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Crowdfunding Update

Monday, February 2, 2015

It was recently announced that an initiative, entitled “Vision and Targets for IFS 2020” will target the creation of 10,000 additional jobs over the next five years. The initiative has been drawn up for the Government and is set to be considered by the Cabinet later this month. Crowdfunding is due to feature in the plan. It will be interesting to see what comes out in the plan and what reaction if any there is to the recent publication from ESMA (the European Securities and Markets Authority) on the issue of crowdfunding in the EU.

On 18 December 2014, ESMA published two important documents (an Opinion and an Advice note) for the benefit of the crowdfunding industry, and specifically investment-based crowdfunding. The documents attempt to highlight issues for consideration by the EU institutions to achieve greater regulatory and supervisory convergence within the EU.

The Opinion is addressed to Member States and the Advice note is addressed to the EU institutions – Commission, Parliament and Council.

By way of background, ESMA is charged with helping to build a common supervisory culture, practices, procedures and approaches through the EU. In tandem with the European Banking Authority, it jointly prepared a paper on crowdfunding as an input to the European Commission’s consultation paper on the industry in October 2013. ESMA hopes that this document will assist Member States in discussing the subject with platforms and interested parties, in a bid to advance the industry.

Highlights from the Opinion include:

  • Further confirmation that EU financial services rules were not built with crowdfunding in mind;
  • Many of the key risks that arise in investment-based crowdfunding arise because of the high failure rate associated with early stage companies and the fact that the securities on offer are not listed. The types of risks referred to include complete loss of investment, dilution, lack of liquidity. The risk of conflicts of interest is raised again. This stems from the potential for some platforms to be conflicted in representing themselves as a form of screening process while at the same time promoting investments and taking fees for completed transactions.
  • The most likely MiFID service / activity undertaken by most platforms is the “reception and transmission of orders”. Therefore, the most likely capital requirement for authorised firms would be €50,000 or an appropriate professional indemnity policy.
  • Where Member States have developed regimes under the exemption offered by Article 3 of the MiFID directive [2004/39/EC], there would be a question mark over the viability of this for scaling a crowdfunding business, as it would mean involving a third party (an authorised firm) with increased cost and no ability to passport the services.
  • The Prospectus Directive [2007/71/EC as amended] is discussed. This directive places an obligation to issue a formal prospectus where there is an offer of securities to the public, unless certain exemptions apply. Platforms that are structuring their offerings to avoid the application of the directive could be damaging to investors and reduce the scalability of the crowdfunding business (e.g. limiting itself to small offers or qualified investors).
  • Investor compensation – we are reminded that there is access to compensation for investors under the Directive on Investor Compensation Scheme [97/9/EC] where an investment firm cannot meet its liabilities. It only applies to authorised firms. e.g. authorised firms under MiFID in connection with financial instruments. In Ireland, the Investor Compensation Scheme Company Limited is established for this purpose where up to €20,000 may be claimed by eligible investors in connection with failed investments. It only applies to authorised firms who are members of the compensation scheme. I am not aware of any platforms in Ireland that are part of this scheme.
  • The potential application of other legislation is discussed, including the Alternative Investment Fund Managers Directive [2001/61/EU], where ESMA points out the possible application of the directive where a platform manages non-UCITS collective investment undertaking which raises funds from a number of investors to invest in line with a defined investment policy. Where you have a platform that pools investors in an SPV to invest into multiple projects / companies, the directive could be triggered bringing with it, increased compliance obligations including for example, registration with local regulator and/or capital requirements.

The Advice Note identifies some risk issues for consideration by regulators which have been well documented to date, including high risk of some or all of investor capital, risk of dilution, lack of liquidity, and conflicts of interest for crowdfunding platforms.

ESMA identifies key components of an appropriate regulatory regime including proportionate capital requirements, ensuring investors understand the risks, segregation of assets in case of insolvency of a platform, and conduct of business rules. ESMA believes there is a misconception in the market on what regulatory compliance would entail, and is concerned that business models are being developed deliberately to try to avoid the regulatory requirements. ESMA advises the EU institutions to consider whether there is a case for action at EU level to reduce the incentive for crowdfunding businesses to structure their business model to avoid regulation. It goes to say that compliance with MiFID would provide a reasonable level of risk mitigation, but short of that, ESMA believes there is a gap in terms of investor protection. While the gap may possible be addressed at national level, it would not apply for cross border activities.

My Feedback

I would agree with the premise that in order to scale a crowdfunding platform, Irish operators will need to think of the opportunities that exist outside of this country – and to do this with confidence, regulatory compliance needs to be tackled. While there is nothing startling new in the two documents, I would view it as positive that the debate is being advanced on the industry and how to make it work cross-border. As you might expect, what it lacks is concrete next steps in order to bring that about. What it does suggest however, is that a toolkit already exists (via the existing legislation) and that if changes are required to specifically suit crowdfunding, why re-invent the wheel? We wait to see if the Commission will provide comment and we may yet hear from the European Banking Authority on the issue this year. I wonder how much attention has been paid to these documents at Government level and whether Central Bank or the Government will comment on them. Maybe we will get some feedback via today’s ‘Vision and Targets for IFS 2020’.


Eoghan Doyle