Crowdfunding has finally entered into Turkish legislation through Omnibus Law no. 7061 dated 5 December 2017, by way of amending certain provisions of Capital Market Law numbered 6362. Although the amendments cover the mainframe of crowdfunding in a very basic form, detailed secondary legislations and policies are needed to implement crowdfunding as a successful system. In anticipation of the secondary legislation it would be beneficial to look at the regulatory approaches to crowdfunding within European Union (EU) Member States and United Kingdom (UK).
EU Level Legislative Framework
Although the European Commission (through a communication1 and two reports) and the European Parliament (through three resolutions) considers crowdfunding a way to broaden access to finance for innovative companies, start-ups and other unlisted firms, including small or medium size enterprises2, there is no specific EU legislation for crowdfunding. Member States implemented one of two main approaches to address concerns around crowdfunding. Some Member States (Germany, the Netherlands and Belgium) adopted guidelines extending prior banking and financial regulations and, amongst others (Italy, France, Spain and UK) adopted specific regulations. However, differences exist amongst the Member States adopting the same approach.
In addition to national legislation, crowdfunding business models may also be subject to EU legislation such as;
* Directive 2000/31/EC concerning electronic commerce;
* Directive 2006/114/EC concerning misleading and comparative advertising;
* Directive 2005/29/EC concerning unfair business-to-consumer commercial practices in internal markets;
* Directive 93/13/EEC concerning unfair terms in consumer contracts;
* Directive 2003/71/EC on the prospectus to be published when securities are offered to the public or admitted to trading;
* Directive 2007/64/EC on payment services;
* Directive 2004/39/EC on markets in financial instruments;
* Directive 2013/36/EU on access to investment firms;
* Directive 2011/61/EU on alternative investment fund managers;
* Directive 2008/48/EC on credit agreements for consumers;
* Directive 2002/65/EC concerning the distance marketing of consumer financial services;
* Regulation (EU) No. 575/2013 on prudential requirements for credit institutions and investment firms;
* Regulation (EU) No. 345/2013 on European venture capital funds; and Regulation (EU) No. 346/2013 on European social entrepreneurship funds.
Furthermore, crowdfunding activities may be subject to EU state aid and competition rules3.
The European Supervisory Authorities have also carried out work on crowdfunding in their respective areas of responsibility. In December, 2014, the European Securities and Markets Authorities (ESMA) published advice and an opinion on investment-based crowdfunding, and in February, 2015, the European Banking Authority (EBA) published its opinion on lending-based crowdfunding4.
Overview of Regulatory Frameworks in a Selection of EU Member States
Two main categories of crowdfunding are donation and investing. Donation crowdfunding raises non-equity capital for creative projects and charity causes. In some business models, donations may support an early stage company or product innovation. In most of the EU Member States, no specific regulations exist for donation-based or reward-based crowdfunding.
Investing types of crowdfunding refers to raising capital by selling financial instruments related to the company's assets or financial performance. Investing types may also include raising debt capital in the form of peer-to-peer lending ("P2P" or "lending-based crowdfunding") or selling claims to the company's intellectual property, and selling to investors' ownership shares (investment-based crowdfunding). The investing type crowdfunding is the most regulation oriented, either by way of extending prior banking or financial regulations, or adoption of ad hoc rules or fully fledged bespoke regimes to the crowdfunding5.
Lending-based platforms exist in the majority of Member States. In most of the business models used for lending-based crowdfunding, platforms act as intermediaries and do not lend money directly, and only facilitate loans amongst their clients. In some business models, either the platform takes participation in the loans made through it, or a bank extends the loans on behalf of the crowd-lenders. A lending-based crowdfunding usually procures borrowers to obtain a mostly unsecured loan, and lenders to invest in the loan, in exchange for a financial return. The services, for which the platforms charge a fee, include (i) registration and checks of borrowers' identity and eligibility for the loan, including their creditworthiness; (ii) online tools enabling lenders either to choose which borrower(s) to lend to, or to use automated bidding functions to better diversify their risk; (iii) setting an interest rate based borrowers' credit profile or enabling online reverse auctions; (iv) processing of lenders' money onto borrowers' accounts, and borrowers' repayments according to the agreed terms and (v) debt collection on behalf of lenders if borrowers do not repay on time. Depending on the business model, some of these activities and services may also be outsourced to external suppliers, including authorized payment service providers6. These investments have a higher return / higher risk than saving accounts offered by banks as no regulatory safeguards such as bank deposit guarantee schemes or investor protection schemes protect these investments. If the borrower defaults or the platform becomes insolvent, the crowd-lenders risk losing part or all of their investment. Some platforms offer provision or contingent funds to cover, mostly in part, crowd-lenders' losses from borrowers' defaults. However, the cumulative effect of the short history of a platform, and the maturity of loans ranging up to five or more years, may render some of these contingent funds incapable to cover losses in the event of level of defaults higher than predicted. Management and money handling are, therefore, vital for the viability of the platform in a longer run, and for the protection of crowd-lenders and borrowers.
There are several approaches in the Member States how to define lending-based crowdfunding, and which legislative framework to be applicable. In some Member States, lending-based crowdfunding is seen as falling under the banking law or subject to payment services regulation or securities regulation. Another approach is to create bespoke regimes for lending-based crowdfunding. France, the United Kingdom (UK), Spain and Portugal have adopted special regimes for lending-based crowdfunding.
The bespoke regimes foresee a new type of intermediary to define the platforms, subject to lighter regulation than the banks and investment firms. The platforms should have authorization from, and/or registration to, financial regulators or intermediary associations. For example, in the UK, authorization by the Financial Conduct Authority ("FCA") is necessary. Platforms may also need other permissions, depending upon the activities they undertake. In France, registration with ORIAS (the association in charge of a single register of finance intermediaries) is necessary. ORIAS has to check if the platform is fit for the legal requirements (knowledge and competence, duty and professional indemnity insurance). Checks are carried out on a declarative basis. Platforms are regulated by the Bank of France - Autorité de contrôle prudentiel et de résolution - ACPR and supervised by the Direction générale de la concurrence, de la consommation et de la répression des fraudes - DGCCRF for consumer protection purposes. No ex-ante authorization is required7.
In the UK, when handling money platforms, borrowers are responsible for client money and are subject to the rules in the FCA Client Assets Sourcebook (CASS), as well as the client money rules (CASS 7), which ensure adequate protection of client money8. In France, platforms may provide payment services, and must follow the specific rules applying to such a service (credit institution, payment institution, or electronic money institution).
The bespoke regimes often limit the scope of newly regulated businesses with respect to either the size of the loan obtainable by each borrower, or to the volume of the offer, to the sums investible by each lender in a project or per year, and to permissible activities. There are minimum capital requirements or professional indemnity insurance requirements for borrowers.
In France, the size of loans is limited to €1 million per year per project, and a term of up to 7 years. Maximum investible amount per lender is limited to €1.000 per project if the loan is with interest, and up to €4.000 per project for an interest-free loan. In the UK, there is no upper limit, and the minimum capital requirement is €50,000, or a percentage of loaned funds (whichever is higher). In France, there is no minimum capital requirement, but the borrower must hold professional indemnity insurance9.
The bespoke regimes concentrate on the disclosure obligations mostly imposed on platforms helping the adoption of an informed decision by the lenders. In France, the platforms should warn the lender about the risks, and provide to lenders the tools to assess the possible loan amount they can afford, given their income and expenses; the relevant elements enabling them to assess the economic viability of the project, in particular, the business plan. In the UK, where creditors do not lend in the course of business and borrowers are consumers, the platform must provide adequate pre-contractual explanation to the borrower. In addition, all communications by the platform must meet FCA requirements to be clear, fair, and not misleading; where the creditor lends in the course of business the full protections required by the Credit Consumer Act and FCA rules apply.
Due diligence obligations in the selection of borrowers by the platforms are recognized in France, while in the UK platforms need to disclose their selection criteria to the public, and warn of the need to conduct additional due diligence before investing, unless a creditworthiness assessment obligation exists on the platform, or on institutional crowd-lenders under the applicable consumer credit law.
The bespoke regimes provide, to a certain extent, responsibility to the platforms regarding the know-your-customer-rules and/or anti-money laundering checks. In France, platforms are subject to anti-money laundering rules; however, no appropriateness or suitability test is foreseen. In the UK, firms providing personal recommendations to invest in P2P agreements will also be providing a regulated activity. No appropriateness test for lending-based crowdfunding, however platforms are established, implement and maintain adequate policies and procedures sufficient to ensure compliance of the firm, including it managers, employees and appointed representatives (or where applicable, tied agents) with its obligations under the regulatory system, and for countering the risk that the firm might be using to further financial crime10. Furthermore, almost all of the bespoke regimes foresee professional integrity on the platforms and, as well, be of good repute and experience. In the UK, platforms should have appropriate resources to employ people who are competent, fit and proper for their role, and have a suitable business model. Furthermore, the employees controlling the business must exhibit honesty, integrity, and be of good reputation. They must be financially sound and have appropriate competence and capability for their role.
The different business models and national approach to the fundamental notions, such as investment product, financial instrument, and investment service creates regulatory differences in the Member States regarding investment-based crowdfunding.
There are mainly four models of authorization of crowdfunding platforms in EU Member States that are not mutually exclusive and, in practice, they are combined in certain Member States11. Some Member States, like the Netherlands, apply securities laws to crowdfunding activities, and require investment-based crowdfunding platforms dealing with financial instruments to hold a Markets in Financial Instruments Directive ("MiFID")12 license, and be compliant with the relevant regime. In two Member States, platforms can be authorized under a national bespoke regulation developed in accordance with the exemption in Article 3 of MiFID. Other Member States do not enforce MiFID and/or prospectus requirements with respect to investment-based crowdfunding, because either of the products offered by the platforms are not considered as financial instruments under MiFID (e.g. profit-participation loans, silent partnerships or non-readily realizable securities), or a general exemption exists for brokers not handling client money13. Additionally, investment services to be provided in investment-based crowdfunding might differ among Member States, always depending on business models, with variations in terms of capital requirements, conduct of business rules, conflict of interest rules and organization requirements and available exemptions. As the ESMA suggested, the service of reception and transmission of orders would better suit investment-based crowdfunding, but other services could also fit, depending on the business model adopted, such as execution of orders, placement without firm commitment, investment advice, and operating a multilateral trading facility. In some cases, also the management of a collective investment scheme might be identified14.
The Member States that have adopted a bespoke regime (Austria, Belgium, Spain, France, the UK, Italy, Germany, Portugal) show relevant differences as to the approach followed and the solutions adopted. For example, in the UK, investment-based crowdfunding fell within the scope of FCA regulations, where platforms allow people to invest in new or established businesses by buying shares or debt securities15. In 2014, the FCA introduced a special regime for investment-based crowdfunding where new customer protection rules for the sale of non-readily realizable securities are applied. In principle, investment-based crowdfunding is regarded as a regulated activity, the type of which depends on the business model adopted, and may not even coincide with one of MiFID's activities, being subject to a lighter regime (e.g. financial promotion and 'arranging deals in investments' when intermediaries only bring together an issuer with potential sources of funding). Moreover, the tied agent exemption is applicable under Art. 29 MiFID to platforms acting as agents of an investment firm and, therefore, under the latter's responsibility.
France adopted a non-MiFID bespoke regime for investment-based crowdfunding using the exemptions foreseen by Article 3 of MiFID by defining crowdfunding services as investment advice.
On the other hand, common trends are identifiable in most of the Member States where Directive 2003/71/EC and MiFID do not apply to crowdfunding, and national laws stipulate bespoke obligations. Some of the Member States foresee new dedicated providers (as in Italy, France and Spain), while others do not (the UK, Austria, Germany)16. The new dedicated providers are restricted in terms of permissible products and activities, and they are not allowed to offer other investment services, nor to hold clients' money or securities unless they have been authorized as payment institutions. Furthermore, platforms are subject to the supervision of a financial markets authority.
Most bespoke regimes allow traditional financial institutions to conduct crowdfunding operations (except for Spain); however, extending to them the special crowdfunding requirements, in addition to the general ones.
Bespoke regimes for investment-based crowdfunding are generally concentrated on disclosure obligations on the risks, costs and fees, past performance, as well as special warnings regarding the issuer. Most of the bespoke regimes foresee information requirements and risk warnings by the platforms. Many Member States also stipulate limits to the sums investible by retail investors, while there are no limitations for professional investors, high-net-worth individuals or legal persons, and in some jurisdictions, persons receiving regulated advice. Similar to lending-based crowdfunding, such limits are generally referred to as investments per project and per year, per issuer and per platform, or only per issuer, with some limits, depending on income. Limits are often set also with regard to the amount that each issuer can obtain through the platform or on a given platform, or in general through crowdfunding platforms17. Investor tests or appropriateness assessments are required only in some countries, while in France, platforms, being investment advisors, need to perform a suitability assessment.
EU Member States have adopted a range of measures to promote the growth of crowdfunding, protect investors, and regulate crowdfunding. They are either implementing the EU legislative framework, or creating national regimes. These national frameworks are generally consistent in terms of the objectives and outcomes they seek to accomplish; however, they are mostly customized for local markets. European practice in crowdfunding shows that existing financial regulations can be successfully adapted to financial technology innovations without wide-ranging amendments.
1 Unleashing the potential of Crowdfunding in the European Union, p.2. http://ec.europa.eu/internal_market/finances/docs/crowdfunding/140327-communication_en.pdf.
2 Action Plan on Building a Capital Markets Union, COM(2015)468/2, 30.09.2015.
3 Delivorias, Angelos, Crowdfunding in Europe, EPRS p.6.
4 Commission Staff Working Document Crowdfunding in the EU Capital Markets Union p.8.
6 Working Document p. 25.
7 Ibid, p. 46.
9 Working Document, p. 47,49.
10 Ibid, p. 48.
11 Ibid, p. 18.
12 Markets in Financial Instruments Directive (2004/39/EC).
13 Ferrarini, p.3.
14 İbid, p.3.
15 FCA, A review of the regulatory regime for croedfunding and the promotion of non-readily realisable securities by other media, February, 2015,p.2.
16 Ferrarini, p.4.17 Ibid, p.4.