What is crowdfunding (“CF”)? Most of us have now at least heard about it and some have even gone as far as trying it out, through companies such as KICKSTARTER, RATESETTER, LENDOPOLIS or OURCROWD.
CF seems to some as no less than a means of strengthening capitalism in our democracies by allowing the public to have a direct stake in it (1).
Through the eyes of a lawyer, however, apprehending CF can compare to the more down-to-earth exercise of peeling off the leaves of an artichoke: once the numerous layers are removed, what remains, i.e. a means of easily and directly connecting the mass with fund seekers, is relatively small.
That is precisely where the peculiarity lies from a legal standpoint: CF is a rather simple and tiny concept forcing its way through pre-existing regimes.
By comparing French and English law, which were significantly amended in the course of last year (2), let us briefly assess how CF is promoted on both sides of the Channel within the space of national discretion left by the EU regulator (3).
What is at the heart of CF?
The possibility to directly and easily connect the mass with fund raisers is in our view at the heart of CF, although the definitions provided under English and French law are not as straightforward, for various reasons including that CF overlaps with existing regimes.
The UK regulator defines loan-based CF (“crowd-lending”) as “operating” “an electronic system” which enables the operator to facilitate lending by individuals (or “relevant persons”) (4), provided the system “is capable of determining which agreements should be made available” to the parties. By contrast, rather than creating a specific definition for investment-based CF (“crowd-investing”), the UK regulator prefers to rely on broader regulations which already exist such as those defining “arranging (bringing about) deals in investments” (5).
On the other hand, the French legislator defines crowd-lending as “putting together, by way of a website, holders of a specific project and persons financing such project” (6). However, unlike the UK regulator, the French legislator shows himself innovative by creating the concept of “CF investment adviser” to regulate crowd-investing carried out by means of a website (7), but does so at the expense of logic as, unlike investment advisers, CF platforms would not typically make truly “personal recommendations” to investors.
Does one need to get authorised to offer a CF service?
In the UK as a general rule, one needs to get authorised to offer a crowd-lending or crowd-investing service subject to certain conditions and exceptions (8).
The need to be authorized is in itself a significant hurdle, to which one should add capital requirements (9), as well as other (compliance, risk management, regulatory reporting, etc.) requirements the meeting of which may not necessarily fall within the scope of expertise of young entrepreneurs venturing into CF (10).
The FCA took the decision to introduce minimum capital requirements “to administer loans in the event that the platform fails” (11). But are those minimal capital requirements really necessary where the CF platform does not hold client money (e.g. by entrusting a payment services provider (“PSP”) to do so)?
By contrast, the French legislator merely requires registration, not authorisation, under circumstances where the CF platform does not hold client funds (12).
Crowd-lending or investing authorisation or registration requirements
(whether or not client funds are held)
Mere registration requirements
(unless holding client funds)
How much can one raise per project?
- Crowd-lending (individual to business)
As summarised in the table below, the difference between English and French law is striking when it comes to loans made by individuals to businesses and the right for CF platforms to raise additional money from other sources of alternative funding such as collective investment schemes (“CIS”). For instance, MARSHALL and EAGLEWOOD recently set up a CF investment trust in the UK to raise from GBP 20 to 30 million (of public money on the London Stock Exchange), the equivalent of which could not be set up in France for banking monopoly reasons (13).
| Individuals to businesses
Total amount per project capped (EUR 1 million);
No more than EUR 1000 per lender and per project;
Loan duration capped at 7 years;
Interest rate capped
| No equivalent restrictions
| Other sources of alternative funding such as CIS
|| Prohibited as a general rule
The success of crowd-lending in France is thus clearly impeded. However, the French legislator, who initially had even more stringent limits in mind but backed down under strong pressure from the CF rising industry, has indicated that the existing framework will be amended from time to time if needs be.
The key question here is whether the exemptions available under the Prospectus Directive (“PD”), either from the PD itself or from its prospectus requirements, are adapted to CF (14).
Under French law, a specific 1 million cap exemption has been adopted to promote CF (15) in addition to the exemptions available under the PD.
By contrast, English law does not provide for a specific CF exemption, leaving it to equity-based CF platforms to squeeze their business model into one of the PD exemptions as implemented under English law.
The provision of payment services is a common denominator for all types of CF activities (investment, lending and even donations), to the extent that a transfer of funds from the payer (a crowd member) to the payee (fund seeker) needs to be carried out, assuming the CF platform or any other third party handles the funds in between. A CF platform may either decide to provide the fund transfer service on its own or rely on a third party service provider duly licensed within the EEA (16) on the basis of the harmonised EEA-wide PSD framework (17). For instance, LENDOPOLIS is using INGENICO as a third party PSP to focus on CF only (18).
The new French rules on CF take into account the EU framework, prohibiting CF platforms from providing payment services without obtaining a PSP licence or relying on a third party PSP, paving the way for cross-border CF platforms such as ULULE (19), subject however to additional host country rules to be assessed on a country per country basis given the lack of EU harmonisation in respect of CF itself.
It is worth noting that the French legislator has not provided for the case where a duly licensed trustee would be appointed to hold and manage the funds raised from the crowd. But this does mean that a trust scheme, whereby the CF would never hold investor money, may not be so appointed.
The UK rules on CF are less explicit regarding how they combine with the EU framework regulating the provision of payment services. And regarding donation-based CF, there is the risk of loss at the level of the CF platform, assuming no protection scheme is available such as the one that goes with holding a PSP licence (20) or complying with CASS rules (21).
It is generally agreed that the risk of unexpected and highly resented loss under crowd-lending and (even more so) crowd-investing schemes generally requires a high level of consumer protection.
Under French law, the legitimate need for high consumer protection reaches its peak in the form of very detailed organisational and conduct of business rules (22) and criminal sanctions for breaching key requirements such as the registration duty owed by crowd-lending intermediaries (23). Last but not least, the maximum investment or loan one can make per project is extremely low (see previous table above).
Under English law, authorisation and conduct of business rules are the two main means by which the regulator wishes to protect consumers. Interestingly, a required back-up mechanism in case of platform failure is provided for to continue managing and administering any outstanding loans. Although the “direct offer financial promotion” of “non-readily realisable securities” to retail clients is prohibited save under specific circumstances (24), its scope of application does not include the primary promotional activity carried out by CF platforms, i.e. the marketing of the platform and information about who can be invited to invest, as opposed to the marketing of any specific investment opportunity (25). Similarly, French canvassing rules will not apply at the stage where no specified investment opportunity is actively promoted (26).
It is worth noting that CF platforms have not waited for their national regulators to care about consumer protection. RATESETTER in the UK has, for instance, included in its contractual offer a default fund mechanism aimed at providing some comfort in the case of a borrower’s default. And WISEED in France offers a holding structure allowing investors to weigh more than if each of them were holding voting rights individually (27).
How much longer is the EU regulator going to resist the temptation of regulating an emerging industry largely falling within the scope of its existing directives? While some already advocate the creation of a new category of EU licensed CF institutions, it is clear that a uniform and fully harmonised compromise between quite divergent approaches risks making no one happy. However, under the MIFID or the EMD (28), a space has been left for national legislators to regulate purely domestic service providers. So why not do the same for CF platforms?
1. Such is the position of Xavier Rolet (chief executive of the London Stock Exchange) as expressed in the Telegraph on 3rd January 2015 (“How can we make capitalism more popular?”).
2. The Financial Conduct Authority (“FCA”) made a policy statement (14/4) in March 2014 and new rules entered into force in April 2014 while others in October 2014. In France, an order (no. 2014-559) was issued in May and several decrees were adopted in September to introduce new rules from October 2014.
3. Regarding the position of the European Commission on CF, please refer to a document published on its website following a workshop held on 3rd June 2013 (“Crowdfunding: untapping its potential, reducing the risks”).
4. Pursuant to chapter 6B of the Financial Services and Markets Act (“FSMA”) 2000 as introduced by an Order issued in 2013, a relevant person is “a partnership consisting of two or three persons not all of whom are bodies corporate” or “an unincorporated body of persons which does not consist entirely of bodies corporate and is not a partnership”. In addition to loans from individuals or relevant persons, loans to borrowers who are individuals or relevant persons are also captured, to the extent that (i) the lender provides the borrower with credit less than or equal to GBP 25 000 or (ii) the loan is not made “wholly or predominantly for the purposes of a business carried on, or intended to be carried on, by the borrower”.
5. Pursuant to Article 25(1) of the Financial Services Markets Act (Regulated Activities) Order 2001 (SI 2001/544) (“RAO”) making arrangements for another person (whether as principal or agent) to buy, sell, subscribe for or underwrite a particular investment is a specified kind of activity which, pursuant to Section 19 of the FSMA, no person may carry on – or purport to carry on – in the UK unless he is an authorised or exempt person.
6. Article L 548-1 of the Financial and Monetary Code (“FMC”).
7. Article L 547-1 of the FMC.
8. Regarding investment-based CF platforms, the RAO refers to “arranging deals in investments” (such as equity or debt securities) as an activity requiring authorisation unless an exemption is available.
9. Pursuant to chapter 12 of “The Interim Prudential Sourcebook for Investment Businesses (IPRU (INV))”, firms which carry on the regulated activity of operating an electronic system in relation to lending are obliged to hold regulatory capital equal to either a percentage of loaned funds per threshold crossed or a fixed minimum of GBP 50,000, whichever is higher.
10. According to the summary of rules for loan-based crowdfunding platforms found on the FCA’s website, firms operating loan-based crowdfunding will, in addition to the capital requirements in the IPRU (INV), be subject to a number of rules found in the FCA Handbook amongst others, Senior Management Arrangements, Systems and Controls, The Principles for Business, The Threshold Conditions, the Statements of Principle and Code of Practice for Approved Persons, The Fit and Proper Test for Approved Persons, the Conduct of Business requirements, the Client Assets rules and the Supervision rules.
11. “The FCA’s regulatory approach to crowdfunding over the Internet”, March 2104 Policy Statement 14/4, section 3.5, page 18.
12. Articles L 548-1 and L 548-3 of the FMC (as interpreted by the French banking and financial markets regulators).
13. Article L 511-5 of the FMC.
14. Articles L 411-2 and D 411-2 of the FMC.
15. See for instance Articles 1.2(h) and 3.2(e) of the 2003/71/EC PD (as amended in 2010).
16. European Economic Area.
17. Payment Service Directive 2007/64/EC or “PSD”.
18. Based on their general terms and conditions as available on their website at the time of writing this article.
19. Based on their general terms and conditions as available on their website at the time of writing this article.
20. Article 9 of the PSD.
21. Under CASS 7.7, any client money received by a CF provider is held by them on statutory trust on behalf of the client. Pursuant to CASS 7A, in the event of a firm’s failure, the firm must distribute client money in accordance with the statutory formula laid out in CASS 7A.
22. Articles L 547-9, L 548-6, R 548-4 to R 548-10 of the FMC, as well as regulations to be issued by the Financial Markets Regulator.
23. Article L 573-15 of the FMC.
24. Pursuant to Section 21 of the FSMA, a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity unless they are authorised or the content of the communication has been approved by an authorised person. The Conduct of Business Sourcebook Rule 4.7.7 (COBs) prohibits a firm from making or approving a direct offer financial promotion relating to a non-readily realisable security to or for communication to a retail client unless the recipient retail client is: (a) certified high net worth investor or; (b) a certified sophisticated investor or; (c) a self-certified sophisticated investor or; (d) a certified restricted investor. The second condition is that the firm or person arranging the non-readily realisable security will comply with COBS 10 or equivalent requirements.
25. “The FCA’s regulatory approach to crowdfunding over the Internet”, section 4.12, pages 37 and 38.
26. Article L 341-1 of the FMC.
27. Based on their general terms and conditions as available on their website at the time of writing this article.
28. Markets in Financial Instruments Directive and Electronic Money Directive, as such EU directives (whether in their original form or following their recent review) are available on the website of the European Commission.
This bulletin should not be taken as definitive legal advice on any of the subjects covered. If you require legal advice on any of the subjects covered or on any other matters, please contact Bruno Fatier on 0207 955 1478 or firstname.lastname@example.org