— Att. Irem Sultan Gulden, LL.M
Oct 31, 2023
- Introduction
In this blog series of which you are reading Part II, I reflect on crowdfunding in Europe and the regulatory framework governing this area. In this post — Part II, I aim to elaborate on the European Crowdfunding Regulation. I will first set the scene by exploring the rationale behind it. Following this, I will particularly examine its subject matter and the scope of application, supervision of crowdfunding activities, authorisation for providing crowdfunding services and the transitional period.
- Rationale for an EU-level legislation
The 2008 financial crisis revealed that the EU’s financial system mostly relies on banks. The severe results of the crisis led banks to tighten the credit capacity for start-ups and small and medium-sized enterprises (“SMEs”). Businesses started seeking financial sources detached from banks as bank lending became so costly for them.
To relieve the results of the crisis and strengthen the EU’s economy, the EU pursued alternative ways of financing to decongest the EU’s reliance on banks. President of the then European Central Bank, Mario Draghi, stated:
The crisis has shown the drawbacks of over-reliance on a bank-centred lending model. So we also need to develop reliable sources of non-bank lending, such as equity and bond markets, securitisation, lending from insurance companies and asset managers, venture capital and crowdfunding.(1)
The European Commission, correspondingly, aimed to diversify financial sources for start-ups and SMEs and make it easier for them to access funds for their business projects. To this end, in 2015, the Capital Markets Union (“CMU”) policy was determined. The CMU policy aims to create a Single Market for capital to flow freely in the EU and to make the EU more attractive for investments. Jean-Claude Juncker, the former President of the European Commission, in this respect, declared:
We are consulting on the future of what we call “a capital markets union” — to improve access to finance for businesses small and large, by using the power of our single market to diversify sources of funding, and cutting the cost of capital.(2)
Against this background, crowdfunding gained prominence as one of the ways of alternative finance and investment for natural and legal persons. However, in the absence of a harmonised EU-wide legal framework for crowdfunding, the area was being governed individually by Member States, leading to a variation in the strictness of the regulatory approaches throughout the EU due to diverse settings of permitted activities, authorisation requirements, and conditions of operation of crowdfunding platforms. Some Member States introduced bespoke regimes for crowdfunding (e.g. Italy, France) while others adhered to the existing financial rules derived from EU financial law (e.g. MiFID II, PSD, AIFMD).
Despite the resemblance of national bespoke regimes, they are tailored to meet the needs of local markets and investors. Hence, neither the domestic legal frameworks provided a uniform application in the EU nor the implementation of MiFID II rules enabled sufficient cross-border activity of platforms. Besides regulatory systems governing crowdfunding services, a self-regulation approach has been developed and minimum requirements for conducting crowdfunding services have been set by industry associations (e.g. European Crowdfunding Network) in the form of a code of conduct.
The diversity of legal frameworks led to a variety of procedures and practices applicable in the crowdfunding industry, causing a lack of legal certainty, difficulty in determining the applicable rules on a cross-border basis, confusion in requirements for the provision of crowdfunding services, and economic burdens for the crowdfunding service providers. As a result, the fragmentation of national laws limited the industry’s expansion beyond local markets, creating an impediment to a level playing field for all platforms. Even if a platform intends to operate in more than one Member State, it would become costly to comply with all national laws in each country it operates. Hence, harmonisation of national laws in this area became a necessity in order to remove the obstacles to the cross-border operation of crowdfunding platforms and reduce complexity and financial/administrative burdens for project owners, investors, and crowdfunding platforms.[3]
On 9 November 2020, Regulation (EU) 2020/1503 on European crowdfunding service providers for business (“ECSPR”) entered into force as part of the objective of establishing the CMU in the internal market. According to Recital (7), addressing the existing obstacles to the proper functioning of the internal market in crowdfunding services and ensuring a high level of investor protection by laying down an EU-level regulation is necessary in order to foster cross-border services and facilitate the exercise of the freedom to provide/receive services in the internal market. Correspondingly, ensuring the exercise of the freedom of movement of capital and freedom to provide services in the internal market, as laid down in Article 26 of TFEU and as referred to in Article 114 of TFEU was the legal base for the adoption of ECSPR.
- Subject matter of ECSPR
As mentioned above, ECSPR essentially aims to accelerate startups’ and SMEs’ access to funding and cross-border operation of crowdfunding platforms. To this end, it seeks to ensure a high standard of investor protection, market discipline, fairness, equality, and transparency. It also intends to reduce operational risks, prevent conflict of interest between actors, reduce costs and administrative burdens, and avoid regulatory arbitrage.
In particular, ECSPR contains a uniform set of rules for the provision of crowdfunding services and operation of crowdfunding platforms along with the requirements in terms of authorisation, organisation and supervision of crowdfunding service providers (i.e. legal persons providing crowdfunding services) within the EU.[4] It also introduces requirements relating to transparency and marketing communications.[4]
- Scope of application
ECSPR does not cover all types of crowdfunding. Instead, it is effective only for the investment- and lending-based models. Pursuant to Recital (1) of ECSPR, since these models can be formed as loans, acquisition of securities, or other admitted instruments for crowdfunding purposes, they can be structured as comparable funding alternatives. Because of the risks that may arise from dealing with financial products and the information asymmetries that may be created by those products, ECSPR only applies to investment- and lending-based models.[5] However, donation- and reward-based models are considered to not deal with financial products.[5] This distinction led to their exclusion from ECSPR as a regulatory intervention would be disproportionate in this area.[5] Likewise, the invoice trading model is not covered by ECSPR. However, instead of being explicitly excluded, it is implicitly left out of the scope of application.
Point (a) of Article 1(2) of ECSPR explicitly leaves out crowdfunding services provided for “consumer” project owners from ECSPR’s scope of application. “Consumer” in this respect is recognised as it is referred to in point (a) of Article 3 of Consumer Credit Directive: “a natural person who, in transactions covered by this Directive, is acting for purposes which are outside his trade, business or profession”. The reason for this is presented in Recital (8) as ECSPR aims to foster cross-border funding of businesses, not consumers. Thus, although the lending-based model is the most widespread form of crowdfunding, an important subset of it remains to be governed by national laws and the EU’s consumer protection law. This situation prompted criticism that comprehensive harmonisation of crowdfunding could not be achieved due to the limited scope of application of ECSPR.[6]
ECSPR intends to reduce administrative burdens and costs imposed on project owners who are seeking funds through a crowdfunding platform. It, therefore, adopts a moderate approach in terms of the requirements on project owners, compared to, for example, a business that intends to offer securities to the public on an exchange market. Since this moderate approach might pose a risk of excessive vulnerability for investors, especially given the consumer inclusivity in crowdfunding, ECSPR introduced some safeguards. In this context, a threshold is recognised for crowdfunding offers to fall within the scope of ECSPR. Therefore, only such offers of a particular project owner are in the scope of ECSPR that are up to € 5 000 000, calculated in a 12-month period, in total consideration with the offerings of the same issuer to the public that benefit from the exemptions to publish a prospectus according to Article 1(3) and Article 3(2) of Prospectus Regulation.[7]
Whilst ECSPR currently does not distinguish crowdfunding service providers based on their operations on a cross-border or national basis, Article 48(3) entrusted the Commission to make an assessment on the application of ECSPR to crowdfunding service providers that provide crowdfunding services only on a national basis.
It is worth noting that here, crowdfunding service providers authorised in accordance with ECSPR are excluded from being governed by MiFID II in order to avoid multiple authorisations and regulatory burdens of different legal frameworks on the same activities and persons.[8] Likewise, the offer of securities from a crowdfunding service provider that is authorised in accordance with ECSPR is exempted from being subject to the requirement to publish a prospectus, as long as they fall below the threshold of € 5 000 000 as laid down in point (c) of Article 1(2) of ECSPR.[9]
- Authorisation
Importantly, ECSPR introduced a European passport regime for crowdfunding service providers. By this means, crowdfunding service providers became eligible to provide crowdfunding services throughout the Union by holding an authorisation that is granted by the competent authority of a Member State where the crowdfunding service provider is established.
Only legal persons are allowed to apply for authorisation as a crowdfunding service provider under ECSPR.[10] Within 25 working days of receiving the application, the competent authority assesses whether all materials required in Article 12(2) of ECSPR have been submitted.[11] If the competent authority determines the application lacks the required information, it allows the prospective crowdfunding service provider to provide the missing information by a deadline.[11] If the application is identified as complete, the competent authority immediately notifies the prospective crowdfunding service provider.[12] Within three months of the receipt of the complete application, the competent authority assesses whether the conditions laid down in ECSPR are met.[13] In the same period, the competent authority adopts a fully reasoned decision granting or refusing to grant an authorisation as a crowdfunding service provider.[13]
The authorisation under ECSPR does not entitle the crowdfunding service provider to provide all types of crowdfunding services. In the application for authorisation, the specific crowdfunding services that the prospective crowdfunding service provider intends to provide should be submitted. Thus, an authorisation under ECSPR entitles the crowdfunding service provider to provide only such crowdfunding services that are specified in the authorisation granted by the competent authority. Extension of the authorisation to additional crowdfunding services is possible following the procedure set out in Article 13(2) of ECSPR.
An EU-wide, public and up-to-date register for crowdfunding service providers is kept by the European Securities and Markets Authority (“ESMA”), based on the information provided by competent authorities in Member States as to the authorisations of crowdfunding service providers.[14]
The authorised crowdfunding service provider is under the obligation to meet all conditions set out in ECSPR.[15] The competent authority may withdraw the authorisation if the situations set out in Article 17 of ECSPR occur.
The authorisation under ECSPR does not restrain crowdfunding service providers from engaging in other activities out of the scope of this authorisation, as long as the entity complies with the relevant applicable national or Union law.[16]
If an entity holds an authorisation under Electronic Money Directive, Capital Requirements Directive, MiFID II, or Payment Services Directive and at the same time intends to provide crowdfunding services, it is also required to apply for an authorisation under ECSPR. Yet, a simplified authorisation procedure is designated for it.[17]
- Supervision and the competent authorities
The supervisory power on activities of crowdfunding service providers is assigned to the competent authority of each Member State. The competent authority of each Member State is responsible for assessing the compliance of crowdfunding service providers with ECSPR. For this purpose, the supervisory authority is entrusted to conduct an on-site inspection.[18] Competent authorities are responsible for fulfilling the functions and duties set out in ECSPR. In order to facilitate this, several investigatory powers are designated for the competent authorities in Article 30 of ECSPR (e.g. to require specific actors to provide information, to carry out on-site inspection and investigations, to temporarily suspend or prohibit a crowdfunding offer or the provision of crowdfunding services, etc.).
Each Member State is required to designate a single point of contact to facilitate and manage communication with ESMA and other competent authorities in other Member States. In ECSPR, the provisions for the cooperation of competent authorities are laid down, including the exchange of information between competent authorities. With the cooperation of competent authorities in other Member States, the investigation, supervision and enforcement activities are facilitated at the EU level, enabling comprehensive conduct of activities by competent authorities without any undue delay. ESMA also takes part in the coordination of an investigation or inspection, upon a request of a national competent authority.[19] In case a crowdfunding service provider engages in activities outside of the scope of ECSPR by holding an appropriate authorisation under relevant national or Union law, the competent authorities for those activities are also responsible for cooperating with the competent authorities designated according to ECSPR.[20]
Finally, competent authorities have the power to impose criminal or administrative penalties for the infringements of ECSPR in accordance with the national laws of Member States.
- Entry into force and the transition period
While ECSPR entered into force on 9 November 2020, the crowdfunding service providers that have already been providing crowdfunding services according to applicable national law preceding ECSPR have not become obliged to get the authorisation under ECSPR immediately. Instead, a transitional period was designated for them in order to ensure legal certainty, replacement of overlapping national law with ECSPR, and provide the crowdfunding service providers sufficient time for both the adaptation of their business activities and the application for an authorisation under ECSPR.[21] The transitional period was, at first, set to end on 10 November 2022 unless the crowdfunding service provider is granted authorisation before that date. Later, the transitional period has been extended by the Commission to 10 November 2023.[22] So, at the time of writing this article, crowdfunding service providers have very little time left.
If a crowdfunding service provider has failed to obtain authorisation under ECSPR by 10 November 2023, it will not be able to issue any new crowdfunding offers after that date.[23] It should also close the calls for funding by that date.[23] Nonetheless, Nonetheless, existing contracts may continue to be serviced (e.g. collecting and transferring receivables), and asset safekeeping services or corporate actions may be processed in accordance with applicable national law.[23]
- Conclusion
Crowdfunding plays an important role in diversifying financial sources, especially for start-ups and SMEs. Prior to ECSPR, fragmented national legal frameworks in this area caused several negative consequences leading to impediments to the cross-border provision of crowdfunding services and the development of the EU’s economy. EU-level legislation, therefore, became a necessity to mitigate such detrimental effects. Moreover, it contributes to the establishment of the CMU in the internal market. Although intended to harmonise national crowdfunding laws in Europe, it only covers lending- and investment-based models.
ECSPR introduced a European passport regime for crowdfunding service providers. A transitional period until 10 November 2023 was set out in order to provide crowdfunding service providers with sufficient time to obtain authorisation under ECSPR. Besides, in order to facilitate easy access to finance for project owners, it is designed to contain moderate requirements. This approach, under specific conditions, entailed exemptions of Prospectus Regulation and MiFID II for these entities. Yet, in order to ensure a high standard of investor protection, appropriate safeguards are set out in ECSPR. Supervision of activities is also shifted to the Union level with the cooperation of competent authorities outlined in ECSPR.
References
[1] Keynote speech by Mario Draghi, President of the ECB, Eurofi Financial Forum, Milan, 11 September 2014.
[2] Speech by President Juncker at the BusinessEurope Day event, 26 March 2015.
[3] European Commission, 2018, Proposal for a Regulation of the European Parliament and of the Council on European Crowdfunding Service Providers (ECSP) for Business, COM/2018/0113 final, 4.
[4] Article 1(1) of ECSPR.
[5] Supra [3] 2.
[6] Ebers, M. & Quarch, B.M., “Chapter 5: EU Consumer Law and the Boundaries of the Crowdfunding Regulation” Crowdfunding and the Law edited by Ortolani, P. & Louisse, M., pending for publication, Oxford
University Press, Oxford 2022, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3822692
[7] Point (c) of Art. 1(2) of ECSPR.
[8] Article 1 of Directive (EU) 2020/1504 of the European Parliament and of the Council of 7 October 2020 amending Directive 2014/65/EU on markets in financial instruments (Text with EEA relevance) OJ L 347.
[9] Point (k) of Art. 1(4) of Prospectus Regulation.
[10] Art. 12(1) of ECSPR.
[11] Art. 12(4) of ECSPR.
[12] Art. 12(6) of ECSPR.
[13] Art. 12(8) of ECSPR.
[14] Art. 12(9) and 14 of ECSPR.
[15] Art. 12(11) of ECSPR.
[16] Art. 12(13) of ECSPR.
[17] Art. 12(14)-(15) of ECSPR.
[18] Art. 15(1)-(2) of ECSPR.
[19] Art. 32 of ECSPR.
[20] Art. 33 of ECSPR.
[21] Recital (76) of ECSPR.
[22] Commission Delegated Regulation (EU) 2022/1988 of 12 July 2022 extending the transitional period for continuing to provide crowdfunding services in accordance with national law as referred to in Article 48(1) of Regulation (EU) 2020/1503 of the European Parliament and of the Council OJ L 273.
[23] Recital (77) of ECSPR.