EU Crowdfunding Regulation: New ways to access capital

Introduction

Crowdfunding is an alternative avenue for start-ups and small and medium-sized enterprises (“SMEs”) to raise finance by typically receiving small investments from a “crowd” of persons and/or organisations. It involves a Crowdfunding Service Provider (“CSP”) acting as an intermediary which operates a digital platform, to match or facilitate the matching of prospective investors/lenders with businesses that seek funding (the “project owners”).

To enhance the development of the EU Capital Market and eliminate legal uncertainty stemming from divergent national laws, the Regulation 2020/1503 on European crowdfunding service providers for business (“ECSP Regulation”) creates a harmonised framework of rules for certain crowdfunding services. It regulates investment-based crowdfunding services which entail raising capital through the sale/acquisition of transferrable securities or private company shares not subject to transfer restrictions, and lending-based crowdfunding services which involve seeking funding via loans. Reward-based and donation-based crowdfunding services, such as Kickstarter, are excluded from its scope.

The ECSP Regulation has entered into force on 10 November 2021.  

Changes to the existing national crowdfunding regime

With the enactment of ECSP Regulation, the CySEC Directive DI87-10 on the provision of crowdfunding services will be phased out on 10 November 2022 when the transitional period prescribed in the Regulation would have elapsed. The said directive only covered investment-based crowdfunding services in relation to transferrable securities and mandated that a prospective CSP must be authorised as a MiFID investment firm, whereas the new regulation has no such requirement unless the CSP also intends to offer investment services.

Authorisation process and timeframes

As per the new Regulation, legal persons intending to provide crowdfunding services must apply for authorisation to the Cyprus Securities and Exchange Commission (“CySEC”). Within 25 days upon receipt of the relevant application, CySEC informs applicants on whether their application is complete or sets a deadline by which the applicant must provide any missing information. A reasoned decision to grant or reject a CSP authorisation is reached within three months from the date CySEC receives a complete application, and the decision result is communicated to the applicant within three working days.

Key provisions of the new regulation

The new ECSP Regulation outlines a series of operational requirements that CSPs must meet, including:

• Prudential safeguards: CSPs must have, at all times a minimum capital of EUR 25,000 or funds equal to 25% of the fixed overheads of the preceding year, whichever is higher.
• Prudential requirements: establish and implement adequate policies and procedures to ensure effective and prudent management, including: a business continuity plan, a conflict of interests policy and a complaints handling policy
• Project owner Due Diligence: CSPs currently fall outside the regulatory perimeter of the Prevention and Suppression of Money Laundering and Terrorist Financing Law 188(I)/2007 (the “AML Law”). However, this is subject to change should the EU Commission consider it necessary and proportional. Presently, CSPs are only required to conduct minimum due diligence of their project owners, by obtaining evidence that they have no criminal record and are not established in a non-cooperative jurisdiction.

With regards to investor protection, CSPs must, among others, follow the below:

• provide fair, clear and not misleading information to clients;
• distinguish between sophisticated and non-sophisticated investors;
• run entry knowledge tests to non-sophisticated investors, issue risk warnings to such investors with insufficient knowledge, skills and experience, and receive express acknowledgements from them that they understood the said risk warnings;
• offer a 4-day pre-contractual reflection period to non-sophisticated investors during which they may revoke their offer to invest or their expression of interest in a crowdfunding offer, without giving a reason or incurring a penalty;
• provide all prospective investors with a Key Investor Information Sheet (KIIS) that is prepared by the project owner, but whose completeness is verified by the CSP;

Our Services

The Financial Services, Funds and Capital Markets team of our firm welcomes all enquiries and can assist you in crowdfunding-related matters, including:

• setting-up and authorisation of a CSP;
• drafting of policies and other documentation to comply with the prudential requirements of CSPs;
• drafting of CSP-related commercial agreements, such as agreements for the outsourcing of operational functions, agreements with third-party custodians, payment agent agreements with payment service providers.
• provision of regulatory monitoring reports in relation to legal changes and amendments in the sphere of crowdfunding services;
• passporting of CSP authorisation to other Member States.

This publication is provided for your convenience and does not constitute legal advice.

Authors: Andria Koukounis, Polyvios Nikolaou