How is Crowdfunding Regulated in the European Union?

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The European Council has approved the uniform pan-European regulation for crowdfunding which was in the making for several years. The EU cross-border crowdfunding regulation is finally adopted and published in the Official Journal of the European Union. The rule sets unified rules for crowdfunding service providers and project owners who seek to attract cross-border crowdfunding in the EU, ensuring additional protection for the investors.

The Regulation (EU) 2020/1503 on European Crowdfunding Services Providers for Business is a long-awaited document aimed at reconciling conflicting national rules for crowdfunding and expanding the investor base to all compliant European countries. It is expected to bring more healthy competition, support the development of the market, and ensure the best professional standards.

Overview of the EU Cross-Border Crowdfunding Regulation

The new EU harmonized crowdfunding regulation was approved on 07 October 2020 and will enter into effect in November 2021. The regulation applies to crowdfunding for business and is not applicable to consumer lending and reward- and donation-based crowdfunding, which are not considered as financial services.

The regulation applies to projects raising up to EUR 5,000,000 over a 12 month period, which is considered as covering the needs of most SME businesses and startups. Other projects which exceed EURO 5,000,000 are regulated by the Market in Financial Investment Directive (MiFID II) and Regulation (MiFI R).

The new EU rule is aimed to solve the differences between existing fragmented national rules for crowdfunding, which have led to substantial compliance expenses disproportionate to the size of the investments. The new regulation will not require transposition (that is incorporation into the national law by Member State) and will be directly applicable.

According to the new rules, those EU Member States that don’t have any crowdfunding regulation in place will apply the new regulation from November 2021. The other Member States, having their own crowdfunding legislation in effect, will have a transition period until November 2022 to replace existing regulations with the Regulation EU 2020/1503.

Changes for Service Providers

The Regulation on ECSP for business focuses on regulating the operation of crowdfunding platforms or service providers, obliging the platforms to act in the best interests of investors. The new rules set up high standards for investor protection and determine common prudential and transparency requirements.

In the first place, the service providers will have to apply for authorization in the EU Member State where they operate. The platforms shall file an application to the competent authority in their home state, enclosing the document to prove compliance with organizational and operational requirements. When filing an application, a service provider has to prove, among others, that they:

  • have complaint handling procedure, which enables clients to file complaints,
  • undertake proper due diligence on the project owners seeking finances,
  • have risk assessment and risk management procedures,
  • have an insurance policy covering the territories of the EU,
  • ensure that their services are suitable for non-sophisticated investors,
  • provide a reflection period for non-sophisticated investors enabling the latter to revoke an offer within four calendar days after the offer was made.

The new regulation imposes a range of penalties on non-compliant organizations. The list of penalties includes a public statement about the infringement, bans on the members of the management body of the infringing companies, and administrative fines of EURO 500,000, among other sanctions. Given the scope of penalties and a non-ambiguous set of requirements, non-compliance with the new EU crowdfunding regulation is not an option.

Changes for Project Owners

The ECSP Regulation sets up specific requirements not only for crowdfunding platforms but also for project originators referred to as project owners who propose a project to be funded. Specifically, a project owner can not have a criminal record in respect to infringements of commercial law, insolvency law, financial services regulations, anti-money laundering law, fraud law or professional liability obligations. Besides, a project owner cannot be established in a high-risk third country or a non-cooperative jurisdiction.

In addition, project owners are obliged to prepare the key information sheet for their projects. The contents of the investment sheet are determined in the Regulation and should warn the prospective investors about the risks associated with participating in the project. The investment sheet should also include a description of the crowdfunding project’s specific features, information about the project owners, investor’s rights, and other material data.

Changes for Investors

The main change for investors initiated by the new regulation relates to the introduction of the knowledge test for non-sophisticated investors to ascertain their understanding of crowdfunding. Meanwhile, the rule doesn’t require running such a test for sophisticated investors, who, by definition, are aware of the pertaining risks.

The knowledge test will require non-sophisticated investors to provide information about their financial situation, experience and objectives, and a description of how they understand the risks. It should be noted that the crowdfunding platforms will be required to run such assessments for non-sophisticated investors every two years after the initial test.

Open Questions

For the moment, the ECSP Regulation addresses key issues for cross-border crowdfunding, establishing specific requirements for crowdfunding platforms, project owners, and investors. Meanwhile, several important questions are still out of the scope of the document. Some of them are expected to be addressed during the 12 months between the publication date in 2020 and November 2021 when the new EU cross-border regulation enters into effect.

One of the key questions that need to be worked out is implementing AML and KYC requirements. At present, the new rule doesn’t require crowdfunding platforms to run their KYC/AML procedures but obliges them to use a payment service provider. Meanwhile, such providers can require the crowdfunding platform to implement the KYC/AML authorization before adding a platform.

It should be noted that the new EU regulation doesn’t mention crypto assets at all in connection with crowdfunding, leaving this issue at its present state. Those interested in obtaining financing in the form of cryptocurrencies or investing their crypto assets into startups will have to wait for a separate set of regulations.

Summing It Up

The new Regulation 2020/1530 on European Crowdfunding Service Providers for Business was a long-awaited move by the European Parliament and European Council, expected to revolutionize non-consumer crowdfunding in Europe, harmonizing national legislations and improving access to investors across the EU Member States. It will also facilitate SME financing in those jurisdictions which didn’t have their national rules for crowdfunding.

The Regulation includes two main requirements, including issuing the key investment information sheet for each project, warning investors of potential risks and providing them with material information. The other main aspect of the new EU crowdfunding regulation is the introduction of the knowledge test for non-sophisticated investors.

The ECSP Regulation calls crowdfunding platforms to act in investors’ best interests, ensuring maximum transparency and mitigating the risks associated with unsecured financing. So, for the moment, the crowdfunding service providers and project owners are given a preparatory period ending November 2021, when the new regulation comes into effect, to file necessary applications and provide for compliance with the new rules for cross-border crowdfunding.