sometimes negotiating) the credit terms offered to potential borrowers.  But given the more limited role that online retailers play in presenting and negotiating BNPL terms, which in most occasions is limited to integrating with BNPL solution providers via APIs and displaying the BNPL buttons in their checkout pages, it is disproportionate to suggest that they should be deemed to be credit brokers.  When discussing this matter, the Woolard report seems to suggest that regulating retailers is the right way to ensure that credit offers are presented correctly. Fintech firms should be ready to reject this policy stance by pointing out the inefficiency in making online retailers responsible for pre-contractual information and potentially forcing them to obtain broker licenses/authorizations. The fact of the matter is that BNPL firms are in a better position to bear this responsibility by creating user interfaces that are both consumer-protective and fully embeddable in online retailer´s marketplaces.  Sensible regulation on this matter that targets BNPL firms exclusively should be entirely sufficient. 

 

All in all, the Woolard report is a fantastic piece that shows the sophistication of the policy discussion around consumer credit in the UK and should serve (and probably will) as an example for policy-makers in other jurisdictions. If I were the Klarna CEO or any other fintech executive heavily invested in BNPL strategies I would read every line of it.

 

Special thanks to my colleague Zoltan Nemeth for his comments on a preliminary draft of this piece.

 Disclaimer: The opinions expressed by the author in this post are strictly personal and do not reflect the official position of Delivery Hero SE, its management or any of its subsidiaries. Any threatened law-suits, hate-mail or angry rebuttals in response to this piece are ideally to be addressed to the author directly in the comments. :)