The introduction of the European crowdfunding service providers regulation
The Commission has been looking at crowdfunding as an important alternative source of funding for SMEs and, after recognising significant obstacles to cross-border activity, especially in terms of regulatory fragmentation, presented in March 2018 a proposal for a regulation on European Crowdfunding Service Providers (ECSPs)/ within its Capital Markets Union program and FinTech Action Plan.
Nonetheless, the legislative process progressed slowly, also because of the differing views about FRC among the Commission, European Parliament and Council that emerged during trilateral negotiations. The final version, which revises the original Proposal in several important aspects, was eventually agreed on 19th December 2019. At the time of writing, the Council has adopted the agreed version on 20th July 2020, but adoption by the European Parliament is outstanding before being published in the Official Journal. This paragraph discusses the main aspects of the Regulation based on the version adopted by the Council on 20th July 2020.
The ECSPs Regulation will introduce a mandatory European regime for crowdfunding platforms, requiring any legal person willing to offer crowdfunding services covered by such Regulation to apply (once the transitional period expires) for new authorisation from the NCA of the Member State of establishment. This applies also, after a (second optional) transitional period, in the case of platforms operating only nationally. The authorisation, ensuring a European passport, is conditional on certain ordinary requirements, such as business plan, adequate internal organisation, ‘fit and proper’ managers, business continuity arrangements, professional insurance cover, and, under the revised text, the description and evidence of certain prudential safeguards and of adequate systems for complying with other conduct and organisational requirements (including managing operational risk, data processing, complaint handling, outsourcing; verifying the completeness, correctness and clarity of the information and the respect of investment limits).
The status as ECSPs would apply to both business-LBC and IBC platforms but, as regards the latter, only when pertaining to transferable securities and - a new category of - ‘admitted instruments’ (ie, shares of limited liability companies not considered financial instruments under national law), and for offers not exceeding €5 million in total consideration within 12 months. The regime, in exemption from MiFID II, only covers crowdfunding activities, defined as ‘the matching of business funding interest of investors and project owners through the use of a crowdfunding platform’. These are only identified, as regards IBC, with the services corresponding to the MiFID II placing without firm commitment and reception and transmission of orders combined (with filtering systems based on objective criteria not accounting as investment advice and the pricing -of debt-instruments-being allowed but conditional on additional requirements). Considering the difficulties and national differences in reconnecting crowdfunding services with investment ones, ad hoc definitions or clarifications would have appeared preferable to simply accommodating under MiFID II.
Systems allowing the exchange among clients of products previously subscribed through the platform (‘bulletin boards’) are also permitted but cannot present characteristics that resemble trading venues. In particular, platforms can only publish on their website indications of the clients’ buy/sell interests, specifying that they are not regulated trading venues, that the exchanges are under the exclusive responsibility of investors and, where a price is suggested, that this is not binding. The requirement to conclude the transaction offline, obviously reduces bulletin boards’ effectiveness and market liquidity.
ECSPs will be allowed to offer additional services (complying with the relevant laws), but if they perform other regulated services such as payment, custodian or banking services and other investment services, they would need separate authorisation. This chapter argues that Regulation (or its secondary acts) still needs to clarify the boundaries between the ECSPs regime and other regimes, in particular whether national crowdfunding regimes can survive.
ECSPs are subject to a regime mimicking the MiFID one but simplified. Under the original proposal, it was primarily based on general conduct rules, such as to act honestly, fairly and professionally in accordance with the best interests of their clients, in addition to
Disintermediation in fund-raising 303 disclosure obligations. Nonetheless, the adopted version, following the Council’s suggestions, has significantly extended ECSPs’ duties also in terms of organisational, risk management and prudential requirements.
As regards disclosure obligations, ECSPs have to provide clients (and potential clients), before they enter into the contract, with information (including marketing information) about themselves, the costs, the financial risks and charges related to crowdfunding services or investments, the crowdfunding project selection criteria and the nature and risks associated with crowdfunding services (including capital loss, illiquidity and insolvency risk). They also need to inform their clients about the lack of a deposit guarantee or securities compensation coverage, the four-day reflection period for un-sophisticated investors (see below) and, when the platform performs credit scoring/pricing, the calculation method used. All information must be fair, clear and not misleading, and, depending on the type, published on a clearly identified section of their website or prominent place of medium, in a non-discriminatory manner.
With reference to single offers, ECSPs have to provide clients with a Key Investor Information Sheet (KIIS), based on the KID-PRIIPs (Regulation No 1286/2014 on packaged retail and insurance-based investment products) model (six pages maximum, without footnotes) and prepared by the project owner. The original Commission proposal required ECSPs to only verify the completeness and clarity of the KIIS but the current version also refers to the ‘correctness’ of the document (an expression requiring further clarifications). This position shows anyway policy-makers’ intention to ensure that platforms act not only as intermediaries but also as gatekeepers for investor protection. Besides certain fundamental information about the specific project owner, instrument and conditions of the offer, in particular as regards risks, main terms, price and fees, the KIIS will contain several warnings, such as about the lack of control/approval by supervisory authorities, of deposit/ investment guarantee schemes or of a proper appropriateness test, about the specific risks as well as about the opportunity not to invest more than 10% of their own net worth (see below).
The final version of the Regulation, following the Council’s suggestions, introduces the new category of ‘non-sophisticated’ investors and provides for them special protections. In particular, ECSPs, before allowing non-sophisticated investors to access the offers, must perform an ‘entry-knowledge test’. This test aims at verifying whether and which crowdfunding services are appropriate for them considering their past investments in transferable securities, admitted instruments and loans and their understanding of risks and professional experience about crowdfunding investments. Non-sophisticated investors must also use platforms’ systems to simulate their ability to bear loss, calculated as 10% oftheir net worth. Additional measures for non-sophisticated investors added are an explicit warning in case of investment above €1,000 or 5% of the client’s net worth, which must be agreed to by the investor, and a four-day withdrawal right.
ECSPs are also subject to organisational requirements: adequate measures to ensure an effective and prudent management, including the segregation of duties, business continuity and conflict of interest prevention and management; management of operational risk coming from outsourcing; complaints handling. Special requirements apply in case of pricing services, for example, that platforms present policies and procedures ensuring reasonable prices, using factors and criteria indicated by EBA and ESMA. ECSPs cannot have any financial participation in the offers, not even when aligning platforms’ and clients’ interests. They can accept their managers, employees and controlling shareholders only as investors (not as project owners) and conditional on disclosure and equal terms. The final version of the Regulation also requires ECSPs to undertake a minimum level of due diligence in respect of project owners, as regards criminal records (for infringements of commercial, insolvency, financial services, AM I./CT, fraud laws and professional obligations) and whether there is establishment in non-cooperative jurisdictions (in AML/CT terms). Finally, the current version has also embraced the Council’s suggestion to introduce prudential safeguards for operational risk, mainly consisting in CETI requirements, in alternative to or combination with a professional insurance. This chapter considers that the Regulation could have also provided explicit cyber security and certain direct AML/ CT obligations. The regime will be detailed and completed by a number of ESMA/EBA’s technical standards.
Regulated providers (banks, investment firms, payment services and e-money providers) are allowed to access the ECSPs regime through a simplified procedure. Furthermore, they are exempt from the above-mentioned prudential safeguard for crowdfunding services when already subject to capital adequacy requirements for operational risk. Although the Regulation is not explicit is this regard, they might need to comply only with conduct of business and investor protection requirements specific to ECSPs Regulation.
-  Art. 12ff. 2 Initially, the Commission had proposed €1 million, while the Parliament and the Council raised the threshold to €8 million, the latter introducing the possibility for Member States to set lower limits according to their transposition of the PR (and, in case, also to prohibit offers above €5 million from raising any capital from their residents), with a significant risk of fragmentation, hindering cross-border activities. The approved version now allows Member States to maintain lower thresholds in line with their Prospectus rules only for a transitional period of 24 months (new Art. 1(2) and 49). 3 For example, in case of natural persons operating IBC platforms; reception/transmission of orders only or investment advice exempted under Art. 3 MiFID II; investment funds; offers between €5 million and €8 million, etc.
-  Art. 23(11). 2 Non-sophisticated investors are those not included in the categories of professional investors and sophisticated investors. In particular, while the former category is defined in MiFID II, the latter consists in investors declaring to be aware of the relative consequences and with certain evidences of high net worth or investment experience (eg, legal entities in terms of own funds/turnover/balance sheet; natural persons in terms of gross income and financial portfolio): Annex II. 3 New Art. 21(l)-(4). The entry-knowledge test (to be repeated every two years) resembles a form of appropriateness test (assessment of knowledge, skills and experience; in case of a negative result, issuance of a warning with client’s acknowledgement) but less product-specific and performed at an earlier stage. The final version incoherently requires ECSPs to collect information also about clients’ financial situation (needed however for the loss simulation test) and investment objectives (like a ‘digital’ suitability test: see Parliament’s version), also with potential GDPR implications.
-  Art. 21(5)-(6). This might recall a suitability test but does not pertain to investment objectives and a negative result does not impede the investment, only requiring an acknowledgement from the client. 2 New Art. 21(7) and 22. 3 New Art. 4-8. 4 The higher between €25,000 and ‘A of overheads of the previous year. 5 For example, about pricing/scoring criteria and factors; governance and procedures for risk management and complaint handling. 6 Art. 11(3).