An introduction to crowdfunding: Part 3

Author

Daniel Hirschfield

Senior Counsel – Knowledge

London

Part 3 – developments in the EU

This is the third article in our four-part series covering UK and EU crowdfunding regulation. Part 1 considered how crowdfunding is regulated in the UK, Part 2 looked more closely at peer-to-peer (P2P) lending, this Part 3 will explore how crowdfunding is regulated across the EU, and Part 4 will consider the effects of the new EU regulation on European crowdfunding service providers.

What is crowdfunding?

The European Commission (EC) describes crowdfunding as "an emerging alternative form of financing that connects those who can invest money directly with those who need financing for a specific project".

As with the UK, the EC divides crowdfunding up into different types:

P2P lending (known as loan-based crowdfunding in the UK) – this is where the crowd lends money to the borrower with the understanding that the money will be repaid with interest.
Equity crowdfunding (known as investment-based crowdfunding in the UK) – this is where a stake in the borrower is sold to number of investors in return for investment.
Rewards-based crowdfunding – this is where the crowd donate to a project or business with expectations of receiving in return a non-financial reward at a later stage.
Donation-based crowdfunding – this is where the crowd donate small amounts to meet the larger funding aim of a specific charitable project while receiving no financial or material return.

These types line up with the FCA's categorisation of crowdfunding in the UK. However, the EC also recognises the following additional types:

Profit-sharing / revenue-sharing – this is where borrowers share future profits or revenues with the crowd in return for funding.
Debt-securities crowdfunding – this is where the crowd invest in a debt security issued by the borrower, such as a bond.
Hybrid models – this is where borrowers combine elements of more than one crowdfunding type.

How is crowdfunding regulated in the EU?

Until recently, the regulation of crowdfunding in the EU was primarily based on national legislation. This meant that crowdfunding platforms wanting to operate across the EU had to comply with fragmented regulatory regimes.

For example, some jurisdictions (such as the Netherlands) had taken a traditional approach, by extending prior banking or financial regulations (such as the Markets in Financial Instruments Directive (MiFID II) rules) to crowdfunding. Others (such as the UK, as discussed in Part 1 of this series) had taken a more innovative approach, by adopting specifically developed crowdfunding regimes. Furthermore, there were divergent requirements surrounding, for example, authorisation, minimum capital, size of offer and maximum investable amounts.

These discrepancies raised compliance and operational costs, which prevented platforms from expanding. For example, business models had to be adjusted according to each jurisdiction. Additionally, the divergences restricted crowdfunding platforms' capacity to penetrate other EU markets, meaning they were unable to benefit from a greater pool of potential investors across the EU.

The EC recognised that this fragmentation was one of the reasons that the EU crowdfunding market remained underdeveloped, as compared with other major economies, and as one of its key initiatives is strengthening sources of alternative finance, such as crowdfunding, it had to consider alternative ways to regulate the market.

How has the regulatory regime developed?

In March 2018, the EC proposed a regulation that would create a standalone, voluntary EU regime applicable to P2P and equity based crowdfunding to "enable crowdfunding platforms to easily provide their services across the EU Single Market", complying with a single set of rules, and ongoing supervision by the European Securities and Markets Authority (ESMA).

Reward-based and donation-based crowdfunding fell outside the scope of the proposal, as the EC did not consider that these could be regarded as "financial services" (which is in line with the FCA's approach in the UK).

The EC explained that the proposal did not "intend to interfere with national bespoke regimes or existing licenses, including those under the MiFID II", instead it would enable crowdfunding platforms, in any EU Member State, to apply for an "EU label" which empowers them to scale up their operations throughout the EU (without needing to seek country-by-country authorisation).

The "EU label" will provide clarity, reduce entry costs and improve access to this innovative form of finance for businesses. It will also provide greater legal certainty to investors and allow for a more coherent approach to supervision.

What are the timings of the new "EU label" proposal?

The EC originally envisaged the regulation taking effect in 2020 but, after significant delays in the expected timetable, Regulation (EU) 2020/1503 was finally published in the Official Journal of the EU on 20 October 2020 and came into force on 9 November 2020. It will apply from 10 November 2021.