Reports released by the Cambridge Centre for Alternative Finance leave no doubt that Europe has fallen a long way behind the United States and Asian countries in development of modern financial services. This is especially noticeable in crowdfunding. In Asia Pacific countries, this method generates more than USD 200 billion per year, but only some USD 8 billion in Europe. The proposed crowdfunding regulation is intended to change this by harmonising European laws and introducing a European passport for service providers operating crowdfunding platforms.
On 8 March 2018 the European Commission presented its FinTech Action Plan, which is also discussed here. An important element, in addition to development of innovative payment technologies and greater transaction security due to blockchain technology, is creation of a friendly legal environment for creating crowdfunding platforms linking small businesses and amateur investors. This is to be achieved by the Regulation of the European Parliament and of the Council on European Crowdfunding Providers (ECSP) for Business, a proposal for which is included as an integral part of the FinTech Action Plan. The main objective of the regulation is not only to facilitate operations of this kind by easing certain strict European law requirements (MiFID II), but also to enable crowdfunding campaigns throughout Europe once a special European passport is obtained.
Current crowdfunding platform laws
The current legal restrictions on European crowdfunding platforms are imposed primarily under legal systems of individual countries and are not harmonised. Some European countries regulate equity- and debt-based crowdfunding themselves, while others do not have their own regulations in place and equity-based crowdfunding is permitted only upon compliance with MiFID II. This presents a number of dangers from a legal point of view for providers of crowdfunding platforms wishing to target their products at investors from all over the EU, and this is often key when finding financing for specialist projects.
This has led the European Commission to propose ways of standardising access to the entire European crowdfunding market and clear rules and requirements for providers to gain authorisation from the European Securities and Markets Authority (ESMA), and safeguard the interests of investors who decide to finance these ventures.
Who will be affected by the new legislation?
The Commission’s proposal mainly applies to crowdfunding providers who collect money to assure investors a return on the invested funds and the option of expanding capital. Thus it will apply to equity-based crowdfunding (in which an investor receives shares or bonds carrying certain rights in return for funding) and debt-based crowdfunding (the investor receives returns on the funds invested).
The regulation will not apply to suppliers offering donation-based and reward-based crowdfunding because projects of this kind cannot be treated as financial services, and will not apply to crowdfunding campaigns in which the beneficiaries are natural persons who are not undertakings. In this case, EU laws on consumer credit (such as Directive 2008/48/EC) will usually apply.
Under Art. 2 of the proposal, the regulation will not be applicable to crowdfunding offers of more than EUR 1 million. These major projects will be subject to more severe restrictions, provided for mainly in the new regulation and MiFID II.
European passport for providers of crowdfunding platform services
The main institution introduced in the regulation, aimed at making the European market competitive in the global arena, is the possibility for crowdfunding platforms to apply for authorisation from the ESMA subject to certain conditions. This authorisation will not be compulsory for service providers. They will have the option of choice of aiming to fulfil all of the requirements set by the European states in which they operate or obtaining a single ESMA passport to provide crowdfunding services across the entire EU. The regulation states explicitly that member states cannot place additional obligations of any kind on service providers that hold an ESMA authorisation.
Authorisation will be granted upon fulfilment of a series of requirements laid down in the regulation. A service provider will firstly be required to ensure that interests of investors making funds available are adequately protected by creating the relevant procedures and observing disclosure obligations (discussed further below). In addition, persons managing a service provider must not have a record of any conviction related to fraud, bankruptcy, money laundering or financing of terrorism. They must also have the relevant knowledge and experience needed to manage the service provider’s operations.
The proposal for the regulation also requires that any payments or raising of money for crowdfunding transactions be conducted by entities that are payment service providers under Directive 2015/2366 (PSD2), regardless of whether transactions are handled by the crowdfunding platform itself or the platform contracts these activities to another entity. Service providers will also be required to take measures to prevent any conflict of interest that may arise in the course of business. In particular, service providers will not be permitted to be involved financially in any projects proposed on their platform, or to present projects announced by their shareholders (holding more than 20% of shares), persons in management positions, or their employees. Service providers will also be fully responsible for compliance with the regulation in the areas of their business activity they decide to contract to other firms.
Before granting the relevant authorisation to a service provider, the ESMA will check whether it meets all of the requirements laid down in the regulation. To do this, it will review the documentation submitted for compliance and maintain a register of European crowdfunding platforms. The EU authority will also monitor rightholders to ensure that they comply with the standards provided for in the regulation. If this standard of conduct is not maintained or the entity breaches the standards laid down in anti-money laundering and financing of terrorism laws, the authority can revoke the authorisation and remove the firm from the list of authorised crowdfunding platforms.
The ESMA will have the appropriate regulatory tools to perform these duties, for instance the right to demand information from an entity, conduct enquiries, or conduct an inspection at the place of business. If infringements of the regulation are found, the authority can impose administrative fines payable periodically or on a one-time basis. Fines can be up to 5% of the service provider’s annual turnover.
Protection of investors
Under the regulation, crowdfunding platforms have numerous obligations concerned with protecting consumers who invest funds in the projects on offer. Above all, they have to be informed of the risk involved in crowdfunding, and warned that investments of this kind are not a typical and certain form of saving money. Websites with crowdfunding platforms will most likely fulfil these obligations by displaying a series of messages and appropriate checkboxes, similar to those currently used in the case of electronic access to traditional financial products.
Before investing in a particular project, consumers will have to undergo a test of their basic knowledge of finance, the risk involved in the investment in question, and types of crowdfunding products on offer on the platform. If the test conducted and the determined profile of the investor reveal that the selected crowdfunding projects are likely to be ill-suited to the investor, the service provider is obligated to inform the investor.
Crowdfunding platform providers and authors of the projects presented on them are required to prepare for each offer a key investor information document containing information about the authors of the project and the venture being supported, the conditions for collecting funds, investors’ rights, and a summary of all fees and possible legal consequences. The document must be worded in a clear, understandable, and specific way and should not contain any references or annotations apart from those referring to applicable laws. It must be easily distinguishable from marketing messages of the entities required to draw it up, and may be no longer than six printed A4 sheets. All of these requirements are intended to ensure that the document is transparent and to make it reader-friendly for potential investors, who could be discouraged by too lengthy a document.
Implications for the crowdfunding market
Even though the proposal will definitely not come into force in the near future (a grace period of 12 months has been proposed for the regulation and it is only now at the stage of consultations in the European Parliament and Council), at the moment it contains precious information for firms operating crowdfunding platforms. Service providers should treat some of the norms in the proposal as a full set of rules on good practice. Appropriate modification to match in-house documentation and procedures will be a step towards transparency and, at the same time, proper preparation for European authorisation application procedures. Implementation of the appropriate customer notification system in particular, and a conflict of interest system, could have a favourable effect on a firm’s market position.
Adam Polanowski, Dispute Resolution & Arbitration practice, Wardyński & Partners