Regulating crowdfunding platforms: A Perspective from the EBRD

Jelena Madir is Chief Counsel, European Bank for Reconstruction and Development

Crowdfunding is routinely hailed as part of the Fintech “revolution” – the disintermediation of finance by ever-greater use of technology, and as a way to, at last, provide enough financing for SMEs and early-stage businesses in the economy. Indeed, the European Commission itself has recognised crowdfunding as “one of many technological innovations that have the potential to transform the financial system.” 

Yet, as many readers of will readily appreciate, for all its potential, crowdfunding also entails a number of risks (such as project and liquidity risks, platform failure and cyber-attack) and concerns (for instance, investors’ inexperience, reliability of the investment, undisclosed conflicts of interest, etc.).  But, with appropriate safeguards concerning investor protection, crowdfunding can be an important source of non-bank financing in support of job creation, economic growth and competitiveness.

Against this background, several of the EBRD’s countries of operations have been very keen to promote crowdfunding and are looking to enact, or have already enacted, crowdfunding legislation (e.g., Turkey, Kazakhstan, Morocco, Egypt, Latvia and Lithuania).   However, because crowdfunding is still in its infancy, there exists no consensus as to what constitutes best practice in this area, which makes it rather difficult to advise lawmakers.  

The absence of a deployable framework has prompted lawyers in EBRD’s Legal Transition Team to join forces with colleagues from Clifford Chance and embark on the preparation of the report which seeks to offer best practice recommendations for the regulation of both equity- and lending-based crowdfunding platforms. 

Our recommendations are based on the analysis of the regulations of six jurisdictions: Austria, the Dubai International Financial Centre (DIFC), France, Germany, the UK and the US, which were selected to provide a cross-section of geographies, approaches and degrees of market maturity.  Why these six jurisdictions in particular?  The UK and the US are considered as leaders in crowdfunding, whose regulatory regimes form the basis for highly developed markets.  Austria, France, Germany and the DIFC are regarded as model jurisdictions in much of EBRD’s region.  

Drawing upon commonalities and best practices identified from across these jurisdictions, the report makes recommendations on the following key issues: (i)  type of authorisation(s) required for the operation of platforms; (ii) capital and liquidity requirements; (iii) KYC  rules and AML checks required; (iv) maximum size of offer/loan; (v) maximum investable amount; (vi) consumer protection measures, including type of investor disclosures; (vii) risk warnings; (viii) due diligence/pre-funding checks; (ix) conflicts of interest inherent in the crowdfunding platforms’ role; and (x) platforms’ governance requirements. A brief summary of our findings include:

• Where platforms’ activities are aligned with other regulated activities, it may be possible to regulate crowdfunding by adapting an existing framework. However, a truly bespoke regime may be more appropriate.

• Imposing minimum capital requirements on platforms can help to ensure that operational and compliance costs continue to be covered in the event of financial distress. Capital requirements should be based on the nature and scale of the activities undertaken by the relevant platform and should be commensurate with the attendant risk.

• Platforms should be required to establish and maintain risk management systems and controls that can identify, track, report, manage and mitigate risks to their business (including operational risk, risks relating to cybersecurity and the protection of personal data, and the risk that the platform could be used to commit financial crimes).

• Platforms need to ensure that their senior management and employees are fit and proper persons. Platforms need to be able to assess this themselves.

• Platforms should have primary responsibility for identifying, reporting, managing and mitigating any conflicts of interest.

• The financial services regulator should, where appropriate, have the power to prevent platforms from investing.

• Platforms should be subject to specific disclosure requirements, in order to ensure that investors and investees understand how platforms operate and earn revenue.

• Disclosures to investors and warnings regarding risks need to be tailored to the relevant product offered by the platform.

• There may be good reasons to differentiate between retail investors and institutional investors when it comes to providing information. Retail investors may benefit from receiving risk warnings and disclosures that are more explicit than those provided to institutional investors.

• A regime which differentiates between different types of investor is preferable to one that requires detailed suitability checks for all investors. Financial services regulators are best placed to decide on appropriate categories of investor.

• Platforms should be required to enter into agreements with their clients governing all key aspects of the client-platform relationship.

• Platforms should be permitted – but not necessarily obliged – to offer automated tools supporting the diversification of investors’ portfolios.

• It is appropriate for lending-based platforms to provide information to investors on their post-investment arrangements and arrangement rights, whether that involves a trustee-type arrangement or a different type of enforcement mechanism.

• Platforms should be required to carry out KYC checks on their clients. The extent of those checks may vary on the basis of a risk assessment performed by the platform. Financial services regulators are best placed to provide platforms with guidance in this regard, which should be in keeping with the KYC requirements of the relevant jurisdiction. Such guidance should also be commensurate with the risk posed by clients.

Our report has been reviewed by, and discussed with, colleagues at the World Bank and the International Organization of Securities Commissions (IOSCO).  It also drew the attention of the British Standards Institute, which in September 2018 hosted a workshop with several crowdfunding platforms and the UK Financial Conduct Authority to discuss our recommendations.

The EBRD’s Legal Transition Team is already putting the recommendations from the report into practice through their ongoing technical cooperation projects on the regulation of crowdfunding platforms in Morocco, Turkey and the Astana International Financial Centre in Kazakhstan. We hope that, thanks to these recommendations, lawmakers will get more comfortable with the formulation of the crowdfunding legislation, which in turn should give legitimacy to crowdfunding platforms, while ensuring appropriate investor protection.

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