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Crowdfunding - The Path towards a regulatory Framework

December 2017 - Finance. Legal Developments by Chetcuti Cauchi Advocates.

More articles by this firm.

1.        Recent developments in the market of Crowdfunding in Malta

 The importance and feasibility of crowdfunding platforms is increasing in stature and importance for current and future the entrepreneurs. Malta has recently acceded to the rising trend by creating its first crowdfunding platform, ZAAR, a reward-based crowdfunding platform who has recently been awarded with the first prize in its section at the National Enterprise Support Awards 2016 also as well as being one of the local projects that have represented Malta at the European Enterprise Promotion Awards 2016, held in Slovakia. Nonetheless start-ups based in Malta with global aspirations often rely on international platforms. An increase in interest has emerged amongst the art and culture community as well in social entrepreneurship projects. Crowdfunding in Malta is still at the early stages of development. Despite this, there are endless opportunities for local entrepreneurs and the local business community. Research has shown that through international crowdfunding platforms, monies have been raised for projects in the field of gaming consoles, apps and software as well as for artistic projects.  Testimony to this is a new game design studio in Malta, that launched its first game, Politicks, raised financing through the crowdfunding platform Indiegogo.


1.1 The Equity Model (individuals make investments in return for a share in the profits or revenue generated by the company/project)

The Malta Competition and Consumer Affairs Authority estimates that Malta’s SMEs represent the larger part of the Maltese Economy, accounting for the 99.8% of the enterprises. Though Maltese SMEs have limited access to traditional sources of funds, equity crowdfunding (also known as investment-based Crowdfunding) has a great potential to help and sustain the SME sector.
As a result, the equity model has attracted the interest of the Malta Financial Services Authority (the “MFSA” or “Authority”) that has recently issued a consultation paper to establish its position regarding equity based crowdfunding.
Equity crowdfunding platforms perform the investment activities of “reception and transmission of orders in relation with one or more instruments” and “execution of orders on behalf of other persons” . The equity crowdfunding platforms intermediate and execute orders in relation to “transferable securities” .  

In particular, equity crowdfunding platforms intermediate the acquisition by investors of “shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares”. Having regard of the fact that the equity crowdfunding platforms are deemed to provide an “Investment Service” in relation to an “Instrument”, such platforms will fall within the realm of the Investment Services Act, 1994  (“ISA”) requiring the authorisation of such businesses as investment service providers by the MFSA. For comparison purposes, the equity crowdfunding business is analogous with a securities brokerage business which intermediates private equity transactions, with the key common factors being the Fintech element (the reliance on technology, dominantly the internet), and the tendency to focus on smaller, retail investors. The general framework of equity crowdfunding also raises some concerns to the MFSA especially due to the likelihood that unsophisticated / inexperienced investors will be the bulk of the investors subscribing to projects seeking funding. A lack of understanding could be detrimental to the market as it may give the sector a poor reputation.

There is yet an insufficient pool of crowdfunding platforms to arrive at reasonable assumptions on which factors that could be helpful to determine the success or the failure of an investment-based crowdfunding platform.  In this moment in time there are no equity based crowdfunding platforms in Malta, albeit progress in this area is expected to take place following the setting of ZAAR. 

1.2 Lending model (individuals lend money to a company or project in return for a repayment of the loan and interest on their investment)

The Crowdfunding Lending model is used to raise funds for a project in the form of a loan agreement, with a promise to repay with (or in certain cases without) interest. Certain platforms may also use institutional money or their own balance sheet to finance such loans.
Although peer-to-peer lending (“P2PL”) and loan-based crowdfunding (which might be considered as a spin-off from the P2PL) could potentially present legal implications under the Financial Institutions Act, 1994, Chapter 376 of the Laws of Malta (“FIA”) and the ISA, there are no direct references in this respect. This is mainly because these laws were drafted before the existence of P2PL and crowdfunding, and therefore such laws are yet to be brought in line with the new realities.
1.3 Donations and Rewards Model (individuals provide money to a company or project for benevolent reasons or for a non-monetary reward).

The donations model is a particular form of crowdfunding whereby, people supporting a project do not receive any financial return, whilst with the rewards model there is a certain element of expected return in the form of either a reward, service or product. Unlike investment-based crowdfunding this form implies lower regulatory risks, and for this reason it has not been addressed by the regulator.
In Malta, the local crowdfunding platform ZAAR follows this model, where ZAAR is a modification of the  word ‘zaghar’ in Maltese meaning ‘small change’ whereby the underlying concept is that prospective investors that believe in a project will contribute to donate to the idea that they believe in.  The aforementioned platform takes an all-or-nothing approach to the fund raising, whereby it is envisaged that all donations are to be refunded in case the project does not meet its pre-defined funding objectives.

1.4 Real estate crowdfunding/ Renewable crowdfunding

Renewable energy plays a crucial role in reducing emissions as well as other forms of pollution. Malta together with the other European Union Member States have agreed on legally binding national targets for increasing the share of renewable energy, so to achieve a twenty per cent (20%) share for the entire Union by 2020. Malta has committed to reach a renewable energy share target of ten percent (10%).  
The European Directive 2009/28/EC also requires Member States to publish a National Renewable Energy Action Plan explaining how such target will be achieved. Malta’s main aim is therefore to incentivize and facilitate the renewable energy industry. Large wind farms, micro wind turbines, larger solar farms and other commercial initiatives are all potentially capable of absorbing the above-mentioned target. So far, this sector has been largely dependent on EU funded subsidy schemes with the downside that whilst these funds are not unlimited the market tends to be dependent on the availability of such funding.

Hence, the existing targets which Malta has committed to achieve within the Horizon 2020, as well as the local guidelines being published by Governmental Authorities, highlights the need and the appetite for alternative sources of funding being complementary to the above-mentioned ones. Unfortunately, at this stage Malta does not have a platform or platforms which address real-estate crowd-funding. Also at present, Malta does not have any on-going Renewable Energy Sources Projects (“RES Projects”) which are being funded via a crowdfunding platform financing model. The current RES Projects in Malta are being financed through private methods, most of them being partially financed by governmental subsides as well as the Horizon 2020 schemes. The majority of renewal energy within Malta is produced through photovoltaic solar panels, and on-going projects are primarily focused on this energy resource. The Malta Environment and Planning Authority (“MEPA”) has issued a solar farm policy in November 2014, encouraging RES Projects in abandoned quarries and large industrial rooftops, highlighting the local need for such projects .

1.5 International approach 

Start-ups based in Malta with global growth objectives are the ones typically involved in seeking funds though crowdfunding platforms or Venture Capital Investments (“VC”). Such companies are usually present in another market as a result of their organisational structure. 
Local players who have successfully managed to get funds have mainly used international platforms. For instance, we can refer to Mighty Box’s crowdfunding campaign who has successfully raised monies on the Crowdfunding platform Kickstarter. 
These examples indicate that the absence of local platforms is not necessarily a hindrance to pursue crowdfunding campaigns. However, since crowdfunding (at least within the EU) is not yet harmonized, the level of effort and cost which one would need to enter into and access the European market with just one platform will be extensive, since the platform would need to ensure that it is adhering to the requirements of not just its host Member State but of another twenty-seven (27) other Member States.

2. Recent developments regarding Crowdfunding regulation in Malta  

The MFSA, the single regulator for financial services in Malta, has issued a discussion paper in November 2016 regarding investment-based crowdfunding, whereby it is proposing to create a legislative framework addressing the area of crowdfunding. The Authority is currently assessing whether crowdfunding should be regulated by the Authority and if yes, what will be the effects of regulating crowdfunding. The MFSA is consulting the industry in general and is requesting feedback on such consultation document before deciding whether to go forward with the proposal for a legal framework on investment-based crowdfunding.

The MFSA discussion paper entered into the merits of some of the key risks which may arise under investment-based crowdfunding, such as loss of capital, lack of liquidity, fraud and platform. It also looked at what is happening at EU level and it highlighted the European Securities Markets Authority (“ESMA”) concerns in its published advice  and opinion  of December, 2014, which provided some clarity to national competent authorities. The MFSA reported that ESMA identified the fact that crowdfunding platforms fall outside the existing regulatory parameters which is thus hindering their growth within the EU. Nonetheless, the MFSA discussion paper noted a Commission Working Document  which ruled out any EU intervention in the near future given that crowdfunding is predominantly local in nature.

The discussion paper noted that the MFSA is minded to regulate crowdfunding by applying the general securities framework which regulates investment services licence holders with the addition of ad-hoc investment protection measures. The MFSA is minded to capture equity-based crowdfunding platforms under a Category 1A Investment Services Licence which would therefore capture such entity as a platform operator which would fall within the scope of the Markets in Financial Instruments  Directive (MiFID). A Category 1A investment services provider will require fifty thousand euros (€50,000) as a minimum capital requirement and can provide “reception and transmission of orders, investment advice and also place investment instruments without a firm commitment.”  

In its discussion paper the MFSA identified the transmission and reception of orders as the service most likely to be provided by investment-based crowdfunding. The Authority also disclosed that it is “currently considering whether to restrict the Category 1A licence when provided to investment-based crowdfunding platforms in order to restrict the platforms’ activity to reception and transmission of orders and placing without a firm commitment only. In general, platforms do not market themselves as providing personalised recommendations on investments. Some platforms operating in the EU are required by their regulator to provide investment advice. The Authority is of the view that platforms should restrict their involvement in the investments to customer due diligence checks and the investors should be encouraged to make their own well informed investment choices.”

The MFSA is also of the opinion that investment-based crowdfunding should be available to both public and private companies and that platforms may be exempt from the Prospectus Directive if such platforms satisfy one of the exemptions or the limitation of scope within such Directive as more clearly explained in section 3.2 below.

The discussion paper also identified the type of financial instruments (securities) which investment-based crowdfunding will use, these being shares and mini-bonds.  The Authority identified that it is also minded to interpret the term ‘transferable security’ as identified in MiFID and the Prospectus Directive in a broad manner and that in only limited instances it will deem securities to be non-transferable. The MFSA also noted that since there is no or limited secondary market for securities offered through online crowdfunding it is its opinion that such platforms will avoid any form of regulation. The discussion paper also touches upon conduct of business requirements, anti-money laundering legislation as well as other investment protection measures such as the possibility of:
i) capping the maximum amount which can be invested by each investor;
ii) capping the maximum project size;
iii) requirements for platforms to undertake a minimum level of due diligence on the projects/project owners and to take measures to reduce the risk of fraud; and
iv) specific disclosure requirements tailored to crowdfunding.

3. Current Regulation of Crowdfunding in Malta  

3.1 Licence under the Investment Services Act or the Financial Institution Act 

3.1.1 Equity model

Currently, there is no regulatory framework which specifically regulates crowdfunding. However, the Authority is considering setting up a local framework for the regulation of investment based crowdfunding, whereby both corporate issuers and platform operators need to be limited liability companies formed and registered in Malta pursuant to the Companies Act. The approach being considered by the Authority is to apply the regulatory framework applicable to Investment Services Licence Holders, with the addition of some tailored measures to better implement investor protection measures. 

Since in the view of the Authority the crowdfunding platform will undertake licensable activities the main legislative documents worth mentioning are the ISA, the Companies Act (“CA”)  and the Financial Institutions Act (“FIA”) .

The approach chosen by the Authority is to apply the general securities regulatory framework. The platform would need to obtain an investment services licence in terms of the Investment Services Act and have both its head office and registered office in Malta. It appears that the platform operator would fall within the scope of the Markets in Financial Instruments Directive (“MiFID”) with the benefit of a passport to carry on the services/activities for which it is authorized throughout the EU without any additional authorization being required. 
In terms of the ISA, a licensable activity takes place when an investment service listed in the First Schedule of the act is offered in respect to an instrument listed in the Second Schedule.

As mentioned above, the Authority identified, among the four possible categories of investment service licence, the Category 1A as the licence which would be most suitable for crowdfunding platforms. This is the least onerous since it requires a minimum capital of fifty thousand euros (€50,000). The Authority has identified the activity most likely to be provided by the crowdfunding platform as the “reception and transmission of orders” since the main activity undertaken by the platform is to receive orders from investors to subscribe for instruments and transmit them to the issuer or another third-party intermediary for the execution. The Authority also identified that some platforms might also wish to undertake the marketing for project owners, carrying out the service of placing without a firm commitment .

The Authority is currently evaluating the hypothesis of restricting the Category 1A licence when given to investment-based crowdfunding platforms to restrict its activities to reception and transmission of orders and placing without a firm commitment.

Many investment-based crowdfunding platforms operating within the European Union avoid regulation, as they use non-transferrable securities. However, the MFSA is minded to interpret this term in a broader way and only in a few circumstances securities are considered not to be transferrable. Thus, since shares, bonds and other securities are listed under “transferable securities” under the Second Schedule of the ISA, this would mean that regulation will apply.

Investment-based crowdfunding platforms may be subject to license conditions applicable to investment service license holders. Consequentially, a range of conduct of business requirements shall be enforced on investment crowdfunding platforms. Therefore, should the MFSA deem it necessary to enforce regulation, the platform may be required to provide appropriate information to allow potential investors to be in a position to make and take an informed investment decision. Additionally, an appropriateness assessment of the financial instrument released by the issuer should be undertaken unless a number of conditions are satisfied. Amongst them, one such condition is that the investment service relates to non-complex financial instruments. Financial instruments listed as non-complex include shares admitted to trading on a regulated market, bonds and other securitised debt, excluding those containing derivatives. Bonds and other debt securities are relevant in the context of crowdfunding, however those shares which are not normally quoted on a regulated market shall require an appropriateness assessment.
In this regard, derivatives and other instruments involving leverage are meant to be complex. Other instruments should be considered non-complex if:
• there are frequent opportunities to dispose or realise the instrument at publicly available market prices; and
• adequate and comprehensive information are available concerning its features allowing the retail investors to make an informed investment choice based on the information gathered.

Since the crowdfunding market is characterised by the lack of a secondary market, therefore having limited possibilities to dispose of the investment, such instruments may be considered as complex. Accordingly, potential investors may also be subject to an appropriateness test to better assess their knowledge and experience in investing in such ‘instrument’. However, at this stage this is all speculation since the Authority still needs to take a stance on how and whether crowdfunding platforms will be regulated. Although an indication was given that the MFSA is considering regulating the business of crowdfunding, the purpose of its discussion paper was to ask the industry to provide its thoughts and thus, the industry may to a certain degree be able to influence the Authority’s line of action.

3.1.2 Donations or Reward Model

The donations or rewards model is not regulated in Malta and at this stage the MFSA has not indicated whether it will consider reviewing this model and possibly also include it under a regulatory framework. At this point in time Malta has a reward based crowdfunding platform called ZAAR  however it is not regulated by any regulatory body in Malta and, one cannot exclude possible regulatory intervention in the future.

3.2   Prospectus requirements

3.2.1 Equity model 

The MFSA is of the view that a crowdfunding platform can be set up both as private or public companies. 
In respect of public companies, Article 89 to the CA requires the issuance of a prospectus whenever there is an offer of transferable securities to the public in a European Member State. Therefore, in accordance with the Prospectus Directive the prospectus must be published unless one of the exemptions mentioned in the Prospectus Directive itself are triggered.

For instance, some offers of securities are exempt from the prospectus requirements such as:
• where the total consideration of the securities for the offer within the European Union and the EEA does not exceed five million euros (€5,000,000), which limit shall be calculated over a period of twelve (12) months; or
• of securities made only to qualified investors ; or
• to less than one hundred-fifty (150) persons per Member State. 
As far as a private company is concerned, Article 209 to the CA identifies a private company as one which: 
• has the right to transfer the shares is restricted;
• has the number of its members is limited to fifty (50);
• prohibits the public to subscribe for any shares or debentures of the company.

As a result of the above, the MFSA has not yet indicated whether a full prospectus will be required in accordance with the Prospectus Directive or whether there will be any derogations or lesser requirements or exemptions for any particular industry. In fact in its discussion paper the MFSA asked the industry two key questions. The first question being “which exemptions from the prospectus requirement are most relevant to crowdfunded offers?” and the second question being “do you agree with the interpretation that crowdfunded offers are likely to fall outside the scope of the Prospectus Directive?”
3.2.2 Donations or Reward Model

As already stated above, the donations or reward model is not regulated in Malta. Having said that one cannot state with absolute certainty whether a prospectus will be required unless clarify if provided and an exemption to this model is given. Malta’s reward model crowdfunding platform in its website does include a brief of the different type of projects including the objective of the project – however this is a far cry from a fully-fledged prospectus.

3.3 Regulation of crowdfunding under the AIFMD regime

The transposition of the Alternative Investments Funds Manager Directive  (“AIFMD”) in Malta has been implemented through the amendment of the ISA and its subsidiary legislation. Platforms which are seen to collectivise investments and fall within the regulatory definition of a collective investment scheme (“CIS”) might also fall within the scope of the AIFMD regime.

The act defines a CIS as: 

“as means any scheme or arrangement which has as its object or as one of its objects the collective investment of capital acquired by means of an offer of units for subscription, sale or exchange and which has the following characteristics:
(a) the scheme or arrangement operates according to the principle of risk spreading; and either
(b) the contributions of the participants and the profits or income out of which payments are to be made to them are pooled; or 
(c) at the request of the holders, units are or are to be re-purchased or redeemed out of the assets of the scheme or arrangement, continuously or in blocks at short intervals; or 
(d) units are, or have been, or will be issued continuously or in blocks at short intervals:
Provided that an alternative investment fund that is not promoted to retail investors and that does not have the characteristic listed in paragraph (a) hereof shall only be deemed to be a collective investment scheme if the scheme, in specific circumstances as established by regulations under this Act, is exempt from such requirement and satisfies any conditions that may be prescribed.”

According to ESMA, the AIFMD should not apply to investment-based crowdfunding platforms operating in line with their current business models. Typically, a platform which offers opportunities for investments in particular projects do so through the use of specific vehicles dedicated to that particular project which allows investors to choose the project they wish to invest in.  In the event that a platform was to offer investors access to a collective investment undertaking which is not considered as an Undertaking for Collective Investment in Transferable Securities (“UCITS”) then it would be likely that the investment vehicle would be classified as an Alternative Investment Fund.

However, the AIFMD contains a number of exemptions that might be applicable to investment-based crowdfunding platforms such as companies operating outside the financial sector (i.e. companies not following any investment policy) remit or holding companies or securitisation special purpose vehicles.
3.3.1 Equity model

The Investment Services Rules which capture Alternative Investment Funds do provide for companies which would like to establish themselves in the form of a fund and which objective would be a particular project, such as real estate, vintage cars, forestry funds, renewable forms of energy. Consequently, the collective investment scheme objective would be to fund a particular project. Therefore, such projects could easily be captured by Malta’s adaptation of the AIFMD - meaning that a crowdfunding platform following the equity model is potentially akin to a CIS especially if some form of return either in the form of dividends or capital appreciation is generated by a project on a platform which utilises the equity model.

3.3.2 Lending model

In terms of Maltese legislation, a CIS may be established as a loan fund. The MFSA has taken as a basis the provisions of the AIFMD and also drew upon the Authority’s Banking Rules to address the specific areas of risk in a manner that ensures consistency with the Banking Act, while retaining the inherent characteristics of collective investment schemes established under the Investment Services Act.

The Authority addressed a number of risks associated with lending - such as risks to the stability of the funds. To mitigate the transmission or acquisition of unwarranted credit risk, loan funds are also required to follow strict credit assessment standards and fund managers must satisfy special competence and remuneration requirements. In order to reduce liquidity risks, loan funds must be closed-ended or at least make use of appropriate redemption gates. Other liquidity requirements also apply and leverage is not allowed.

Should the elements of a CIS as outlined above, be fulfilled, and the thresholds outlined by the AIFMD reached, the MFSA could be open to consider loan based crowd-funding as an arrangement falling within the scope of AIFMD. At this stage, this is mere speculation and one will need to better understand and engage with the Authority to understand its intended course of action.

3.3.3 Donations or Rewards Model

This model does not seem to be captured by the AIFMD, since such model does not offer any form of financial return.
3.3.4 AIFMD concluding remarks

It can be argued that a crowdfunding platform do not technically fall under the remit of the AIFMD since a crowdfunding platform is not raising financing for its own use and that it is not managing the funds which have been raised. Therefore, the crowdfunding platform would not be captured as an AIF or an Alternative Investment Fund Manager. Nonetheless the establishment of certain types of fund platforms in Malta are regulated to a lesser extent. In terms of Legal Notice 119 of 2012 – The Companies Act (Recognised Incorporated Cell Companies) Regulations, the Maltese legislator created a set of requirements for the establishment of a RICC company and its incorporated cells. A RICC may only provide services of an administrative nature for which it is issued with a Recognition Certificate in terms of Article 9A of the ISA. Unlike other structures, the RICC structure provides promoters with a flexible ICC structure that may be used as a vehicle to achieve various objectives including the setting up of a fund platform. A RICC must be established as a limited liability company and may not carry out any licensable activity. The RICC requires a memorandum of association restricted to the provision of administrative services to its incorporated cells. By analogy the crowdfunding platform may be similar to a RICC and the underlying projects are the equivalent of an Incorporated Cell under the RICC, which Incorporated Cell is a CIS with separate legal personality.

3.4 Regulation under the Payment Service Directive 

In the past, few years Malta has become a European hub for payment service providers given the favourable legal environment provided to these entities as well as the possibility of passporting such services throughout Europe.

One of the main issues that can arise from the development of the crowdfunding platform is whether a lender who regularly lends to borrowers in Malta through a platform could be considered to be undertaking a licensable activity in terms if relevant laws and regulations.
In this context, it is relevant to note that although the platform acts as an intermediary between the lender and the borrower it is not part of the contractual arrangement between the parties.

The Crowdfunding Lending model is used to raise funds for a project in the form of a loan agreement, with a promise to repay with (or in certain cases without) interest. Certain platforms may also use institutional money or their own balance sheet to finance such loans.

Although peer-to-peer lending (“P2PL”) and loan-based crowdfunding (which might be considered as a spin-off of the P2PL) could potentially present legal implications under the FIA and the ISA there are no direct references in this respect. This is mainly due to the fact that these laws were drafted before the existence of P2PL and crowdfunding, and therefore such laws are yet to be brought in line with the new realities.

Unlike investment-based crowdfunding to date there is no formal position taken by the MFSA on this subject. However, since crowdfunding will increase in prominence and gain market share as time goes by, it is possible to predict that the MFSA will look at whether such crowdfunding platforms will also be caught under the Authority’s regulatory framework.

In the event that it does, we are of the understanding that such type of crowdfunding may be captured by the FIA. The Second Schedule of the FIA provides the list of activities to be undertaken by a licensed Financial Institution in Malta, among which there is lending, money remittance and electronic money. 

However, a crowdfunding platform has “borderline” features since it does not perfectly fit in any of the above listed activities.

The crowdfunding lending platform does not typically lend money directly, since it is acting as an intermediary between the lender and borrower, thus holding itself out from being a party within the lending agreement. Therefore, the platform serves to provide a framework to:
• increase the visibility of the projects; 
• enabling interaction with the two parties;
• provide the support documentation to allow parties to reach the investment agreement as well as facilitating the contractual terms and conditions;
• coordinate and monitor the effective fulfilment of the contractual obligations.
A crowdfunding lending operation with a collective investment element may fall within the remit of the ISA. Based on the regulatory rules it is possible for CIS to be established as loan funds.
“Investment through loans” generally means that the:
• loans are directly originated by the Scheme; and
• Scheme would then acquire a portfolio of loans or direct interest in loans which would give rise to a direct legal relationship between the Scheme and the projects, as respectively lender and borrower.

One still needs to determine whether the Authority will consider such activity to be a licensable activity or not. In the meantime, operators of crowdfunding platforms may take into consideration the possibility of co-operating with either banks or similar financial institutions providing payment services to avoid being caught on the wrong end of the regulatory stick, should the MFSA consider that the platform is undertaking a licensable activity. 

3.5 Possible additional Regulations

• Prevention of Money Laundering Act (“PMLA”); 
• Prevention of Money Laundering and Funding of Terrorism Regulations (“PMLFTR”); 
• Distance Selling (Retail Financial Services) Regulations;  
The MFSA is also proposing the introduction of several other investment protection measures apart from the authorisation and conduct of business requirements applicable to investment service providers as explained in the last paragraph to section 2 above.
4. Regulatory barriers for Crowdfunding cross borders

4.1 Applicable Law
The European Commission is monitoring on an ongoing basis the development of investment-based and lending - based crowdfunding. Nowadays the development of crowdfunding activity occurs within the countries’ borders and is not so common to find platforms able to operate on a cross-border basis. The implementation of European directives across Member States differs from one Member State to another and thus creates various bespoke regimes providing different guidelines and principles. The lack of harmonisation concerning consumer or investor protection can be seen as the main barrier for a cross-border crowdfunding development. As a consequence, this may lead to the platform’s refusal to provide their services to non-residents and new markets might be targeted only through the establishment of crowdfunding platforms in the various member states, which could become cumbersome and not cost-effective. 
Other potential barriers to the international development of crowdfunding platforms include:
• definitions of crowdfunding and the scope of activities for investment-based models; 
• different conditions for authorisation (for example capital requirements);
• business requirements (i.e. professional qualifications, information and risk warnings, due diligence, conflict of interests, investment limits, etc.). 

This will inevitably affect the cross-border strategies of the crowdfunding organisation as they might need to develop different platforms or sustain important web development work. Moreover, they might seek approvals, licenses, or authorizations from different regulatory authorities, undermining the cost-effectiveness of such cross-border activity. 

The lack of harmonisation between countries, also qualified as “fragmentation”, may be a decisive barrier for the international implementation of the crowdfunding practice. Although, the industry can grow within the country’s borders, it cannot easily cross borders, thus affecting the size and scalability of their campaigns as well as of the platforms themselves. 

The problems regarding the regulatory framework differ for each type of crowdfunding, with loan-based and investment-based being the most constrained. The European Commission, states that thirty-eight percent (38%) of platforms offering financial returns are active in cross border transactions whereas nearly fifty percent (50%) of them want to extend their operations in other countries. The same considerations and observations related to the regulatory barriers could be easily transposed to the field of taxation. 

It is a common feature that many bespoke regimes require a certain level of local substance when it comes to licensable activities. For instance, the MFSA, requires a licenced entity to have at least three (3) directors, one of which would need to be based in Malta and fulfil the role of a non-executive director. Even though such requirements might not pose specific problems for large banks and insurance companies, their suitability is doubtful and they can negatively impact smaller financial service providers.  Whilst the residence requirements are justified for the purposes of easier oversight and supervision, ensuring effective management and prevention of fraud, the European Commission invites Member States to remove residence requirements on managers of companies in the financial sector where they are not justified, suitable or proportionate.

Moreover, the latest Capital Markets Union (“CMU”) Communication , stressed out the negative impact that the differences and inefficiencies in national insolvency regimes have on cross-border investment and lending. 

Although the differences in national insolvency regimes may such as crowdfunding platforms, especially in their cross-border activities. The negative effects of the different national insolvency regimes could lead to a decrease of trust and confidence from the potential investors that might be afraid of a non-consistent legislative framework.

Whilst the above has given a flavour of how Europe is looking at the matter, Malta still needs to formalise its position and therefore one cannot say what are the requirements for crowdfunding platforms and which applicable laws will apply. 
4.2 Inbound

The question is if the crowdfunding platform addresses Maltese investors or wants to promote Maltese companies/projects on its platform
4.2.1 Foreign Crowdfunding platform addresses Maltese investors / companies

Currently there is no legislation or regulation which captures crowdfunding activity. The MFSA, through its discussion paper, has kick-started the debate on the potential regulatory requirements which could apply, such as licensing requirements, conduct of business requirements, compliance and risk management implications. Furthermore, current Maltese legislation may apply for companies seeking funding for projects which would therefore require adherence to the preparation of a prospectus as well as fiduciary obligations. 
As mentioned above the MFSA still need to position itself on crowdfunding and therefore one cannot say whether foreign crowdfunding platforms address the needs of Maltese investors.  
4.2.2 Crowdfunding platform

There appears the need to have more clarity from the European institutions in respect of crowdfunding platforms. Should a platform hold a MiFID (or MiFID II) licence as being envisaged by the MFSA for local crowdfunding platforms, crowdfunding platforms could reach a larger market and pool of investors thanks to the ability to take advantage of passporting and market the platform in the various EU territories. Therefore, in theory an EU based crowdfunding platform which holds a MiFID licence can passport into Malta. 
On the other hand, if the crowdfunding platform does not hold a MiFID licence, one would need to understand whether such platform would be subject to any regulatory requirements at a local level over and above existing laws such as anti-money laundering legislation. 
4.2.3 Company/project

Most EU legislation on financial services, including MIFID and the Prospectus Directive only apply where the financial instruments are transferable securities. However, as far as investment-based crowdfunding is concerned, as previously mentioned the MFSA interprets the term transferable securities in a broad way, so it is likely that since most of the financial instrument are deemed to be transferable securities a prospectus shall be provided.
Furthermore, in the view of investor protection, a key information document related to the project seeking funds could be considered useful. In particular, this key document shall contain:
• Audited annual account summary (if any);
• Statement of the strengths (technology, patents) and weaknesses/threats (competition/obsolescence);
• Short biography of the founders, the board members and the senior management;
• Current capital structure and dilution due to fundraising;
• Commercial information about the product/service.

4.3 Outbound 

4.3.1 Crowdfunding platform

In this situation, what is being described is the possibility of having a Maltese crowdfunding platform entering a foreign market, thus addressing foreign investors. 
Based on the assumption that the platform might undertake licensable activities passporting rights shall be addressed to the licenced platform. Therefore, we can differentiate between freedom to provide services on a remote basis or setting up a branch.
In the first case the notification to the overseas the Authority shall be accompanied by:
• information relating to the services intends to provide together with a programme of operations also indicating whether it intends to operate through tied agents;

• an indication of the Member States that will be targeted.
Moreover, in case the platform would hypothetically opt for the setting up of a branch it would therefore need provide a notice accompanied by:
• An indication of the Member States within the territory of which the platform plan to establish a branch;
• A programme of operations identifying the operations it seeks to carry out through the branch also indicating whether there is an envisaged use of tied agents;
• The address of the proposed branch;
• The proposed organisation structure of the branch.

4.3.2 Maltese crowdfunding platform addressing foreign (EU) investors

The debate on crowdfunding platforms in Malta is still in its infancy from a regulatory and legal perspective. The MFSA discussion paper has started to address and encourage debate in this area and as mentioned above the MFSA is looking to regulate and require that a MiFID licence would be required for equity based crowdfunding platforms. 

4.4 Impact of EU Regulation

4.4.1 Prospectus
In Malta, only prospectii under the Prospectus Directive are harmonised as well as the definition of transferable securities under MiFID. As a result of this one can say that a negligible amount of any potential Maltese crowdfunding market is overseen by harmonised EU legislation and implemented into Maltese law due to the current stance by the EU institutions of allowing crowdfunding to be the competence of national regulators.
4.4.2 AIFMD
Malta has fully transposed the AIFMD and the possible impact of this directive is described in the above sections. One would also need to assess the MFSA’s views on whether the AIFMD would or could have an impact of equity based and lending based crowdfunding. To date there is no formal position by the Authority.

4.4.3 MiFID
Since the MFSA position within its discussion paper is to implement and apply a MiFID licence to crowdfunding, Maltese based crowdfunding platforms may be impacted by MiFID and eventually MiFID II. The purpose of a MiFID licence will be not only to regulate the crowdfunding platform but also to be able to benefit from the passport.
4.4.4 PSD / PSD II

The requirement of the Payment Services Directive has been transposed into Maltese legislation under the Financial Institutions Act as amended from time to time. The FIA captures not only payments but also money remittance, an activity which could potentially be captured by the FIA in respect of crowdfunding platforms since they receive the monies of subscribers to a project and then pass on such monies to the project owners. As mentioned earlier, it may be prudent for crowdfunding platforms to enter into a co-operation agreement with either a credit institution or licenced payment institution rather than acting as intermediary between the project owner and the investor.
4.5 Summary

The way that crowdfunding is developing from a legislative and regulatory perspective, leading to different interpretations and across a number of different EU member states (as well as non-EU member states), it is very likely that the establishment of a pan-European or global crowdfunding platform will be very cumbersome, costly and potentially ineffective. Rather than having the EU leading the way and developing a harmonised product within the single market, the exact opposite is taking place. Whilst from a Maltese perspective, the debate is still open, other regulators are implementing their own legislative frameworks. The cross-border facility offered by a passport currently does not apply and either foreign or Maltese crowdfunding platforms may face barriers of trade, since a licence in one jurisdiction may not be sufficient for other jurisdictions.
5. Lesson learned from Malta’s for a possible harmonised European Crowdfunding regulation

5.1 Role model (“dos”)

The MFSA’s discussion paper on Investment-based crowdfunding is a positive signal that the Authority is of the view to recognize crowdfunding as an economic instrument that might imply licensable activities. Thus, the MFSA is giving crowdfunding more visibility as a reliable alternative source of financing for newly created SMEs.
For a possible harmonised European crowdfunding market the following aspects can serve as a role model:
• a lighter touch regime for crowdfunding platforms in relation to existing financing models and/or products;
• appropriateness assessment for non-professional investors;
• transparency and reliability of the information provided to the investors
• Continuity plan in the view of investors protection – including capping of investments for non-sophisticated investors
5.2 Aspects that should be avoided (“dont’s”)

The wait and see approach by the EU in respect of crowdfunding, should not be used as a means of seeing different legislative frameworks across the EU and then piecing them together to form an EU directive. The reason being that each regulator would be looking at different aspects of their own legislative framework and the hurdle to bring about a common front on such a matter may take time, energy and effort which could be utilised and invested in a better manner. Having said that any future harmonised crowdfunding legislation should not allow for over-regulation, excessive bureaucracy and lack of transparency.

6. Conclusion
Nowadays, we are witnessing an extensive growth of crowdfunding both in terms of popularity and in the term of effective use. It is currently considered as an important source of alternative finance for projects that would have otherwise experienced difficulties using traditional sources. Small businesses play a central role in the European economy as well as in the Maltese one, where small and medium enterprises account for more than ninety percent (90%) of the overall economy. The Entrepreneurship Action Plan for 2020 invites Member States to “assess the need of amending current financial legislation with the aim of facilitating new, alternative forms of financing for start-ups and SMEs in general, in particular as regards platforms for crowdfunding”. Its increasing importance is demonstrated also by the interest shown by the Maltese regulator, willing to create a defined legislative framework following the inputs given by the industry players. 
As every novelty, crowdfunding raises particular concerns under several points of view in particular on the investor protection side:
Some of the key risks pertaining to crowdfunding are outlined below:
a) Loss of capital: platforms will mostly be used by start-up and SME’s that might not have an established track record, therefore the failure rate is exponentially increased. These risks will be even higher for non-expert/professional investors;

b) Lack of liquidity: there is no secondary market that allows one to trade the securities acquired through crowdfunding, therefore investors may face the risk of not having the possibility of selling their securities or, alternatively, they might be sold at a significant discount;

c) Fraud: since fundraising is carried out via online platforms, there will be not personal contact between lenders and borrowers, as there is no intermediary acting in between. There might be also limited information of the projects being funded. Hence, the risk of fraud is significantly increased;

d) Platform closure or failure: in the event of a temporary or permanent shut down of a crowdfunding platform that handles clients’ monies, investors may face losses unless safeguards are put in place.
Despite the increasing growth which crowdfunding as a mode of financing is experiencing, it still remains mostly a domestic trend. The real challenge will come up when, or if, crowdfunding will mature into a well-defined international phenomenon. At that point, European regulators will then have to reconcile and harmonize different national rules, without adding new layers of regulation that may threaten and stymie growth. Having a second regulatory regime to comply with would create a cost burden for platforms wishing to expand their business outside their national borders. The European Commission recently stated that it would prefer to see the crowdfunding blossom before proposing to create a unique legislative framework preferring national regulators to take the lead at the early stages, despite some divergences. 
Hence, given the fast-growing rate crowdfunding is experiencing and its extraordinary value (yet not totally unleashed), the continuous and effective monitoring of the degree of harmonization of the national regimes shall be considered extremely important.
Notwithstanding the last provision, whilst the establishment a single regulatory licence is still relatively far away, it is envisaged that some sort of pan-European framework will be likely to be created.

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About the Authors:

Dr Maria Chetcuti Cauchi

B.A., LL.M.(Warwick), LL.D., TEP

Chetcuti Cauchi Advocates 
Legal | Tax | Corporate

Co-founding partner, Maria is the partner in charge of the Financial Services of the Firm.

On a day to day basis, Maria’s team advises an array of clients on regulatory issues, compliance matters, commercial and financial transactions and corporate governance issues in general. Maria has vast experience of start-ups, corporate restructurings, takeovers, mergers, privatisations, and equity and debt financing structures. Maria’s team regularly handholds banks and financial services companies on the procedure to set up in Malta, the compliance and regulatory aspects of their business including client intake and due diligence, ongoing compliance procedures, reporting and general regulatory observance matters.

Maria’s pet subject centres around the application of traditional notions of Intellectual Property and Financial Services Law to the online world, as well as the conversion of brick and mortar notions to cyberspace. These mostly include projects with a fusion of technology law and investment/finance law, such as payment gateways, gaming operations, e-money institutions and ICT online operators.

Mr Nicholas Warren

MBA, BCom(Hons) Banking & Finance

Senior Manager, Financial Services

Nicholas graduated from the University of Malta in 2004 in the field of Banking & Finance. He obtained his ACCA qualification in 2009 and also obtained a Diploma in Islamic Finance from CIMA. He is currently reading for a Master’s Degree in Strategic Planning from the Herriot Watt Edinburgh University. Within Chetcuti Cauchi, Nicholas acts as Senior Manager to the corporate and accounting department whilst also lending advisory expertise to the financial services regulatory team.

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