On March 8, 2018, the European Commission (“Commission”) released a new proposal (“Proposal”) to regulate crowdfunding service providers (“CSPs”) as part of its Fintech Action Plan (summarized in our recent post).
CSPs can provide businesses and individuals with a digital platform to reach out to potential investors for funding. Presently, some EU countries have their own national legislation on crowdfunding while others require CSPs to be licensed and operate under EU frameworks such as the Markets in Financial Instruments Directive (MiFID II), the Payment Services Directive (PSD) and the Alternative Investment Fund Managers Directive (AIFMD).
The impetus for the Proposal stems from the fact that divergent national laws on CSPs, in the absence of a coherent, European-wide regulatory framework, may hinder the ability of CSPs to scale their operations across the EU. The Proposal aims to fill this void with the goal of reducing the financial and administrative burden of complying with varying national legislation while ensuring a level playing field across the EU.
The Proposal is aimed at promoting greater access to crowdfunding platforms for small and medium enterprises (“SMEs”), entrepreneurs, scale-ups and start-ups. However, it excludes from its coverage donation and reward-based crowdfunding, platforms for personal loans, investment firms, crowdfunding offers exceeding 1 million euros, and CSPs already regulated under national law. In other words, a CSP can choose to provide services nationally under applicable state law or seek authorisation to do so on a wider basis under the regulation put forward by the Proposal. The Proposal is not meant to replace existing national laws on crowdfunding, including those member states that apply MiFID II to CSPs.
A European-wide approach to licensing CSPs differs from the one taken here in Canada. As summarized most recently in our blog post here, the crowdfunding rules here in Canada largely operate as an exemption to the prospectus requirement. There is not, however, a coherent national approach. Whereas some provinces such as British Columbia and Quebec have adopted harmonized registration and prospectus exemptions (summarized here), other provinces, including Ontario, have instead adopted Mulitlateral Instrument 45-108 Crowdfunding (see our blog post summarizing the development here).
Though it seems that both European and Canadian regulatory authorities share concerns about investor protection, their approaches are different. Whereas in Ontario, for instance, both accredited and retail investors are subject to limits on how much they can invest, the Proposal released by the Commission only provides warnings to investors about their potential for loss. Highlights of the Proposal are further outlined below:
Application and authorization
Under the Proposal, only CSPs that have received authorization from the European Securities and Markets Authority (“ESMA”) can provide crowdfunding services. The application for authorization includes, among other things: proof that those responsible for the management of the CSP have the appropriate knowledge and experience and are of good repute; a description of the rules that would prevent those with more than 20 percent of share capital or voting rights of the CSP from engaging in crowdfunding transactions with that CSP; and a description of any outsourcing arrangements. A CSP need not have a physical presence other than in the EU member state where it was established to provide services across the EU.
The ESMA will maintain a public registry of CSPs which would include, among other things, information on any withdrawals of authorization for a period of five years as well as any sanctions that have been imposed on a CSP or its managers.
Each crowdfunding offer cannot exceed 1 million euros. Offers exceeding that amount would require a prospectus under existing EU law.
CSPs are required to maintain a procedure for handling complaints, which includes permitting clients to file a complaint free of charge as well as recording the complaints received and how they were handled.
Conflicts of interest
CSPs cannot participate in any crowdfunding offers on their own platforms and must take steps to manage and disclose conflicts of interests to clients and potential clients. CSPs cannot accept as their clients any of their shareholders holding 20 percent or more of share capital or voting rights, their managers or employees, or anyone directly or indirectly linked to their shareholders, managers and employees by control as defined under Article 4(1)(35)(b) of Directive 2014/65/EU.
Outsourcing and client safekeeping
CSPs remain responsible for complying with applicable law where operational activities are outsourced. CSPs must also disclose to clients the terms on which asset safekeeping services are provided and whether payment and asset safekeeping services are provided by the CSP or a third party.
Investor protection and entry knowledge test
Among other investor protection measures, CSPs have to assess whether the services offered are appropriate for a prospective investor. This would include obtaining information about the investor’s understanding of investment risk, past investments, and knowledge about crowdfunding. This assessment would ideally be done on a biennial basis for each investor going forward. If prospective investors do not provide such information or the CSP deems them to have insufficient knowledge, the CSP should provide these investors with a risk warning. However, that risk warning does not prevent prospective investors from investing in crowdfunding projects.
The CSP must provide investors (including prospective investors) a way to simulate their ability to bear a financial loss, estimated at 10 percent of the investor’s net worth. The result of the simulation would not in itself prevent investors from investing in a crowdfunding project.
The CSP must also provide to prospective investors an investment information sheet which includes a warning that not more than 10 percent of net wealth should be invested in crowdfunding projects and that the crowdfunding offer is neither verified nor approved by the ESMA or national authorities.
In addition to general investigatory, supervisory and on-site examination powers, the ESMA can impose fines and penalties for non-compliance with the Proposal.
The Commission accepted feedback on the Proposal until May 11, 2018. The Proposal is now being considered by the European Parliament and Council.
The key takeaway is that rules concerning crowdfunding continue to change, as most recently evidenced by our recent blog post here on the British Columbia Securities Commission’s notice and request for comment, which includes potential amendments to crowdfunding rules.
We will continue to monitor these developments closely.
By Laure Fouin, Shauvik Shah and Adrienne Ho
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