Clifford Chance

On 8 March 2018, as part of its Fintech Action Plan, the European Commission presented a proposal for an EU Crowdfunding Regulation for investment-based and lending-based crowdfunding. Within the European Commission there was a strong desire to fix the patchwork of local legislations and to develop one set of harmonised rules for certain crowdfunding services within the EU.

With the publishing of the Crowdfunding Regulation (EU) 2020/1503 (the Regulation) in the Official Journal on 20 October 2020, the European Commission has  made good on this promise.

The Regulation creates an EU wide framework of rules to help crowdfunding services function smoothly by harmonizing the rules and foster cross-border business funding. The Regulation will improve access to this innovative form of finance for small investors and businesses in need of funding, particularly start-ups. The Regulation shall apply from 10 November 2021.  

Crowdfunding Regulation Scope

Crowdfunding represents an increasingly important type of intermediation where a crowdfunding service provider, without taking on own risk, operates a public digital platform in order to facilitate the matching of prospective investors or lenders with businesses that seek funding. Under the Regulation such funding can take the form of loans (lending-based crowdfunding) or the acquisition of transferable securities or of other admitted instruments within the meaning of the Regulation (investment-based crowdfunding). The Regulation only applies to those crowdfunding services entailing a financial return for investors, such as investment and lending-based crowdfunding.

In general, crowdfunding services involve three types of actors:  

• Project owner – any natural or legal person who seeks funding through a crowdfunding platform (consumers fall outside the scope of the Regulation);
• The crowdfunding service provider (CSP) – legal person who provides crowdfunding services (i.e. brings together project owners and investors through its online platform); and
• Investor – any natural or legal person who, through a crowdfunding platform, grants loans or acquires transferable securities or admitted instruments for crowdfunding purposes.

Crowdfunding projects cannot be initiated by consumers (i.e. consumers cannot be project owner) as this does not fall within the scope of the Regulation. However, consumers can, of course, invest in crowdfunding projects.

Given the risks that are associated with crowdfunding investment, the Regulation includes a threshold of EUR 5 million, to be calculated over a period of 12 months, for the total consideration for crowdfunding offers made by a particular project owner.  Project owners are not required to publish a prospectus in accordance with the Prospectus Regulation ((EU) 2017/1129). However, they do need to provide a Key Investor Information Sheet (KIIS). Where Member States currently apply a stricter threshold, they may temporarily derogate from the threshold until ultimately 10 November 2023.  

Lending-based crowdfunding services

Lending-based crowdfunding services are crowdfunding services that consist of the facilitation of granting of loans, including services such as presenting crowdfunding offers to clients and pricing or assessing the credit risk of crowdfunding projects or project owners. Loans within the meaning of the Regulation are loans with unconditional obligations to repay an agreed amount of money to the investor. The CSP facilitates the conclusion by investors and project owner of loan agreements without the CSP at any moment acting as a creditor of the project owner. The facilitation of granting of loans within the meaning of the Regulation differs from the activity of a credit institution, which grants credits for its own account and takes deposits or other repayable funds from the public.

Investment-based crowdfunding services

Investment-based crowdfunding services facilitate the acquisition of transferable securities or of other admitted instruments for crowdfunding purposes. For investment-based crowdfunding, transferability is an important safeguard in order for investors to be able to exit their investment since it provides the possibility for them to dispose of their interest on the capital markets. The Regulation covers and permits crowdfunding services related to transferable securities. The Regulation applies to crowdfunding services that consist of the joint provision of reception and transmission of client orders in and the placement of transferable securities and/or admitted instruments for crowdfunding purposes without a firm commitment basis on a public platform that provides unrestricted access to investors. The joint provision of those services is the key feature of investment-based crowdfunding services compared to certain investment services provided under MiFID (Directive 2014/65/EU), even though individually those services match those covered by MiFID.

For investment-based crowdfunding the requirements concerning safekeeping of assets are crucial for the protection of investors. Transferable securities or admitted instruments for crowdfunding purposes which can be registered in a financial instruments account or which can be physically delivered to the custodian should be safe-kept by a qualified custodian, which is authorised in accordance with CRD IV (Directive 2013/36/EU) or MiFID. The Regulation will apply without prejudice to national law governing the transfer of such instruments.

Interesting aspects of the Regulation

European authorisation

In the absence of EU rules and regulation, Member States have introduced domestic bespoke regimes on crowdfunding under which national crowdfunding service providers have been authorised to provide their services. To take away any legal uncertainty these national regimes will be phased out by the Regulation through a transitional period. National crowdfunding service providers may continue to provide crowdfunding services that are included within the scope of this Regulation until 10 November 2022. During the transitional period, Member States may put in place procedures to enable national crowdfunding service providers to convert to a CSP.

National crowdfunding service providers that fail to obtain an authorisation as a CSP by 10 November 2022 may not issue any new crowdfunding offers after that date. However, after 10 November 2022, national crowdfunding service providers may continue servicing of the existing contracts in accordance with applicable national law. After the transitional period, CSPs may only provide their services if they have been authorised under the Regulation.

CSPs that have been authorised under the Regulation will be able to provide their services on a cross-border basis throughout the EU upon a notification to the relevant competent authority.

Sophisticated and non-sophisticated investors

The Regulation distinguishes between sophisticated and non-sophisticated investors (NSIs), and introduces different levels of investor protection for each category. The distinction between sophisticated and non-sophisticated investors builds on the distinction between professional clients and retail clients established under MiFID. Under certain circumstances a CSP can also approve the treatment of an investor as a sophisticated investor.

Investor protection for non-sophisticated investors includes:

• CSPs are required to run an entry knowledge test of prospective NSIs in order to ascertain their understanding of such investments.
• CSPs need to explicitly warn prospective NSIs that have insufficient knowledge, skills and experience that investments may be inappropriate for them and CSPs may only accept investments from NSIs if they expressly acknowledge to understand the warning. This introduces also duty of care obligations for CSPs.
• CSPs are required to simulate the NSI's ability to bear losses.
• If the NSI wishes to make an investment of EUR 1000 or 5% of its net worth, the CSP is required to: (i) provide a risk waring, (ii) request explicit consent from the NSI to complete the order and (iii) request proof from the NSI that it understands the investment risks.
• The NSI has a four day reflection period in which the NSI can revoke its investment without giving a reason and without incurring a penalty (although under certain specific circumstances the reflection period does not apply).
• CSPs are required to ensure that no money is collected from the NSI or transferred to the project owner before the reflection period has expired.

Given that sophisticated investors are, by definition, aware of the risks associated with investments in crowdfunding projects, they are not required to complete an entry knowledge test neither do CSPs need to issue risk warnings to sophisticated investors. A reflection period does not apply to sophisticated investors.

KIIS

CSPs need to provide a key investment information sheet (KIIS) to prospective investors for every crowdfunding offer in order to enable them to make an informed investment decision.

The KIIS will need to include:

•  material information about
  • the project owners,
  • the investors' rights and fees, and
  • the type of transferable securities, admitted instruments for crowdfunding purposes and loans offered.
• a warning that investments are covered neither by deposit guarantee schemes nor by investor compensation schemes.
• a disclaimer stating that it has neither been verified or approved by the competent authority.

The project owner or its administrative, management or supervisory bodies will need to be responsible for the information given in the KIIS. These persons will also need to declare that, to the best of their knowledge, the information contained in the KIIS is in accordance with the facts and that the KIIS makes no omission likely to affect its offer. However, as the CSP is responsible for providing the KIIS to prospective investors, it is the CSP that should ensure that the KIIS is clear, correct and complete. CSPs will therefore need to have in place and apply adequate procedures to verify the KIIS.

Identified omissions, mistakes or inaccuracies in the KIIS, will be notified by the CSP to the project owner. Where the project owner does not update the KIIS swiftly, the CSP may, under certain conditions, suspend or cancel the crowdfunding offer.

The KIIS does not need to be approved by the competent authority. However, the competent authority may require an ex ante notification.

Bulletin board

A CSP may operate a bulletin board which allows clients to advertise interest in buying and selling loans, transferable securities or admitted instruments for crowdfunding purposes that were originally offered on the crowdfunding platform, provided that the bulletin board shall not be used to bring together multiple third-party buying and selling interests in a way that results in a contract. In other words, the bulletin board may not consist of an internal matching system that executes client orders on a multilateral basis (as this would result in a requirement to apply for a licence to operate a MTF or OTF within the meaning of MiFID).

To stay away from any requirement to apply for an authorisation as a MiFID investment firm in relation to transferable securities, a CSP shall clearly inform investors that (i) it does not accept the reception of orders for the purposes of buying or selling contracts in relation to investments originally made on the crowdfunding platform, (ii) that any buying and selling activity on its crowdfunding platform is at the investor's discretion and responsibility, and (iii) that it does not operate a trading venue within the meaning of MiFID.

Payment service providers required

CSPs will need to handle the fund flow from the investors to the project owner. Only authorised payment service providers are permitted to provide payment services within the meaning of the PSD2 (Directive (EU) 2015/2366). A CSP may itself, or through a third party, provide payment services provided that the CSP or the third party is licenced as a payment service provider. Where a CSP does not provide payment services in relation to the crowdfunding services, either itself or through a third party, such a CSP will need to put in place and maintain arrangements to ensure that project owners accept funding of crowdfunding projects, or any other payment, only by means of a payment service provider. In other words, a payment service provider will always need to be involved in the crowdfunding platform. This is also to ensure that the funds that flow through the crowdfunding platform is handled by an entity subject to, amongst others, the relevant anti-money laundering and terrorist financing rules and regulations.

The European Commission will assess the necessity and proportionality of subjecting CSPs to obligations to comply with national law implementing AMLD (Directive (EU) 2015/849) and of adding such crowdfunding service providers to the list of obliged entities for the purposes of the AMLD.

Conclusion

These are exciting times to operate a crowdfunding platform, soon crowdfunding services can be provided on a cross-border basis throughout the EU. This allows crowdfunding platforms to scale-up significantly. There will be challenges, such as keeping the KIIS' clear, correct and complete and the (extensive) investor protection on point. However, these challenges will weigh up against what is to gain, a whole continent of investors and project owners to serve/fund.