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Financial Services 

Supervisory expectations of regulated financial services firms have steadily been increasing over the past decade or more.

In the wake of COVID-19, we are seeing a renewed emphasis on these expectations with consumer protection related concerns underpinning many of the requirements. At the same time, the growth of the investment funds industry continues to attract increasing regulatory focus arising from concerns relating to the potential impact on financial stability.  

Leverage and liquidity are likely to continue to feature on the regulatory agenda over the coming months, with the Central Bank consultation on property funds representing one step towards increased macro-prudential regulation.  Financial stability related concerns also informed the Central Bank’s focus on operational resilience and outsourcing, leading to the publication of its detailed cross-industry guidance in late 2021.  Compliance with these guidelines will be a significant project for all regulated financial service providers in 2022. 

Funds and their managers will focus on completing the mandatory disclosure templates under the Sustainable Finance Disclosure Regulation (“SFDR”) and the Taxonomy Regulation and engaging with the Central Bank on its planned thematic inspection in relation to SFDR / Taxonomy Regulation compliance.   UCITS will be required to adapt to the PRIIPs KID requirements and there may be further developments relating to performance fees of UCITS and retail AIFs.  We will continue to monitor the progress of the Commission’s proposed reforms of the AIFMD through the EU legislative process.

From a Capital Markets perspective, although COVID-19 is by no means a thing of the past, there are good reasons to hope that 2022 will allow us to return, in a sense, to “business as usual”.  We expect that legislators and regulators will re-focus their attention on the European Commission’s flagship Capital Markets Union (“CMU”) project, the package of amendments to the Capital Requirements Directive and Regulation, the ongoing reviews of the Securitisation Regulation, Prospectus Regulation and MiFID, as well as on key trends such as the rise of ESG investing and the digitalisation of finance.

In this section, we will review a selection of the most recent pronouncements from the Central Bank and Irish and EU legislative proposals that will impact across the financial services sector, as well as a number of industry specific requirements.

Key Themes in Financial Services

Key Themes in Asset Management and Investment Funds

Sustainable Finance and Investment Funds - A lot more to do

Following a busy end to 2021 driven by compliance with the Taxonomy Regulation Level 1 requirements, there will be further key developments and deadlines in the coming months under the EU's sustainable finance agenda.

Level 2 Requirements
It is expected that the final regulatory technical standards (“RTS”) under both the SFDR and the Taxonomy Regulation will be published in Q1 2022, providing the necessary detail and mandatory templates for fund managers to comply with their pre-contractual, periodic reporting and principal adverse impacts disclosure obligations.  In November 2021, the Central Bank indicated that filings to comply with the RTS could be made at any point after 31 March 2022 and no later than 27 May 2022.  Following the Central Bank statement, the application date for the RTS was delayed further from 1 July 2022 to 1 January 2023, so it may be the case that this filing deadline will be changed.

Thematic Review and Spot Checks
The Central Bank has confirmed its intention to carry out a thematic review later in 2022 of the implementation of the SFDR and the Taxonomy Regulation by fund management companies.

In the first half of this year, the Central Bank will undertake a spot-check of a sample of offering documents submitted as part of the fast-track filing to meet the 1 January 2022 Taxonomy Regulation deadline.  These spot checks will include consideration of SFDR categorisations, sustainability risk disclosures and Taxonomy alignment disclosures.

The CSRD
The progress of the Corporate Sustainability Reporting Directive (“CSRD”) through the EU legislative process will be closely monitored by fund managers.  The CSRD will revise and ultimately replace the Non-Financial Reporting Directive, extending sustainability reporting requirements to a far wider category of EU companies.  These extended reporting obligations will assist fund managers in complying with their sustainability disclosure obligations, where funds under management invest in companies within the scope of the CSRD. 

Minimum Sustainability Criteria
Under its Renewed Strategy for Sustainable Finance, the Commission is to consider the introduction of minimum sustainability criteria for Article 8 SFDR products.  In November 2021, the Central Bank indicated its strong support for this initiative, which it believes is necessary to mitigate potential greenwashing risks.  On 11 February 2022, ESMA published its Sustainable Finance Roadmap, in which it indicates its intent to contribute to the Commission’s planned work on minimum sustainability criteria, or a combination of criteria, for Article 8 SFDR products.

 

Fund Management Developments

Preparing for PRIIPs
The application of the requirement to prepare a Key Information Document (“KID”) under the Packaged Retail and Insurance-based Investment Products (“PRIIPs”) Regulation to UCITS marketed to EEA retail investors has been delayed numerous times and will now apply from 1 January 2023. 

UCITS managers must now prepare for the transition to the PRIIPS KID over the course of 2022.  There are a number of significant differences between the UCITS Key Investor Information Document and the PRIIPs KID, which will necessitate the gathering of more data to meet the KID content and presentation requirements.  These include the presentation of forward looking performance scenarios, different costs methodologies and more detailed costs disclosures.

More Change for Money Market Funds?

The Commission is required to review the Money Market Funds Regulation (“MMFR”) by 21 July 2022.  In March 2021, ESMA launched a consultation on reforms to the MMFR, intended to assess the impact of the March 2020 market disruption on money market funds (“MMFs”).  In addition to the feedback provided by ESMA, which is expected to be published shortly, the Commission’s review will also be informed by the European Systemic Risk Board (“ESRB”) policy recommendation aimed at increasing the resilience of money market funds, published on 25 January 2022, as well as the Financial Stability Board and the International Organisation of Securities Commissions work in this area. 

One core objective of the CSA is the consistent and effective supervision of valuation methodologies, policies and procedures of supervised entities to ensure that less liquid assets are valued fairly during both normal and stressed market conditions, in line with applicable rules.  The Central Bank will engage with fund managers during 2022, likely through industry questionnaires, desk-based reviews and potentially on-site inspections for a sub-set of fund managers.

Regulatory Focus on Costs and Fees to Continue
Following the CSA on costs and fees of UCITS in 2021, the Central Bank indicated in November 2021 that it would publish findings in relation to the CSA “in due course”.  The CSA aimed to assess the compliance of supervised entities with the relevant cost-related provisions in the UCITS framework and the obligation to not charge undue costs to investors.  Fund managers can expect further engagement with the Central Bank on this topic focused on implementing the CSA findings.

The Commission has indicated that it is likely to complete its review by the 21 July 2022 deadline and the Council and European Parliament will then consider the Commission’s reform proposals.

Valuation in the Regulatory Spotlight
On 20 January 2022, ESMA launched a common supervisory action (“CSA”) focusing on compliance of authorised UCITS and open-ended alternative investment funds (“AIFs”) with the valuation-related provisions in the UCITS and AIFMD frameworks, in particular in relation to the valuation of less liquid assets.  

Risk Outlook for Securities Markets

Getting Governance Right
In its Securities Markets Risk Outlook Report, the Central Bank has indicated that it will continue to focus on governance, following its thematic review of fund management company effectiveness in 2020 and the requirement for fund management companies to put action plans in place to address the findings of that review by the end of Q1 2021.  

The Central Bank expects fund management companies to consider and address how resources and operational capacity will need to change to take account of any increase in the nature, scale and complexity of funds under management.   In the specific context of the conversion of many self-managed funds to externally managed funds, the Central Bank requires third party fund management companies to critically assess the impact of proposed new business in order to ensure that they are appropriately resourced to service any additional business.

The Central Bank has also expressed concerns relating to the role of investment advisors appointed to a fund and situations where investment advisors may exercise more control and influence than is appropriate.  

The Central Bank expects fund management companies to provide a detailed rationale for the appointment of an investment advisor and a clear description of the role the entity will fulfil.  Reports from investment managers on portfolio management should include any interaction with investment advisors during the period in question.

Will crypto assets become eligible investments?

In updates to its UCITS Q&A and AIFMD Q&A in 2021, the Central Bank outlined its current position in relation to investments by UCITS or AIFs, directly or indirectly, in crypto assets. 

In the Securities Markets Risk Outlook Report, the Central Bank acknowledges that, while such assets may be suitable for wholesale or professional investors, it is highly unlikely to approve a UCITS or retail investor AIF proposing any exposure (direct or indirect) to crypto-assets. 

This takes into account the specific risks attached to crypto-assets and the possibility that appropriate risk assessment could be difficult for a retail investor without a high degree of expertise. 

In the case of a QIAIF seeking to gain exposure to crypto-assets, the relevant QIAIF will be required to make a submission to the Central Bank outlining how the risks associated with such exposures could be managed effectively by the AIFM.

The Central Bank will keep its approach to crypto-assets under review and will continue to be informed by European regulatory discussions on the topic.  There will be further consideration of the Commission’s proposed Markets in Crypto Assets Regulation (“MiCA”) during 2022.  This regulation is intended to create uniform rules for crypto-assets and related activities and services throughout the EU.


Key Themes in Finance and Capital Markets

Developments in Securitisation

Securitisation Regulation Under Review

The European Commission ("EC") launched a consultation on the Securitisation Regulation in July 2021 on various topics:

  • addressing “capital non-neutrality” (i.e., the application of significantly higher capital requirements to securitised assets than to equivalent non-securitised assets);
  • streamlining and harmonising the significant risk transfer ("SRT") process;
  • improving the liquidity treatment of securitisations by aligning their treatment (for the purposes of banks’ liquidity coverage ratio) with that of covered bonds; 
  • making disclosure requirements more targeted, by amending the disclosure templates to remove disclosure requirements which are considered duplicative or of limited value to investors;
  • disclosure of information; and
  • environmental performance and sustainability.

The publication of the Commission's report, and the progress of any associated proposals to amend the Securitisation Regulation, will be closely followed by the European securitisation industry. Based on the discussions to date, any proposed amendments are likely to be largely welcomed by the industry.

The finalisation of the Basel III requirements will affect the capital treatment of securitisations through the standardised approach and will also affect securitisations under the internal ratings-based approach ("IRBA"), under which risk weights will increase. This will need to be factored into the discussion about the general review of the securitisation framework.  

Sustainable Securitisation is on its way

The EBA Report on developing a specific sustainable securitisation framework for the purpose of integrating sustainability-related transparency requirements into the Securitisation Regulation and the forthcoming European Commission Sustainability Report on the creation of such a framework will be closely followed by the securitisation industry. 

To date, we have seen substantial interest from investors and managers in ESG securitisations, particularly in the area of CLOs.  Many managers have agreed to provide investors with transparency around the ESG characteristics of their portfolios on a voluntary basis. 2022 may be the year we see the emergence of a formal regulatory framework for such disclosures.

Article 45a of the Securitisation Regulation specifically states that the EBA Report should, where relevant, mirror or draw upon certain key provisions of the Sustainable Finance Disclosures Regulation (“SFDR”).   Consistency between the sustainable securitisation framework and SFDR would be welcomed by market participants, who are already looking to SFDR as a source of standards for sustainability disclosure in some ESG securitisations.

 

 

EU Banking Package: Sustainability to the Forefront
In October 2021, the European Commission adopted a package (the “Banking Package”) of legislative proposals involving revision of the Capital Requirements Regulation ("CRR") and the Capital Requirements Directive ("CRD IV"). 
Among other things, the Banking Package aims to contribute to sustainability and the transition to climate neutrality.

Strengthening the resilience of the banking sector in relation to managing environmental, social and governance (“ESG”) risks is an important component of the Commission’s Sustainable Finance Strategy.

The Banking Package proposal will require banks to systematically identify, disclose and manage ESG risks as part of their risk management. Disclosure rules will be proportionate to size, so that smaller banks will not be unduly burdened.

The proposal provides specifically for:

  • regular climate stress testing by both supervisors and banks;
  • assessment of ESG risks as part of regular supervisory reviews; and
  • all banks to disclose the degree to which they are exposed to ESG risks.
Book-Entry Securities: The Day Approaches

From 1 January 2023, newly issued transferable securities that are admitted to trading or traded on a trading venue will be required to be represented in book-entry form, either as immobilisation or subsequent to a direct issuance in dematerialised form. 

From 1 January 2025, this requirement will apply to all in-scope transferable securities in issue on that date.  While the requirements will not apply until 2023 at the earliest, issuers who may be affected will need to consider the impact of the requirements on their issuance processes.

Sustainable Securitisation is on its way

As part of the ongoing wider review of MiFID II, the European Securities Markets Authority (“ESMA”) launched a consultation in September 2021 on the rules around transparency, focusing on technical issues relating to post-trade data, including the basis for any future consolidated tape.

This is part of a general approach to improving the information provided to investors and encouraging them to use the information in making their investment decisions. The EC will likely introduce proposals for amendments in 2022, particularly following the Wirecard case. 

These will focus on:

  • enhancing cooperation between authorities across the EU;
  • enhancing coordination and governance on a national level;
  • strengthening the independence of the NCAs; and
  • strengthening harmonised supervision of information across the EU.
Clearing: A Big Challenge
I am very clear that June 2025 is the end of equivalence for UK clearing houses”. 

Mairead McGuinness, EU Commissioner responsible for Financial Services, Financial Stability and Capital Markets Union.
In order to avoid any short-term financial stability risks arising from Brexit and the consequent non-recognition of UK clearing houses, the Commission adopted a new equivalence decision granting access to UK CCPs for another three years, until 30 June 2025.

Pension scheme arrangements ("PSAs") have been exempt from mandatory clearing since 2012. On 25 January 2022 ESMA sent a letter to the European Commission, providing its views on the clearing obligation for PSAs and recommending the end of the current exemption from the clearing obligation with a one-year implementation period. ESMA recommends starting to apply the clearing obligation to PSAs from 19 June 2023.


Key Risk and Regulatory Themes

Operational Resilience: A Key Regulatory Focus

The continued fall out from COVID-19 has resulted in resiliency, now and into the future, being placed high on the agenda of both businesses and regulators and the financial services sector has been no exception. 

At an Irish regulatory level, we have seen operational resilience feature in several outputs of the Central Bank including its 2021 regulatory priorities, its Consumer Outlook Report for 2021, and several speeches made by its senior members. This culminated in the publication of the Central Bank’s Cross Industry Guidance on Operational Resilience on 1 December 2021. 

The Guidance sets out the Central Bank’s expectations of firms in terms of implementing an effective operational resilience framework. 

The 15 Guidelines are framed around three pillars of operational resilience: 

  • Identify and Prepare;
  • Respond and Adapt; and
  • Recover and Learn. 

Firms are expected to apply the Guidance by 1 December 2023, at the latest.  While this timetable provides firms with a good lead-in time, compliance will require participation and input from various functions within firms before substantial changes are made to documentation, processes and procedures.

Consequently, firms would be well advised to allocate resources to this, without delay. Firms should also be cognisant of the plans at a European level to put in place a comprehensive framework on digital operational resilience ("DORA").


Individual Accountability Framework and SEAR – Status Update

Since the publication of the Central Bank’s Report on the Behaviour and Culture in Irish Retail Banks in July 2018, the financial services industry has awaited the formalisation of the Central Bank’s proposal for an Individual Accountability Framework (“IAF”) and the Senior Executive Accountability Regime (“SEAR”) (a key component of the IAF). 

Some three and a half years on, the publication of the  final text of The Central Bank (Individual Accountability Framework) Bill is still awaited, although classified as priority legislation in the government’s Spring Legislation Programme. We understand however, that the Joint Committee on Finance, Public Expenditure and Reform and An Taoiseach, which conducted pre-legislative scrutiny (“PLS”) of the General Scheme of the Bill on 3 and 10 November 2021, is in the process of finalising its report on the outcomes of the PLS. It is anticipated that the text of the Bill will follow shortly thereafter. 

Regarding the timing once published, the Minister for Finance’s comments during the PLS are helpful. He stated that he hoped the legislation would be “operational in the early part of 2023…. because I anticipate it will take time to get the legislation through the Oireachtas effectively and deal with the matters”. 

Central Bank publishes Dear CEO Letter on Climate and ESG Issues
On 3 November 2021, the Central Bank published a Dear CEO letter (“Letter”) on climate and Environmental, Social, and Governance (“ESG”) issues. 

The Letter describes the Central Bank’s expectations of regulated financial service providers (“RFSPs”) and includes five specific areas of focus for RFSPs. While we have heard a lot from the Central Bank in recent times in relation to the importance of climate and broader ESG matters, this is the first official communication to RFSPs from the Central Bank. It delivers a clear message that this is an area of priority for the Central Bank and RFSPs should be minded of this. 

The Letter makes it clear that the Central Bank’s supervisory approach to this topic is informed by regulatory developments at EU level, the work of its peers and its broader supervisory objectives. Consequently, having an awareness of the direction of travel at a European level is also important for RFSPs.  The letter explicitly states that these expectations will apply in a proportionate manner aligned with the nature, scale and complexity of RFSPs, something which will be welcomed, in particular, by smaller RFSPs. 

The Letter details that the expectations are not binding on RFSPs. However, it is worth noting that this statement is made in the context of the expectations not replacing or overriding any legal, regulatory or supervisory requirements applicable to RFSPs.

Consequently, RFSPs would be advised to consider their current practices as against the identified areas of focus and begin to make proportionate changes. 

Finalisation of the Crowdfunding Regulatory Regime
The component parts of the regulatory regime pertaining to the business of crowdfunding in Ireland are now in place. For many Crowdfunding Service Providers (“CSP”), a decision to become authorised under this regime will be their first move into the regulatory environment. With this in mind, careful consideration of the legislative and regulatory developments (see below)  is needed. 

The Central Bank has high standards in terms of governance arrangements, policies, procedures and processes which must be in place for all entities seeking an authorisation from it.  

While existing unregulated CSPs will no doubt be comfortable with their operating processes we expect that it is the extra expectations of the regulator which will inevitably take longer and cost more than anticipated to address. 

 

Crowdfunding Regulation Timeline

13 December, 2021 Publication of the European Union (Crowdfunding) Regulations 2021 [S.I. No. 702 of 2021] (“Crowdfunding Regulations”) giving effect to the EU Crowdfunding Regulation (Regulation (EU) 2020/1503) in Ireland and designating the Central Bank as the competent authority responsible for the authorisation and supervision of crowdfunding service providers in Ireland.

5 January, 2022 Central Bank published its Guidance Note on Completing an Application Form for Authorisation as a Crowdfunding Service Provider which provides guidance in relation to the authorisation process and Central Bank’s requirements for establishing a CSP in Ireland. Of particular note are the Central Bank’s expectations of CSP’s post authorisation.

13 January, 2022 Central Bank published its feedback statement to its April 2021 consultation on Crowdfunding Marketing Requirements - CP141, along with an Addendum to the Consumer Protection Code 2021, extending rules on advertising for CSPs to ensure enhanced protection for investors in addition to ensuring that they are informed as to potential risks.

 

General Scheme of the Insurance (Miscellaneous Provisions) Bill

On 20 October 2021, the government published the General Scheme of the Insurance (Miscellaneous Provisions) Bill (“Insurance Bill”) and subsequently listed the Insurance Bill as priority legislation in its’ Spring Legislation Programme.  

As the name suggests, the proposed legislation seeks to address a number of pertinent issues in the area of insurance, which align with the government’s promises in the area of insurance reform. 

The proposed changes range from enhancements to data collection by the National Claims Information Database, proposals in respect of the practice of “price walking”, amendments to the Consumer Insurance Contracts Act 2019 (“CICA”) and changes to the temporary run off regime (“TRR”) established under the Brexit Omnibus legislation. 

In particular, the proposals relating to the CICA and the TRR are welcome developments for the Insurance sector. The proposed amendments to the CICA will resolve certain technical issues that were identified post-enactment. While the TRR related amendments will ensure that third country reinsurers currently providing reinsurance cover in Ireland pursuant to the “Reinsurance Exemption” and entities in liquidation can legally run-off their existing business within the TRR framework. 

During the Insurance Bill's PLS by the Joint Committee on Finance, Public Expenditure and Reform and Taoiseach on 16 December 2021, the Minister of State in the Department, Deputy Sean Fleming explained that he was hopeful that government would be in a position to publish the bill in the New Year. As at the time of writing, it has not yet been published.

Crowdfunding Regulation - Cross Border Opportunities on the Horizon

Apr 15, 2021, 14:37 PM
In this article, we build on Matheson’s Insight article published in November 2020 (please click here to view same), consider CP141- Crowdfunding Marketing Requirements, recently released by the Central Bank of Ireland and consider some of the potential wider implications of the Crowdfunding Regulation.
Title : Crowdfunding Regulation - Cross Border Opportunities on the Horizon
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Engagement Time : 4
Insight Type : Article
Insight Date : Apr 15, 2021, 14:36 PM

In recent years, crowdfunding has become an increasingly important form of alternative finance for start-ups and small and medium sized enterprises (“SMEs”).  A crowdfunding service provider (“CSP”) operates a digital platform to act as an intermediary and facilitate the matching of prospective investors with these type of companies seeking capital.  Globally the crowdfunding market has grown rapidly with the largest markets being China, the United States (the “US”), and the United Kingdom, (“UK”)[1].  In recent years, the UK has accounted for three quarters of the crowdfunding activity in Europe[2].  The development of a significant crowdfunding market in the UK has been supported by a comprehensive regulatory framework comprising both legislation and detailed rules issued by the local regulator.

At present within the European Union (“EU”) the is no Union-wide legislation of crowdfunding. Instead, several, but by no means all, Member States have established their own regimes.  Ireland is one of those Member States which has not implemented any specific regulations regarding crowdfunding, although the adoption of regulations has been proposed in various government plans.  As has been noted by the European Commission[3] (“Commission”), this fragmented regulatory environment in Europe creates substantial legal costs for retail investors attempting to decipher the various applicable laws affecting the provision of cross-border crowdfunding services.  The effect of these obstacles has been to discourage CSPs from expanding their product offering cross-border to other Member States. It was against this backdrop that Regulation (EU) 2020/1503 (the “Crowdfunding Regulation”) was introduced.  By establishing a single market for the provision of an alternative source of financing for start-ups and SMEs, crowdfunding can provide a viable solution to the lack of access for such entities, further contribute to the establishment of the Capital Markets Union (“CMU”) and grow the EU’s market share in this sector.

The Crowdfunding Regulation is accompanied by Directive 2020/1504 (“MiFID II Amending Directive”), which exempts CSPs from the application of Directive 2014/65/EU (“MiFID II”).

In this article, we build on Matheson’s Insight article published in November 2020 (please click here to view same), consider CP141- Crowdfunding Marketing Requirements (recently released by the Central Bank of Ireland) and consider some of the potential wider implications of the Crowdfunding Regulation.

When will the Crowdfunding Regulation apply?

The Crowdfunding Regulation will apply from 10 November 2021.  Member States are required to adopt and publish the necessary laws, regulations and provisions to give effect to the MiFID II Amending Directive by 10 May 2021, and to apply those measures from 10 November 2021.

What is the Scope?

The Crowdfunding Regulation does not apply to project owners who are classified as consumers as defined in Article 3 of Directive 2008/48/EC, namely, where the project owner is acting for purposes which are outside its trade, business or profession[4].

The Crowdfunding Regulation will not apply to crowdfunding platforms offering funding in excess of €5 million, calculated over a period of 12 months per project owner.  However, the Commission has introduced a temporary derogation provision whereby a Member State may, for a period of 24 months from 10 November 2021, adopt a lower threshold to the limit stated in Article 1(2)(c) of the Crowdfunding Regulation.  This is to reduce the risk of regulatory arbitrage which may arise in circumstances where a Member State has set a threshold below €5 million exempting offers of securities to the public from the obligation to publish a prospectus in accordance with Regulation (EU) 2017/1129 (“Prospectus Regulation”).  Once Member States have had this opportunity to align the thresholds set out in the Crowdfunding Regulation and the Prospectus Regulation, CSPs which offer securities on their digital platform to investors not exceeding €5 million, and which are exempt from the application of the Prospectus Regulation, will be required to prepare a Key Investment Information Sheet (“KIIS”) instead.  Annex 1 of the Crowdfunding Regulation provides the content of what the project owner is to include in its KIIS, which must be produced in respect of each crowdfunding offer.

Summary of Key Provisions

Authorisation

Prospective CSPs must apply for authorisation to the designated competent authority in the Member State in which they are established (where they are currently engaging in these activities) before 10 November 2022.  Authorisation will require provision of name, legal form, constitutional documents, programme of operations, description of governance arrangements and details of policies in relation to risk assessment, complaints handling, business continuity and other matters, and details of the natural persons responsible for the management of the CSP.  The Central Bank of Ireland (“Central Bank”) will be the designated competent authority in Ireland[5].

The Central Bank must provide a decision within three months of receipt of a complete application, refusing or granting authorisation.  The European Securities and Markets Authority (“ESMA”) must be informed of all authorisations and will maintain a public register of all authorised CSPs across the  EU.  Article 12 of the Crowdfunding Regulation sets out in further detail the authorisation process and timelines for legal persons who intend to provide crowdfunding services.

CSPs will be subject to ongoing supervision by the Central Bank and will need to provide an annual report to the Central Bank.  Authorisation can be withdrawn if, among other things, the CSP is not providing services or no longer meets the conditions for authorisation.

The Crowdfunding Regulation also contains provisions relating to passporting, such that an CSP authorised in an EU Member State will be able to passport its services into other Member States.  The relevant provisions are consistent with the overall approach to passporting for other financial services within the EU.  This is anticipated to be one of the most significant benefits of becoming authorised under the Crowdfunding Regulation.

Investor Protection

The Commission has placed an emphasis on the distinction between different categories of investor for the purpose of varying levels of investor protection and this has been reflected in the Crowdfunding Regulation.  The Crowdfunding Regulation distinguishes between sophisticated and non-sophisticated investors. 

A sophisticated investor is defined as “an investor who possesses the awareness of the risks associated with investing in capital markets and adequate resources to undertake those risks without exposing [itself] to excessive financial consequences.”  This builds on the distinction between professional clients and retail clients established in MiFID II.  Annex II of the Crowdfunding Regulation outlines the criteria for this categorisation of investor.

Each investor will  initially have a non-sophisticated categorisation by default, but may formally request categorisation as a sophisticated investor, provided they meet the criteria laid out in Annex II.  Categorisation as a sophisticated investor will mean the investor will not be subject to entry knowledge tests (as provided for under Article 21 of the Crowdfunding Regulation) nor be subject to certain disclosure requirements such as investment objectives and basic understanding of risks.  A non-sophisticated investor must satisfy these criteria prior to obtaining full access to invest in projects on the platform.  However, once categorised as a sophisticated investor, an investor will not be able to avail of the pre-contractual reflection period outlined in Article 22.  This four day period will commence from the date in which the investor makes the offer / expression of interest.  This provision only applies to non-sophisticated investors.

Individual Portfolio Management of Loans

CSPs may propose crowdfunding projects to individual investors based on parameters and risk factors pre-determined by the investor and communicated to the CSP.  However, in the recitals, the Commission has clarified that authorisation as a CSP under the Crowdfunding Regulation does not grant CSPs the right to provide individual or collective asset management services.  Article 6 provides that the investor shall grant the mandate to provide such services accompanied by at least two of the following parameters that a crowdfunding project must satisfy:

  • the minimum and maximum interest rate payable under any loan facilitated for the investor;
  • the minimum and maximum maturity date of any loan facilitated for the investor;
  • the range and distribution of any risk categories applicable to the loans; or
  • if an annual target rate of return on investment is offered, the likelihood the selected loans will enable the investor to achieve the target rate with reasonable certainty.

    The CSP will also be required to keep the investor updated with information concerning the investor’s portfolio, such as a list of the loans the portfolio is composed of, applicable interest rates and fees under the loans, and risk mitigation measures adopted in respect of these loans.  As noted under Article 3(5) of the Crowdfunding Regulation, while CSPs may exercise discretion on behalf of their investors upon the grant of this mandate, they must ensure to act strictly within the risk parameters provided by the investors as outlined above.

    Key Investment Information Sheet and Bulletin Board

    As highlighted above, CSPs will be required to provide the KIIS in respect of each crowdfunding offer, and to be prepared by the project owner (borrower).  Annex I of the Crowdfunding Regulations contains the information disclosures the project owner will be required to make, such as the project owner’s principal business activities, the provision of financial statements, conditions for the capital raising and identification of the main risks associated with the project.  While the Central Bank may seek prior notification of a KIIS at least 7 (seven) working days before making it available to prospective investors, the KIIS will not be subject to prior approval by the Central Bank.

    Provision is also made for a secondary market facility under the Crowdfunding Regulation, whereby a CSP may operate a bulletin board on its platform, upon which investors can advertise their interest in buying or selling loans, transferable securities and other admitted instruments originally offered on the platform.  This feature promotes the transferability of admitted instruments, which the Commission has identified as an important safeguard to enable investors to dispose of their interest on crowdfunding projects.

    Operational Requirements

    The Crowdfunding Regulation also identifies operational requirements which must be complied with. These include such requirements as:

  • a duty to act honestly, fairly, professionally and in the best interests of investors;

  • to exercise effective and prudent management and adopt risk assessment and risk management procedures and policies;
  •  a minimum level of due diligence in relation to the project owners;
  • effective and transparent procedures in relation to complaints handling, whereby clients can file complaints free of charge using a standard template; and

 ​avoiding conflicts of interest.

Crowdfunding Marketing Requirements

On 13 April 2021, the Central Bank published its Consultation Paper on Crowdfunding Marketing Requirements – CP141.  The Consultation Paper sets out the advertising rules that the Central Bank is proposing to apply to crowdfunding provided by CSPs to Irish consumers, in line with Member States’ entitlement set out in the Crowdfunding Regulation.

The Consultation Paper highlights that the Crowdfunding Regulation sets out a number of marketing requirements applicable to CSPs, including requirements to ensure that information contained in any marketing communication must be fair, clear and not misleading and consistent with the information contained in the KIIS.  CSPs should note that all marketing communications about their services must be clearly identifiable as marketing communications under the Crowdfunding Regulation. The Consultation Paper also notes that CSPs must ensure that marketing communications do not disproportionately encourage investment in any one crowdfunding project.

The Central Bank has utilised Provision 9 (advertising) of the Consumer Protection Code 2012 (the “Code”) as the basis of identifying the requirements which must be complied with.  The Consultation Paper states that this decision was taken to ensure that Irish consumers of crowdfunding services “receive the same protections as regards advertising communications as is required for other financial services.”

In addition to the above, it is also proposed that a requirement for a specific warning in CSP advertisements be included.  This is proposed as a new Provision 9.53 of the Code, which would be introduced through an addendum to the Code.  Under existing Code provisions, a warning is required in advertisements for investment products that “The value of your investment may go down as well as up”.  The Central Bank is of the view that this is not consistent with the investor warning to be contained in the KIIS and so has proposed specific wording for CSP advertisements.  The two alternative risk warnings proposed are detailed below and the Central Bank has request feedback in respect of same:

Option A:

WARNING "Investment in crowdfunding projects entails risks, including the risk of partial or entire loss of the money invested.”

Option B:

WARNING "Investment in crowdfunding projects entails risks, including the risk of partial or entire loss of the money invested.  Your investment is not covered by a deposit guarantee scheme or by an investor compensation scheme.”

In addition to seeking input on the proposed wording of the Addendum, the Central Bank has also posed a number of specific questions.  These include:

(1) Do you support the proposal to apply national marketing requirements to CSPs, as foreseen by the Crowdfunding Regulation?

(2) Do you consider all of the proposed advertising requirements for CSPs are appropriate to the business model of CSPs?  If not, please specify:

(a)       which provision is not appropriate and why; and

(b)       whether the entire provision should not apply, or whether it could be amended to fit with the CSP business model.

(3) Do you consider that there should be additional advertising requirements for CSPs, appropriate to their business model, in addition to those proposed here?  If so, please provide details.

The Central Bank is to be commended for posing these considered questions, particularly given that this will for many impacted firms, be their first time to engage with a regulator.  Impacted firms should take the opportunity to make their views known to the Central Bank in respect of the questions raised before the closing date of 13 July 2021.

Commentary

The Crowdfunding Regulation is a welcome regulatory development to facilitate the integration of crowdfunding services provided across member states of the EU and one which is expected to contribute to further growth in the crowdfunding market in the EU.  As highlighted above, CSPs have previously been reluctant to provide their services on a cross-border basis, owing to the significant divergence in national laws governing the activities of these entities, and the legal and administrative costs that reflect this reality.  Additionally, the fact that investors/project owners do not require to be licensed as credit institutions is also expected to make crowdfunding more cost-efficient and more attractive to investors/project owners.

What does this mean for the CMU?

The Crowdfunding Regulation must also be considered in the context of the EU’s ambition of achieving a CMU amongst its member states.  By mobilising capital and enabling the cross-border flow of investment, the EU envisages a fully functioning and integrated market for capital, which will ultimately make the EU economy more competitive.

Furthermore, given the current Covid-19 pandemic, government imposed restrictions have had a detrimental impact on SMEs. The CMU promotes the availability of financing alternatives for struggling SMEs, reducing their reliance on a single source of finance. Without such alternatives, excessive demand would pose a strain on traditional lenders’ capital, and slow down the recovery from the pandemic.  As part of its CMU Action Plan, the Commission notes that the banks can play an important role in facilitating the move towards the CMU by advising SMEs seeking a loan of alternative services to meet their financing needs.  From November of this year, CSPs will be another key actor in achieving the CMU and fulfilling such a need by permitting CSPs to access new funding sources on a pan European basis.

What should CSPs be doing now?

For some CSPs, authorisation pursuant to the Crowdfunding Regulation, will be their first move into the regulatory environment. The Central Bank has high standards in terms of governance arrangements, policies, procedures and processes which must be in place for all entities seeking an authorisation from it.  While existing CSPs will no doubt be comfortable with their operating processes we expect that it is the extra expectations of the regulator which will inevitably take longer and cost more than anticipated to address.  CSPs would be well advised to begin their preparations for this move without delay.

We are already seeing several UK authorised CSPs weighing up the benefits of an EU authorisation to access the 27 Member States.  Ireland  is extremely well placed to provide this legal and regulatory base, as it has done for multiple other financial service entities in the context of the UK’s departure from the EU.  Many of our clients which made that move tell us that they made their location decisions based on the strength of the talent pool, the reputation of the regulator, the proximity to and cultural similarities to  the UK. We expect that CSPs which want to establish in the EU will also reach this conclusion.

Should you require further information in relation to the material contained in this article, please get in touch with a member of the team or your usual Matheson contact.  Full details of Matheson's Financial Institutions group together with further updates, articles and briefing notes written by members of these teams, can be accessed at www.matheson.com

[1] The Global Alternative Finance Market Benchmarking Report, Cambridge Centre for Alternative Finance, January 22, 2021.

[2] 4th European alternative finance benchmarking industry report Shifting Paradigms, Cambridge Centre for Alternative Finance, November 2019.

[3] In the recitals to Regulation (EU) 2020/1503 on Crowdfunding

[4] In scope are (1) P2P crowdfunding platforms facilitating ‘business funding’ and (2) investment-based crowdfunding platforms in relation to transferable securities only.

[5] See CP141 – Crowdfunding Market Requirements

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