The European Commission has been looking at crowdfunding as an important alternative source of funding for SMEs (as part of its Capital Markets Union program and FinTech Action Plan) and has underlined the potential of digital finance in the wake of the COVID-pandemic crisis (see its recent Digital Finance Strategy). The Commission presented in March 2018 a proposal for a regulation on European Crowdfunding Service Providers (hereinafter ECSPs Regulation). The legislative process has progressed slowly, not least because of the differing views about financial-return crowdfunding intermediation that emerged during trilateral negotiations (see the European Parliament’s resolution of 27 March 2019 and the very different suggestions of the Council of 24 June 2019). I have described and analysed these different views and compared them with current national approaches to crowdfunding in my recent EBI Working paper. As a result of those divergent views, the original text of the Regulation has undergone several relevant revisions and, while a final agreement was eventually reached on 19 December 2019, the final text was adopted and made public by the Council only on 20 July 2020 and is now waiting for formal adoption by the European Parliament before being published in the Official Journal.
The present contribution summarizes the main and innovative aspects of the adopted Regulation (for a detailed analysis as well as a discussion about the intermediation role of crowdfunding platforms, see my paper, forthcoming in the European Business Law Review, also in its recently updated version, and my chapter ‘Disintermediation in Fund-raising: Marketplace Investing Platforms and EU Financial Regulation’, forthcoming in Chiu & Deipenbrock, eds, Routledge Handbook on FinTech and Law, 2020).
1. Main aspects: type of the regime and authorization requirements
The Regulation will introduce a mandatory European regime for crowdfunding platforms, requiring any legal person seeking to offer crowdfunding services covered by such Regulation to apply for the new authorization from the national competent authority (NCA) of the Member State of establishment. Doubts exist about the survival of national crowdfunding regimes for services not covered (eg investment advice exempted under Art 3(1) MiFID II) and offers between €5 million and €8 million. The new version makes the authorization also conditional on evidence of complying with certain prudential safeguards and with a long list of new organizational and conduct duties.
2. Scope and limitations (activities and products)
The Regulation covers both business-marketplace lending and marketplace investing but only when corresponding to:
- as regards marketplace lending, the ‘facilitation of granting of (business) loans’ (ie matching of crowd-lenders’ and crowd-borrowers’ interests); the adopted version has also allowed more complex models, entailing the scoring/pricing of loans and individual portfolio management of loans (including either the use of discretion or of auto-investing systems based on objective factors), subject to additional requirements.
- as regards marketplace investing, MiFID II placement without firm commitment and reception and transmission of orders (with filtering systems based on objective criteria not counting as investment advice) when pertaining to transferable securities and—the new category of—‘admitted instruments’ (ie shares of limited liability companies not considered financial instruments under national law).
Any offer should not exceed €5 million in total consideration within 12 months and Member States that have set lower thresholds in the Prospectus Regulation framework will be able to maintain that lower threshold in respect to crowdfunding only for a transitional period.
3. Investor Protection
ECSPs are subject to a regime mimicking the MiFID one but simplified. Nonetheless, the approved version, following the Council’s suggestions, has significantly expanded ECSPs’ duties, not only conduct ones but also in terms of organizational, risk management and prudential requirements, especially in the case of marketplace lending.
Besides general conduct rules, the adopted version has introduced the duty of ECSPs to undertake a minimum level of due diligence in respect of project owners, as regards criminal records and establishment in AML/CT non-cooperative jurisdictions.
In addition to making available to clients/potential clients, before they enter into the contract fair, clear and not misleading information about fundamental aspects of the service and the sector, ECSPs must provide clients with a Key Investor Information Sheet (KIIS) about single offers, based on the KID-PRIIPs model (six pages maximum, without footnotes) and prepared by the project owner, with certain risk warnings. The original proposal required ECSPs to verify only the completeness and clarity of the KIIS but the approved version also refers to the ‘correctness’ of the same.
Certain special protections are reserved to the new category of ‘non-sophisticated’ investors, corresponding to investors other than professional investors and those declaring to be aware of the relative consequences and with certain evidence of high net worth or investment experience. In addition to an ‘entry-knowledge test’ (aiming at verifying whether and which crowdfunding services are appropriate for un-sophisticated investors) and a loss simulation test (verifying their ability to bear loss, calculated as 10% of their net worth), the adopted Regulation inserts a warning (followed by an explicit client’s consent) in case of investment above €1,000 or 5% of the client’s net worth and a 4-day withdrawal right.
Additional requirements have also been introduced for ECSPs offering pricing services or individual portfolio management of loans in terms of conduct rules, precontractual disclosure and KIIS (in case of portfolio management, this is written by the ECSP).
4. Organizational and prudential requirements
ECSPs must establish adequate measures to ensure effective and prudent management but, in case of marketplace lending, the adopted version also requires ‘appropriate systems and controls to assess the risks related to the loans intermediated on the crowdfunding platform’. Additional requirements apply when platforms offer portfolio management of loans (eg, risk management and financial modelling, parameters to be used) or pricing (eg, reasonable and fair assessment of credit risk/project owner, factors to base the assessment on).
Finally, the adopted version has also embraced the Council’s suggestion to introduce prudential safeguards for operational risk, mainly consisting in CET1 requirements, in alternative to or combination with professional indemnity insurance equal to the higher between €25,000 and ¼ of overheads of the previous year.
5. Final remarks
The original ECSPs Proposal had tried to characterise marketplace lending/investing platforms as more ‘neutral’ financial intermediaries (ie with a limited role, involvement and consequent responsibility) and to balance, on the one hand, a light regime with relevant limitations in terms of maximum offering size, permissible products/activities; and on the other hand, investor protection with ECSPs and project owners’ costs, through new, technologically-based and simplified measures (eg entry-knowledge test, loss simulation system) and synthetic and comprehensible information, also in consideration of the existing differences in the respective frameworks of loans and investments.
The approved version, while filling some relevant gaps, seems to share the same vision only partially and ‘re-intermediate’ marketplace lending/investing, looking at ECSPs as gatekeepers and like traditional financial intermediaries. On the one hand, it correctly extends the Regulation’s coverage (with stricter requirements for more complex models), improves and focuses the protections around non-sophisticated investors (also adding investment limits) and introduces a minimum due diligence obligation on platforms (in line with the recommendations in my paper). On the other hand, it significantly increases and details ECSPs requirements (also through a number of future EBA/ESMA draft rules), making the regime more inflexible and moving crowdfunding providers’ duties and role closer to traditional investment firms’ (eg in terms of conduct and organizational requirements, liability, language rules), especially in case of loan intermediation (an area not harmonized yet and generally less regulated). This might end up limiting the need for (and platforms’ interest in) such Regulation since platforms (at least marketplace investing ones), obtaining instead a MiFID II license, would be able to offer more services, across borders, with fewer restrictions but similar requirements. It raises the level of investor protection and increases comparability (especially for marketplace lending platforms) but might curtail, on the other hand, innovation and financial inclusion. Designing a legal framework for ‘disintermediated’ intermediaries is not an easy task.
Dr. Eugenia Macchiavello is an Assistant Professor in Business and Banking Law at the University of Genoa, Department of Law