HomeBanking and Financial Services NewsNew EU crowdfunding rules will protect investors and regulate crowdfunding service providers

New EU crowdfunding rules will protect investors and regulate crowdfunding service providers

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Over the past decade, crowdfunding has evolved from a novelty source of finance to a legitimate, effective, and widely deployed way for firms to raise finance.

Crowdfunded investments more than doubled during Covid, with more than €6 million raised through crowdfunding platforms during the first 8 months of 2021 alone. This growth has led to some major developments in this previously unregulated sector, including the introduction of the European Union (Crowdfunding Regulations 2021).

What is crowdfunding?

Crowdfunding is essentially where a ‘crowd’ funds a project or business, rather than one or two major investors. It is a method of raising capital from a large number of people who each contribute a relatively small amount, typically via the internet. Crowdfunding has become synonymous with Crowdfunding Service Providers (CSPs) such as GoFundMe and Kickstarter who host the crowdfunding process and generate revenue from a percentage of funds raised.

For start-ups and certain SMEs, crowdfunding is seen as a low-risk way of raising funds without having to part with equity and also as a stepping-stone to further capital. However, crowdfunding is not always successful and is often a futile and time-consuming exercise as failure rates are high and in the previously unregulated system, investors were often left in a vulnerable and legally precarious position.

Gerry Cross, Director of Financial Regulation – Policy and Risk at the Central Bank of Ireland, said, “Crowdfunding provides a form of alternative finance for start-ups and SMEs, typically relying on small investments. Trust, confidence, and fair dealing are essential for any financial market or product. It is therefore vital that investors are made aware of the risks of any such investment.

The European Union (Crowdfunding) Regulations 2021

The European Union (Crowdfunding) Regulations 2021 (‘Regulations’) were transposed into Irish Law on the 13th of December 2021 and gave effect to EU Regulation 2020/1503 (‘Crowdfunding Regulations’). The Regulations set out a uniform set of rules for the operation and supervision of crowdfunding across the EU. In doing so, a CSP authorised in one Member State will be able to passport its services into other Member States.

The Regulations introduce a number of obligations on CSPs to offer added levels of protection to investors. A minimum due diligence requirement puts an obligation on CSPs to look into the background of project owners, including any criminal records or jurisdictional issues. Conflict of interest provisions ensure that CSPs cannot offer crowdfunding services to people closely related to them. The Regulations also introduce a complaint handling procedure whereby CSPs must publish transparent procedures for prompt, fair and consistent handling of complaints and significant administrative penalties for CSPs who are found to have infringed certain provisions.

Consumer Protection Code 2012

Under the new system, several provisions of the Consumer Protection Code will also now apply to CSPs. These include that any advertisement must be fair and clear and must not mislead or misinform investors. That service providers must provide a clear warning of the risks involved with crowdfunding and that engaging with the process could result in a partial or complete loss of investment and those investments are not covered by a deposit guarantee scheme.

Key dates

The Regulations were transposed into Irish law on the 10th of November last. Platforms existing before this date will have until November 2022 to comply with Regulations as part of the transitionary period. Those Platforms created after the date of transposition must comply with the Regulations immediately.

Conclusion

Given the growth of crowdfunding platforms over the past decade, the Regulations are to be welcomed as business owners and investors will benefit from the protections and certainty of a regulated system. This greater certainty is all the more welcome in the wake of Brexit and the pressure of Covid-19 felt by businesses of all sizes.

About the Author: Ciarán Leavy is Partner and Head of Commercial Litigation and Dispute Resolution.