FinTech Regulation: The new European Regulatory Framework for Crowdfunding Campaigns
Remember the days when crowdfunding was all the craze? Praised as a way to deliver much needed funding to start-ups when credit was scarce and a way to allow everyone to invest in the next Spotify or Airbnb, it soon hit several roadblocks that blocked it from realizing its full potential. One such roadblock has been regulation, especially in the EU.
Overwhelmed by the challenges of financial innovation and anxious to protect investors, the regulatory response took some time and unfortunately came in varying forms.
It resulted in an uneven playing field across EU member states and the need for authorisation based on these differing rules if a company decided to offer their services in more than one jurisdiction. This also means that it can have severe financial consequences for both the platform and the start-up: For example, a project can be very attractive for investors in general but often it is limited to a national market because the platform that runs the project can only allow investors from that are nationals of the country where the platform itself is based. Ergo, the reach is very limited and so is the investor base, which means that the required funds are less likely to be found. If you want to extend it to other jurisdictions though in order to invite more prospective investors, in many cases means running multiple campaigns at the same time in different jurisdiction for a single project.
It isn’t that the EU wasn’t aware of the issue but despite various initiatives to harmonise the single market in the European Union, crowdfunding was for years still regulated on a national level rather than on the EU level. When the Commission introduced its new EU fintech action plan a few years back, it also included plans for new rules that aim to harmonise crowdfunding, because the European legislator acknowledged that access to finance remained difficult for innovative companies, start-ups and other unlisted firms.
Back then Commission Vice-President Dombrovskis on the eve of the publication of the Action Plans on Sustainable Finance, FinTech and a proposal for a Regulation on Crowdfunding highlighted that “an EU license for crowdfunding would allow both lending and investment-based crowdfunding platforms to operate across the EU based on a single authorisation, and without complying with 28 different sets of requirements. This would help them to scale up. That way, they could offer more choice for investors, and more opportunities for entrepreneurs to attract funding across the EU.”
However, the road to a new framework has been (and still is) a long and winding one. Many aspects had to be considered, for example, whether this would present an opportunity to include another new phenomenon in the shape of Initial Coin Offerings in the crowdfunding rules. Token issuance boomed when everyone seemed to raise a fortune and the price of cryptocurrencies had exploded, so why not acknowledge the similarities between other forms of crowdfunding and ICOs and hit two birds with one stone? Just one of the many elements, lawmakers had to consider and the structure of the legislative process in the EU did not help to speed things up. And then there was, of course, Brexit.
When in March 2018, the European Commission adopted a proposal for a regulation on crowdfunding the Brexit scuffle was in full swing and might not have been the most convenient time for such a task, but the Brussels based institution was set on enabling crowdfunding platforms to easily provide their services across the EU and to provide investors with legal certainty as regards the applicable protection rules and send their proposal to the European Parliament. After careful consideration, the MEPs responded by asking for various amendments to change the scope of the new rules by, for example, raising its application to crowdfunding offers of up to 8 million Euros (the Commission looked at limit of a million Euros), the introduction of a requirement for crowdfunding service providers to disclose annually the default rates of the crowdfunding projects offered on their platforms, or specify that all marketing communications to clients must provide information about the financial risks and charges related to crowdfunding services. So it took a full year until from the publication of the Commission proposal to the adoption of the final position the Parliament on 27 March 2019, which was then sent to the Council. The Council produced its own position with regard to the different proposals andoffered a compromise. Trilogue negotiations to agree upon a draft text started in October 2019 while in the meantime the new European prospectus rules entered into effect on 21 July 2019 that brought significant changes to the crowdfunding sector as well like the introduction of exemptions from the obligation to publish a prospectus for crowdfunding instruments that include profit participation rights, the extension of exemptions to certain kinds of institutional investors, and the increase of thresholds for the crowdfunding exemptions from €2.5m to € 6m.
All’s well that ends well, Shakespeare wrote, and if you’ve lost track in this whole confusion, the good news is that there is light at the end of the tunnel: This week, the Council adopted new rules to improve the way crowdfunding platforms operate across the EU. When the EP negotiating team reached a deal with the Council just before Christmas on the EU-wide rules to help crowdfunding services function smoothly and foster cross-border business funding, the door seemed wide open, but again it took several more months until this breakthrough in the legislative process.
The new framework consists of the EU Crowdfunding Directive and the EU Crowdfunding Regulation that presents a combination of rules that automatically apply across the Union through the regulation and some leeway given to national legislators with the directive to address national peculiarities though the large majority of rules is set out already in the regulation.
In a nutshell, the new rules will cover crowdfunding campaigns of up to EUR 5 million over a 12 month period. Larger operations will be regulated by MiFID and the prospectus regulation. Since the new rules focus on financial services, reward- and donation-based crowdfunding fall outside the rules’ scope because they cannot be regarded as such. The Council wrote in its announcement that the adopted rules provide a high level of investor protection, whilst taking into account compliance cost for providers: they set out common prudential, information and transparency requirements and include specific requirements for non-sophisticated investors. The rules for EU crowdfunding businesses will be tailored depending on whether they provide their funding in the form of a loan or an investment (through shares and bonds issued by the company that raises funds). The framework defines common authorisation and supervision rules for national competent authorities. The European Securities and Markets Authority (ESMA) will have an enhanced role to facilitate coordination and cooperation, through a binding dispute mediation mechanism and the development of technical standards.
Still, we are not there yet: The attentive reader of the drafts will notice that there is no exact date for the entry into force of the regulation or the directive in the submitted drafts. The reason is simply that as a next step the regulation now needs to be adopted by the European Parliament at second reading before it can be published in the Official Journal and enter into force. While it is should be formal step that hopefully will not require any return to the drawing board, we won’t get any news for at least a while on this due to the summer break in Parliament.