The Crowdfunding Services Regulation (EU 2020/1503) came into force this week, providing harmonised regulation of European Crowdfunding Service Providers (ECSPs).

The concept of crowdfunding provides an alternative form of finance for start-ups and SMEs, offering validation to business ideas, insights and information and also serving as a major marketing tool. It operates through three actors:

1. The Project owner that initially proposes the project be funded
2. The Investors who provide the funding
3. The Intermediating organisation via crowdfunding service providers joining the two actors through an online platform.

Although this is not a new concept, with some countries already having their own rules covering this notion, this regulation was essential. It allows for cross-border crowdfunding without conflicting laws which previously hindered the smooth operation of crowdfunding online platforms.

It is worth noting that this Regulation does not apply to crowdfunding services that are provided to project owners that are consumers and caps the consideration for crowdfunding offers up to €5,000,000 calculated over a period of 12 months.

The term “crowdfunding services” is defined to include “the matching of business funding interests of investors and project owners through the use of a crowdfunding platform” which can either occur through the facilitation of granting loans or the “placing without a firm commitment basis of transferable securities and admitted instruments for crowdfunding purposes issued by project owners or a special purpose vehicle, and the reception and transmission of client orders, in relation to those transferable securities and admitted instruments for crowdfunding purposes”.

ECSPs are the only legal persons authorised to provide crowdfunding services, and they must act honestly, fairly, and professionally according to the best interest of the clients. They must not pay or accept remuneration/discounts/benefits for routing an investor’s order to any crowdfunding offer on any platform. Furthermore, they cannot participate in any crowdfunding offer available on their own platforms.

To become an ECSP, one must apply to the competent authority of the Member state and provide the necessary information and documentation, including the programme of operations and a description of the ECSP’s operational risks. Authorisations of ECSPs shall be kept in a public register by ESMA.

The management body of the ECSP must establish and oversee the implementation of adequate policies and procedures to achieve effective management and controls to assess risks related to loans. Specifically, they must review the description of the prospective ECSP’s prudent safeguards and the business continuity plan at least once every two years.

Once the ECSP establishes the price of an offer, it shall:

1. Undertake reasonable assessment of the credit risk of the project/project owner before the offer is made, based on:
   • Audited accounts of the last two financial years
   • Information of which it is aware at the time the assessment is carried out
   • Information obtained from the project owner
   • Information enabling the ECSP to carry out its reasonable assessment
2. Establish, maintain, and publish clear and effective policies and procedures on credit risk assessment.
3. Ensure that prices are fair and appropriate
4. Conduct a valuation of each loan, at least:
   • At the moment when the loan is originated
   • When the ECSP considered the project owner unlikely to fulfil the obligation to repay the loan
   • Following a default
   • Where ECSP is facilitating an exit for a lender before the maturity date of the loan.
5. Have and use a risk management framework to achieve compliance with the above requirement
6. Maintain a record of each crowdfunding offer demonstrating credit risk assessments and that the price was fair and appropriate.

The ECSP is also responsible to undertake at least a minimum level of due diligence on the project owners, considering evidence such as their criminal record or if they are established in a non-cooperative jurisdiction. Furthermore, they must provide a list of projects funded through their platform annually to the competent authority, specifying:

• The project owner and amount raised
• The instruments used
• Aggregate information about the investors and invested amount distinguishing between sophisticated and non-sophisticated investors.

In order to facilitate the possibility of cross-border crowdfunding, the ECSP must notify the competent authority which granted authorisation with:

• A list of Member States where the services will be provided
• Identity of natural and legal persons responsible for the services in those MS
• Starting date of said service
• List of other activities provided by the ECSP not covered by the Regulation.

All information relating to the costs and financial risks, or the crowdfunding services or investments must be fair, clear, and not misleading to the investor. The ECSP is thus required to provide a Key Investment Information Sheet to each prospective investor, drawn up by the project owner. The Regulation outlines the exact information to be included in this information sheet together with specific disclaimers and risk warnings for the investor.

This article was written by Dr Cherise Abela Grech and Legal Trainee Ms Jodie Arpa.

For more information, please contact Dr Ian Gauci or Dr Cherise Abela Grech.

Disclaimer: This article is not intended to impart legal advice and readers are asked to seek verification of statements made before acting on them.