Debt & Equity Crowdfunding: What is it & how is it Regulated?
Crowdfunding has risen in prominence over the past decade to become a major source of business financing for companies and entrepreneurs all over the world. It is a method of financing a venture, project or business idea. For start-ups and small and medium sized enterprises crowdfunding is a low-risk way of raising funds.
Given the vibrant nature of if Ireland’s start-up community and the stream of innovative young companies that emerge from that scene, Ireland is an ideal location for crowdfunding platforms. However, the sector is currently unregulated. The Central Bank of Ireland issued a Consumer Notice in 2014, which warned consumers about the unregulated nature of crowdfunding investments and advised to exercise caution when investing. In addition, the new EU Crowdfunding Regulation means that the unregulated nature of this type of funding will change in the very near future, with the key date for application of the EU Crowdfunding Regulations being 10 November 2021. In this briefing, we consider the implementation of the new EU Crowdfunding Regulation and its effect on crowdfunding platforms.
How is crowdfunding currently regulated?
Crowdfunding is not currently a regulated activity in Ireland and no legislation applies directly to crowdfunding services. It should however be noted that any of the Prospectus Regulations, MiFID and the Companies Act 2014 may catch some aspects of crowdfunding platforms.
EU Crowdfunding Regulation
A new framework has been introduced which consists of a new EU Crowdfunding Regulation together with relevant amendments to MiFID II. The initiative was part of the European Commission’s fintech action plan and the mid-term review of the capital markets union action plan.
The framework requires crowdfunding service providers (“CSPs”) to be authorised, imposes operational requirements and introduces investor protection measures. The new regulation will apply across the EU from 10 November 2021.
The directive excludes CSPs covered by the EU Crowdfunding Regulation from the scope of MiFID II in order to avoid CSPs from being subject to two regulatory schemes at the same time.
Who does the new framework apply to?
The new framework will apply to two types of crowdfunding:
- peer-to-peer lending; and
- investment-based crowdfunding.
However if, in the course of providing those crowdfunding services, a crowdfunding offer (calculated over 12 months on a per-project owner basis) has a total consideration in excess of €5 million, that particular offer will be out-of-scope and will instead be subject to the rules set out in MiFID II and the Prospectus Regulation.
Any CSP which facilitates in-scope crowdfunding must be authorised. An in-scope CSP may also be subject to the requirements of the Payment Services Directive if it provides payment services.
What is peer-to-peer lending?
Peer-to-peer lending is a form of debt crowdfunding, which involves a company receiving money from the crowd, with the intention that it is repaid with interest. Debt crowdfunding is similar to traditional borrowing however, an advantage is that the company typically pays lower interest rates than they would ordinarily and investors get a better return than they would with a bank savings account.
What is investment-based crowdfunding?
Better known as equity crowdfunding, this is where a large number backers each invest a relatively small amount in a business in return for equity shares in the company. Platforms facilitating investment-based crowdfunding have become increasingly popular in recent years, with seed investments in particular utilising them.
How will authorisation work?
A CSP that falls within the scope of the EU Crowdfunding Regulation will be required to apply for authorisation to the designated authority in the Member State where they are established. The Central Bank of Ireland has confirmed that it will be the national competent authority (“NCA”) in Ireland. The NCA decides whether to grant or refuse the authorisation within 3 months of an application being made.
The new framework will allow authorised CSPs to passport their services across the EU without the need to have a physical presence in another Member State.
CSPs that are already engaged in activities that will require authorisation can continue to engage in those activities on a transitional basis until 10 November 2022 without authorisation.
What will the EU Crowdfunding Regulation change?
(a) Uniform crowdfunding platform
The regulation will bring clarity and certainty to the crowdfunding platforms that operate throughout the EU. The new rules are expected to aid companies by increasing the availability of this innovative form of finance & simultaneously benefitting investors with a clear protection framework.
New requirements for marketing communications will be applicable to CSPs, including an obligation to ensure that marketing communication are fair, clear, not misleading, and are consistent with the information contained in the key investment information sheet.
(b) New responsibilities
Responsibility is placed on NCAs to ensure compliance of authorised CSPs with the EU Crowdfunding Regulation and authorisation may be withdrawn if a CSP is not in compliance. Each CSP must provide a confidential annual report to its NCA of projects funded through its platform. This information will then be shared with the ESMA.
(c) Heightened informational requirements for authorised CSPs
The regulation provides for a number of operational requirements on authorised CSPs, for example:
- to avoid conflicts;
- to carry out specified minimum levels of due diligence on project owners;
- to implement transparent complaints-handling procedures;
- a duty to act honestly, fairly, professionally & in the best interests of investors;
- to adopt risk management procedures & assessments; and
- to not accept inducements.
(d) Investor Protection
The regulation establishes new protections for investors such as an effective and transparent complaints procedure and clearly labelled marketing communications. The regulation distinguishes between “non-sophisticated investors” and “sophisticated investors” and a number of protections (regarding assessments of appropriateness, simulation of loss and reflection periods) only apply to non-sophisticated investors.
How can we help?
McCann FitzGerald is a premier Irish law firm. With over 650 staff located in our principal office in Dublin and our international offices in London, New York and Brussels, our specialists are ready to help your business thrive. Our Corporate practice combines with our Company Secretarial and Compliance Services group to offer your start-up enterprise the market-leading advice that you need to grow, from corporate advice on fundraising and governance, to day-to-day advice on compliance matters – leaving you free to focus on developing your business. Please contact any member of the McCann FitzGerald Start Strong team for assistance.
Also contributed by Ashley Braham.
This document has been prepared by McCann FitzGerald LLP for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.
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