The final draft of the EU-Regulation on Crowdfunding – a brief analysis of its scope and main features
The EU-Regulation on European Crowdfunding Service Providers (ECSP) – not applicable to consumer financings but only to business financings – has been almost 2,5 years in the making after the European Commission kicked-off the legislation process in March 2018. This is a fairly long process for this rather concise piece of legislation. However, firstly, European Parliament considerations and drafting proposals to expand this legislation to include a regulation of initial coin offerings (ICO-s) – later abandoned – and, secondly, the European elections in May 2019 and the formation of a new Commission have caused delay. But finally, in July 2020, the final text was published in all official EU languages.
In the following, we offer a brief analysis of the scope and main features of the ECSP regulation (an extended version of this article with a full discussion can be found in the Journal of Banking Law and Banking (JBB), vol. 32 (2020) at p. 217-224, in German).
Purpose and general concept of the regulation
The regulation of crowdfunding platforms is currently fragmented all accross Europe. In some countries (in particular eastern EU countries), the platform does not require a license. Germany, for example, requires an investment brokerage license under section 34f of the German Commercial Code („Gewerbeordnung“). There are manifold differences also on the product level regarding e.g. the information material to be provided to investors and on whether and to what extent there is the requirement of an advance review and approval of investor information by supervisory authorities.
The Commission has identified this regulatory patchwork as a major obstacle to the creation of a European investor base for internet-based crowdfunding projects and thus a major obstacle to the perfection of the EU-wide capital markets union in this segment – and who could deny that? The few platforms that in the light of this regulatory patchwork have sought to expand their businesses across Europe had to go through time and cost intensive legal set-up projects in each Member State. And until today there is no crowdfunding platform with a truly EU-wide reach.
The EU approach to fix this situation is to provide a new license category for crowdfunding service providers which through a passporting mechanism will be recognised throughout the EU. But the EU legislator also realised that until today quite different business models of crowdfunding exist in the EU with different legal structures, tailored to the peculiarities of the national laws. Therefore, as stated explicitly in recital (76) of the ECSP regulation, the regulation seeks to cover only certain types of crowdfunding structures whereas other structures outside the scope of the ECSP regulation may continue to be operated in accordance with the applicable national laws. However, regarding those structures that do fall under the scope of the ECSP regulation, it does indeed have “teeth”: such structures will be – following the end of a 24 month transition period which will begin 20 days upon publication of the regulation in the Official Journal of the EU – only permissible with an ECSP license.
Scope of application of the regulation
This leads to the important practical question which structures will fall under the scope of the ECSP and which will not. This will need to be answered with view to each business model in question individually. In Germany – looking at crowdlending (debt issuing) as opposed to equity investing – two different models have become established: firstly, loans provided by crowd investors with a so-called qualified subordination clause and, secondly, loans provided by banks who syndicate to the crowd simultaneously with the disbursement of the loan.
The result of the legislation process is as follows: the first model (i.e. loans where the borrower / issuer does not have to repay the debt if and to the extent this would lead to an insolvency) will fall outside the scope of the ECSP regulation. The second model (non-subordinated loans) will fall within the scope of the ECSP. At the same time, and this is a major step for European banking regulation, the ECSP orders all Member States not to impose banking license requirements on crowd investors granting senior loans in the course of an ECSP project (and likewise, the borrower / issuer will not need a deposit taking license in the course of an ECSP project). This distinction between subordinated loans outside the scope of the ECSP and non-subordinated loans within the scope is made in a somewhat hidden place of the ECSP, but nevertheless clearly: in the definition of “loans” which will fall under the scope of the ECSP only if the obligation to repay is “unconditional”.
As a consequence, partner banks as “fronting banks” will, following the transition period, no longer play a role in crowdinvesting models – unless they are involved for payment services. Also – and this is likely to give a positive boost to crowdinvesting generally – there is no longer the need to do subordinated loans just to avoid licensing requirements (note that under some national laws, including German law, currently subordinated loans are exempt from banking licensing requirements). In ECSP projects, senior loans will no longer require a banking license, so why organise subordinated loans given that they contain a high credit risk from the investor’s perspective? Looking at the issue of prospectus requirements, ECSP projects will bring a clear EU-wide framework. The ECSP only applies to projects with a volume of no more than EUR 5 million. Up to that volume no prospectus is required, but only an investor information sheet for which the European Commission is yet to set regulatory technical standards (RTS) based on proposals to be prepared by the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA).
Also securitized issuings, i.e. projects including the issuance of financial instruments falling under MiFiD II, will be covered by the ECSP regulation, i.e. exclusively regulated by the ECSP, however only projects with a volume of no more than EUR 5 million and only if the financial instruments are distributed by an internet-based platform.
Main features of the ECSP regulation
ECSP licenses are granted by the authorities to be designated by each Member State (in Germany this will be BaFin) in accordance with the requirements laid down in the ECSP regulation. The requirements are fairly similar to a MiFiD II license.
Investor protection plays a major role in the ECSP regulation (see the comprehensive chapter in Art. 19 et sqq.). On many issues relating thereto, the Commission is yet to set regulatory technical standards (RTS), e.g. on credit scoring methods to be used by the platforms, on the disclosure of numbers and volumes of defaults arising in financings of the platform in question, on the entry knowledge test which the platforms have to apply to prospective investors and, as already mentioned, on the details of the standardised investor information sheet. An important innovation is the explicit permission of “auto-invest” functions where the investor sets certain investment parameters on the platform (e.g. loan volume, term of the loan, range of interest rate and credit scoring) and instructs the platform to select projects and invest automatically. This portfolio investment service function is included in the ECSP license.
Other features appear to have been designed rather hastily. There is a consumer revocation right of – which is quite short – only four days in the case of each investment. Apparently, the EU legislator did not have in mind that under other EU directives on distance marketing (which will apply to an ECSP who necessarily performs online marketing) a revocation right of two weeks applies. We therefore have two different revocation periods in parallel which will make things somewhat confusing for consumers and platforms alike.
In summary
These are rather minute problems that are known also from other fields of regulation. Practical solutions will be found.
There are good prospects that the ECSP regulation will give the EU crowdinvesting community a fresh boost for the future.