Max Pacella
Investment Analyst
11 May, 2021

With Afterpay dipping below $100 for the first time since December 2020, commentary has re-entered the market around the value of Buy Now, Pay Later (BNPL) companies in general and the regulatory risks for this disruptive business model.

Source: Bloomberg

As BNPL players like Afterpay (APT:ASX) and Zip (Z1P:ASX) look to take on the credit card and short-term-loan markets, there is a lack of clarity around how these companies are/should be regulated.

Will regulation cripple these businesses, or will it lend them legitimacy?

Today we’ll examine the current regulatory environment for BNPL and changes that have occurred in the last few years, as well as what potential legislative or industry changes may lurk in the future of this growing industry.

Buckle up as we try to make consumer law enjoyable in 1,000 words or less.

Place in the Industry

A quick refresher on the current market for BNPL within the Australian finance industry.

There are over 10 major providers of BNPL services, with Afterpay and Zip by far the largest.

Source: Mason Stevens, RBA

As of 2020, ~30% of our adult population held an active BNPL account (Source: ASIC), with S&P Global Research finding that 10% of all e-commerce transactions in Australia were done through BNPL services.

Current regulatory environment

The current regulatory environment is largely one of “buy now, regulate later”, languishing in industry and legislative fear that regulation will stifle what is still an innovative and disruptive business model.

A senate enquiry from September 2020 found that, since BNPL is operating on the fringe of regulation due to innovation.

“it is inappropriate to fit each innovation into a one size fits all approach”

In other words, we are finding it particularly difficult to find ways to help regulation keep up with the speed of technological progress, without hampering new businesses with excessive compliance or operating procedures which may not be appropriate to their model/offering.

One recommendation from the enquiry was the development of an ‘industry code of practice’, a voluntary set of codes/guidelines of best practice, which businesses must sign-up to and which has the consultation of ASIC.

As of 1 March 2021, one such code of practice has been incorporated, the “AFIA Buy Now Pay Later Code of Practice”, focussing on ‘consumer protection measures’ and whose signatories represent ~95% of the BNPL market in Australia.

Why does the fear of regulation remain then?

The introduction of the Code of Practice does not seem to have abated the market’s fears that BNPL remains a ‘grey area service’ and that more direct government regulation could lurk in the future to impact the bottom line of these companies.

This is perhaps not an unreasonable assumption, given the ongoing concerns around consumer welfare – in 2020, ASIC reported that 21% of BNPL users had missed a payment in the last 12 months, with over 55% of these users having multiple BNPL accounts.

The most jarring statistic you may read in this note is the following: to make up for late fees, 20% of consumers surveyed by ASIC had to cut back or go without meals to make loan payments. It’s unlikely that the government will allow this level of overburdening to continue at these levels if the Code of Practice does not make significant steps to rectify the situation.

Currently, one of the most challenging aspects of regulation is that BNPL providers are not listed as “credit providers” under the National Consumer Credit Protection Act, the piece of legislation that governs credit cards, lines of credit and other consumer finance products.

For reference, I signed up for an Afterpay account for the purpose of this note, which took around 15 minutes, with no extensive processes and little-to-no mention of a credit check. The average credit card process, including AML/KYC, credit checks and existing debt declaration, takes around 2 weeks.

What this means is that ASIC cannot impose compliance or operational obligations onto Afterpay but can only ‘focus on consumer outcomes and harms’ – so rather than prescriptive/pre-emptive action on the part of regulators, they can only be ‘reactive’ in response to a harm that has already been proven.

Outlook for BNPL

The biggest question the market needs to answer for BNPL (in particular APT and Z1P) is, “will regulation hamper innovation?”.

On the one hand, we know that regulation can impact new/disruptive business models.

S&P Global attributes BNPL’s stratospheric growth over the last 5-7 years in a large part to its lack of regulation and therefore free ability to alter and adapt business models to best meet budding market demand.

With the introduction of more direct (i.e. government) regulation, new compliance costs and processes will be introduced into the industry, meaning businesses cannot change as quickly or be unable to branch into new products/sectors at all.

On the other hand, if direct regulation is enacted with the existing Code of Practice, the whole process would be made more efficient and only introduce supplementary oversight by regulators (ASIC/APRA) with some enhanced obligations already explored in the Code.

From a company-specific point of view, regulation may actually benefit AfterPay and Zip – as the two most established players with robust business models and a stable product offering, the barriers to entry created by increased compliance and regulatory oversight may create ‘moats’ around their positions in the market.

The lack of regulation has lent a sense of illegitimacy to BNPL in comparison to a credit card from a major bank – but this comparison only becomes more favourable if BNPL are regulated similarly but offering a product that can be implemented in a fraction of the time.

The final word on the matter is this:

As major banks introduce their own BNPL products, see NAB’s interest-free ‘StraightUp’ card as reference, it is inevitable that more structured and direct regulation will hit the industry sooner or later – once the big four become involved, ASIC and APRA will follow.

For new BNPL businesses this may be an obstacle too large, but for established providers the legitimacy, structure and barriers to entry may actually lend a long-term structural benefit to their business. Investors and businesses should anticipate regulation eventually, to assume otherwise is to tempt ASIC’s wrathful gaze.

The views expressed in this article are the views of the stated author as at the date published and are subject to change based on markets and other conditions. Past performance is not a reliable indicator of future performance. Mason Stevens is only providing general advice in providing this information. You should consider this information, along with all your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.