Following the adoption of the recent crowdfunding regulation by the European Parliament, Estonia is seeking to implement the new framework and go one step further.
The draft Crowdfunding and Other Investment Instruments Act, recently published by Estonian Ministry, aims to transpose the EU Crowdfunding Regulation into Estonian law and, more importantly, to create a legal framework regulating business activities related to the issuance and trading of cryptocurrencies and other novel financial instruments that were previously unregulated. It is expected that the law will be adopted before November 10, 2021.
The New Requirements for Crowdfunding Service Providers
Until now, there has been no single framework for crowdfunding services in European Union, which has meant that each country has set its own rules for services that are not covered by MIFID II. This lack of uniform rules has created barriers to the provision of cross-border services. As a result, the current market share of European crowdfunding is minuscule compared to uniformly regulated markets such as the US and China.
In addition, the existing rules created active barriers to growth, as any issue of securities above €1 million, calculated over a 12-month period (in some Member States the threshold is raised up to €8 million as an exception to the general rule of the Prospectus Regulation), was subject to the prospectus requirement.
The new Crowdfunding Regulation addresses most of these issues by introducing clear rules for all crowdfunding providers in Europe. It clarifies the meaning of crowdfunding, which is now defined as "the bringing together of the funding interests of investors and project owners through the use of a crowdfunding platform" and which consists of either the facilitation of lending or the placement of securities.
The new regulation provides that such crowdfunding services can only be provided by service providers that have obtained a license. The licenses will be issued by the competent supervisory authorities of the country where the service provider is established (in Estonia this will be done by Estonian Financial Supervision and Resolution Authority).
The list of documents that must be submitted with the application for licensing includes, among others: a description of operational risks, a description of the service provider's systems, resources and procedures, a description of the persons responsible for management and evidence of their good reputation, etc.
Licensed crowdfunding service providers must comply with certain obligations, including disclosing loan default rates, assessing the potential investor's capabilities, and providing investors with a pre-contractual cooling-off period.
The pre-contractual cooling-off period will be four calendar days. During this period, a prospective non-sophisticated investor may withdraw his interest in the crowdfunding offer at any time without giving any reason and without incurring any penalty. Companies seeking funding through such crowdfunding services must publish a 6-page document containing key information about the investment.
The Regulation doubles the threshold above which the preparation of a prospectus becomes mandatory for project owners (€5 million per year) and allows for an EU-wide passport, i.e. a licensed crowdfunding service provider can extend its licensed activities to any other EU state by notifying its home regulator.
As a result, more and larger crowdfunding projects and platforms are likely to emerge across Europe.
The secondary market for crowdfunding instruments offered through crowdfunding platforms will not allow for automated execution of buy/sell orders as is the case with traditional exchanges. Instead, a service provider may set up a system of bulletin boards.
A bulletin board allows customers to express their interest in buying and selling instruments for crowdfunding purposes that were originally offered on the respective crowdfunding platforms. In this system, there is no internal matching system, so trading between investors is manual.
In summary, the new rules will revitalise EU crowdfunding, help to protect investors and give the market the legal certainty it has long needed.
Although the EU regulation is an important step towards harmonising rules in the fintech sector, it does not aim to fully regulate the market, but is limited to regulating crowdfunding services. This means that services such as facilitating consumer lending through crowdfunding (peer-to-peer or P2P lending) do not fall within the scope of the Regulation.
Estonian lawmakers are preparing to soundly regulate all relevant areas of the fintech industry. This includes creating a framework for P2P consumer loans similar to the one that applies to business loans. This system would take into account existing consumer legislation and expand on existing regulation for credit intermediaries to improve investor protection.
With the EU regulation, there is still a hurdle for projects seeking to raise more than € 5 million, as from this point there is a requirement to produce a prospectus. The publication of a prospectus must be preceded by a formal approval procedure with the competent supervisory authority, which in the case of Estonia can take up to 20 days.
The prospectus itself is a complicated piece of documentation that takes a lot of time and resources to prepare. EU states can provide for simplified prospectus requirements for offers of up to €8 million, but only some EU states have decided to make use of this possibility, including Estonia.
Thus, if a project decides to conduct a public offering of securities valued between €5 million and € 8 million, there is an obligation to obtain approval for the publication of a prospectus. However, the requirements for such a prospectus would be more similar to those required for crowdfunding information sheets, which are less detailed and presumably cheaper to produce.
The EU regulation also does not affect the fast-growing markets of cryptocurrency exchange / trading / wallet, which are still virtually unregulated at the European level. Estonian legislators have recognised their growing importance and were one of the first in the world to create a framework for cryptocurrency-related activities.
As one of the pioneering nations, the Estonian legislator plans to expand the existing framework for cryptocurrency services by introducing many of the organisational requirements (e.g. risk management rules, administrative reliability, etc.) that will also apply to crowdfunding providers.
These additions are expected to make these services more attractive, both for users, who can expect better protection of their investments and more reliable services, and for European credit and financial institutions, which still consider most cryptocurrency-related ventures too risky, even for conducting basic business.
In recent years, Estonia has witnessed numerous ICOs (Initial Coin Offerings) and TGEs (Token Generation Events). Such instruments are not regulated by the latest crowdfunding regulation, although they are a popular alternative to traditional investments.
Therefore, Estonia will integrate token offerings and generation events into the new crowdfunding framework, with the same obligations as all other crowdfunding offerings.
The only case not directly regulated by the new legislation is utility tokens, which are considered sufficiently regulated by existing regulations. This fully recognizes cryptocurrencies as a viable investment mechanism within the legal system.
The expected framework in Estonia will thus be unique in that it will regulate all possible areas of the fintech industry with the exception of non-commercial cases and utility tokens.
Specialists from AlphaLAW will be happy to help you with the preparation of the list of required documents, help in developing of prospectus, translation of documents into Estonian/English and support throughout the whole licensing and application process.
In case you have any questions or are interested in establishsing of Crowdfunding Platform or Alternative Investment Fund in Estonia, please contact us through the following communication channels.