Feedback Paper on the Regulation

of Crowdfunding in Ireland

Following on from public consultation

January 2018

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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INTRODUCTION

Department of Finance | Paper for Policy Committee on Crowdfunding

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BACKGROUND TO THE

PUBLIC CONSULTATION

IFS 2020 ACTION PLAN

2017

The 2017 IFS 2020 Action Plan commits the Department of Finance to conduct a public consultation on the potential regulation of crowdfunding in Ireland, having regard to emerging international best practice and in the context of the EU Commission Action Plan on Building a Capital Markets Union.1 IFS 2020 is the Government’s five-year strategy for driving the growth and development of the International Financial Services sector in Ireland, aiming to create 10,000 new jobs. In this regard, the European Commission has recognised that crowdfunding is part of the broader FinTech universe and has potentially transformative implications for the financial system.2 Crowdfunding is an innovative, technology-based form of finance that can be a valuable source of funding for SMEs, either as a complement, or as an alternative, to traditional bank finance. Crowdfunding can also provide consumers and smaller investors with a higher rate of return, at a higher risk, than is generally available from deposits or traditional investments. Crowdfunding does not involve raising finance from one single source such as a bank. Rather, crowdfunding involves obtaining small amounts of individual funding from a large number of different sources through online platforms. These online platforms match lenders and investors with businesses or individuals seeking funding and arranges payments between them. Crowdfunding falls into two general categories, non-financial and financial. Financial forms of crowdfunding involve the expectation of a financial return on behalf of the lender or investor. Non-financial crowdfunding is not considered to involve lending or investment type activity as there is no expectation of financial return. Therefore, non-financial crowdfunding was not considered as part of the public consultation on the regulation of crowdfunding.

1 http://www.finance.gov.ie/sites/default/files/17-01-16%20IFS2020%20Action%20Plan%20FINAL%20for%20web_0.pdf 2 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52015DC0468&from=EN

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Crowdfunding is not currently a regulated activity in Ireland. Given this, there are no formal consumer protections available for those using crowdfunding platforms to provide funds. Consequently, the Central Bank of Ireland has issued an information notice alerting consumers to this fact, available at: https://www.centralbank.ie/consumer-hub/consumer-notices/consumer-notice-on-crowdfunding-including-peer-to-peer-lending/ The Department of Finance conducted a six-week public consultation process on the regulation of crowdfunding that closed on 2nd June 2017.3

The European Commission recently proposed a pan-European regulatory regime for crowdfunding in its 2018 work programme stating, “…we will make proposals to tackle the interaction between finance and technology and we will propose rules on crowd and peer-to-peer funding. 4 This will involve a proposal for an EU framework on crowd and peer to peer financing, and will include a legislative proposal, under Article 114 TFEU in Q1 2018, including an impact assessment.5 The European Commission’s work programme was published after the completion of the Department of Finance public consultation on the regulation of crowdfunding.

3 http://www.finance.gov.ie/sites/default/files/200417%20Final%20Crowdfunding%20Consultation%20Paper.pdf 4 https://ec.europa.eu/info/sites/info/files/cwp_2018_en.pdf at page 5. 5 https://ec.europa.eu/info/sites/info/files/cwp_2018_annex_i_en.pdf at p.4, no.10.

Department of Finance | Paper for Policy Committee on Crowdfunding

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CROWDFUNDING IN

IRELAND AND THE

INTERNATIONAL

CONTEXT

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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CROWDFUNDING IN

IRELAND

Size of the crowdfunding market in Ireland The crowdfunding market in Ireland is relatively small. There are currently only three crowdfunding platforms operating in the market, all of which provide peer-to-peer lending services. There are no equity crowdfunding platforms operating in Ireland currently.6 Currently, crowdfunding constitutes approximately 0.33% - 0.4% of the SME finance market; for comparison, this is 12% in the UK.7 Additionally, the demand for alternative sources of financing, including crowdfunding, from Irish SMES is quite muted, for example, in the latest wave of the Department of Finance SME Credit Demand Survey, covering the period October 2016 – March 2017, only 6% of the SMEs surveyed were seeking non-bank finance.8 The average spend on or investment through crowdfunding in Ireland is $1 per capita; for comparison, this is $75 per capita in the UK. As of 24th May 2017, Linked Finance had more than 15,650 registered users. More than 880 loans have been provided to Irish SMEs and over €25.6 million of business lending has been facilitated with €16 million in principle outstanding. Linked Finance accounts for over 90% of the market share of peer-to-peer lending in Ireland.

6 Linked Finance, GRID Finance and Flender. 7 Based on SME Credit Demand Survey & Linked Finance figures. 8 http://www.finance.gov.ie/sites/default/files/170703%20SME%20Credit%20Demand%20Survey%20Oct%202016%20to%20Mar%202017.pdf

Department of Finance | Paper for Policy Committee on Crowdfunding

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International Comparison and context Regulatory regimes for crowdfunding in other jurisdictions A number of European member states have introduced, or are planning to introduce, bespoke national regulatory regimes for crowdfunding. These include: the United Kingdom, France, Italy, Germany, Spain, Latvia, Sweden, the Netherlands, Belgium, Greece, Finland, Portugal, Romania and Austria. Chart 1: Regulated Platforms by country in 2016 as compared to 2014.

Source: ESMA Chart 1 (above) indicates that the number of regulated platforms has increased in the period 2014 – 2016 in a number of Member States.

15

1

11

2

26

15

23

1317

51

41

30

05

101520253035

Regulated Platforms by country in 2016 versus 2014

Number of platforms 2014 Number of platforms 2016

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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Chart 2 (below) outlines the basis for the regulation of crowdfunding. The majority of crowdfunding platforms in the EU operate under an Article 3 exemption from the MiFID legislation. Chart 2: Basis for Regulation

Source: ESMA It appears that comparatively, the European crowdfunding market is not as well developed as the crowdfunding market in the United States. In 2013-2014, the European crowdfunding market successfully raised €2.3 billion.9 The volume of funding raised through equity platforms grew by 167% and the volume of funding raised through loan (peer-to-peer) crowdfunding platforms grew by 112%.10 The total European online alternative finance market, which includes crowdfunding, peer-to-peer lending and other activities, grew by 92% to reach €5,431m in 2015.11 Peer-to-peer consumer lending is the largest market segment of alternative finance, with €366m recorded for 2015 in Europe.12 Peer-to-peer business lending is the second largest segment with €212m, with equity-based crowdfunding in third with €159m and reward-based crowdfunding, fourth, with €139m in 2015. 13 However, between European member states, there are significant differences in terms of level of activity. The UK is the largest market for both loan and equity crowdfunding projects with €1.6 billion of funding raised through loan (peer-to-peer) crowdfunding projects and €89 million raised through equity crowdfunding projects in 2013-2014.14

9 https://ec.europa.eu/info/system/files/crowdfunding-report-03052016_en.pdf 10 https://ec.europa.eu/info/system/files/crowdfunding-report-03052016_en.pdf 11 https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternative-finance/downloads/2016-european-alternative-finance-report-sustaining-momentum.pdf 12 https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternative-finance/downloads/2016-european-alternative-finance-report-sustaining-momentum.pdf 13 https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternative-finance/downloads/2016-european-alternative-finance-report-sustaining-momentum.pdf 14 https://ec.europa.eu/info/system/files/crowdfunding-report-03052016_en.pdf

34%

41%

5%

1%

19%

Regulatory Status

MiFID Article 3 exemption tied agent AIFMD other

Department of Finance | Paper for Policy Committee on Crowdfunding

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Excluding the United Kingdom, the largest market in Europe by a considerable margin, the European online alternative finance industry grew 72% from €594m in 2014 to €1,019m in 2015. Although the absolute year-on-year growth rate of the European online alternative finance market slowed by 10%, the growth rate between 2013 and 2014 was 82%, the Second European Alternative Finance Industry Report argues that the industry is sustaining momentum.15

15 https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternative-finance/downloads/2016-european-alternative-finance-report-sustaining-momentum.pdf

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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PUBLIC

CONSULTATION

Department of Finance | Paper for Policy Committee on Crowdfunding

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Public Consultation In total, there were nine submissions received to the Department’s public consultation on the regulation of crowdfunding.16 The respondents included two Irish crowdfunding platforms, a UK crowdfunding platform, solicitor’s firms and the Irish Stock Exchange. All of the respondents were generally in favour of regulation but were of the view that it should be proportionate and were concerned that it should facilitate the development and growth of the industry as opposed to stifling or hindering it. Whether or not to regulate crowdfunding In terms of the first question, on whether or not to regulate crowdfunding, all of the participants were in favour of regulation in principle but also noted that it should be proportionate and that it should not impact the development and growth of the industry. In this regard, it was suggested that regulation should take into account the varying levels of risks and complexity of the different types of crowdfunding and should be tailored accordingly. Respondents felt that regulation should distinguish between crowdfunding involving lending to individuals, involving lending to businesses and investment/equity crowdfunding. Some of the reasons given for regulation included risks to those providing funds through crowdfunding platforms and risk of fraud and misapplication due to there not being a regulatory regime in place. Regulation was seen as offering protections not only for those providing funds but also to businesses receiving the funds. A lack of regulation was also viewed by some respondents as resulting in inefficiencies and uncertainties as well as discouraging the entry in to the market of new crowdfunding platforms. It was felt that regulation would establish consistent and transparent standards for crowdfunding and would promote confidence in the sector. A number of respondents suggested that regulation should be introduced on a phased basis. Some of the respondents were of the view that regulation had the potential to attract international crowdfunding platforms and stated that the regime should allow cross-border lending and investment and be MiFID compatible as well as allowing domestic lending and investment. Some of the respondents raised the issue that certain domestic legislation might need to be reviewed in order to examine its application to crowdfunding platforms. For example, with regards to possibly allowing private companies to offer securities to the public, in terms of the prospectus thresholds and in relation to dual authorisation for platforms that could also be considered other types of regulated entities.

16 http://www.finance.gov.ie/news-centre/press-releases/submissions-regulation-crowdfunding-public-consultation

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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Risks that should be addressed through crowdfunding

In terms of the question of what risks should be addressed, there was consensus surrounding the main risks posed by crowdfunding, which were identified in the consultation paper, outlined below.

Lack of understanding of the level of risk on the part of consumers. Identity theft, money laundering, terrorism financing, data protection

and fraud. Misleading and insufficient disclosure of information by businesses

on crowdfunding platforms. Risk of unfair contract terms or misleading commercial practices

resulting from information asymmetry. If the business fails or the crowdfunding platform itself fails, there is

a risk that lenders or investors will lose all of their money. Risk that the return on the investment is less than expected. The lack of a secondary market for equity stakes means that it is

difficult to value them and they can be diluted by further equity sales. Absence of dispute resolution mechanism. Risk arising from conflict of interest. Risks to businesses seeking funding through crowdfunding platforms.

None of the respondents suggested other risks that had not been mentioned. Rather, they focused on how these risks could be dealt with by regulation. The main elements that were put forward by respondents that should form part of a regulatory regime included risk warnings, minimum information requirements, a client money process, identity verification and a contingency process in the event of platform failure. It was noted that crowdfunding did not pose a systemic risk at present, given the current size of the market. However, this risk may potentially occur as the size and scale of industry increases. Respondents felt that consumer awareness and understanding of the risks associated with crowdfunding could be adequately addressed through a regulatory requirement to display a risk warning before proceeding to use a crowdfunding platform. Some respondents suggested that positive action confirming and acknowledging the risks should be required on the part of users. Additionally, respondents felt that encouraging lenders/investors to do their own due diligence and diversify their lending and investment would ameliorate both a potential lack of awareness and understanding of the risks on the part of lenders/investors as well as the risk of business failure. It was noted that, in the event of platform failure, client asset rules that required separation of client funds from those of the platform, were critical, as well as a contingency plan, such as a backup service provider. Indemnity insurance was another means raised by the respondents of addressing this risk. In terms of the risk of money laundering, there was general recognition from respondents that there should be procedures in place for verifying the identity of those using crowdfunding platforms, such as know your customer rules and client due diligence. Most of the respondents seemed of the view that the Criminal Justice (Money Laundering and Terrorist Financing) Act 2010 was applicable. Some of the respondents noted that it was their view that money-laundering risks were not enhanced in the case of crowdfunding and that regulation should not provide additional scrutiny or requirements in this respect.

Department of Finance | Paper for Policy Committee on Crowdfunding

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It was noted that general data protection laws also apply to crowdfunding platforms irrespective of regulation. In respect of liquidation of investment, a possible lack of a secondary market and unfair contract terms, respondents highlighted that these were all issues that were more relevant to equity/investment based crowdfunding. Respondents were of the view that information about the ability to liquidate and redeem an investment as part of standard risk warnings would be sufficient to address this as well as clearly setting this out in the terms of the arrangement. In relation to the fairness of the contract terms, respondents considered that loan based crowdfunding/peer-to-peer lending was a more straightforward model and it appeared that, generally platforms tend to use standard loan agreement documentation. It was suggested by one respondent that, in respect of the risk of a lack of protection for intellectual property rights of those seeking funding through crowdfunding platforms, this risk was less relevant for more established businesses. Minimum standards of due diligence, disclosure and process in the event of default, insolvency or bankruptcy Respondents were of the view that there should be minimum standards of due diligence, disclosure and process in the event of default, insolvency or bankruptcy and these should form part of any regulatory framework. Some respondents stated that prescriptive due diligence requirements could result in a situation where deal specific issues are missed out in the due diligence process. Some respondents suggested that there should be minimum professional standards, similar to the Central Bank’s Minimum Competency Code and Fitness and Probity Regime. Most of the respondents emphasised that crowdfunding platforms should carry out their own due diligence. For example, this could include basic checks on companies seeking funds through the platforms including financial statements, a CRO check, restriction of directors searches and litigation searches. It was suggested that those seeking to lend or invest through crowdfunding platforms should be able to presume a minimum standard of due diligence. It was also suggested that consumer loans should be reported to the Central Credit Register and a credit score, either a bespoke score from the platform, a standardised credit bureau score or a combination, could be provided. Respondents were of the view that crowdfunding platforms should not necessarily have to publish all of the information assessed during due diligence; however, there should be transparency and clarity about any credit assessment and financial advice provided by the crowdfunding platform. Respondents stated that crowdfunding platforms should clearly set out processes for dealing with late payments, arrears and defaults.

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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Information Requirements Some respondents were of the view that there should be different information requirements for loan and equity based crowdfunding. Generally, this was to account for the different levels of risk and complexity associated with these different types of crowdfunding. However, others felt that there should not be any material differentiation in terms of the information requirements. Respondents stated that information provision requirements should be balanced. Some respondents were not in favour of prescriptive information requirements expressing a preference for a more principled approach. In terms of the information that respondents felt should be provided, they were of the view that it should be clear, consistent, comprehensive, accurate and factually verifiable without imposing too onerous a burden on those seeking funds. It was noted by some respondents that business plans, cashflow projections and promotional material are not always easy to independently verify and validate. Conduct of business rules, client assets and prudential requirements The main issue that was raised in terms of conduct of business rules was a complaints process. All respondents agreed that there should be a clear complaints process outlining the process for making a complaint and to whom a complaint may be made. Some respondents felt that an external complaints and redress process was not needed while others were of the view that an independent, third party complaints and redress mechanism was necessary, with some suggesting that this should be within the remit of the Financial Services Ombudsman. Respondents felt that conduct of business rules were important for the reputation of and trust in crowdfunding platforms but some did not feel that they should be introduced just yet as part of a regulatory regime. In terms of client asset rules, respondents agreed that client funds should be separate. Security of information and payments was also considered an important part of the client asset rules. Some of the respondents were of the view that capital requirements and liquidity rules were not relevant to crowdfunding platforms on the basis that they do not hold funds “on deposit” and consequently, there should not be the same level of requirements imposed. Respondents also noted that high capital requirements had the potential to stifle the industry. Applicability of the SME Regulations In general, respondents were in favour of applying the principles, such as fairness and transparency, contained in the SME Regulations. However, respondents were not generally in favour of simply applying the regulations without adaptation for crowdfunding platforms. Some respondents felt that they would create an extra burden on crowdfunding platforms without a significant additional benefit to or protection for SMEs. Some respondents suggested that further analysis on this matter was needed. Additionally, it was pointed out that the SME Regulations are focused on the provision of credit and lending and are not applicable to investment/equity based crowdfunding.

Department of Finance | Paper for Policy Committee on Crowdfunding

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Limit on the amount of funds that can be provided through crowdfunding platforms Overall, respondents were not in favour of imposing a limit on the maximum level or amount of investment that could be made by individuals through crowdfunding platforms in a year. It was suggested that limits could overly restrict the industry. Respondents made the point that funding through crowdfunding platforms is provided by both individuals as well as institutional lenders and investors which promoted financial inclusion and was more egalitarian in terms of the provision of opportunities. It was felt that there was the potential for such limits to reduce the democratic and egalitarian nature of crowdfunding. It was recognised that there are such restrictions in other European Member States with regulatory regimes in place for crowdfunding. Some of the respondents suggested that any limits on the amount of funding that could be provided through crowdfunding platforms should be seen as a guide, rather than a mandatory requirement, and should take into account the variety of profiles of lenders and investors. It was also noted that such limits could potentially be difficult to enforce in practice. The cost of a regulatory regime and compliance In terms of the cost of regulation, the respondents felt that any regulatory regime should be as low cost as possible, with many suggesting that a regulatory regime and cost could be brought in on a phased basis. There was a concern that the cost of regulation and compliance should not be prohibitive to the industry and that the cost could be passed on to the industry over the long term. Conflicts of Interest Respondents did not really consider conflict of interest to be a significant concern. Some respondents suggested that existing regulations for financial services firm that address conflicts of interest may be sufficient and appropriate. Respondents recognised the need to treat all potential lenders and investors using crowdfunding platforms in a fair and transparent manner emphasising that what was important was that the same information should be provided to all users. However, respondents were generally of the view that people should not be prevented from availing of an opportunity solely due to their employment status or involvement with a crowdfunding platform. It was also noted by one respondent that the similarity with “insider trading” and the issue of conflict of interest did not apply in the case of peer-to-peer lending. Another respondent noted that it could potentially be burdensome to regulate conflicts of interest in practice. Some respondents addressed the “auto bid” system that is sometimes used by crowdfunding platforms. Their position was that once auto bidding is optional, it has the potential to help reduce users’ risk exposure by diversifying their lending and investment. Auto bidding can also be tailored to users’ preferences, including risk appetite.

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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Non-regulatory supports The main non-regulatory supports sought by respondents for crowdfunding included tax incentives and reliefs, including offsetting losses against interest earned for the purposes of calculating net taxable income. Some respondents also suggested that the Government could provide funding for business loans through crowdfunding platforms as a policy measure, citing the example of the British Business Bank. One respondent also addressed the issue of crowdfunding for litigation. Although it is an interesting point, the funding of litigation where the person providing the funds is not directly party to the litigation in exchange for a share in any proceeds from the outcome of the case is currently contrary to both public policy and the law.

Department of Finance | Paper for Policy Committee on Crowdfunding

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CONCLUSIONS

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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Conclusions

Crowdfunding is an emerging and innovative industry that is growing. The Irish crowdfunding market in particular is nascent and comparatively small. Equally, while the European crowdfunding market has been growing it is still relatively small and growing at a relatively low rate. Based on the findings of the public consultation carried out, there was general support from the crowdfunding industry and stakeholders for the regulation of crowdfunding in Ireland and it was felt that regulation would be beneficial to both industry and consumers. The main concern was that regulation might be overly burdensome or onerous and stifle or hinder the development of the industry.

Next Steps Subsequent to the Department of Finance holding a public consultation on the potential regulation of crowdfunding, the European Commission proposed a pan-European regulatory regime for crowdfunding in its 2018 work programme. The European Commission is due to bring a proposal for an EU framework on crowd and peer-to-peer finance for discussion in March 2018. The Department of Finance will monitor the progress and developments on this and implement European regulations as necessary. It appears that this decision to regulate crowdfunding on a harmonised, European level, which has been prompted by the European Commissions’ ongoing monitoring of the crowdfunding market and industry, will potentially make the European crowdfunding market more competitive. This may also allow for the possibility of Irish crowdfunding platforms passporting their services to other European member states, thereby widening their prospective market.

Department of Finance | Paper for Policy Committee on Crowdfunding

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SECTION 3 > Appendix A

Appendix B

Appendix C

Appendix A: Consultation

document and submissions to

public consultation

Appendix B: Central Bank

Notice

APPENDICES

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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Appendices

Appendix A: consultation document and submissions to the public consultation Department of Finance 2017 Publications

Appendices

Appendix B: Central Bank Notice Department of Finance 2017 Publications

Department of Finance | Feedback Statement on Public Consultation on Crowdfunding

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Consumer Notice on Crowdfunding, including

Peer-to-Peer Lending

Information Notice June 2014 The purpose of this notice is to alert consumers to the fact that crowdfunding, including peer-to-peer lending, is currently not a regulated activity in Ireland. As a result, certain protections do not apply to consumers of crowdfunding, and consumers who engage in this activity should be aware of the following: The Central Bank of Ireland’s codes of conduct and the protections which they provide to consumers, do not apply to crowdfunding platforms; Crowdfunding platforms are not required to comply with client asset rules; Consumers of crowdfunding are not protected by the Deposit Guarantee Scheme or the Investor Compensation Company Limited (ICCL) scheme; and Complaints in relation to crowdfunding cannot be made to the Financial Services Ombudsman (FSO) as the FSO only deals with complaints in relation to a regulated firm. While any investment, even through a regulated firm, carries with it an element of risk, there are specific risks to consider when any consumers consider participation in crowdfunding, including: The risk of the crowdfunding platform failing with a potential loss of some or all of their money; The risk of losing some or all of their money, should the business receiving the loan or investment fail, or the borrower default on loan repayments; The risk that the return on their investment is less than expected; and The risk of misleading or insufficient information disclosure, unfair contract terms or misleading commercial practices, and the absence of dispute resolution and redress mechanisms. The Central Bank of Ireland is actively monitoring developments in this area and will continue to work closely with other European authorities in this regard. As this work progresses, the Central Bank may publish further information on this topic.

What is crowdfunding? Crowdfunding can be described as a way in which money can be raised from a large number of individuals or organisations, to fund a business, project or personal loan, and other needs through an online web-based platform. It is a type of market-based finance that could help stimulate funding to small and medium-sized enterprises (SMEs) as well as personal lending. In addition, crowdfunding investments could potentially make up part of a diversified investment portfolio, especially for sophisticated investors.

Department of Finance | Paper for Policy Committee on Crowdfunding

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How does crowdfunding work? Crowdfunding can be structured in a number of ways. The most common models are: The Lending based Model where individuals lend money to a company, project or consumer in return for repayment of the loan and interest on their investment; this is also known as peer-to-peer lending. At this time, peer-to-peer lending is the only form of crowdfunding to have an established presence in Ireland. The Equity based model where individuals make investments in return for a share of the profits or revenue generated by the company/project. The Donations or Rewards based model where individuals provide money to a company or project for benevolent reasons or for a non-monetary reward.

Government Buildings,

Upper Merrion Street,

Dublin 2,

D02 R583

Ireland.

T: 353 1 676 7571

F: 353 1 678 9936

www.finance.gov.ie