European crowdfunding platforms - new opportunities for alternative financing for start-ups and SMEs
On 20 October 2020 the new EU regulation on crowdfunding for businesses was published. The regulation will enter into force on 10 November 2021 and will, within its scope, radically transform the European crowdfunding space presenting both new challenges - e.g. authorisation requirements, investor protection rules and regulation of internal governance - and opportunities such as cross-border passporting regime and exemptions from MiFID rules for equity crowdfunding.
On 20 October 2020 regulation (EU) 2020/1503 of the European Parliament and of the Council of 7 October 2020 on European crowdfunding service providers for business (the "Regulation") was published in the Official Journal of the European Union together with directive (EU) 2020/1504 (the "Directive") amending directive 2014/65/EU on markets in financial instruments ("MiFID II"). The purpose of the Regulation is to regulate European crowdfunding service providers for business while the Directive takes aim at ensuring that persons authorised as crowdfunding service providers (as defined in the Regulation) will not be subject to MiFID II.
The new crowdfunding framework will ensure a harmonised EU crowdfunding regime with the aim of promoting legal certainty as to the rules regulating crowdfunding activities across the EU member states.
In anticipation of the application of the Regulation from 10 November 2021, we will in this Plesner Insight, take a closer look at the new rules.
Scope of the Regulation
The Regulation will apply to the provision of crowdfunding services offered by crowdfunding service providers in connection with crowdfunding campaigns of up to EUR 5 million over a 12-month period. (Equity) crowdfunding offerings above the EUR 5 million threshold will be subject to the rules pursuant to MiFID II and the EU prospectus regulation 2017/1129.
Notably, for crowdfunding campaigns over EUR 5 million over a 12-month period which consists of the facilitation of granting of loans (crowdlending), these will due to their nature not fall within the scope of MiFID II and the EU prospectus regulation 2017/1129. As there is no general EU legislative framework in place for non-consumer lending or credit activities, such larger crowdlending campaigns will therefore only be subject to national regulation (to the extent that such regulation exists).
The Regulation will not apply to neither reward nor donation-based crowdfunding as these are not regarded as financial services. Furthermore, crowdfunding services provided to project owners that are consumers (e.g. lending to consumers) is outside the scope of the Regulation and remains subject to the EU Consumer Credit Directive as well as relevant national legislation (to the extent applicable).
Crowdfunding services and crowdfunding service providers
Notably, the Regulation defines a "crowdfunding service" as the matching of business funding interests of investors (i.e. any natural or legal person granting loans or acquiring transferable securities or admitted instruments for crowdfunding purposes through a crowdfunding platform) and project owners (i.e. the natural or legal person seeking funding through a crowdfunding platform) through the use of a crowdfunding platform and which consists of either (i) the facilitation of granting of loans (i.e. crowdlending) or (ii) the placing of transferable securities and admitted instruments for crowdfunding purposes. Thus, the scope of the Regulation includes both investment-based crowdfunding and lending-based crowdfunding.
The Regulation defines "admitted instruments for crowdfunding purposes" as, in respect of each member state, shares of a private limited liability company that are not subject to restrictions that would effectively prevent them from being transferred, including restrictions to the way in which those shares are offered or advertised to the public. As Danish private limited liability companies (in Danish: anpartsselskaber) are subject to national restrictions on the offering or advertisement of such shares to the public, it is uncertain whether the offering of shares in a Danish private limited liability company would fall within the definition of "admitted instruments for crowdfunding purposes" and consequently whether such offers fall within the scope of the Regulation.
Furthermore, the Regulation includes a broad definition of "crowdfunding service provider" as a legal person who provides crowdfunding services.
Provision of crowdfunding services
Authorisation for the provision of crowdfunding services
Crowdfunding service providers within the scope of the Regulation will henceforth need to be authorised to provide their services. In order to obtain an authorisation, a prospective crowdfunding service provider must file an application with the relevant national authority. Such application must include, among other, a description of:
- the types of crowdfunding services the prospective it intends to provide;
- the crowdfunding platform it intends to operate;
- its governance arrangements and internal control mechanisms;
- its systems, resources and procedures for the control and safeguarding of the data processing systems;
- the operational risks, prudential safeguards and business continuity plan of the prospective crowdfunding service provider; and
- outsourcing arrangements.
Furthermore, the prospective crowdfunding service provider must also provide evidence of the management members being "fit & proper" which is a requirement not unlike the requirements for other financial services firms in general.
Any successful applicant will be registered in a register of all crowdfunding service providers established by ESMA.
Cross-border provision of crowdfunding services
Of key importance, under the Regulation crowdfunding service providers authorised in their home member state will have the right to provide crowdfunding services on a cross-border basis, under a traditional passporting regime already known from other EU financial regulation.
Similar to other EU financial regulation, the Regulation requires most crowdfunding service providers to adhere to certain own-funds requirement. Specifically, most crowdfunding service providers must, at all times, have in place prudential safeguards equal to an amount of at least the higher of (i) EUR 25,000 and (ii) one quarter of the fixed overheads of the preceding year, reviewed annually, which are to include the cost of servicing loans for three months where the crowdfunding service provider also facilitates the granting of loans.
These prudential safeguards must either be in the form of (i) own funds (limited to Common Equity Tier 1 capital), (ii) an insurance policy or comparable guarantee, or (iii) a combination of (i) and (ii).
Conflicts of interest
To ensure that crowdfunding service providers operate as neutral intermediaries between clients on their crowdfunding platform, the Regulation lays down certain requirements for crowdfunding service providers, their shareholders, managers and employees, and any natural or legal person closely linked to them by way of control.
Specifically, the Regulation prohibits crowdfunding service providers from participating in any crowdfunding offer on their crowdfunding platforms. Furthermore, a crowdfunding service provider may not accept any of the following as a project owner on their crowdfunding platform:
- its shareholders holding 20 %, or more, of share capital or voting rights;
- its managers or employees; or
- any natural or legal person linked to those shareholders, managers or employees by control.
In addition to the above prohibitions, the Regulation requires that crowdfunding service providers maintain effective internal rules to prevent conflicts of interest and disclose to their clients the general nature and sources of conflicts of interest and the steps taken to mitigate them.
Bulletin Board - non-contractual advertisement of interest
One of the key concerns of crowdfunding platforms today is creating a liquid secondary market for investors. This is particularly challenging in equity crowdfunding where market-related activities will often trigger a requirement for a license as an investment firm or operator of a regulated market.
The Regulation seeks to address this challenge by introducing the concept of a "bulletin board" on crowdfunding platforms where investors will be able to interact with each other and advertise their interest in buying or selling loans, transferable securities or admitted instruments which were originally offered on that crowdfunding platform. The bulletin board may, however, not be used to bring together interested buyers and sellers in a way that results in a contract, unless (in relation to transferable securities) the crowdfunding service provider holds a separate authorisation as an investment firm or regulated market operator pursuant to MiFID II.
A crowdfunding service provider allowing such advertisement must adhere to certain rules set out in the Regulation, including the requirement for it to ensure that any clients advertising a sale of a loan, security or instrument makes available a Key Investment Information Sheet (see below).
While the Regulation widens the possibilities for crowdfunding service providers to offer their services on a cross-border basis, the Regulation also imposes certain requirements on providers to ensure an adequate level of investor protection. In the below, we have elaborated on some of the more significant investor protection rules.
Information and disclosure requirements
Among the requirements aimed at protecting investors, the Regulation includes a requirement for the crowdfunding service provider to undertake to ensure that all information, including marketing communications, regarding the crowdfunding service provider, the crowdfunding services being offered or the crowdfunding project selection criteria, are fair, clear and not misleading.
Furthermore, in respect of crowdfunding service providers offering the facilitation of granting of loans, such providers must disclose annually the default rates of the crowdfunding projects offered on their platform over at least the preceding 36 months as well as publish a statement within four months of the end of each financial year indicating, among other, the expected and actual default rate of all loans the crowdfunding service providers has facilitated.
These requirements seek to make crowdfunding project descriptions and result statements less opaque and give prospective investors a more complete overview of the performance of the projects being offered.
Entry knowledge test and ability to bear loss
Borrowing from the existing MiFID II regime, the Regulation distinguishes between sophisticated and non-sophisticated investors and requires crowdfunding service providers to perform an assessment whether and which of their prospective crowdfunding services are appropriate for non-sophisticated investors. This will require crowdfunding service providers to obtain information on any prospective non-sophisticated investor's experience, investment objectives, financial situation and basic understanding of risks involved in general.
Furthermore, when carrying out the assessment of any non-sophisticated investors, the crowdfunding service providers must also simulate their ability to bear loss, calculated as 10 % of their net worth.
Pre-contractual reflection period
The Regulation also introduces a pre-contractual reflection period for non-sophisticated investors. Specifically, a four-calendar day mandatory "reflection" period will apply, during which the prospective non-sophisticated investor will be able to revoke his or her offer to invest or expression of interest in a crowdfunding offer wit. In case of revocation, the crowdfunding service provider will not be permitted to require any reason or impose any penalty on the prospective non-sophisticated investor.
Key Investment Information Sheet - KIIS the KIDs goodbye?
Under the Regulation, crowdfunding service providers will be required to provide prospective investors with a Key Investment Information Sheet ("KIIS") drawn up by the project owner for each crowdfunding offer. The KISS must include information on, among other, the project owner(s), the crowdfunding project, main features of the crowdfunding process, conditions for the capital raising or funds borrowing, risk factors, investor rights, fees and legal redress.
Notably, the Regulation clearly states that when a KIIS has been prepared and provided to the prospective investors, the crowdfunding service providers and the project owners will be considered to have satisfied any obligation to draw up a key information document (KID) in accordance with the PRIIPs Regulation (Regulation (EU) No 1286/2014).
Safekeeping of assets
To ensure the safekeeping of investors' assets, the Regulation sets out certain requirements on any crowdfunding service provider offering asset safekeeping services and/or payment services (the rendering of payment services being subject to the relevant service provider having a license to operate as a payment service provider in accordance with the EU Payment Services Direct (Directive (EU) 2015/2366)).
Specifically, when the crowdfunding service provider carries out payment transactions related to transferable securities and admitted instruments, it must deposit the funds with either a central bank or a credit institution.
As for the transferable securities or admitted instruments offered on the crowdfunding platform, these must be held in custody by the crowdfunding service provider or by a third party (either of which must hold an authorisation to providing custody service).
In order for crowdfunding services providers already offering their services pursuant to national law to have sufficient time to adapt their business activities to the new rules, the Regulation includes a transitional period pursuant to which such crowdfunding services providers may continue to provide crowdfunding services that are included within the scope of this Regulation in accordance with the applicable national law until 10 November 2022 or until they are granted an authorisation pursuant to the Regulation (whichever event is sooner).
The Future of Crowdfunding
Ahead of the entry into force and application of the Regulation on 10 November 2021, it remains to be seen whether the rules for authorisation of crowdfunding services providers as well as the detailed investor protection rules will become barriers to entry for prospective crowdfunding services providers for the detriment of start-ups and SMEs.
However, the Regulation's aim to ensure a uniform approach to the regulation of crowdfunding as well as the simplified possibility for crowdfunding services providers to provide cross-border services must be seen as a positive step for the validation and future of start-up and SME crowdfunding. Plesner will be following this development closely.