Crowdfunding, which refers to an open call to the public to raise capital targeted for a specific project, is developing rather rapidly across the globe. It is augmenting economic growth through new and increasing flows of credit to SMEs. This cost-efficient, highly accessible form of finance is enabling investors to diversify their portfolio as well as providing them a low-cost alternative for channeling savings to the real economy. In light of the EUR 4.2 billion (circa) raised through crowdfunding platforms in the EU in 2015, it comes to no surprise that one of the main objectives set forth in the Capital Markets Union Action Plan is to strengthen the different sources of alternative finance, including crowdfunding.
To this effect, the Malta Financial Services Authority (“MFSA”) opted to introduce a tailored regulatory framework for investment-based crowdfunding (“IBC”) by publishing a new set of requirements (the “Requirements”) regulating the operation of IBC services under the Investment Services Act.
As with all types of investments, crowdfunding also entails a number of risks, be it liquidity risks, platform failure, cyber-attacks, as well as investors’ inexperience, and information asymmetry. To cater for these concerns, the MFSA has sensitively intervened to provide a proportional regime, with the appropriate safeguards so as to enhance investor protection. Its aim is to ensure that crowdfunding remains an important source of non-bank financing which supports economic growth and competitiveness, while promoting market integrity.
The rules have been issued in line with the applicable frameworks including Markets in Financial Instruments Directive (MiFID) and having regard to the feedback statements received in response to its Discussion Paper on Investment-Based Crowdfunding published in November 2016.
The Requirements stipulate that for a platform to provide IBC services, it shall apply for a licence under the Investment Services Act, which application shall include a detailed business plan outlining, inter alia, (i) the nature and the manner in which the relevant activities will be carried out, (ii) any investments services being carried out, and (iii) whether it intends to outsource and/or delegate any of its activities and processes. Considering that there is no pan-EU regime regulating equity-based crowdfunding, the licence obtained under the Requirements is not passportable in other EU Member States. It is key to note that licensees under the Investment Services Act who intend to tap into the IBC market shall apply for MFSA approval, prior to the provision of the new services. In addition, they must ensure that there is clear segregation between the crowdfunding component in their business model and other investment services.
Capital Requirements and Disclosure Requirements
In addition to having to meet minimum capital requirements when they become fully authorized and also on an ongoing basis, equity-crowdfunding service providers shall also be subject to mandatory disclosure obligations. Unless the offer of securities is within scope of the Prospectus Directive (in which case, the EU regime would apply), the issuer must provide an information document, which document will however not be approved or verified by the MFSA. This document, which is intended to assist potential investors to make informed decisions on whether or not to invest, must contain full details inter alia on the identity of the issuer, the project in relation to which the investment offer is being made and any potential risks associated with it. Other disclosure obligations relate to the treatment of client money focusing, amongst others, on the details of the entity entrusted with the safekeeping of assets, and the manner and timing of fund transfers.
Due-diligence and Anti-Money Laundering requirements
As aforementioned, the promotion of the benefits of crowdfunding need to be pursued in parallel with ensuring appropriate safeguards. In order to ensure integrity, good faith and competence of the persons involved, applicants must establish adequate procedures to perform due-diligence checks on the issuers to appease fraud concerns.
Tailoring and Investment caps
A novel feature is the introduction of an online entry knowledge test, in order to determine whether the products and services are suitable for the prospective investors. IBC platforms must feature procedures to assess investors’ investment experience, knowledge, and investment objectives. The Requirements, besides prohibiting the marketing of complex instruments, also impose investment limits both in terms of the amount allowed per individual investor and also on the maximum project size in terms of total value of securities issued. An investor cannot invest (i) more than € 5,000 over a period of 12 months in any issuer listed on an IBC platform; and (ii) more than 20% of their net annual income through an IBC platform over a period of 12 months. Moreover, an offer of securities made on an IBC platform cannot exceed the value of € 1,000,000 over a period of 12 months, and an issuer shall only be allowed to place a project on one platform.
On one hand, advocates of crowdfunding services believe that this novel avenue of capital raising will revitalize the IPO market and meet the need for early stage capital currently unavailable to small enterprises. On the other side of the spectrum, sceptics are concerned that perceived fraud will make the market unattractive to investors. As with every form of regulation, the ideal scenario is for the competent authorities to strike the balance between investor protection and opportunity in the context of small offerings. Although it seems that a harmonized IBC approach in Europe still seems like a distant mirage, it is noteworthy that individual European Member States, such the UK and Sweden, have been rather proactive in establishing well-functioning crowdfunding niche markets. Hopefully, their experience will help shape regulation across the EU.
This article was first published in The Times of Malta (31 July 2018)