New EU Crowdfunding Regulation: 2 out of 3
The regulation of crowdfunding platforms in the European Union (EU) remains in its infancy. To support the industry growth, the European Parliament and Commission are discussing for more than two years now how P2P platforms seeking to offer their services to users across the EU can have a set of harmonized rules and how investors can get additional information.
This article explores the implications for P2P platforms if the regulation is adopted. In case you want a basic contextualization, please check A Single EU Crowdfunding Regulation Closer to Reality?
Reference: Womble Bond Dickinson LLP article on EU crowdfunding.
A Long Road towards a EU Regulation
On 8 March 2018, the European Commission submitted a proposal for a new regulation on European Crowdfunding Service Providers for Business. Now, over two years later, the final compromise text has been published.
What are the conditions for a P2P Platform obtain an authorization as a Crowdfunding Service Provider?
P2P platforms that aim to get a crowdfunding service provider (CSP) authorization must apply to the competent authority in the Member State of their establishment, providing the following information:
- Legal status and constitution of the CSP;
- The platform website;
- The program of operations;
- The CSP’s governance arrangements;
- The protocols for data processing systems management by the CSP;
- A operational risk analysis;
- A prudential safeguards report;
- A proper business continuity plan;
- Information about its managers;
- Protocols and procedures for internal controls to prevent those involved with it from engaging as project owners (receptors of funds raised from the crowd);
- Any outsourcing arrangements;
- Procedures for handling complaints;
- Procedures for provision of payment services;
- Procedures for required information verification;
- Procedures in relation to investment limits for non-sophisticated investors.
Any applicants that are already authorized under relevant EU laws covering credit institutions, investment firms, e-money institutions or payment services providers do not need to provide information that they have already provided previously to the regulators.
The proposal stresses that CSPs may also carry on other activities, so long as permitted under EU or national law.
In order to facilitate transparency for investors, the proposal also requires the national regulator to tell the European Securities and Markets Authority (“ESMA”) when it approves and application, and requires ESMA to establish a public and up-to-date register of all authorised CSPs and of all operating crowdfunding platforms in the Union.
What will be the Operational Requirements?
Crowdfunding services may be provided only by legal persons that are established in the EU and have been authorized as CSPs. Once authorized, they must meet a number of high-level organizational and operational standards:
- Acting honestly, fairly and professionally – CSPs must act honestly, fairly and professionally in accordance with the best interests of their clients.
- Not paying or accepting any remuneration, discount or non-monetary benefit – CSPs must not pay or accept any remuneration, discount or non-monetary benefit for routing investors’ orders to a particular crowdfunding offer made on either their platform, or a third party platform.
- Considering the investor’s chosen parameters or risk indicators – CSPs may propose to individual investors specific crowdfunding projects which correspond to one or more specific parameters or risk indicators chosen by the investor. However, investors are required to review and expressly take an investment decision in relation to each individual crowdfunding offer.
Further, CSPs are required to disclose to investors the decision process they use when acting on a discretionary mandate, but may then make decisions within the agreed parameters without requiring investor consent.
Effective and Prudent Management
- Establishing adequate policies and procedure – CSPs must have adequate policies and procedures to ensure effective and prudent management, including the segregation of duties, business continuity and the prevention of conflicts of interest, in a manner that promotes the integrity of the market and the interest of their clients;
- Establishing appropriate systems and controls – the management of CSPs should establish, and oversee the implementation of, appropriate systems and controls to assess the risks related to the loans intermediated on the platform, and those that allocate investor loans between projects should have appropriate risk and financial modelling controls; and
- Assessing the credit risk – where a CSP determines the price of a crowdfunding offer, it must carry out a reasonable assessment of the credit risk and the price, based on set criteria, monitor its compliance with these conditions and keep appropriate records to demonstrate compliance”.
Undertaking Due Diligence
CSPs should undertake at least a minimum level of due diligence in respect of project owners to include (1) evidencing that the project owner has no criminal record for breach of national commercial, insolvency, financial services, anti-money laundering or fraud laws or national professional liability obligations, and (2) evidencing that the project owner is not established in a non-cooperative jurisdiction or in a high-risk third country.
Portfolio Management of Loans
Where a CSP offers individual portfolio management of loans (essentially, auto-investing for investors) the mandate from the investor must include that every loan in the portfolio will have to comply with at least two of the criteria on maximum and minimum interest rates and maturity dates, range and distribution of risk categories and reasonable certainty of achieving a target return. The CSP must have in place processes and methodologies to assess these factors. Records of mandates will need to be kept, and the CSP will need to keep records on every investment for at least 3 years after its maturity and report on the investor’s request on the composition of the portfolio with details of the investments.
CSPs must have in place and publish descriptions of effective and transparent procedures for the prompt, fair and consistent handling of complaints. Clients must be able to file complaints against CSPs free of charge and CSPs must develop and make available to clients a standard template for complaints, keeping a record of all complaints received and the measures taken. CSPs should investigate all complaints in a timely and fair manner and communicate the outcome within a reasonable period of time.
Conflicts of Interest
CSPs must not have any participation in any crowdfunding offer on their crowdfunding platforms, and may not have shareholders who hold 20% or more of share capital or voting rights, or individuals linked to them, acting as “project owners”. CSPs that accept such persons as investors in the projects offered on their crowdfunding platform are required to fully disclose this on their website, ensure that these investments are made under the same conditions as those of other investors and ensure that these investors do not enjoy any preferential treatment or privileged access to information.
In addition to this, CSPs are required to maintain and operate effective internal rules to prevent conflicts of interest and take all appropriate steps to prevent, identify, manage and disclose conflicts of interest. CSPs are required to disclose to their clients the general nature and sources of conflicts of interest and the steps taken to mitigate those conflicts.
When relying on a third party for the performance of operational functions, CSPs should take all reasonable steps to avoid additional operational risk. Additionally, the CSP will remain fully responsible for the activities, and outsourcing of operational functions should not impair the quality of the CSP’s internal control and the ability of the competent authority to monitor the CSP’s compliance with the proposal.
Client Assets Safekeeping and Providing Payment Services
Where asset safekeeping services and payment services are provided CSPs should inform their clients about the nature and terms and conditions of those asset safekeeping services, whether those services are provided by them directly or by a third party, and whether payment services are provided by the CSP or through a third party provider acting on their behalf. It sets requirements to protect investors where CSPs provide payment transactions, and where instruments are held in custody.
CSPs to have in place at all times prudential safeguards, within set criteria based on own funds, appropriate insurance or a mixture of the two, that are equal to an amount of at least the highest between (1) €25,000, and (2) one quarter of the fixed overheads of the previous year, including the cost of servicing loans for three months when the CSP also facilitate the granting of loans.
Will there be any ability to passport?
An authorised CSP intending to provide crowdfunding services in another Member State must submit specified information to its “home state” regulator noting the services it wishes to provide and how it will do so. The “home state” regulator must provide this information to the “host state” regulators and to ESMA within 10 days, and inform the CSP that it has done so. Once the CSP gets this confirmation it may start to provide crowdfunding services in the target Member State.
What is ESMA’s role?
ESMA will play a key role in setting standards, maintaining registers, and monitoring compliance with the Regulation. As is increasingly the case, the proposal requires ESMA to provide a number of technical standards detailing the requirements under various provisions of the Regulation, as well as maintaining the Register.
Loans included in the scope of the proposal are loans with unconditional obligations to repay the amount owed to the investor, whereby lending-based P2P platforms merely facilitate investors and project owners to conclude loan agreements without acting as a creditor of the project owner.
What is your opinion on this subject?
I would like to learn your opinion on this EU initiate and how do you see the objectives described above reflecting into more trust from investors in P2P platforms. Remember that this will be still a long process and it is critical that investors mobilize towards ensuring their view point is considered.
Part 3 of this series will focus on the key provisions of the proposal around acceptance of investors on a P2P platform, and the information they must receive for safeguard.