Implementation of the Crowdfunding Regulation in the EU
The objectives of the event were to bring together European crowdfunding ecosystem stakeholders, policy makers, and industry experts to share experiences and provide information on the European regulation, discuss crowdfunding practices and the possibilities for the sector, and of course, to promote crowdfunding in Europe. Payment institutions, legal offices and media groups, as well as professional associations participated in the event. Three different conferences were held simultaneously on the same day. Workshops were organised in several key crowdfunding areas: adoption of the Regulation and feedback, taxation issues and reality of secondary markets, investor protection, the role of institutional investors and business scaling.
The sector’s regulatory framework
The EU crowdfunding Regulation was adopted two years ago, and as a result the issue of investor protection was taken seriously. The alternative finance market in France grew on average by 25% each year. Crowdfunding services, as alternative financing, currently present on the market cover major needs: consumer finance, real estate investments, lending to small and medium-sized enterprises (SMEs), and invoice financing. This means that crowdfunding services show sustainable development and close the gap in each sector of the traditional finance. Currently, capitalisation and maintaining trust among investors in the industry are an important focus to ensure a successful development of crowdfunding services. The European crowdfunding Regulation represents a step forward in strengthening trust. In addition, all European public structures should work together to support growth of the industry.
Some level of market protection has already been achieved by the Regulation.
Despite its complexity, the Regulation provides equal benefits, like passporting of operations. Cross-border activity is crucial for small countries and platforms that focus on specific industry segments.
Crowdfunding platforms in large EU countries benefit from market size in relation to projects and investors. The structure of the market in each country differs however similar development trends are obvious: the consolidation of small platforms, specialisation in financing of specific industries (green energy, agriculture, local regional business loans).
However, the number of operators that have obtained an authorisation from local national competent authorities (NCAs) in Europe is quite small – 21, including SIA CrowdedHero Latvia that has received an authorisation to provide crowdfunding services in Latvia.
Challenges during the transition period
A number of requests still require clarifications. Convergence is the main objective of ESMA that has published materials containing questions and answers to support the industry and help it interpret and explain requirements. There are still some ongoing discussions in relation to platforms that are authorised under the old national legislation. As the speed of industry development differs from country to country, there are platforms on the market that have no capacity to fulfill the requirements of the new Regulation. Even experienced platforms that have historically gained a notable market share and recognition encounter problems during the transition period of the Regulation.
ESMA analyses activity across the NCAs, looking at statistics of applications, and facilitates interpretation of the Regulation to ensure that all market participants are treated in the same way.
Also, ESMA will check how passporting works across the countries and will analyse whether investors are satisfied with the Regulation.
Another visible and important trend is the consolidation of the industry. Most probably, some platforms will not survive and some will consolidate. This means that consolidated platforms will be able to offer more financial services to customers and become one-stop-shop platforms for SMEs. Challenging is the fact that platforms are still waiting for the end of the transition period in order to apply for an authorisation. In such a situation, the processing risk does exist, i.e. all EU NCAs will be overloaded with applications and the timeline for authorisation will not be predictable.
The European Commission very strongly recommends to start the licensing process immediately, without waiting until the end of November 2023. There can be no delays anymore.
NCA approaches in countries
For example, in Spain crowdfunding services were regulated by the national law, so the NCA introduced a short process for platforms that were already authorised and operated. At the same time, the new European Regulation was applicable in full to newcomers. In Latvia, "smart" crowdfunding service providers started approaching NCAs two years ago. For example, in Latvia, the local NCA organised several webinars and meetings with industry representatives to explain the Regulation and its requirements to start the authorisation process immediately upon adoption of the Regulation. The Latvian regulator offered free consultations during the transition period and support to companies in each step of the licensing process. As a result, in August 2022 the first licence was issued to a local crowdfunding service provider, which already had the passporting regime.
The Innovation Hub of Latvijas Banka is available for advice and consultations regarding preparation of documents, requirements of the Regulation, interpretation of legislation during the authorisation period and beyond.
Voice of the platforms
Due to the fact that too many small platforms operate in markets, the number of licences issued across the European Union is low. These small platforms find that the requirements of the Regulation are too heavy to fulfill, and they suffer from the lack of competences to proceed with authorisation. The view that the Regulation was developed for large platforms is partly true. Therefore, it is complicated for small companies to comply even with minimum requirements to provide a safe infrastructure and ensure financial services to customers. On the other hand, small platforms from small countries can attract investors from abroad using the passporting regime that makes investment services available even to small investors.
Platforms that have started passporting have to respect some specific legislative provisions in other countries. Some of them are struggling with localisation, e.g. all agreements need to be translated into local languages to adapt them to local legislative provisions. This imposes additional responsibility on platforms. Another issue is related to cross-border payments, as the location of investors and business owners is geographically diverse, and transactions across countries are performed in different payment systems. As a result, payments become more expensive.
The way platforms communicate project risks and make smart use of marketing tools is important. Financial literacy of investors plays a central part in crowdfunding services. There are different practices among the platforms in respect of how to treat unprofessional investors that are unable to continue the investment test. Some may decide not to accept unsophisticated investors for the provision of services. The educational materials, which explain risks, are available on service providers’ websites can be mentioned as good practice. At the same time, there is a lack of openness, transparency, and clarity of the risk policies. They are drafted by platforms using different approaches, competences in risk assessments and legal advice. It is crucial for crowdfunding service providers to communicate with customers regarding default rates, portfolio quality, non-performing loans, and debt collection procedures not only during the daily operation cycle, but also in crisis situations. In addition, the requirements related to market communication have to be strictly followed.
During the discussions, several areas have been identified for potential improvement of regulation in the future: standardisation of loan agreements, collateral evaluation, and the rating system.
Combining crowdfunding with EU institutional funds
Since 2002, when the European Commission called crowdfunding services as innovation, we can see the development of new services and instruments in crowdfunding business. Since then, new business models have appeared on the market: invoice financing, real estate investments, seasonal loans for agriculture. The discussions among the participants focused on the future role of crowdfunding services from an EU perspective. The next step in the development of business models may include the distribution of EU institutional funds to SMEs through crowdfunding platforms. This will open a huge opportunity for the industry and affect the local regions and the economy. Until now, programmes of EU funds have been complicated, but they have represented a proven model of how these funds can be distributed in the economy. The crowdfunding industry might be one of the chain elements and distribution channels. Previously, EU funds were mainly distributed by banks, but now the European Commission is looking for motivation in crowdfunding. One of the goals of the European Commission is to ensure access to finance and equity distribution to SMEs and to bring Europe closer to citizens.
Some similar projects were successfully implemented in Italy, combining private and public money. The Municipality of Milan has been working with crowdfunding platforms since 2014, and it has extensive experience gained from 53 completed projects. As a result, crowdfunding platforms, were included into public funding programmes. The experiment was part of the strategy to combine innovation with an inclusive approach. In the very beginning, it is important to build a crowdfunding community to gain trust and ensure the transition and sharing of competences between the public and private sectors. Currently, other European countries are assessing whether is it possible to apply a similar approach in local municipalities to facilitate the distribution of European funds in their countries and to support the economic sectors such as agriculture and sustainable green production.