What could BNPL regulation mean for UK fintechs?

Buying items now and paying for them later is a trend that has boomed over the past few years, principally thanks to the low-rate environment, but inflation has led to a slowdown in spending. There are also heightened calls to regulate the market.

• BNPL user sentiment has waned as inflation has pushed interest rates higher.
• The UK is looking to regulate the market; Block could exit the UK as a result.
• The ARK Fintech Innovation ETF is up 18.5% in the past six months.

From pet food, to Peloton [PTON] bikes, to Lululemon [LULU] sportswear, the pandemic triggered an online shopping gold rush. Many impulse purchases were made easier thanks to buy now, pay later (BNPL) services, which allowed people locked-down at home to instantly acquire goods and pay for them at a later date.

Payments via BNPL accounted for $2 for every $100 spent on ecommerce purchases in 2021, according to research published by analytics firm GlobalData. The ease of access to BNPL has meant that its transaction value jumped more than 260% between 2019 and 2021, from $33bn to $120bn.

BNPL’s explosive growth potential at the height of the pandemic sparked a flurry of dealmaking activity. Jack Dorsey’s Block [SQ] acquired Afterpay for $29bn, while rival Affirm [AFRM] signed a partnership with Amazon [AMZN].

Most recently, Apple [AAPL] has roared into BNPL with its Apple Pay Later service, which allows iPhone and iPad users to split purchases into four payments over six weeks. The service launched in March.

“There’s no one-size-fits-all approach when it comes to how people manage their finances. Many people are looking for flexible payment options,” declared the vice president of Apple Pay and Apple Wallet, Jennifer Bailey, in a press release.

Yet BNPL providers are coming under pressure on a number of fronts.

Higher rates weigh on consumer spending

UK consumers spent £1.3bn in April using BNPL, according to Adobe, representing a 16% share of the total online spend of £8bn. This was down 1.7% from the previous month and down 2.2% year-over-year. However, despite BNPL spending remaining elevated, there’s good reason to be cautious.

“Consumers were earlier inclined to use BNPL when interest rates were at low levels because of its simplicity and ease of access to credit,” Shreyasee Majumder, social media analyst at GlobalData, wrote in a May report.

The firm recently analysed mentions of BNPL companies on social media in the 12 months to the end of March. Apple topped the list with a 19% share of the market, while Afterpay had an 18% share. The rest were Klarna (17%), PayPal [PYPL] (16%), Affirm (10%) and Mastercard [MA] (7%). The list was propped up by a handful of smaller players.

The research also found that social media influencer sentiment declined 22% in the 12-month period, as the cost of living crisis weighed on young people’s willingness to purchase discretionary items.

“The combined effect of rising inflation and interest rates has a detrimental effect on BNPL providers due to reduced consumer spending and rising repayment rates,” added Majumder.

Regulation calls could stymie growth

BNPL thrived in the low-rate environment and it was an easy answer for young people, especially those who have no credit history or low credit scores. A report published by the US Consumer Financial Protection Bureau in March showed that around half of BNPL users had made purchases that they couldn't afford.

As people struggle to make ends meet, there’s pressure on the BNPL market to change its ways. Unlike traditional credit cards and other payment options, BNPL schemes are interest-free and are designed to keep people out of debt. But the argument is that, without regulation, it could end up doing exactly the opposite.

In February this year, the UK set out its plan to regulate the BNPL market, which could potentially see BNPL lenders fined or banned by the Financial Conduct Authority should they fail to carry out credit checks on potential borrowers. Theodora Hadjimichael, CEO of trade body Responsible Finance, has described the market as the “wild west of credit”.

BNPL players could exit the UK

The UK’s uncertain regulatory environment has raised questions about whether the country is a favourable place to operate in.

“The current proposals do not reflect the simple and transparent nature of BNPL products, and will create an unlevel playing field,” a Block spokesperson told CNBC in April on the sidelines of an event.

The UK’s decision on whether to introduce a credit check system could also influence Klarna’s position. The Swedish start-up is on track to achieve profitability later this year, as it announced in its first quarter earnings in May, which would edge it even closer to its hotly anticipated IPO.

Banks to become big BNPL players

While there may be near-term headwinds, BNPL is unlikely to disappear as a credit option. If anything, the market could get more crowded.

This could provide banks with an opportunity to muscle in and grab their slice of the BNPL pie — and they’re well-placed to navigate any future regulation.

“Banks are also likely to be in a better position to assess the overall risk level of customers, to respond to changes in their financial circumstances and to set appropriate limits to their total credit,” noted researchers at Accenture.

Citibank [C] and JPMorgan [JPM] are just two of the major financial institutions that have moved into the BNPL market over the past few years.

Funds in focus: ARK Fintech Innovation ETF

The ARK Fintech Innovation ETF [ARKF], which has Block as one of its biggest holdings, offers exposure to companies that derive “a significant portion of… revenue or market value from the theme of fintech”. These company include those within the spaces of transaction innovation, blockchain technology, risk transformation and frictionless funding platforms. The fund is up 7.8% in the past year and up 18.5% in the past six months.

The Global X FinTech ETF [FINX] is weighted in favour of the information technology (IT) sector (81.50%), while financials accounts for 9.30%. Industrials, communications services and healthcare have each been allocated under 5% of the portfolio as of 30 April. The fund is down 15.7% in the past year and flat over the past six months.

The Invesco KBW NASDAQ Fintech UCITS ETF [FTEK.L] offers exposure to financials (76.30%), industrials (13.00%), IT (8.6%) and communications services (2.20%). The fund is down 4.1% in the past year, though flat over the past six months.