Crowdfunding Service Providers – Cyprus update
Crowdfunding Service Providers– Cyprus update
As access to funding via traditional routes becomes increasingly challenging and expensive, crowdfunding is gaining notable popularity. Crowdfunding via digital platforms opens investment opportunities to investors at large and is a great funding tool for start-ups and small/medium sized businesses which are unable to secure accredited investors or financing via conventional routes. Crowdfunding platforms provide significant added benefits such as campaign marketing exposure, validation of a business idea/proof of concept, ability to test the marketability and obtain feedback and access to insights and information.
Although crowdfunding in the EU has been underdeveloped, the increasing popularity and need for safeguards steered the EU into establishing common rules and licensing requirements within the EU, with passporting benefits. Regulation 2020/1503 on European crowdfunding service providers for business has been introduced (the Crowdfunding Regulation).
The Crowdfunding Regulation regulates the matching of business funding interests of investors and project owners through the use of a crowdfunding platform (a publicly accessible internet-based information system operated by a legal person who provides crowdfunding services). There are thus three key players: project owners, investors and an intermediary organisation that provides an online crowdfunding platform bringing project owners and investors together.
Within the framework of the Crowdfunding Regulation, the crowdfunding service can only be provided by legal persons that are established in the Union and that have been authorised by the relevant competent authority.
The Crowdfunding Regulation covers the following types of funding:
- Lending-based crowdfunding – whereby an investor makes available to a project owner an agreed amount of money for an agreed period of time and the project owner assumes an unconditional obligation to repay that amount back to the investor with interest.
- Investment-based crowdfunding – this entails the placing without a firm commitment basis of transferable securities and admitted instruments for crowdfunding purposes, issued by project owners or a special purpose vehicle, and the reception and transmission of client orders in relation to those transferable securities and admitted instruments for crowdfunding purposes. It is noted that admitted instruments include shares of a private limited liability company that are not subject to transfer restrictions or restrictions in the manner in which such shares are offered or advertised to the public.
The following types of crowdfunding transactions are, amongst others, not caught by the Crowdfunding Regulation however care must be taken to ensure compliance with other domestic legislation where applicable:
- Crowdfunding offers with a consideration of more than EUR 5 000 000, calculated over a period of 12 months as specified in the Crowdfunding Regulation. Offers above the aforementioned amount will be subject to the relevant regulations on public offers
- Crowdfunding services that are provided to project owners that are consumers
- Reward-based crowdfunding (the investors receive a non-financial consideration)
- Donation-based crowdfunding (that is, the investors do not receive any consideration)
With a vision to facilitate and promote innovation, and to set itself at the forefront of becoming an attractive destination which will allow start-ups to flourish and with an aim to attract fintech investments, Cyprus took preliminary steps to introduce a bespoke regime on the regulation of crowdfunding service providers who intend to provide crowdfunding services from Cyprus and to that effect allowed entities operating as investment firms in Cyprus, to obtain an additional authorisation allowing them to offer investment-based crowdfunding services.
Nevertheless, due to a pending obligation to align with the Crowdfunding Regulation, on 13 March, 2023, the Cyprus Securities and Exchange Commission (CySEC) issued a Policy Statement on the application of the Crowdfunding Regulation essentially expanding both the type of entities which can apply to operate as crowdfunding service providers and their scope . CySEC is now accepting applications from prospective crowdfunding providers and has issued a directive, namely Directive D173-2009-02, outlining, inter alia, the mechanics of the authorisation process.
Cyprus Investment Firms which were previously authorised under the former domestic regime to provide crowdfunding services that now fall within the scope of the Crowdfunding Regulation have a transition period up until 10 November, 2023, after which they must obtain authorisation within the framework of the Crowdfunding Regulation in order to continue providing such services. Entities operating under the said transition period may not benefit from passporting opportunities.
With the new regime, the applicant need not be a Cyprus Investment Firm in order to apply. The applicant must specify the relevant services and activities it wishes to provide such as the following:
- provision of individual portfolio management of loans;
- use of special purpose vehicles for the provision of crowdfunding services;
- establishment and operation of contingency funds for its activity related to individual portfolio management of loans;
- provision of asset safekeeping services;
- provision of payment services;
- application of credit scores to crowdfunding projects on their crowdfunding platform;
- proposal of pricing of crowdfunding offers on their crowdfunding platform; and
- operation of a bulletin board.
Needless to say, if certain of the above-mentioned services such as the provision of payment services, custody services and investment services, are to be provided directly by the crowdfunding service provider and not via a separate licensed entity, additional licensing will be required in accordance with the relevant legislation.
The intention by a Crowdfunding Service Provider to provide or undertake any of the above services or activities must be notified to CySEC prior to providing such services/activities.
As part of the prudential requirements, crowdfunding service providers must maintain at all times prudential safeguards equal to an amount of at least the higher of:
- EUR 25 000; and
- One quarter of the fixed overheads of the preceding year, reviewed annually, which include the cost of servicing loans for three months where the crowdfunding service provider also facilitates the granting of loans, using forward looking business estimates if it has been in operation for less than 12 months.
In order to ensure investor protection, the Crowdfunding Regulation specifies a set of key information that is required to be provided to prospective investors in the form of an information sheet drawn up by the project owner for each crowdfunding offer, the so called “KIIS”. The officially accepted language of the KIIS in Cyprus is Greek and English, provided that it is made available in the Greek language at all times. CySEC has also made it a requirement that the KIIS is notified to it at least seven working days prior to being made available to prospective investors.
Further, the Crowdfunding Regulation sets out a number of organisational and operational requirements in order to minimize risks and ensure sufficient protection, some of which are as follows:
- Duty to act honestly, fairly and professionally in accordance with the best interests of the client;
- Duty of the management body to establish and oversee adequate policies and procedures to ensure effective prudent management, including segregation of duties, business continuity and the prevention of conflicts of interest;
- Duty of the management body to establish and oversee the implementation of appropriate systems and controls to assess the risks related to the loans intermediated on the crowdfunding platform;
- Duty to undertake a periodic review of the relevant safeguards and business continuity plan;
- Where the crowdfunding service provider determines the price of a crowdfunding offer it must, inter alia: (i) undertake reasonable assessments of the credit risk basing the same on sufficient information; (ii) establish and maintain clear and effective policies and procedures to carry out the credit risk assessments; (ii) ensure the price is fair and appropriate; (iv) conduct a valuation of each loan where necessary; (v) have and use a risk-management framework; and (iv) maintain a record of each facilitated crowdfunding offer;
- Undertake at least a minimum level of due diligence in respect of project owners;
- Where the crowdfunding service provider offers individual portfolio management of loans, it must comply with the mandate provided by the investor specifying the parameters for providing the services and maintain robust internal processes and methodologies, use appropriate data to achieve this and keep a record of the mandate given and of every loan in an individual portfolio;
- Maintain effective and transparent procedures for the prompt, fair and consistent handling of complaints;
- Avoid participation in the crowdfunding offer on their crowdfunding platforms to avoid any conflicts of interest;
- When outsourcing the performance of operational functions, take all reasonable steps to avoid additional operational risks;
- Comply with the asset safekeeping and payment service requirements.
Following the policy statement and directive issued by CySEC which now officially introduces and clarifies the authorisation procedure, we expect to see a number of Cyprus based crowdfunding service providers being formed and gaining considerable traction in the crowdfunding sector. Crowdfunding service providers are an essential tool for start-ups and one cannot overlook the noticeable increase in start-up opportunities on the Island resulting from attractive tax incentives. This therefore is definitely a sector worth keeping an eye out for.