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EIFR Crowdfunding SeminarESMA’s work on investment-based crowdfunding

28 September 2015, Paris

Anne Choné, Paris

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ESMA’s approach to crowdfunding

• A balanced approach

• Collaborative work with EBA, ESMA focusing on investment-based

(equity and debt) crowdfunding, while EBA focuses on loan-based

crowdfunding

Economic benefits by facilitating

access to finance by project

owners

Specific risks to investors (mostly

retail) and projects owners

Support the development of a pan-

European market as far as possible

Provide for a safe environment for

both investors and project owners

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Key achievements

• Contribution to EC’s consultation (Dec 2013)

• Opinion and Advice to National Competent Authorities (NCAs) and

EU institutions (Dec 2014) (https://www.esma.europa.eu/content/Opinion-Investment-based-crowdfunding)

(https://www.esma.europa.eu/content/Advice-Investment-based-crowdfunding)

• Response to EC’s Green Paper on Capital Market Union (May 2015)(https://www.esma.europa.eu/news/Press-Release-ESMA-publishes-response-Capital-Markets-Union-Green-Paper)

• Survey to NCAs (May 2015)(https://www.esma.europa.eu/system/files/esma-2015-856_ann_1_esma_response_to_ec_green_paper_on_cmu_-_crowdfunding_survey.pdf)

• Q&A on anti-money laundering (July 2015) (https://www.esma.europa.eu/news/ESMA-issues-QA-anti-money-laundering-and-investment-based-crowdfunding-platforms)

• Supervisory Forum with NCAs (2015-2016)

Assist NCAs and market participants

Contribute to regulatory and supervisory convergence

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Where does crowdfunding stand?

• Still relatively new phenomenon, modest volumes but

growing quickly

• Involving mostly retail investors

• Different and evolving business models

• EU regulation not designed with crowdfunding in mind

• Lack of awareness/clarity about the regulation likely to apply

• (Perceived?) incentives for platforms to structure their

business models so as to fall outside of the regulation

• Potential that some risks may be left unaddressed

• Increasingly individual initiatives by some Member States to

regulate crowdfunding (FR, IT, PT, SP)

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A step-wise response

• Analysis of the different business models and how they may evolve

• Assessment of risks – Threefold perspective: Project owners, investors, platforms

• Assessment of the likely components of an appropriate regulatory regime

• Detailed analysis of how the typical business models map to the existing EU legislation

• Identification of potential gaps and issues

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Specific risks to consider

• Risks related to investment in smaller companies– Significant potential of capital loss (high failure rate)

– Risk of dilution through further capital raising

– Lack of exit options (unlisted instruments, lack of secondary market)

– Limited information available on which to base an investment decision

• Risks related to the platforms’ business model– Potential for conflicts of interest

– Impact of platform failure (especially if hold/administer client assets)

– Risk for investors to over-estimate the due diligence carried out

• Opportunity costs (if unduly constrained)– Lack of funding for the real economy

– Loss of investment opportunities for investors

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Appropriate regulatory regime – Likely components

• Proportionate capital requirements or similar mechanisms

for safeguarding operational continuity

• Mechanism to ensure that investment opportunities reach

investors for whom they are appropriate

• Means of ensuring that investors are aware of the risks

• Means of ensuring appropriate safeguarding/segregation of

client assets

• Proportionate regulation of the platform’s organisational

arrangements and conduct of business

• Certainty and clarity about the nature and extent of the

platform’s responsibilities towards clients

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Applicable EU regulation - Prospectus Directive

The Prospectus Directive (PD) requires publication of a prospectus before the offer of securities to the public or the admission

to trading of such securities on a regulated market, unless certain exclusions or exemptions apply. The prospectus cannot be

published until it has been approved by the NCA.

• Applicable to crowdfunding offers provided that:– Instruments involved are transferable securities as defined in MiFID

– Size of offer triggers the application of the PD• Offers with a total ‘annual’ consideration below €5m are outside the scope of the Directive

Offers with a total ‘annual’ consideration below €100k are excluded from the obligation to

publish a prospectus; however, Member States have discretion to apply national

requirements to offers between €100k and €5m and practices in this regard vary widely

– Exemption if the offer is only addressed to ‘qualified investors’

– Exemption if the offer is addressed to fewer than 150 persons per Member

State other than ‘qualified investors’

• In practice, platforms seem to structure their business to

avoid the PD requirements

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Applicable EU regulation - MiFID

Where applicable, MiFID would impose duties on the crowdfunding platform in its capacity as investment intermediary. To be

within MiFID scope, a firm needs to be carrying on MiFID services/activities in relation to MiFID financial instruments, and not

exempt. The benefit to a platform of being within the scope of MiFID is that it has a passport to carry on the services/activities for

which it is authorised throughout the EU without any additional authorization being required, in accordance with a single set of

rules. This is at the ‘cost’ of complying with capital and other requirements.

• Key questions– Which financial instruments?

• Many Member States have had experience of crowdfunding using forms of participation which

are not ‘financial instruments’ and therefore fall outside of MiFID

– Which MiFID services/activities?• Case by case assessment needed as business models vary and the definitions were not

designed with these models in mind

• Requirements, notably capital requirements, vary depending on the type of services/activities

• Most likely in ESMA’s view is ‘Reception and Transmission of Orders’ (RTO), meaning that

capital requirement applicable under MiFID would be €50,000

– Are there relevant exemptions?• Exemption under article 3 only applicable in the case of ‘RTO’ and ‘investment advice’

• Reduced requirements but loss of the EU passport

• May frame business models in an unintended way

28. September 2015 | Location,City

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AIFMD

The Directive on Alternative Investment Fund Managers (AIFMD) lays down the rules for the authorisation, ongoing operation

and transparency of the managers of alternative investment funds (AIFMs) which manage and/or market alternative investment

funds (AIFs) in the Union […] AIFs means collective investment undertakings, including investment compartments thereof, which

(i) raise capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the

benefit of those investors and (ii) do not require authorisation pursuant to Article 5 of Directive 2009/65/EC [UCITS].’

• Technically applicable to platforms which operate models

based on indirect investments which qualify as AIFs

• Limited experience but likely to become more widespread

• Key questions– Existence of a ‘defined investment policy’? (in order to qualify as AIF)

• Most likely answer would be yes in ESMA’s view

– Are there relevant exemptions? (e.g., SPV, holding companies)• Some SPVs established by platforms could in theory qualify for the exemption in ESMA’s view

– Possible interactions with MiFID?

– Was AIFMD intended to capture all these types of structures? Relevance of

EuVECA and EUSEF?

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Other potentially applicable regulations

• Directive on investor-compensation schemes (in MiFID scope) [97/9/EC]

• Market Abuse Directive (not where unlisted securities) [2003/6/EC]

• Distance Marketing of Financial Services Directive [2002/65/EC]

• Third Anti-Money Laundering Directive [2005/60/EC]

• Payment Services Directive [2007/64/EC]

• Unfair Commercial Practices Directive: [2005/29/EC]

• Misleading and Comparative Advertising Directive [2006/114/EC]

• Unfair Terms in Consumer Contracts Directive [93/13/EEC]

• Consumer Alternative Dispute Resolution (ADR) Directive [2013/11/EU]

• Consumer Credit Directive and Mortgage Credit Directive (unlikely)

[2014/17/EU]

• E-commerce directive [2000/31/EC]

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Gaps and issues in current EU framework

• Use of instruments outside MiFID scope

• Structuring offers to avoid Prospectus Directive requirements

• MiFID Article 3 exemption: lower capital but other costs

• AIFMD: single company vehicles in but SPVs out?

• Capital requirements where multiple legislation applies?

• Risks to users are increased

• Industry less scalable (e.g., loss

of the passport)

• Unnecessary barriers?

• Level playing field?

Can incentives to operate outside

regulation be reduced?

Will the legislative framework need

to evolve?

Consider an EU framework especially for platforms operating outside MiFID

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Survey to NCAs

• 46 regulated entities as of December 2014

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Survey to NCAs

• Services/activities carried out vary greatly

• Implications in terms of capital requirements + ability to hold client money

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Survey to NCAs

• Mostly but not exclusively direct investments

• Predominantly equity

• Different remuneration models– Remuneration by project owners only: most frequent, on average 4 to 6% of amount raised

– Remuneration by both project owner and investor: 4 to 6% of amount raised + 2.5 to 5% of amount

invested and/or 5 to 20% of profit made at exit

– Remuneration by investor only: relatively unusual

– Incentive for platforms to market projects aggressively and be less selective on projects?

– Little visibility on future profitability? Potential viability issues?

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Q&A anti-money laundering

• Clarifies the extent of terrorist financing and money laundering risks in

relation to investment-based crowdfunding activities– Increased risk where there is limited or no due diligence on project owners or their projects

– Increased risk where platforms collect funds for later onward transmission

• Considers the risk profile of the platforms depending on their regulatory

status

• Considers how investment-based crowdfunding should be treated under

AML3D– Platforms operating within MiFID are automatically subject to AML3D

– Platforms outside of MiFID but carrying payment services within the meaning of the PSD will be

subject to AML3D; the same holds true for participation in securities issues and the provision of

services related to such issues, and safekeeping and administration of securities

– The requirements likely to apply to other platforms will depend on the scope of national law

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Supervisory Forum with NCAs

• Forum for informal discussion of challenges faced in the authorisation

and/or supervision of investment-based crowdfunding

• With a view to promoting effective and convergent supervision

• Established for an initial period of 18 months

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Questions?

This presentation is a summary of ESMA’s Advice ESMA 2014/1560 ,

Opinion ESMA 2014/1378 and Q&A ESMA 2015/1005.

Only the Advice, Opinion and Q&A should be regarded as authoritative.