CROWDFUNDING – EU REGULATIONS ALREADY IN PLACE, POLISH REGULATIONS STILL MISSING, 25 March 2022
Continuing the series of articles on crowdfunding in the area of commercial projects, in this entry we will focus on key aspects related to the EU regulation providing a uniform legal framework for crowdfunding in the European Union. We also encourage you to read the previous article in this series presenting a general outline of the idea of equity and loan crowdfunding as a manifestation of broader processes of democratization of investment and one of the most dynamically developing areas of the financial market on a global scale, including Poland.
The potential of crowdfunding as an alternative form of financing for businesses including startups and small and medium-sized enterprises has been recognized by the European Union authorities already in the past decade and since 2018 intensive work has been going on the Regulation of the European Parliament and of the Council on European Crowdfunding Service Providers for Business (“ECSP Regulation“) adopted on 7 October 2020.
The above ECSP Regulation creating a uniform legal framework for the provision of crowdfunding across the European Union became effective as of 10 November 2021. Unfortunately, due to the delay in drafting and enacting a Polish law to apply the ECSP Regulation, the EU regulation in the area of crowdfunding remains in our country essentially dead. In particular, the Polish legislator has not formally appointed an authority responsible for performing the functions and obligations under the ECSP Regulation (in all likelihood, this will be the Polish Financial Supervision Authority), so there is currently no entity authorized to grant licenses to crowdfunding providers.
Counting on the work on the Act on crowdfunding for business ventures to gain momentum (currently, the draft is still at the stage of being worked on by the Council of Ministers), it is worth familiarizing oneself today with the key assumptions of the EU regulation and considering crowdfunding as a tool in one’s activity, both from the perspective of an entity seeking financing as well as a financial institution able to extend the range of products it offers with crowdfunding services.
- Definition of crowdfunding services
Under the ECSP Regulation, a crowdfunding service is the matching of investors interested in financing business ventures with project owners using a crowdfunding platform, in one of the following two models:
(i) debt financing through loans (loan crowdfunding);
(ii) an investment funding model based on the purchase by interested investors of marketable securities (and instruments authorized for crowdfunding purposes) issued by project owners (equity crowdfunding).
- Uniform rules for running crowdfunding platforms
The ECSP regulation addresses one of the main limitations of the European crowdfunding market to date, namely the lack of consistent regulation across the entire internal market. The very idea of crowdfunding stems from the need to reach the widest possible range of potential investors, and electronic communication tools (Internet crowdfunding platforms) would seem to be free of the constraints of national borders within the European Union. Unfortunately, until the ECSP Regulation entered into force, the crowdfunding platforms operating to date were to a large extent limited to a given national market. To a large extent, it resulted from the necessity to meet certain legal requirements in force in individual Member States, which differ significantly from one another. The ECSP Regulation places emphasis on enabling the cross-border provision of crowdfunding services. A license granted under the ECSP Regulation in any State of the Union will allow a crowdfunding provider to operate throughout the European Union (subject to national notification obligations).
- High limit on the acceptable value of crowdfunding offers
The EU legislator, motivated by the desire to protect investors as well as to introduce a mechanism to discipline the market, established a limit for the total value of crowdfunding offers made by a particular project owner. However, this threshold was set at a relatively high level of EUR 5,000,000.
The above threshold coincides with the threshold applied by most Member States for the purpose of exempting public offers of securities from the obligation to publish a prospectus pursuant to Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market. It is worth noting that Poland is one of the countries in which the above threshold has so far been at a much lower level. The entry into force of the ECSP Regulation prompted the national legislator to change and gradually raise it to the level of EUR 5,000,000.
- Obligations and restrictions on crowdfunding providers
In order to mitigate the risks associated with crowdfunding and to guarantee a high standard of investor protection, the ECSP Regulation has introduced a number of obligations and restrictions for crowdfunding providers, the most important of which are:
– an obligation to have a real and stable establishment in the European Union and to have the necessary resources for their activities;
– an obligation to comply with prudential requirements in the amount arising from the ECSP Regulation;
– an obligation for crowdfunding providers to develop and comply with internal procedures and policies for their effective and prudent management
– an obligation to exercise due diligence on project owners submitting projects for funding through the platform (crowdfunding providers should put in place policies to ensure that the selection of projects on their platforms is carried out in a professional, fair and transparent manner and that crowdfunding services are provided in the same manner)
– an obligation to avoid conflicts of interest, which amounts to a prohibition for crowdfunding providers to hold any interest in crowdfunding offers on their platforms and significant restrictions on the holding of such interests by affiliates of crowdfunding providers.
- Investor protection
In an attempt to balance investor protection with the additional restrictions and rigidities it entails, the ECSP Regulation introduces a distinction between sophisticated and non-sophisticated investors. This division is essentially based on the distinction between professional and retail clients established by the MiFID II Directive.
Due to the above classification, investors who, on the basis of the data provided by them, qualify as sophisticated investors will be exempted from additional requirements and restrictions applicable to non-sophisticated investors.
Non-sophisticated investors will be required to carry out an initial knowledge test and a simulation of their ability to bear losses before investing via a crowdfunding platform. Although the ECSP Regulation does not introduce an absolute limit on the amount of investment for non-sophisticated investors, investments with a higher value (i.e. above EUR 1,000 or 5% of the net asset value – whichever is higher) will require prior fulfillment of additional requirements by non-sophisticated investor.
In conclusion, the entry into force of the ECSP Regulation will certainly be a breakthrough in the functioning of the European crowdfunding market. In the following months we may expect the emergence of new entities interested in starting up crowdfunding services. In turn, entrepreneurs currently operating in this area will adjust their business model to the new requirements of the ECSP Regulation.
It is to be hoped that the aforementioned work on the Polish law for the application of the ECSP Regulation in our country will result in its rapid enactment, which will allow Polish entrepreneurs to join the European trend for accelerated development of equity and loan crowdfunding.
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Disclaimer: This publication has been prepared for clients and professional associates of Miller Canfield, and is based on the facts and guidance available at the time of its release which may be subject to change. The purpose of the publication is to draw attention to the legal events indicated in it and should not be the sole basis for any decision regarding a particular course of action; nor should it be relied on as legal advice or regarded as a substitute for detailed advice in individual cases.