Monday, November 23, 2020
The regulation of crowdfunding in Ireland, and indeed a unified approach across Europe has been long awaited.
Due to the continued growth and development of crowdfunding across Europe over the past number of years the following pieces of legislation have been brought into effect to provide that much needed unified framework for the regulation of the sector across Europe:
- Regulation (EU) 2020/1503 (the "Regulation"); and
- Directive (EU) 202004/1504 (the "MiFID II Amending Directive").
The Regulation will apply from 10 November 2021, with member states being required to adopt and publish the necessary laws, regulations, and provisions to give effect to the directive by 10 May 2021, and to apply those measures from 10 November 2021.
Crowdfunding Service Providers ("CSPs") covered by the Crowdfunding Regulation are excluded from the scope of the MiFID II Amending Directive, to simplify the applicable rules for CSPs.
Crowdfunding is not currently regulated in Ireland. Instead, some aspects of a crowdfunding platform services may be caught by various legislative provisions such as MIFID investment services or payment services, the Prospectus Regulations and/or the Companies Act 2014. The Regulations are a welcomed boost to the sector by providing for key investor protections, increasing investor confidence, and enabling CSPs passport their services across Europe.
Why are the Regulations necessary?
With the absence of a unified set of crowdfunding rules across the EU, this can lead to legal uncertainty and in turn discourage investment in projects. It is also a barrier to crowdfunding service providers offering cross-border services. For companies operating in smaller markets, it has limited their opportunities to benefit from investments by a large number of people.
Who do the Regulations apply to?
- P2P crowdfunding platforms who facilitate 'business funding'
- Investment based crowdfunding platforms in relation to transferrable securities only.
Donation and reward based crowdfunding models are not caught by the new regulations.
It will apply to all CSPs in respect of offers of up to €5,000,000, calculated over a period of 12 months per project owner; offers above that threshold will be regulated by MiFID II and the Prospectus Regulation.
A CSP may also be required to be separately authorised under the Payment Services Directive ("PSD") where it is carrying out payment service in the course of providing the crowdfunding platform, unless the payment service will be performed by an appropriately authorised third party provider.
Does this mean additional protections for investors?
The introduction of the legislation will require CSPs to give investors clear information about any potential financial risks associated with a given project.. The legislation will ensure key investment information relating to the project will be provided by the project owner or the platform providing the service.
Authorisation and supervision of CSPs
A legal person who intends to provide crowdfunding services shall apply to the competent authority in the Member State where it is established for authorisation as a CSP as set out in Article 12 of the Regulation. CSPs will be required to provide their name, legal form, programme of operations, constitutional documents, description of their governance policies in relation to risk assessment, complaints procedure and business continuity. The CSP must also furnish details of the appointed management.
A fully reasoned decision must be provided by the relevant competent authority within three months of the application. Any authorisations must be recorded with the European Securities and Markets Authority (ESMA) who will maintain a public register of all CSPs. Once authorised, CSPs will be supervised by the relevant authority on an ongoing basis and will be required to produce an annual report of their work to the relevant authority. If the CSP no longer meets the conditions for authorisation or is no longer providing services, authorisation can be withdrawn.
The Regulation also details the investigative and supervisory powers of Competent Authorities in relation to CSPs.
Operational requirements of Crowd Funding Service Providers
- CSPs shall act honestly, fairly, and professionally in accordance with the best interests of their clients.
- Effectively employ risk assessment and risk management procedures and policies in a prudent manner.
- In the interest of avoiding conflicts of interest, CSPs should operate as neutral intermediaries between clients on their crowdfunding platform.
- CSPs shall undertake at least a minimum level of due diligence in respect of project owners that propose their projects to be funded through the crowdfunding platform of the CSP.
- CSPs shall have in place effective and transparent procedures for the prompt, fair and consistent handling of complaints received from clients and shall publish descriptions of those procedures.
All information, including marketing communications as from CSPs to clients about themselves, about the costs, financial risks and charges related to crowdfunding services or investments, about the crowdfunding project selection criteria, and about the nature of, and risks associated with, their crowdfunding services shall be fair, clear and not misleading.
CSPs shall inform their clients that their crowdfunding services are not covered by the deposit guarantee scheme established in accordance with Directive 2014/49/EU and that transferable securities or admitted instruments for crowdfunding purposes acquired through their crowdfunding platform are not covered by the investor compensation scheme established in accordance with Directive 97/9/EC.
If CSPs apply credit scores to crowdfunding projects or suggest the pricing of crowdfunding offers on their crowdfunding platform, they shall make available a description of the method used to calculate such credit scores or prices. If the calculation is based on accounts that are not audited, that shall be clearly disclosed in the description of the method.
It is notable that the Regulation provides for specific protection for "sophisticated" and "non-sophisticated investors", including whereby, the latter must undergo a suitability assessment by the CSP. The Regulation recognises that a sophisticated investor (e.g. an investment firm, institutional investors, large corporates etc) is aware of the risks associated with investments in crowdfunding projects, and therefore the barriers or checks that are applicable to non-sophisticated investors are not required. Such barriers or checks include a loss simulation exercise to show a non-sophisticated investor can withstand a 10% loss to their net worth (to be reviewed by the CSP annually).
The introduction of a pre-contractual "reflection period" may prove problematic in practice or require revisions to existing platforms, where non-sophisticated investors may revoke any offer to invest within 4 days of making an offer.
The requirement for a company raising funds (i.e. the "Project Owner") to prepare an investment information sheet was to be expected and is good practice. The CSP must verify the accuracy of this information and where there are inaccuracies that are not addressed properly, the CSP must take steps to cancel the crowdfunding offer.
Member States shall, in accordance with their national law, ensure that competent authorities have the power to impose administrative penalties and other administrative measures including fines of up to at least €500,000 and take any other suitable measures for infringements of certain provisions of the Regulation.
A decision imposing administrative penalties or other administrative measures for infringement of the Regulation shall be published by competent authorities on their official websites immediately after the natural or legal person subject to that decision has been informed of that decision. The publication shall include at least information on the type and nature of the infringement and the identity of the natural or legal persons responsible.
The Regulations have been a long time coming and are a much-welcomed development for companies small and medium, looking to scale globally.
In August 2017, on foot of an invite from the Department of Finance for submissions for a crowdfunding regulatory framework in Ireland, Philip Lee was the only Irish law firm to address the consultation in full. Many of the issues identified in the Philip Lee submission and other industry submissions have materialised in the Regulation, including due diligence checks, the applicability of the Prospectus Regulations, suitability assessments for investors, the concept of a key information sheet and robust complaints handling processes.
Crowdfunding platforms that comply with the new rules and become "authorised crowdfunding service providers" may offer their services to potential investors across the EU under the EU passporting regime. This is a significant development for the sector, where Irish based companies using a CSP can have access to the European investment market via crowdfunding, and investors across Europe can have confidence in the sector and the CSP itself, where all players are adhering to the same rulebook.
Ireland is already a world leader in attracting foreign direct investment. To date, some of the most successful CSPs have operated from the UK under local rules. Given Ireland's prominent position as a destination for doing business, coupled with Brexit and the challenges that local businesses in the UK will have in accessing the European market, the implementation of the Regulation in Ireland has the potential to pave the way for Ireland to be a global hub for the crowdfunding sector.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.