MiFID II is among the hottest topics right now in the world of regulation. It is going to bring widespread changes to the regulatory framework that governs the financial services industry and extends its scope significantly. So you operate a Business Angel Network (“BAN”) or are an existing/potential member of one and you’re wondering whether you need to worry about it?
Well, for starters the question of whether BANs are affected by EU legislation and, if so, how, isn’t new and the European Commission kind of dealt with it on the basis of the first MiFID some time ago. The potential problem was that the matching services provided by BANs to investors and entrepreneurs/unquoted companies could be considered to constitute “investment advice” and subsequently, if this “advice” is remunerated through a success fee, and this would bring the activities of business angel networks within the scope of MiFID. This leads to a couple of additional questions, in particular:
(1) Is such a concern warranted, as MiFID applies to investment firms and regulated markets and business angel networks are neither?
(2) In any case, would business angel investments in unquoted companies constitute transferable securities within the meaning of Article 4(1)(18) of MiFID?
(3) Are there any other possible activities of angel networks (eg. syndicated investments in enterprises by groups of angels where a network would be involved; co-investments with venture capital funds, etc.) that would bring business angel networks under MiFID?
With regard to the first question, the Commission clarified that whether something is or is not an investment firm is a matter of the activities it conducts on a professional basis, rather than the type of internal business organisation it has. If an entity conducts investment services and activities on a professional basis, it would generally need authorisation as an investment firm unless an applicable exemption applies. The Commission based its clarification on the assumption that a BAN is an organisation whose aim is to facilitate the matching of entrepreneurs (looking for venture capital) with business angels. BANs tend to remain neutral and generally refrain from formally evaluating business plans or angels. They may make introductions but they do not receive and transmit orders for execution, nor are transactions in investments concluded by means of their systems. According to this understanding, a BAN would not typically be conducting investment services and activities within Annex I, Part A of Directive 2004/39/EC, and would therefore not require authorisation as investment firm. A “business angel” is a private individual who invests part of his personal assets in a start-up and also shares his personal business management experience with the entrepreneur. According to Section B(3) of Annex 1 of Directive 2004/39/EC, the activity of “advice to undertakings on capital structure, industry strategy and related matters and services relating to mergers and the purchase of undertakings” is to be considered an ancillary service (not an investment service). Therefore, an entity providing only this type of advice does not require authorisation as an investment firm under MiFID.
In respect of the second question, the Commission confirmed that in order to be financial instruments, shares have to be transferable securities within the meaning of Article 4(1)(18) of MiFID and in particular be ‘negotiable on the capital market’. Those terms have to be understood in a broad manner in the sense that only under limited circumstances will a share that is negotiated not fall under the definition of financial instrument. In this sense, the phrase ‘negotiable on the capital market’ will include shares which are unlisted and not traded on any exchange or MTF, but which are still transferable in accordance with certain rules (which usually relate to private companies).
Lastly, the Commission explained that a BAN should be considered an investment firm requiring and authorisation to perform investment services or activities only in case it performs any of the investment services and activities listed in Annex I Section A of Directive 2004/39/EC in relation to financial instruments, such as reception or transmission of orders, execution of orders on behalf of clients, operating a multilateral trading facility, dealing on own account, portfolio management, investment advice, etc. However, in many cases one or more of the exemptions in Articles 2 and/or 3 of Directive 2004/39/EC will apply. The Commission warned though that the precise application of the rules is a matter for detailed advice in the circumstances of each case and advice or guidance should be obtained professionally or from a financial regulator.
So, this means that if the BAN operates within the traditional definition set out above, it is unlikely to fall under the scope of the first Directive, but is that going to change under MiFID II?
Well, you may have heard that the legislative package commonly called MiFID II actually consists of a directive, a regulation and several so called Level II acts, which are currently in the process of finalisation (for more on the subject have a look here: https://planetcompliance.com/mifid-toolbox/ ). However, let’s have a look of how things are likely to change based on the rules already finalised and the proposals of the rest and what the consequences would be:
With regard to the first question, it still seems unlikely that a BAN or a Business Angel would considered conducting investment services and activities and therefore require authorisation as an investment firm or for investment services. A caveat is required though regarding what has been said about ancillary services above: this aspect has been subject to technical standards that were drafted by the European Securities and Markets Authority (ESMA), which the Commission did not approve and instead recently sent it back to ESMA to give the proposal another stab. It cannot be said with certainty whether a second draft will bring changes that may have an impact on the activities conducted by BANs, but it would be prudent to monitor the developments.
On the subject of transferable securities touched upon in the second question, MiFID II now deals with it under Article 4(1)(44), but other than moving it further down, it does not seem to have undergone any changes, so what the Commission has said on the subject in accordance with the first MiFID should remain valid once MiFID II takes over.
Since the Commission referred in its answer to the third question to what it had said about investment services or activities before and based on our analysis made on the first question above, the Commission’s stance should remain the same for the third question, too. Having said that, any interest party should bare in mind that other provisions in the new MiFID package may have an impact on respective activities, which is particularly true if a BAN varies from the standard model the Commission based its advice on. Another aspect to bear in mind is that like most regulators, the EU has arrived somewhat late to the party and could decide that alternative finance activities like Angel Investing should be deal with as part of this regulatory initiative, so watch out for future developments.
Lastly, in the spirit of the Commission advice above, we would like to remind you that this article doesn’t constitute legal advice. So, if you run a BAN, are a Business Angel or simply need to be sure about this for whatever reason, you better speak to a specialised law firm or have a chat with your national regulator.