Crowdfunding regulation: what you need to know

The EU parliament has passed a final vote on the crowdfunding service providers on the 5th of October 2020. The new rules are part of the Fintech Action Plan proposed by the European Commission. While the new regulation will enter force on 10 November 2021, the text is already available in the Official Journal of the European Union. We have prepared a summary of the most important points and what you need to know about the first regulation on the crowdfunding platforms.

The Findings

The 50-page long regulation is prepared by the EU Parliament, after consulting with ECB, EU Commission, and other EU governing institutions. The document starts with the acknowledgment that SMEs (small and medium-sized enterprises) all across the Union are lacking access to finance, even in those member states where bank lending was stable throughout the financial crises.

Besides helping European entrepreneurs crowdfunding is beneficial in terms of validating the business idea, giving access to a large number of people, providing insight, and even giving the marketing campaign boost.

The regulation has two main goals:

  • Protection of investors. Because crowdfunding is open to a relatively unlimited pool of investors, it is the regulator’s duty to ensure a platform is treating fair the investors and have appropriate policies in place.
  • Strengthening of the crowdfunding industry. The EU- wide legislative framework will allow for the platforms to operate across borders without regulatory hurdles. The regulation will foster the cross-border funding of businesses. This will enhance the internal market and will create a competitive fintech environment.

The regulation will come in force on the 10 of November 2021, and all crowdfunding platforms, subject to regulation, will have to apply for authorization at the competent authority in the local Member State. In three months’, time the authority has to make an assessment of whether the applicant is complying with the current regulation and decides whether to grant a license or reject it. In case of a positive decision, the local financial watchdog will have to inform ESMA (European Securities and Markets Authority) to include the provider in the register, which will be established on ESMA’s website and will be monitored regularly.  

CROWDESTOR welcomes the developments in the regulatory framework and hopes the crowdfunding market in the EU will become stronger and flourish over the years. We have prepared a summary of the most important points so the investors will know what the regulation is about.

General Provisions in a nutshell

1. The crowdfunding service provider shall act honestly, fairly, and professionally with the best interests of their clients.

How?

Firstly, the platform cannot transfer the clients’ funds to the projects clients didn’t choose to invest, or any other third-party platform. Secondly, the platform can propose clients to invest their money only in projects that correspond to clients’ preferred risk parameters or indicators. Thirdly, when the platform offers portfolio management services, it shall strictly adhere to the clients’ stated investment parameters.

2. The management should ensure the effective and prudent management of the platform.

How?

It is the duty of the managing body to ensure there are no conflicts of interest and to ensure the price of the crowdfunding offer is fair. Also is the duty of the management to implement appropriate systems and controls to assess the risks of the loans listed on the platform by assessing the information on the project owners, audited accounts, and other information. Besides, the regulation states the minimal due diligence requirements applicable to the project itself and its owner.

3. Have a transparent complaint handling procedure.

How?

The platform has to ensure that customer service is effective and fair when handling complaints from its clients. ESMA (European Securities and Markets Authority) will submit technical requirements by 10 November of 2021 which will be used for the creation of the standard template for filing complaints.

4. The platform must ensure there is no conflict of interest.

How?

The crowdfunding platform should not accept the project from its employees, managers, and their related persons. The crowdfunding operator cannot place projects where they own 20% or more of the share capital. Additionally, the platform has to disclose if these people can be accepted as investors.

5. The crowdfunding platform should ensure the clients’ assets are kept safe.

How?

Client money must be deposited with either a central bank or an authorized credit institution (according to a Directive 2013/36/EU) on a segregated account opened in the client’s name.

6. The platform needs to think about how to prepare for the negative scenario.

How?

The crowdfunding platform has to have safeguard funds available to prepare for the adverse events equal to an amount at least of the higher a) Eur 25,000 b) one-quarter of the fixed overheads for the previous year.

The safeguards can be possessed in terms of own funds consisting of Common Equity Tier 1 or the insurance policy provided by the third-party company.

7. The crowdfunding platform will have to report on a regular basis to the local supervising authority.

How?

The crowdfunding platform will have to report each year the list of the crowdfunded projects, including the information about the project owners, raised amounts, and the information about investors’ fiscal residency and break-down of sophisticated and non-sophisticated investors. The local supervisor in turn will submit data to ESMA, where it will be processed and included in the aggregate statistics database, available to the wide public on its website.

8. Platforms need to have a distinction between sophisticated investors and non-sophisticated investors and to tailor communications and risk warnings accordingly.

How?

This distinction is present in the traditional financial sector and it is positive news the crowdfunding will also be suited for both investors’ types- sophisticated and not-sophisticated. Sophisticated investors are those who either have a Eur 60,000 annual income or a financial instrument portfolio exceeding Eur 100,000 or if he or she works in the financial industry.

9. Marketing, communications & information disclosure should be fair, clear, and not misleading.

How?

The platforms have to warn clients that their money is not protected by the deposit guarantee scheme, fairly disclose the information about the investment opportunities easily accessible on their website, and aimed at all clients (sophisticated or not). Whenever the platform is using its own proprietary scoring model, there should be details about the model, and clear disclosure of whether audited accounts are used in the credit scoring or not. Additionally, the platform must disclose the default rates, clearly stating which risk category the defaulted projects have been attributed to.

The marketing topic in the regulation has its own dedicated chapter. This means that the EU governing bodies are taking seriously the quality of the provided information. Overall, the regulation is focused on the protection of the investors thus it is essential to disclose all information that is sufficient for clients to make an informed investment decision. It is great to see how the crowdfunding industry is transitioning to a more mature investment class, and the regulation will help to build trust and will facilitate transparency.