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Equity crowdfunding in Europe has been touted by many organizations, ours included, as evidence that crowdfunding can work in the U.S. Indeed, platforms like Seedrs and Crowdcube have operated there for several years now. The regulatory picture, however, is not quite so rosy, explain Chris Bates and Peter Chapman of London-based Clifford Chance LLP. While some platforms have managed to comply with relevant regulations, European laws remain quite hostile to equity crowdfunding. Complicating matters is the two-tier system of laws – companies must comply with not only E.U. regulations, but also with their countries’ interpretations of these rules. There is also the ongoing financial crisis, which has taken up the E.U. agenda. We spoke with Chapman and Bates to get a better understanding of how European laws function and what they mean for equity crowdfunding. The first half of our conversation is below, and the second part is here.
Anton Root, Crowdsourcing.org: Thank you for joining me. Can you briefly introduce yourselves and how you became interested in this field?
Chris Bates: I’m Chris Bates, partner at Clifford Chance LLP, in our financial regulation practice here [in London]. This is a topic of current interest, so it’s something we’ve recently been taking an interest in. It’s relatively early days for crowdfunding in the U.K. and Europe yet, but there has been some interest here, both from an investor protection front – the FSA [Financial Services Authority] has recently commented on this – and also from a shadow banking, alternative to bank finance front. For example, the Bank of England, in its financial stability review, recently commented on crowdfunding as one of new sources of financial activity. It’s an area that is becoming more noticed here and elsewhere across Europe. Peter Chapman is one of the associates on our team here who works with me.
Let’s start on the ground floor and work our way up. Can you give us a general overview in terms of crowdfunding laws in the European Union?
There are no specific European legislative measures which provide for crowdfunding and until recently, [there's been] very little in the way of individual European member states having specifically addressed crowdfunding. Before we get into that though, it may be worth us providing a bit of an overview of how financial regulation works in Europe.
Financial regulation consists of a mixture of E.U. law and national law. E.U. law regulates quite a lot of areas: for example, prospectus regulation, which is our equivalent to your 1933 [Securities] Act, is essentially harmonized at the European level. There is a Prospectus Directive, which all European member states have to implement by passing national laws that must achieve what the Prospectus Directive requires. This Directive sets out when a public offer of securities requires the publication of a prospectus, and then defines what the contents of the prospectus are. Prospectus regulation is an example of the highly harmonized area of financial regulation in Europe.
There’s also regulation of intermediaries, a bit like what I would think of as your 1934 [Securities Exchange] Act in the States. It regulates advisors, arrangers, and people who put investors in contact with people who want to raise money, that sort of role. That is, again, largely regulated at the E.U. level by the Markets in Financial Instruments Directive, and this again must be implemented by member states across the E.U.
Other pieces of E.U. legislation may also be relevant in a crowdfunding context. Some of the legislation regulating funds (which are essentially pooled investments) may be relevant, for example.
On top of the E.U. legislation, not only do you have national laws which implement the E.U. legislation, you also have national laws that are idiosyncratic – each member state has its own laws that regulate financial products and markets, some of which go beyond the minimum requirements of E.U. law.
In the U.K., for example, we have laws around what’s called ‘financial promotion,’ which is marketing activity relating to investment activities that are regulated. This legislation is something which is not required by the E.U., but it is legislation that the U.K. has had for many years. The U.K. legislation is idiosyncratic, however; it has not been harmonized across Europe. Some other countries have different laws dealing with the same sorts of promotions issues – in France, they have the demarchage law, for example. Other countries will have different approaches to the same issue.
So, when you’re looking at financial regulation in Europe, you have a mixture of harmonized laws at the E.U. level (as implemented in each member state by their own national legislation) and, in addition, unharmonized laws at the national level.
The other thing that I think that’s important to think about is that whilst a lot of focus has been around the marketing of investments, you also have corporate law rules around how companies treat their shareholders: do they need to give them annual reports, how are shares dealt with, how payout is dealt with? All those issues get less coverage because the focus has been on the establishment of the initial relationship between people who want to raise money (the company) and this potential investor group (the crowd). There is, however, a second phase – what happens in the relationship between the investor and the investee company after the investment. This is an important issue, but it has received less attention.
I’ll ask you about the financial promotions law. What is the current framework around that, and is there conversation about potentially changing it?
The general position, to put it in perspective, is that there are exemptions from the prospectus laws for small offers. A lot of people who raise money would be below the level that would require the publication of a former prospectus. So that makes these other marketing laws, such as the 'financial promotions' regime in the U.K., much more important to consider.
The point with the 'financial promotions' regime (and other similar regimes) is that, broadly speaking, promoting investment to anyone other than large or sophisticated investors needs to be approved or made through a licensed firm. The licensed firms would be subject to regulation in the way they promote those investments. The way that the current law works is designed to try to channel people who are seeking to promote investments into a regulated environment, unless they’re potentially doing it with sophisticated, high-level investors.
The result of this is that it points your towards almost the opposite of crowdfunding, in a sense. You could say the law is generally not that favorable to mass fundraising by people (at least not in an unregulated way where there is any business component, which there will normally will be in the sorts of companies seeking crowdfunding).
What the FSA has said recently on this is that they view micro, first-stage investments as being something that is only suitable for sophisticated investors as they are better placed to understand the risks with such investments.
Whilst there has not been much to date about promoting crowdfunding, there has been debate about making lives easier for SMEs [small and medium enterprises] under existing law but this debate has tended to focus around how SMEs can become listed on exchanges, and generally create liquid markets for their stocks (i.e. within a regulated environment).
There’s not been the same focus, as I think there has been in the U.S., on trying to facilitate crowdfunding techniques.
Why do you think that is?
I don’t think it’s being seen as politically very important and it’s not something that has caught the political agenda yet. One reason it may struggle to get traction is that we have had a lot of concern in recent times about the selling of investments to retail clients, so I think there is an inclination against allowing unregulated – if you want to put it that way – investment products to reach the general public. There’s a concern that retail investors have been misled in the past and this has affected the authorities’ approach to crowdfunding. Nobody’s taken it up yet as being good for micro-enterprises, which I think has been the flavor in the U.S. and possibly what has underpinned crowdfunding gaining support in Italy more recently.
Peter Chapman: Generally, I don’t think crowdfunding has been as popular or as well known a concept here as it has been in the States, either.
Chris Bates: Now, that’s not to say crowdfunding won’t take off; I suspect that like many things, it needs some political backing. But I think the words 'retail' and 'investment' make people (and regulators particularly) worry that it could create the next mis-selling scandal and the U.K. public has had quite a number of problems with investing in products that they don’t understand already.
You brought up the FSA’s recent warning against crowdfunding – can you give your take on it and tell us why it’s significant?
Crowdfunding has tended to be thought of in the same vein as the sort of "ostrich farm"-type concept whereby people are sold investments that actually, when you delve into them, really aren't that great as investments. There are a number of investment products that have been thought of in this way – the FSA, for example, has recently been taking action against people marketing wines as investments.
I think there’s a risk that with crowdfunding, even if you capped investments at small amounts of money – no one can lose more than one hundred pounds, for example – there would still be the same mis-selling concerns.
I think it would take a fairly strong political initiative, somebody saying, “Look, we really want to do this, it’s great for micro-enterprises, we’re going to find a way around the investor protection problems in these ways,” to really get it off the ground. I’m somewhat skeptical that people would invest the political will in that, at least in the U.K. I think that may be different for other European countries though, and notably Italy has recently passed a decree which would seem to put crowdfunding onto a legal footing (although I understand that the financial regulator there will still need to put in place the technical legislation which would implement this). In the U.K. at the moment though, it’s not something I’ve seen politicians get particularly interested in. We’re going through changes of all sorts in our regulatory system, and trying to do something in this area seems a bit unlikely at the moment and I’ve not seen it on any U.K. legislative agenda. If anything, I would say the political agenda is perhaps running contrary to these sorts of initiatives.
Regarding the investor protection issues – people aren’t pointing out the 'crowd wisdom' advantages of opening up investing to the larger population?
There probably are people making these points, but it’s not hit the mainstream regulatory agenda, yet. There are regulatory initiatives going on, mainly at the European level, to reform a number of areas but, as I said, crowdfunding is not on that agenda, as far as I’ve seen.
I think it would take some political initiative by a group that sees this as a way of promoting micro-enterprise. I think that would be the way in which it would have to be packaged – around jobs and part of the growth agenda, perhaps. But at the same time, someone would have to address the investor protection issues. I think saying the wisdom of crowds is going to sort it out is probably not going to sell that well here, because crowds of people have in the recent past managed to buy ill-judged investment products, and tended to buy them in size. I think we’re still waiting for the political initiative that would capture some imagination. Until then, I don’t really see major changes in the current position.
Click here for part two!