CySEC Introduces Investment-Based Crowdfunding Rules

CySEC has introduced investment-based crowdfunding rules as very sustainable financing and inventing alternatives to participants.

November 18, 2019, | AtoZ Markets – The Cyprus Securities and Exchange Commission (‘CySEC’) has issued a Consultation Paper on adopting rules for investment-based crowdfunding.

In a financial climate where it is very difficult for small and medium enterprises (‘SMEs’) to source finance, particularly for start-up projects, crowdfunding presents a viable alternative to seeking funding from venture capital funds or angel investors.

Summary of the proposed CySEC crowdfunding rules

CySEC’s proposal to introduce a Crowdfunding Directive relates solely to investment-based crowdfunding. This will be possible through transferable securities but will exclude loan-based, reward-based and donation-based crowdfunding.

The proposal for a Crowdfunding Directive comprises a set of secondary rules for investment-based crowdfunding under Cyprus’ Investment Services and Activities and Regulated Markets Law (the ‘Law’), into which MiFID II is fully transposed.

Furthermore, the proposed Crowdfunding Directive prescribed under the Law complements MiFID II’s obligations. This includes but not limited to: conduct of business rules; management of conflict of interests; holding clients’ money and financial instruments and product governance.

In offering cross-border transferable securities via investment-based crowdfunding, crowdfunding service providers and their platforms will be subject to prospectus thresholds governing the marketing, sale and distribution of securities across the European Union.

Classifying crowdfunding service providers

The licensing regime will classify crowdfunding service providers such as Cyprus Investment Firms (‘CIFs’) dealing in Transferable Securities. However, CIF will be subject to additional provisions as they relate to investor protection for investment-based crowdfunding.

These provisions on CIFs acting as crowdfunding service providers, contained within the proposed Crowdfunding Directive, include:

  • Conflicts of interest: (i) CIFs will be subject to neural intermediation through licensing and activities restrictions thereby ensuring fees paid by the project owner to the CIF are not linked to order routing;
  • Customer due diligence: Additional customer and financial due diligence in respect of both the crowdfunding project (including credit risk) as well as the project owner, which must be implemented before a project can be listed on a platform.
  • Transparency obligations: Project owners must produce a standardized pre-contractual document (under the responsibility of the project owner), including the natural persons effectively conducting the project owner’s business.
  • Safeguarding clients’ funds and financial instruments: All monies raised via the crowdfunding platform must be transferred by the CIF to the project owner only after the successful closing of the relevant offer (i.e. only if it meets or exceeds the funding goal).
  • Fair pricing: Clarifications will be provided on the operation of a bulletin board by the CIF, through which crowdfunding clients of the CIF advertise their interest to buy or sell (as the case may be) transferable securities that had been made available through the CIF’s platform, thus providing exit opportunities for the end-investor.

CySEC crowdfunding risks

CySEC expects its initiative to alleviate some but not all of the risks involved in investment-based crowdfunding and enhance investor protection therein. To this end, investors should understand the high risks entailed before proceeding with any investment-based crowdfunding investment, even where bespoke rules are in force. From CySEC’s market due diligence, these recurrent risks include:

  • The high likelihood of investors losing their entire invested amount, primarily because the means of alternative financing is most common in support for start-up businesses where the risk of corporate failure is high;
  • Dividend or coupon payments are not only subject to a successful trajectory of the project in question, but also to a decision to pay such dividends, by the project owner;
  • Startups may proceed with several rounds of share issuance, which in effect may result in diluting the value of the initial investment;
  • The exit opportunities (i.e. cashing in) might be severely constrained as a result;
  • The possibility of fraud cannot be ruled out.

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