Crowdfunding

Article VI – The power of the crowd: the EU Crowdfunding Regulation to establish EU-wide alternative financing market  

by , on Nov 10, 2021 07:00:15 AM

 With a few weeks to go to the official entry into force of Regulation (EU) 2020/1503 also known as the EU Crowdfunding Regulation (hereinafter the Regulation), this article comes as a timely introduction to the objectives and benefits that the Regulation is anticipated to bring about.  

Published in the Official Journal of the European Union on 30th October 2020, the Regulation will enter into force with effect of 10th November 2021. Existing crowdfunding platforms will benefit from a grandfathering period of 12 months (which may be extended by the European Commission by a further 12 months), after the lapse of which the requirement to obtain authorisation to operate as European Crowdfunding Service Provider (hereinafter ‘ECSP’) will be triggered. After the expiry of this grandfathering period, only ECSPs, authorised in accordance with the Regulation, will be allowed to offer crowd-equity or crowd-lending services in the EU.  

 

Background to the Regulation 

The European Commission concluded that crowdfunding is a beneficial source of alternative financing which may contribute positively to job creation, economic growth and competitiveness within the EU single market. In fact, one of the foremost strategic priorities identified by the European Commission in its EU FinTech Plan was that of empowering small-to-medium-sized enterprises to tap into the crowdfunding as a substitute to bank-intermediated funding and capital markets financing aimed at larger and more established enterprises. However, the prevailing regulatory and legal landscape for crowdfunding characterised by numerous Member States having introduced their own ad-hoc regulatory regimes for crowdfunding services resulted in a fragmented environment for the operation of crowdfunding platforms, the scope of permitted activities and their licensing requirements. Against his background, the Regulation is aimed at improving access to finance and facilitating cross-border operability by establishing a harmonised regulated environment for crowdfunding.  

During the transitory period, existing crowdfunding platforms may continue to carry out their activities in accordance with pre-existing national law and contractual arrangements they may have entered into, whilst ensuring the adoption of any required legal, technical or operational measures to adhere with the rules of the new Regulation. 

 

Crowdfunding platforms captured by the Regulation and applicable requirements 

The Regulation lays down uniform rules across the EU for the provision of investment-based and lending-based crowdfunding services for offers up to €5 million. Donation and reward crowdfunding are; however, explicitly excluded from the scope of the Regulation.  

Prospective crowdfunding platforms seeking authorisation must demonstrate to the competent regulatory authority (in our case, the Malta Financial Services Authority) how they satisfy the applicable governance, organisational and consumer protection requirements, including the obligation to:  

  • act honestly, fairly, and professionally in accordance with the best interests of their clients; 
  • have in place effective and transparent procedures for the prompt, fair, and consistent handling of complaints received from clients and publish descriptions of those procedures; 
  • categorise future investors as either ‘sophisticated’ or ‘non-sophisticated’, with knowledge and investment capacity testing applicable to the latter type of investors;  
  • grant prospective lenders with a ‘Key Investment Information Sheet’ (KIIS) which has been prepared by the borrower, in compliance with the prescriptive requirements; 
  • conduct due diligence concerning project owners; 
  • disclose information about financial risks and charges, including insolvency risks and project selection criteria; 
  • retain appropriate records concerning the services provided and the transactions executed for the past five years (as a minimum);  
  • comply with prudential requirements (including regulatory capital and own funds requirements,  as well as requirements relating to organisational structure, risk management and internal controls, processes and procedures), and rules relating to conflicts of interest management and inducements;
  • ensure that all payment services for crowdfunding transactions take place through entities authorised under the EU Payment Services Directive (EU Directive2015/2366).  

Furthermore, the Regulation allows crowdfunding platforms to apply for an EU passport to provide their services on a cross-border basis within the EU.  

Finally, the European Securities and Markets Authority (‘ESMA’) will be entrusted with the power to facilitate the smooth cooperation and coordination among national competent authorities and to exercise supervisory powers, including the development of technical standards and rules for alternative dispute resolution mechanisms. In particular, the Regulation already envisages that it will be by 12 technical standards 8 regulatory technical standards (RTS) and 4 implementing technical standards (ITS). 

 

Concluding remarks 

Comparatively speaking, the EU market for crowdfunding is underdeveloped compared with other major world economies. Acknowledging this market gap, the harmonisation to be brought about by the Regulation is expected to alleviate industry bottlenecks surrounding high compliance and operational costs, which prevented crowdfunding platforms from efficiently upscaling the provision of their services.  

Overall, the EU Crowdfunding Regulation presents an opportunity to spur economic growth and investment via equity and lending crowdfunding, offering an alternative avenue for SMEs to raise finance and move up the proverbial financing ladder. In turn, prospective investors will benefit from enhanced and uniform investor protection measures, allowing investors to tap into new market segments and diversify their investment portfolio into previously inaccessible enterprises.  

 

 For further information on the EU Crowdfunding Regulation and its impact on crowdfunding service providers or investors, please do not hesitate to contact us at [email protected] 

 

Author: Stephanie Marinova