Why is the Crowdfunding Act needed?
We’ve compiled some questions and answers on crowdfunding.
Crowdfunding in Finland and abroad
What is crowdfunding?
Crowdfunding typically involves the online collection of relatively small sums from a large number of people. At the same time, it’s possible to engage in cooperation and attract attention for a project.
What forms does crowdfunding take?
- Crowdfunding based on donations: Donations are collected from people for a specific project. The collection lasts for a specific period of time and it is promoted through social media and elsewhere on the internet.
- Crowdfunding based on the receipt of goods, compensation, reward or pre-sales: Contributors are offered something in return for their participation. In a profit-sharing scheme, contributors are promised a part of future profits made by the project being financed.
- Investment-based crowdfunding: A company or other party issues shares, bonds or other financial instruments.
- Loan-based crowdfunding: This involves borrowing money from people and a promise to pay back the capital with (or in certain cases without) interest.
How big is the crowdfunding market in Finland?
The size of the crowdfunding market in 2015 was approximately EUR 84.4 million. This was 48% higher than the previous year.
The market is divided as follows:
- investment-based crowdfunding: EUR 15.5 million (equity capital collected from people for companies)
- loan-based crowdfunding: approximately EUR 68.9 million (peer-to-peer loans mediated to consumers EUR 46.3 million and loans mediated to companies EUR 22.6 million).
The estimates are based on data collected from market participants.
What about elsewhere?
Estimates of crowdfunding markets throughout the world in 2015:
- Europe: EUR 6 billion euros (+100% from previous year)
- USA: USD 17 billion (+80 %)
- Asia: USD 11 billion (+220 %)
- Whole world: USD 34.4 billion (+112%)
Why is crowdfunding is considered an important form of financing?
Crowdfunding is a new form of financing that complements traditional financing channels or even partly replaces them. It has been of particular interest in recent years to seed and growth companies as well as SMEs both in Finland and internationally.
For investors, crowdfunding offers higher-yielding and higher-risk investment opportunities than traditional investments.
Why has crowdfunding become more common?
One reason is the financial crisis. Access to finance from banks has become more difficult, or at least more expensive, because banks’ capital adequacy and solvency requirements have been tightened. Companies have therefore needed new alternative sources of funding. In Finland, the availability of financing from banks has not deteriorated as much as in many other EU countries. Nevertheless, crowdfunding has also become more popular in Finland, because research shows that banks have tightened their requirements relating to collateral and special conditions (covenants) and have increased the margins on their loans.
Demand and supply of crowdfunding have also been increased by the fact that it is nowadays possible to reach large numbers of people cost-effectively online.
What are the risks associated with crowdfunding?
Crowdfunding is typically used by seed and growth companies as well as SMEs to acquire financing. Investments in startups, in particular, are high risk. It is estimated that more than half of startups go out of business within a few years. Of the surviving startups, only a few become big and successful, and most of them struggle daily to keep afloat and continue in business.
On the other hand, in all investment activity there is a risk of losing some or all of the invested assets. The Crowdfunding Act aims to ensure that investors are informed of all relevant information to enable them to make informed investment decisions. Moreover, crowdfunding as a sector is also in a growth phase, and all procedures have not yet been established. In this respect, too, the Act seeks to steer the sector in the right direction and to define the rights and obligations of intermediaries, investors and companies seeking finance in a centralised way.
It should also be noted that no regulated secondary marketplace exists for securities (e.g. shares of non-listed companies) given as consideration to investors for financing in crowdfunding. For this reason, they are usually not traded in the secondary market, which may make it difficult to convert the investment into cash later.
What’s the aim of the Crowdfunding Act?
The proposal aims to establish clear ground rules for crowdfunding at the legislative level to ensure that the sector can operate and grow in Finland. The aim is also to clarify the responsibilities of various authorities in the supervision of crowdfunding, to improve investor protection and to diversify the financial markets.
A further goal of the proposal is to increase in particular the financing options of SMEs as well as small innovative and growth-oriented companies. Investors will receive higher-risk and higher-yielding investment opportunities.
What forms of crowdfunding does the Act cover?
The Crowdfunding Act covers only loan-based and investment-based crowdfunding utilised to finance business activity.
The proposed Act essentially applies to crowdfunding intermediaries. To ensure adequate investor protection, the Act also lays down obligations on the party collecting the financing through crowdfunding and, correspondingly, certain rights for investor-customer.
Who can act as a crowdfunding intermediary?
Under the proposal, crowdfunding can be mediated only by businesses that are entered in a special register of crowdfunding intermediaries. The conditions for registration are specified in detail in the Act. The register will be open to reliable operators that have adequate knowledge of the financial markets. The Finnish Financial Supervisory Authority will be responsible for the register and the supervision of the intermediaries.
Why is registration needed?
Through registration, the aim is to create a sufficient threshold for entry into the market, which in turn is of great significance from the perspective of the credibility of investor protection and this form of financing (i.e. crowdfunding). In preparing the registration of crowdfunding intermediaries, the aim has been to make it lighter than other financial market regulation (often heavy, with an expensive operating licence process), because the objective is to diversify the domestic financial markets by providing sustainable and predictable conditions for new, alternative forms of financing. The relative lightness of regulation is based on the sector’s small size, growth phase, risk profile and other characteristics (proportionality principle).
Why and how will entry into the sector be facilitated?
The sector’s operators are small compared with established market operators, and they have only limited administrative resources at their disposal. In addition, the sector to date is responsible for only a small part of the money collected and mediated in the financial markets.
An operating licence requirement (authorisation from Finnish Financial Supervisory Authority) and the process associated with it therefore constitute an unreasonably high threshold for entry into the sector and do not promote the development of crowdfunding in the domestic market or its competitiveness in relation to established financial market operators.
The current operating licence process will be replaced by a lighter model in which intermediaries will be registered with the Finnish Financial Supervisory Authority. Crowdfunding intermediaries will no longer need to join the Investors’ Compensation Fund, and the minimum capital requirement for crowdfunding intermediaries will be reduced from the present EUR 125,000 to EUR 50,000. An alternative to the capital requirement will be proposed, such as professional liability insurance, a bank guarantee or other corresponding guarantee that the Financial Supervisory Authority deems to be sufficient. Moreover, disclosure obligations will be clarified and simplified, and this will apply both to the crowdfunding intermediaries and to the companies acquiring financing through crowdfunding.
Can a single company collect crowdfunding without a crowdfunding intermediary?
Yes. The Act will have no effect on situations where a business entity seeking funding exercises its option within the scope of business freedom to obtain funds from people by independently offering its own securities. Securities may be offered, for example, through the business entity’s own website in the form of a share issue. A crowdfunding intermediary is not used in such an arrangement. In such cases, the business entity seeking funding must independently ensure that it complies with legislation, for example the Limited Liability Companies’ Act and Securities Market Act.
From a legal standpoint, this is not crowdfunding, but a share issue independently implemented by the business entity or a corresponding acquisition of funds arrangement directed at the public. The application of the Crowdfunding Act requires that acquisition of funds takes place via a service platform provided by a crowdfunding intermediary.
Who can collect crowdfunding?
Under the new Act, crowdfunding for business activity can be collected by a business entity (limited company, cooperative, limited partnership, general partnership, European limited company, European cooperative, association) or a foundation. The party collecting crowdfunding cannot be in bankruptcy or other insolvency procedure. On the other hand, a restructuring procedure does not prevent the collection of crowdfunding as long as investors are adequately informed about the issue and the associated risks. The party collecting crowdfunding cannot be a listed company, i.e. the securities of listed companies cannot be the investment objects of loan- or investment-based crowdfunding investment. The party collecting crowdfunding is not required to be a legal person; a business name is also possible.
How does the Act improve investor protection?
The Act clarifies the terminology and the responsibilities of the authorities in the sector, and makes a complex subject more understandable. It also strengthens the position of investors by specifying clear rules on investor protection and disclosure requirements. At the same time, crowdfunding will become part of the regulated financial markets.
Investor protection will be improved, for example, by extending under the Act the obligation to disclose information also to situations in which securities other than those referred to in the Securities Markets Act are utilised in acquiring or mediating crowdfunding. Currently, securities other than those referred to in the Securities Market Act, essentially non-transferrable securities, are not included within the scope of the Securities Market Act or the Investment Services Act. They are therefore largely outside of regulation and thereby investor protection. In addition, investor protection will be specified in a separate decree of the Ministry of Finance relating to the disclosure obligation of an entity acquiring financing through crowdfunding. The decree will include provisions on risk warning, among other things. The Act, for its part, has provisions on a crowdfunding intermediary’s procedures and its obligations towards the investor. In addition, the Acts lays down provision on supervision and sanctions.
How are other types of crowdfunding regulated in Finland?
Donation-based crowdfunding is activity in which the contributors receive nothing in return for their participation. This is regulated by the Money Collection Act, which is the responsibility of the Ministry of the Interior. The comprehensive reform of the Money Collection Act has been suspended until further notice.
Goods-based crowdfunding is regulated by the Consumer Protection Act where a relationship between a consumer and a business is involved. The Sale of Goods Act is applied where a relationship between two consumers or a relationship between two businesses is involved. The Ministry of Justice is responsible for both Acts.
Peer-to-peer consumer lending falls within the scope of the Consumer Protection Act. The Ministry of Justice is currently specifying the regulation of peer-to-peer consumer lending as part of the implementation of the Mortgage Credit Directive. A Government proposal on the matter will be submitted to Parliament in April 2016.
Why do we need a separate law on crowdfunding?
A separate law is necessary because crowdfunding takes a number of different forms that are connected in different ways to the existing laws currently in force. This applies particularly to loan-based and investment-based crowdfunding.
The proposal aims to:
- enhance financial intermediation and thereby economic growth
- clarify the ground rules for crowdfunding and to reduce the costs of the sector and the authorities
- resolve demarcation problems in relation to other national legislation, such as the Investment Services Act and the Securities Markets Act
- make a clear distinction between transferrable securities referred to in the Securities Markets Act and securities other than those referred to in the Securities Market Act, essentially non-transferrable securities, which is of key significance for crowdfunding intermediaries with respect to the operating opportunities prescribed in the Act
- improve investor protection where, in acquiring and mediating crowdfunding, securities other than those referred to in the Securities Market Act, essentially non-transferrable securities, are utilised
- facilitate the mediation of crowdfunding with lighter administrative requirements than at present without an administratively heavy and expensive operating licence procedure (implementation of Article 3, optional for Member States, of the Market in Financial Instruments Directive, MiFID I, with respect to investment-based crowdfunding)
- support the growth of crowdfunding such that a prospectus needs only be published for a securities offer exceeding EUR 5 million (the current national prospectus limit value is EUR 2.5 million), with the aim of facilitating the utilisation of crowdfunding in business financing more extensively than at present without the obligation to prepare a separate and often rather expensive prospectus
- promote with respect to investors and the rest of the general public as well as companies and other issuers seeking financing through crowdfunding an understanding of their rights and obligations.
How may a crowdfunding intermediary operate in relation to non-professional customers?
Based on the Act, a crowdfunding intermediary may provide both loan- and investment-based crowdfunding regardless of whether it uses in its activities transferrable securities or non-transferrable securities.
If an intermediary uses transferrable financial instruments, it must use an authorised financial market operator as an intermediary or agent (implementation of Article 3 of the Market in Financial Instruments Directive, MiFID I). There is no such obligation, however, in every instance if the transferrable securities are offered only to certain professional investors defined in detail in the Market in Financial Instruments Directive. A crowdfunding intermediary, moreover, may mediate assignments for non-transferrable securities directly to non-professional investors without the need to use an authorised intermediary or agent.
Is the proposal also significant for authorised financial market operators?
Yes. Authorised financial market operators may utilise the fact that the Act has a lighter structure than other financial market regulations. They may, for example, set up a subsidiary to mediate loan- or investment-based crowdfunding or link up a crowdfunding intermediary already operating in the market with their own authorised activities through a tied agent arrangement. A basis of the Act is that credit institutions, payment institutions, fund companies, investment service companies and alternative fund managers may also mediate crowdfunding by virtue of their own operating licence as long as they adhere to certain separately specified provisions of the Crowdfunding Act.
How may a crowdfunding intermediary operate in other EU countries?
The easing of regulation applies to crowdfunding mediation and acquisition in Finland. With respect to operating in other EU countries, it is recommended that an intermediary still apply for an investment service company operating licence, which will facilitate simple access to European markets.
The Market in Financial Instruments Directive (MiFID I) provides an opportunity for cross-border activity in accordance with the so-called single authorisation principle (europass). If a credit institution, fund company, investment service company or insurance company has obtained an operating licence in a state of the European Economic Area (EEA), it may engage in activity under its operating licence in all EEA states. A company may either establish a branch or provide cross-border services through a separate notification procedure. The europass provides an opportunity to expand crowdfunding mediation to cross-border EU-level activity.
If a company is still in the growth phase, it may find it difficult to grow at the same time into an EU-level operator. A company should generally establish its position in Finland first, and the Crowdfunding Act will provide better opportunities for it to do so.
Preparation of the project
How has the Ministry of Finance prepared the project?
The Ministry of Finance has prepared the project in cooperation with market operators and the authorities. The draft Act was circulated for comment in May-June 2015. Statements were received from 47 interest parties and most responded positively to the proposal. The Ministry of Finance has also arranged two consultations with authorities and one consultation with market operators. Those drafting the Act have met with key stakeholders dozens of times in connection with the project. Every effort has been made to take the feedback from consultations and statements into account in drafting the Act.
Does the project have special political status?
Yes, because the project is part of the key Government projects action plan, in which the Government has outlined as follows:
“The Government considers it important that the Ministry of Finance prepare Government proposals to create framework legislation on crowdfunding.”
Why a national Act and not EU regulation?
EU regulation of crowdfunding is not expected in the near future. It is therefore advantageous to implement regulation nationally with the limits set by EU legislation.
Do other EU countries have similar legislation?
National regulation has been implemented in Italy, France, the UK, Germany, Spain, Austria and Portugal. In addition, Belgium, the Netherlands and Lithuania intend to bring legislation on the issue into force by next summer at the latest. The need for regulation is currently being explored in a number of other EU states, including Sweden, Estonia and Latvia.
What about the rest of the world?
The USA is bringing into force legislation (the Jobs Act) similar to that being prepared in Finland. Similar developments are also taking place in Canada, Japan, South Korea and Australia, for example.
Crowdfunding Act to provide new financing options for business growth (press release 7 April)
Aki Kallio, Ministerial Adviser, tel. +358 2955 30477, aki.kallio (at) vm.fi