Our previous article confirmed that the final compromise text for a Proposal for a Regulation of the European Parliament and of the Council on European Crowdfunding Service Providers for Business (CSPs) has been published.
In that article, we looked at what the proposal says on the operational, organisational and authorisation requirements for CSPs. In this article we consider the provisions that deal with ensuring investor protection, including examining who can invest on a crowdfunding platform, what standards apply to investor communications and marketing, what the pre-contract information requirements are and what the proposal says about investors who wish to cancel or sell their investments.
Who can invest on a crowdfunding platform?
The proposal recognises that crowdfunding services aim to facilitate the funding of a project by raising capital from a large number of people who each contribute relatively small amounts through a publicly accessible information system. Crowdfunding services are, by their nature, open to an unrestricted pool of investors.
That said, in order to ensure adequate protection of different categories of investors participating in crowdfunding projects, the proposal distinguishes between sophisticated and non-sophisticated investors and introduces different levels of investor protection safeguards for each of these categories of investors.
The proposal provides that the distinction between sophisticated and non-sophisticated investors should build on the distinction between professional clients and retail clients established in Directive 2014/65/EU (MiFID 2). However, it notes that this distinction should take into account the characteristics of the crowdfunding market and the experience and knowledge of potential investors in crowdfunding, which should be re-assessed every two years. As a result, the proposal introduces a definition of "sophisticated investor" to include all "per se" professional clients under MiFID 2 and any person who has been approved by the CSP in accordance with the criteria in the Regulation.
Under Article 15 of the proposal, CSPs are required to run an entry knowledge test on prospective non-sophisticated investors (per se professionals are assumed to be sophisticated on providing proof of their status under MiFID 2 to the CSP) before giving them full access to invest in their crowdfunding projects. This is to ensure that CSPs assess which crowdfunding services offered are appropriate for non-sophisticated investors, and to ensure that the investors understand the level of risk associated with crowdfunding investments.
The "test" must request information about the investor’s experience, investment objectives, financial situation and basic understanding of both the risk in investing generally and in the types of investments specifically offered on the crowdfunding platform. Where a CSP considers that a prospective non-sophisticated investor has insufficient knowledge, it must inform the investor that the services offered may be inappropriate and give them a risk warning clearly stating the risk of losing the entirety of the money invested. But these investors should not be prevented from using the platform.
For the purposes of this assessment, CSPs should also require prospective non-sophisticated investors and non-sophisticated investors to simulate their ability to bear loss – which is calculated as 10% of their net worth – based on information like their regular and total income, their assets and their financial commitments.
CSPs must provide a template to investors who are not per se professionals, which they can complete to request to be treated as a sophisticated investor, and which will require them to attest they meet the relevant criteria (which are to be (i) a corporate with own funds of at least €100,000, net turnover of at least €2m or balance sheet of at least €1m or (ii) natural persons who meet two of the conditions of (a) personal gross income of at least €60,000 pa or a portfolio of cash deposits and financial assets worth over €100,000, (b) working in the financial sector or holding an executive position that requires knowledge of the transactions envisaged for at least 12 months and (c) has carried out an average of 10 transactions on the capital markets per quarter of significant size over the past year), and are aware of the consequences of losing the protection available to non-sophisticated investors. The must also agree to be liable for the information they have provided.
Further, if an investor has been classified as non-sophisticated, before that investor enters into an investment of an amount that exceeds the higher of either 1000 EUR or 5% of their net worth, the CSP must ensure that the investor receives a risk warning, provides explicit consent to this, and proves that they understand the investment and its risks.
CSPs are required to assess the knowledge and experience of each non-sophisticated investor every two years and their ability to bear losses every year.
What standards apply to investor communications and marketing?
Under Article 14 of the proposal all information, including marketing communications, from CSPs to clients about themselves, about the costs, financial risks and charges related to crowdfunding services or investments, about the crowdfunding conditions and about the nature of and risks associated with their crowdfunding services should be fair, clear and not misleading. The information must be provided whenever appropriate, and at least before entering into a transaction. It must be available on a clearly identified and easily accessible part of the website and on every webpage on which an offer is made, and also in what the proposal describes as a "prominent place of the medium", including on an app. CSPs must also tell their clients that crowdfunding services are not covered by the deposit protection or investor compensation schemes set up under EU Directives.
Article 19 deals specifically with requirements in relation to marketing communications and requires CSPs to ensure that all marketing communications, including those outsourced to third parties, about their services, are clearly identifiable as such.
The proposal specifies that before the closure of raising funds for a project, marketing communications must not disproportionately target individual planned, pending or current crowdfunding projects or offers. The information contained in a marketing communication should reflect the information contained in the key investment information sheet offered to investors where this is already available, or should reflect the information required to be in the key investment information sheet where this not yet available.
Further, for their marketing communications, CSPs are required to use one or more of the official languages of the Member State in which the communications are disseminated, or a language accepted by the competent authorities of that Member State.
Credit-scoring of projects
If CSPs apply credit scores to crowdfunding projects or suggest pricing of crowdfunding offers on their crowdfunding platform, they must offer a description of the method used to calculate these. If the estimation is based on accounts that are not audited, this should be clearly disclosed in the description of the method. The proposal requires the European Banking Authority ("EBA") and the European Securities and Markets Authority ("ESMA") to develop draft regulatory technical standards to specify the elements to be included in this description, the information and factors CSPs should consider when complying with credit risk assessments and valuation requirements, the factors CSPs should consider when ensuring that the price of a loan they facilitate is fair and appropriate, and the minimum contents and governance of the policies and procedures required under the proposal.
What are the pre-contract information requirements?
In addition to the other information requirements discussed in this article, there are some requirements specific to pre-contract information.
In order to enable all prospective investors to make an informed investment decision, there is also a requirement under Article 16 of the proposal for CSPs to provide prospective investors with a "key investment information sheet" for each offer. This should be prepared at least in the language of the Member State in which the CSP is authorised and in a language accepted by the authorities in any other Member State into which it is marketed. The sheet must be fair, clear and not misleading, and must be in a standalone, durable medium not exceeding 6 sheets of A4 paper if printed. The sheet must contain:
- Detailed information about the project owner and the project, main features of the process and conditions for the fund raising, risk factors, information on the offering, including terms of subscription for transferable securities, any guarantees or collateral and whether a special purpose vehicle is involve. It must also include the key investor rights in relation to the instruments and relevant restrictions, disclosures relating to any loan that is part of the offer, details on fees, costs and redress and any relevant information on individual portfolio management of loans to be provided by the CSP
- A statement in prescribed wording, that the offer has not been verified or approved by any regulator or ESMA, that the appropriateness of the offer has not necessarily been assessed and that the investor accepts the risk of the potential loss of the entire investment
- A risk warning of possible total loss, and the fact the investment is not covered by the Deposit Guarantee or Investor Compensation Directives, together with advice not to invest more than 10% of net worth in crowdfunding projects, and a warning of illiquidy and potential nil returns.
The project owner should be responsible for the information in the sheet and for keeping the CSP up to date with any changes. The sheet should identify the persons responsible for it, and they should make declarations that to the best of their knowledge the information in the sheet is accurate and there are no material omissions. CSPs, however, must have in place and apply adequate procedures to verify the completeness, correctness and clarity of the information and, if they identify any need for change, must suspend the offer until the changes are made and contact all investors who have made an offer.
There are similar requirements on a CSP offering individual portfolio management services.
ESMA is to develop RTS for the presentation and disclosures required on the sheet.
Do investors have cancellation rights?
Yes. Article 15b of the proposal is clear that a CSP must provide for a pre-contractual "reflection period", during which a prospective non-sophisticated investor may revoke their offer to invest or expression of interest in the crowdfunding offer without incurring a penalty, and without providing a reason. Clients must be informed about the reflection period.
When a CSP makes an offer, the terms and conditions of the offer are binding on it from the moment it lists the offer until the earlier of any stated expiry date or when the target or maximum target funding goal is reached.
This reflection period starts at the moment when a prospective non-sophisticated investor puts forward their offer to invest or their expression of interest and it expires four calendar days later. Immediately after an offer to invest or an expression of interest is made, CSPs are required to inform the investor that the reflection period has started.
The proposal simply states that the modalities to revoke an offer to invest or an expression of interest should include at least the same modality by which a prospective non-sophisticated investor is able to make an offer to invest or express interest in a crowdfunding offer.
If an investor has signed up to auto-invest (that is, in the words of the proposal, individual portfolio management of loans), the reflection period apples only to the initial mandate and not to each individual investments.
What if an investor wants to sell their investment?
In the interest of transparency and flow of information, the proposal provides that a CSP may operate a bulletin board on which they allow their clients to advertise interest to buy and sell loan agreements, transferable securities or admitted instruments for crowdfunding purposes which were originally offered on their crowdfunding platforms.
However, the bulletin board cannot be used to bring together buying and selling interest by means of the CSP's protocols or internal operating procedures in a way that results in a contract. The bulletin board should therefore not consist of an internal matching system which executes client orders on a multilateral basis – otherwise it would risk being a multilateral trading facility, for which the operator would require authorisation under MiFID 2.
CSPs that suggest a reference price for such buying and selling are required to inform their clients that the suggested reference price is non-binding, substantiate the suggested reference price and disclose key elements of the methodology.
Now we wait to see whether there will be any further changes in the proposal as it completed the EU legislative process. Once adopted, Member States will have 12 months from entry into force of the Regulation to adopt and publish legislative measures, but there will be some transitional provisions.