The Council of the European Union has adopted a new regulation aimed at harmonising the minimum requirements for the operation of crowdfunding platforms in EU Members States and creating a common set of investor protection rules.
Crowdfunding platforms which 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.
Crowdfunding has the potential to play an important role in broadening competition in the SME finance market and providing greater access to finance for the SME sector. The new regulation provides a framework in which the Irish crowdfunding sector can grow both domestically and internationally and increase Ireland's attractiveness as a location for international crowdfunding platforms.
Application of the Regulation - Debt and Equity
The Regulation on European Crowdfunding Service Providers for Business amending Regulation (EU) 2017/1129 and Directive (EU) 2019/1937 (the "Regulation") was adopted by the Council on 8 July 2020. The Regulation (which is awaiting adoption by the European Parliament) is part of the EU Capital Markets Union initiative and the Commission's FinTech Action Plan. The aim of the Regulation is to "foster the cross border funding of businesses through the establishment of a harmonised legal framework for crowdfunding which will better facilitate cross-border crowdfunding".
The Regulation identifies the three main participants in a crowdfunding operation being: (a) the borrower (referred to in the Regulation as the "Project Owner"); (b) the lenders on the crowdfunding platform or investors who acquire shares through the crowdfunding platform (the "Investors"); and (c) the operator of the crowdfunding platform (the "Crowdfunding Service Provider" or "CSP"). Project Owners must not be consumers.
The Regulation applies to the financing of projects up to a value of ?5,000,000 per project (calculated over a 12 month period). Reward and donation based crowdfunding operations fall outside of the scope of the Regulation which is focused on crowdfunding for business.
The Regulation applies to both lending based platforms and investment based crowdfunding. The Regulation has brought some much needed clarity to the regulatory position of equity-based crowdfunding platforms (equity-based crowdfunding platforms potentially fall to be regulated under prospectus and financial promotion rules). In particular, the Regulation provides that the Prospectus Regulations will not apply to offers of securities by Project Owners (via a regulated crowdfunding platform) where the value of the securities offered is ?5,000,000 or less. In addition, a CSP will not be required to hold a MiFID authorisation.
Operational Requirements of Crowdfunding Service Providers
The Regulation places new (investor focused) obligations on CSPs. It provides that CSPs have a duty to act honestly, fairly, professionally and in the best interests of their clients (ie the Investors). CSPs are required to exercise effective and prudent management and adopt risk assessment and risk management procedures and policies.
CSPs must undertake a minimum level of due diligence in relation to the Project Owners. In particular, CSPs must ensure that Project Owners do not have a criminal record arising from infringements of national rules in the areas of commercial law, insolvency law, financial services law, anti-money laundering law, fraud or professional liability obligations or be established in a non-cooperative jurisdiction or high risk third country.
CSPs are also required to have in place effective and transparent procedures in relation to complaints handling, whereby clients can file complaints free of charge using a standard template.
CSPs must avoid conflicts of interest and cannot participate in any offer on their platforms or accept as Project Owners businesses in which they have an interest. Minimum insurance requirements also apply to CSPs under the Regulation.
Authorisation and Supervision of Crowdfunding Service Providers
Prospective CSPs must apply to the designated competent authority in the Member State in which they are established (the "Competent Authority") for authorisation to operate as a CSP. Article 12 of the Regulation sets out the content of the application, with CSPs required to provide their name, legal form, constitutional documents, programme of operations, description of their governance arrangements and details of their policies in relation to risk assessment, complaints handling and business continuity (amongst other matters). Details of the natural persons responsible for management of the CSP must also be provided.
The relevant Competent Authority must provide a fully reasoned decision within three months of receipt of the application, refusing or granting authorisation to the prospective CSP. The European Securities and Markets Authority ("ESMA") must be informed of all authorisations and will maintain a public register of all authorised CSPs.
Authorised CSPs will be subject to ongoing supervision by the relevant Competent Authority and will need to provide an annual report of their work to the Competent Authority. Authorisation can be withdrawn on a number of grounds, including if the CSP is not providing services or if it no longer meets the conditions for authorisation.
The Regulation also contains provisions relating to passporting such that a CSP authorised in an EU Member State will be able to passport its services into other EU Member States (subject only to notification requirements and local conduct of business rules).
The Regulation outlines the investigatory and supervisory powers of Competent Authorities in relation to CSPs.
The Regulation provides significant protection for Investors who are categorised as "sophisticated" or "non-sophisticated investors". In particular, CSPs are required to assess whether and which services offered on their platforms are suitable for prospective non-sophisticated investors.
In order to carry out this assessment, the CSP must request information from non-sophisticated investors and each assessment of a non-sophisticated investor must be reviewed every two years.
Non-sophisticated investors are required to simulate their ability to bear loss and are to receive risk-warnings if they invest more than ?1000 or 5% of their net worth. Non-sophisticated investors are not prevented from investing by these measures, however, they must acknowledge that they received the results of the assessment.
A pre-contractual "reflection period" also applies to non-sophisticated investors, whereby the non-sophisticated investor can revoke any offer to invest within 4 calendar days of the making of that offer.
The Regulations require that investors must be provided with a key investment information sheet, drawn up by the Project Owner. The key investment information sheet must include details of the project, a responsibility statement by the Project Owner, details of the crowdfunding process and descriptions of risk factors and investor rights.
In addition, marketing communications from CSPs must be clearly identifiable as such and be fair, clear and not misleading.
Administrative Penalties and other Administrative Measures
Member States are required to provide Competent Authorities with the power to impose administrative penalties including fines of at least up to ?500,000, public statements, orders and bans; and take other suitable administrative measures for infringements of certain provisions of the Regulation. The Regulation also provides for the publication of decisions and reporting of administrative measures and penalties imposed to ESMA.
The adoption of the Regulation represents an important milestone in the evolution of crowdfunding as an alternative source of capital for European SMEs. The introduction of the new regime should greatly enhance the attractiveness of crowdfunding as an investment model for retail investors and the enhanced protections for investors which the Regulation enshrines are to be welcomed.
The ability of CSPs to passport services across the EU is also highly significant and represents an opportunity for Irish SMEs to access capital from investors across the EU without having to navigate a fragmented set of national rules.
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.