Embedded Finance (`EF`) is the availability of financial products which are integrated into a company’s infrastructure by APIs, enabling computer interfaces to ‘communicate’, and placed in a customer journey at the point of customer need.
Buy Now, Pay Later (`BNPL`) is the best-known EF product. However, EF is an umbrella term covering far more than just BNPL. Currently, EF could be divided into three principal categories: payments, banking, and lending. There is a clear nexus between EF and ecommerce, with the COVID-19 pandemic driving businesses to move online.
Sophie Guibaud (co-founder and chief commercial growth officer at Fiat Republic) puts it simply - EF is `financing when you need it, but without having to think about it`.
Global regulatory compliance: many EF firms have, or aspire towards, a broad geographic reach. For example, Klarna’s business-to-consumer (“B2C”) ‘Klarna In-Store’ product boasts availability in 17 jurisdictions. Jurisdictional expansion provides a larger customer base and the opportunity to develop alternative products. Regulatory regimes differ from jurisdiction to jurisdiction and there are operational and practical implications (including costs) of understanding and complying with multiple regulatory regimes.
Power in partnership: partnerships are increasing between firms and traditional financial institutions and payment companies. For example, Liberis partnered with Barclays to provide the Barclaycard Business Cash Advance, a revenue-share offering for SMEs. In May 2023, Mastercard announced their strategic partnership with Fabrick, described by Mastercard as aiming to `develop Embedded Finance solutions that improve the digitalisation of businesses, financial institutions and fintechs across Europe`. Apple’s Pay Later - a US B2C offering – is enabled through the Mastercard Instalments programme. Partnerships mean greater or broader opportunities for product marketing and increased distribution channels. The question is, will this power in partnership last or, by sharing know-how, do firms run the risk of losing their competitive advantage?
AI: one of EF’s USPs is speed of delivery. The evolution of AI-based solutions provides opportunities for further development in the speed of EF products. Harjeet Singh has said (in his June 2023 FinTech Marketing blog) that AI solutions will inject “fun” into creating new content for the marketing of business-to-business (`B2B`) products. Beyond assisting with the personalisation of marketing of EF products, AI could enhance the EF product applications in terms of identification and onboarding processes. Using AI does not come without risks. For example, it can amplify biases and result in system failures. This can lead to reputational, financial, and legal risks for users. Providers adopting AI should take steps to mitigate these risks, such as utilising preventive, detective, and corrective controls.
The provision of finance in the UK is predominantly regulated through the UK’s overlapping financial services and consumer credit regimes. Firms offering finance propositions that fall within the UK regulatory perimeter are overseen by the Financial Conduct Authority (the `FCA`). If a firm is within the regulatory perimeter, there are requirements for both the firm and its senior personnel to be FCA-approved, it determines certain aspects of the form and content of customer-facing documents, and it requires certain affordability assessments and implementation of other operational processes.
Whether a firm’s offering falls within the UK’s regulatory perimeter and what rules apply, is determined according to whom the product is offered to (e.g. consumers, SMEs, large corporates), what the financing relates to (e.g. financing individual products, financing business expenses), and the repayment terms (e.g. the number and duration of repayments; whether interest and fees are charged).
Many EF offerings currently take advantage of carve-outs to the regulatory regime by limiting their offerings to corporate entities in the B2B environment. The consumer credit regime, and therefore most regulatory rules, only apply when dealing with individuals and small partnerships. Alternatively, or additionally, firms rely on the ‘12 payments or fewer’ exemption. This generally means that most BNPL products offered at online checkouts fall outside the regulatory regime. As we discuss further below, the Treasury and FCA are currently looking at taking steps to reduce the scope of certain exemptions, so firms may find themselves brought into the scope of regulation in the future.
Change is coming within the UK regulatory landscape. The UK government is seeking to expand the scope of regulation and grant additional supervisory powers to the FCA. This is mainly due to the increasing number of credit offerings, the fact that many firms rely on exemptions and, ultimately, EF growth.
Once the proposals are implemented (anticipated towards the end of 2023), the FCA is likely to take further interest in the way EF products are presented to customers by firms. The way in which the firm approaches defining what a ‘good’ customer outcome is will also likely be subject to FCA consideration.
Both the UK government and the FCA have shown a willingness to work with the EF industry to create targeted regulation focused on what they see as the greatest risks to customers. Credit regulation is intended to be a dynamic regime, reacting to changes in approach that the regulators think could cause undue detriment to customers.
B2B lending in the UK is generally not regulated but in certain circumstances, B2B offerings will fall within the UK regulatory regime, including:
Providers of B2B offerings may also want to align their products to consumer regulatory standards and principles by way of “voluntary compliance” in terms of a robust offering from a customer perspective (and for their investors and key stakeholders too).
EF appeared on most 2023 fintech prediction lists. However, that does not mean it is resigned to being a trend or the latest fintech buzzword. Bain & Company’s September 2022 EF report projects that by 2026 EF `will exceed USD 7 trillion of total US financial transactions` (an increase from USD 2.6 trillion in 2021). As described by Simon Taylor (in his 4 June 2023 newsletter, ‘Fintech Brain Food – The Future of Embedded Finance’), `all finance is becoming embedded`. EF is fully integrated with consumer trends and journeys. Soon, it will no longer be a question of what financing is embedded, but rather, what is not.
James Dickie is a senior associate in the financial services regulatory team, specialising in consumer credit and payment services
Laura Collins is an associate in the banking team, specialising in fintech
CMS is a full-service international law firm with over 5,000 lawyers in 79 offices across 44 countries, offering local and cross-border legal expertise to clients worldwide. Within its fintech practice, the firm has a specialist embedded finance industry team in the UK who advise lending platforms and embedded finance companies.
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