Europe is likely to get its first public securitization of buy now, pay later loans this week, when KKR prices its first German consumer finance securitization, backed by BNPL loans originated by PayPal.
This looks like the start of a growing asset class in Europe, aping the better developed BNPL ABS market in the US. Another development that could help the market is that the UK and European Union are both planning on bringing these products under the same legislation which they use to regulate mainstream unsecured consumer lenders.
There is no universal definition of a BNPL product, but they often involve the lender providing a borrower with credit to buy an item at the point of sale. The borrower repays the loan with zero interest, either in a single payment or in instalments over a short period of a few months.
These loans have frequently been able to escape the regulations that govern consumer credit in the UK and EU.
BNPL loans are typically smaller than standard unsecured consumer loans, which are usually paid back with interest over a longer period, sometimes years. BNPL lenders make a profit by charging a fee to the merchant selling the goods for which credit is used.
By operating outside regulation, many BNPL lenders have not been required to follow the rules which most consumer lenders in the UK and EU have to obey.
In the UK, there is an exemption in article 60F(2) of the Financial Services and Markets Act 2000, one of the main consumer credit laws along with the Consumer Credit Act 1974, which allows interest-free credit arrangements repaid in 12 or fewer instalments over 12 months or less to be unregulated.
That will change on Wednesday when the Financial Conduct Authority officially brings deferred payment credit (DPC), more commonly known as BNPL, under its remit. BNPL will then be regulated in the same way as any other unsecured consumer credit products.
BNPL lenders must be authorised by the FCA and will have to provide consumers with clear information about loans, conduct affordability checks and offer support when needed. Consumers will be able to complain about agreements to the Financial Ombudsman Service.
Europe to follow
The EU has also updated its Consumer Credit Directive (CCD I), which does not apply to interest-free credit agreements, those that must be repaid in under three months, or loans under €200. The Second Consumer Credit Directive (CCD II), coming into force on November 20, will include all of those.
The EU regulations impose similar requirements on lenders as those in the UK, making them check loans' affordability and communicate clearly about loan terms, risks and costs.
In both jurisdictions, the rules will only apply to third party BNPL lenders, not merchants making their own DPC agreements with customers.
So what?
For the securitization market, BNPL lenders becoming regulated could be a breakthrough.
KKR's deal is backed mainly by 12 and 24 month interest-bearing loans, which are already regulated. But it is possible that lenders may want to securitize interest-free and very short term BNPL loans in future.
While some larger BNPL lenders, like Klarna, say they already fulfil many or all of the duties observed by mainstream consumer lenders, regulation would give greater confidence that they were doing so.
That should encourage more consumers to use BNPL. In the UK, section 75 of the Consumer Credit Act 1974 would apply, giving consumers legal protections around refunds on purchases over £100 if the goods are faulty or do not arrive.
Regulation would also be likely to foster confidence among ABS investors, by reducing the risk of reckless lending that could lead to defaults and reputational damage.
Financial firms do not instinctively welcome regulation. But the BNPL market should accept its new future under regulators' scrutiny. The product is becoming a mainstream form of credit, which should make investors more likely to believe in the quality of the assets, and to embrace investing in them.