DIGITAL/FINTECH WHITE PAPER

CROWDFUNDING

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table of contents

Table of contents 3

Foreword 5

Chapter I What is crowdfunding? 7

Chapter II Crowdfunding in the EU context 8

Chapter III Legal framework in Luxembourg 9

Chapter IV How to attract capital 11

Chapter V Why set up in Luxembourg? 12

Chapter VI Alternative finance in figures 13

Glossary 14

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foreword

Crowdfunding and Luxembourg Crowdfunding has become an increasingly popular form of technology-enabled financing, allowing to make capital calls to a very large community of investors via the internet, social and investor networks. As there is no harmonised European legal framework currently in place, crowdfunding is regulated at national level, if at all, and in very different ways across the EU Member States.

Providing solutions to crowdfunding business is an opportunity for Luxembourg and highly relevant in the context of Luxembourg as a global leader in investment solutions. Luxembourg is currently offering providers of crowdfunding services a range of structures to best address their target investor base.

Objective

This paper aims to guide potential initiators on the different Luxembourg ways to (re)fund via crowdfunding platforms.

We would like to thank all those participating in our digital working groups for their dedication and very valuable input. We are very much looking forward to meeting you at the events we will be organising in the coming months. We hope that you find these recommendations interesting and useful.

ALFI, Association of the Luxembourg Fund Industry

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chapter I What is crowdfunding?

Terminology In the absence of a common EU definition, crowdfunding may be referred to as the practice of funding a project or venture by raising money from a large number of people who each contribute a relatively small amount.

Crowdfunding platforms, typically accessed via a website or an app for mobile devices, can be used to finance projects, products, start-ups and much more. Often a predefined minimum amount of money has to be collected within a fixed period of time in order for the crowdfunding to be successful and the project to be realised.

There are four categories of crowdfunding:

• Donation-based crowdfunding, where the funders do not receive any consideration, except, in some cases, non-material benefits such as a public acknowledgement. This form of crowdfunding is particularly suitable for financing social and non-profit projects.

• Reward-based crowdfunding, where the funders receive a non-financial consideration, like a copy of the project result. This form of crowdfunding is almost universally applicable and is particularly suitable for financing cultural and artistic projects and for the implementation of new product ideas.

• Equity-based crowdfunding, where the crowd aims to receive a return on investment based on the project's success. Since the micro-investments made by the funders have a quasi-equity character, this form of crowdfunding is suitable for supporting start-ups, small and medium-sized companies, real estate projects, and film projects.

• Peer-to-peer lending, where the funders issue a loan at an agreed interest rate over a fixed term, with or without security, or via an invoice finance-like structure as opposed to “vanilla” loans. This alternative to the traditional bank loan is primarily used by private individuals, self-employed persons and small and medium-sized enterprises (SMEs).

Crowdfunding involves three types of participants:

• The project owner that proposes the project to be funded,

• Investors who support the proposed project through funding, and

• An intermediating organisation, typically in the form of an online platform, that brings together project owners and investors.

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chapter II Crowdfunding in the EU context

Overview The European Commission has adopted a proposal for a regulation on crowdfunding in March 2018. This initiative aims to ensure that SMEs will have additional sources of funding available as an alternative to traditional financing measures such as bank loans, overdrafts and credit card debt that are often expensive for early-stage businesses.

Providers of crowdfunding services must align their business model with the rules of the national market in which they operate. As the respective national legal environment depends on the interpretation and implementation of existing EU directives by the Member States’ competent authorities, regulatory frameworks for crowdfunding service providers are currently ranging from no regulation to strict application of investor protection rules.

As noted by the Commission, several Member States “have to date introduced national bespoke regimes for crowdfunding, while others require crowdfunding platforms to get licensed and operate under existing EU frameworks such as the Markets in Financial Instruments Directive (MiFID II), the Payment Services Directive (PSD) and the Alternative Investment Fund Managers Directive (AIFMD)”.

This patchwork of different regulations prevents providers of crowdfunding services from reaping the benefit of the internal market and hinders the potential scale of crowdfunding activity at EU level.

For this reason, the European Commission presented a first proposal of a regulation for crowdfunding service providers that enables cross-border activity and seeks to address risks in a proportionate manner. The Commission sees this initiative as part of its priority of establishing a Capital Market Union (CMU), which aims to broaden access to finance for innovative companies, start-ups and other unlisted firms.

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chapter III Legal framework in Luxembourg

Existing vehicles Currently, Luxembourg has no specific legal framework for crowdfunding or peer-to-peer (P2P) lending. Therefore, an initiator contemplating to establish a crowdfunding or peer-to-peer lending platform in Luxembourg must consider existing pieces of legislation to support his project.

Two structures are predominantly used: the alternative investment fund and the securitisation vehicle.

The alternative investment fund (AIF) An AIF is a fund solution targeting first and foremost professional investors.

Apart from non-regulated AIFs, the three most common fund solutions are currently:

• The so-called “Part II fund”

Non-UCITS that are not subject to a specific product law (such as the SIF or SICAR law) are considered undertakings for collective investment (UCIs) established under Part II of the Law of 2010 on undertakings for collective investment (“Law of 2010”).

UCIs can be sold to all types of investors.

Part II funds are directly regulated and supervised by the Commission de Surveillance du Secteur Financier (CSSF), the competent supervisory authority of the financial sector.

There is no restriction in terms of eligible assets of a UCI. However, the investment objective and strategy is subject to prior approval by the CSSF, who also defines risk diversification requirements.

Part II funds are tax-neutral vehicles.

• The specialised investment fund (SIF)

A SIF is a regulated, operationally flexible and fiscally efficient multipurpose investment fund regime for international, institutional and “well-informed” investors requiring a limited level of protection and looking for investment flexibility suitable to their particular expertise and needs.

In comparison with institutional funds created under Part II of the Law of 2010, the SIF is characterised by greater flexibility with regard to its investment policy and a less stringent regulatory regime.

SIFs are directly regulated and supervised by the CSSF. There is no restriction in terms of eligible assets of a SIF. SIFs are however subject to the principle of risk-spreading.

SIFs are tax-neutral vehicles.

• The reserved alternative investment fund (RAIF)

The RAIF combines the characteristics and structuring flexibilities of regulated specialised investment funds (SIFs) and investment companies in risk capital (SICARs) qualifying as AIFs managed by an authorised AIFM, except that RAIFs are not subject to CSSF approval before they are launched. This permits the achievement of a significantly enhanced time to market for new fund launches.

RAIFs are reserved for “well-informed” investors requiring a limited level of protection and looking for investment flexibility suitable to their particular expertise and needs.

There is no restriction in terms of eligible assets of a RAIF. RAIFs are subject to the principle of risk-spreading, unless the RAIF is investing in risk capital.

A RAIF is indirectly regulated by the CSSF: the Luxembourg manager of a RAIF is supervised by the CSSF.

Under certain conditions, these funds may be distributed in all EU Member States using the EU product passport.

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Legal framework in Luxembourg

The securitisation vehicle (SV) The securitisation vehicle is a generally unregulated structure often used for refinancing that benefits from a dedicated Luxembourg legal framework.

SVs are very flexible in terms of their legal form and potential asset classes. Just like investment funds, they may set up several compartments within one legal entity, each compartment having its own segregated assets financed by dedicated securities.

Consequently, the same legal entity can be used for several independent transactions. No risk diversification is required, i.e. single-asset transactions are possible.

Securitisation vehicles usually issue debt securities, like bonds with interest and principal payment solely depending on the performance of the securitised assets.

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chapter IV How to attract capital

How can crowdlending platforms attract capital? Crowdlending platforms often face difficulties in attracting institutional capital, as many institutional investors are either not allowed by regulation or by their internal investment policy to invest directly into loans, i.e. to directly purchase the respective loan receivables. These investors therefore often use a fund or a securitisation vehicle to investing into the loans.

There are currently two ways for investors to invest via crowdfunding and/or P2P platforms:

• Solution 1: portfolio investment

One attractive solution is for the AIF or the SV to acquire a portfolio of loans from the platform. This purchase is either financed by the issuance of units (in the case of an AIF) or by the issuance of securities (in the case of an SV). Such portfolio purchase fulfils the requirements for diversification of an AIF.

• Solution 2: platform-based single-asset securitisation

The second attractive solution is a single-asset securitisation, which offers a direct transformation of single loans into tradable bond-like securities for various types of originators. Using a securitisation platform allows various types of loans to be securitised, each using a separate compartment for each loan in order to separate the risks.

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chapter V Why set up in Luxembourg?

Why set up a crowdlending platform in Luxembourg? There are many good reasons:

• Central location in the heart of Europe • High political and social stability • AAA-rated economy • State-of-the-art legal, regulatory and fiscal framework • Large double taxation treaty network • Highly international and diversified financial centre • Diversity of investment vehicles allowing for tailor-made solutions meeting the needs and preferences

of an international clientele • Very dynamic and fast-growing FinTech sector • Highly skilled multicultural and multilingual workforce

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chapter VI Alternative finance in figures

Alternative finance intermediaries in figures A recent study, the 3rd European Alternative Finance Industry Report published by the Cambridge Centre for Alternative Finance at the University of Cambridge Judge Business School (the “Study”), provides the following figures:

• The total European online alternative finance market grew by 41% to reach EUR 7,671 million in 2016. Excluding the United Kingdom, the European online alternative finance industry grew by 101% from EUR 1,019 million to EUR 2,063 million in 2016.

• The United Kingdom remains the largest individual market. The Study covers 344 crowdfunding, P2P lending and other alternative finance intermediaries from across 45 countries in Europe, out of which 267 platforms operate outside of the United Kingdom. They reach a market volume of EUR 5,608 million.

• With a total of EUR 697 million, or 34% of all volume, P2P consumer lending accounts for the largest market segment of alternative finance in Europe (excluding the UK). P2P business lending has a 17% market share.

• 45% of P2P consumer lending and 29% of P2P business lending are funded by institutions such as pension funds, mutual funds, asset management firms and banks. 13% of the investment in equity-based crowdfunding was also funded by institutional investors such as venture capital firms, angel investors, family offices or funds.

• Online alternative finance for businesses provided EUR 1,126 million to 14,521 businesses across the region. Debt models accounted for 67% of all business finance, while equity models (equity-based crowdfunding etc.) accounted for 27%.

• Although 77% of platforms in 2016 reported some level of cross-border inflows in support of local campaigns and 44% reported outflows of local users’ support for campaigns abroad, cross-border transaction flows still represent only a modest share of alternative finance platforms’ volumes.

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glossary

AIF Alternative Investment Fund

AIFM Alternative Investment Fund Manager

AIFMD Directive 2011/61/EU on Alternative Investment Fund Managers

CMU Capital Markets Union

CSSF Commission de Surveillance du Secteur Financier

FinTech Financial technology

Law of 2010 Luxembourg Law of 17 December 2010 on undertakings for collective investment

MiFID II Directive 2014/65/EU on Markets in Financial Instruments

Part II fund UCI governed by Part II of the Law of 2010

P2P Peer-to-peer

PSD (PSD2) Directive (EU) 2015/2366 on payment services

RAIF Reserved Alternative Investment Fund

SICAR Société d’investissement en capital à risque

SICAR Law Luxembourg Law of 15 June 2004 on the investment company in risk capital

SIF Specialised Investment Fund

SIF Law Luxembourg Law of 13 February 2007 on specialised investment funds

SMEs Small and medium-sized enterprises

SV Securitisation vehicle

UCI Undertaking for collective investment

UCITS Undertaking for collective investment in transferable securities

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notes

February 2019© 2019 ALFI. All rights reserved.

Crowdfunding