LONDON, Feb 14 (Reuters) - Britain's financial watchdog said on Monday it had told four 'buy now pay later' firms (BNPL) to change their contracts after identifying "potential harms" to consumers.

BNPL firms, which are unregulated, typically offer on-the-spot interest-free short-term loans that spread payments for retail goods like clothing.

The market more than trebled in size during 2020 to 2.7 billion pounds ($3.65 billion), when COVID-19 lockdowns saw more people struggling to make ends meet.

"The four firms involved, Clearpay, Klarna, Laybuy and Openpay, have fully cooperated with our work. We welcome their cooperation and their actions to address our concerns," the Financial Conduct Authority said in a statement.

While unable to regulate BNPL firms, the watchdog said it was able to use Britain's consumer rights laws to make their contracts fairer, easier for consumers to understand and better reflect how they use them in practice.

Klarna said it had already implemented the FCA's proposed changes.

"We have never received a customer complaint specifically related to our terms and conditions but are always open to ways in which they can be improved," said Alex Marsh, Head of Klarna UK.

The watchdog said that all firms in the sector should comply with all requirements of consumer protection laws that apply to their business.

One of the terms that involved late payment fees has resulted in Clearpay, Laybuy and Openpay agreeing to voluntarily refund customers who have been charged such fees in specific circumstances, the FCA said

Laybuy said it has worked hard to simplify its contract terms to make sure they are fair, transparent and easy to understand.

Clearpay said a very small group of customers may have incorrectly been charged a late fee, and it will automatically refund affected customers it is able to identify.

Openpay did not immediately respond to requests for comment.

A review by former FCA acting CEO Christopher Woolard in February 2021 said BNPL can pose potential consumer harms https://www.fca.org.uk/publication/corporate/woolard-review-report.pdf that need to be addressed as soon as possible.

Britain's finance ministry promised to bring forward legislation to regulate BNPL when parliamentary time allowed.

StepChange, a charity which helps people cope with debt, said the FCA's intervention was not a substitute for regulation to bring the sector under the watchdog's rulebook.

The FCA said it will consult on rules for BNPL after the government has decided which firms and activities will be regulated. ($1 = 0.7400 pounds) (Reporting by Huw Jones Editing by Kirsten Donovan and Michael Urquhart)