On 16 December 2021 the Ministry of Finance released a new redaction of the draft law for the Law on Crowdfunding and Other investment Instruments, and Virtual Currencies of Estonia. Known as “ÜVIMS” (in Estonian: “Ühisrahastuse ja muude investeerimisinstrumentide ning virtuaalvääringute seadus”), it will regulate novel or innovative ways of raising capital within the FinTech sector, with a view of ensuring greater investor protection. The new law is partly tied to the application of the Regulation (EU) 2020/1503 of the European Parliament and of the Council of 7 October 2020 on European crowdfunding service providers for business and amending Regulation (EU) 2017/1129 and Directive (EU) 2019/1937 (Regulation on Crowdfunding) into national law.
Crowdfunding is normally done through public online platforms, where funding applicants aim to find investors for their project within a fixed timeframe.
The Estonian Financial Supervisory Authority (EFSA) has identified three types of crowdfunding:
credit-based crowdfunding: brings together an applicant willing to take out a loan and investors willing to provide it for an interest fee
investment-based crowdfunding: the applicant offers, through the crowdfunding platform, the possibility to invest in the applicant’s securities, shares, units or equity instruments, and in return the provider receives a stake, a bond or a share of the proceeds of the project in return
non-financial crowdfunding: supporting projects or donating money to charity without any financial or material benefits
Crowdfunding involves three main types of actors: the project owner (the applicant), the investor and the crowdfunding platform (the crowdfunding service provider). Investors, of course, want to receive a return on their investment, e.g., interest income or a share of the profits – as the area has remained mostly unregulated, some investors have fallen victim to fraud and lost their investment. The explanatory note of the Ministry of Finance for ÜVIMS highlights that while the principles for investing and raising capital have not changed significantly over time, the investment opportunities arising from technological developments have changed markedly. For example, with crypto assets, there are no legal guarantees and safeguards that normally accompany financial services and investments for neither, consumers or investors. Neither does crowdfunding in general find its place in the current regulation system as often the participation in a crowdfunding project may not qualify as a negotiable instrument.
Currently, crowdfunding is partly regulated by the Securities Market Act (SMA) in Estonia, which regulates the securities falling under the Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (MiFID II). MiFID II regulates securities that are „transferable and negotiable on the capital market”, problem is, so-called ownership in the legal entity does not necessarily qualify as a negotiable instrument within the meaning of the MiFID II. Therefore, this gap has called for a new regulation, that we now know as ÜVIMS, which aims to target the “non-MiFID II” securities, including investment or payment instruments issued in encrypted form, inter alia, if such property is recorded, for example, in a blockchain or other distributed ledger technology (aka tokens). In fact, already in 2016, the Ministry of Finance has made a proposal for the regulation of crowdfunding – meaning that bringing such change has already been in the works for a while.
Broadly said, the investment instruments covered by ÜVIMS will include the non-MiFID II instruments as mentioned above, this means:
- Instruments released in a crowdfunding project which do not qualify as negotiable in the meaning on MiFID II and fall under the objectives of the Regulation on Crowdfunding;
- Claims arising from credit agreements;
- derivative instruments that give its holder the right to obtain the instruments in the above points.
ÜVIMS will recognize two types of crowdfunding services:
- credit-based services;1
- investment or equity-based instrument services.
Currently the regulatory environment can get confusing, when classifying said investment instruments, as some instruments could be just partly regulated, and others are completely left out. At the same time the, raising capital through innovative solutions is on the rise; but when the investment instruments are not offered with sufficient information, there is a high chance of making misinformed decision and the investment losing its value. Deriving from these risks, the Ministry of Finance has found that the best solution would be to develop a completely new law – the objectives for this new law, were divided into 3 categories:
Obligation to disclose necessary information to investors and consumers, while preserving the ability of investors to take investment decisions with sufficient flexibility. Obligation of activity license, incl. requirements for shareholders and board members, capital and risk mitigation.
Simply, to make it clear, which areas are regulated under the securities law framework.
To modernize novel financial instruments, incl. tokenized securities, and create conditions for their wider usage.
As said, the overall subjective is consumer protection. The service providers will be obliged to publish a key information document if the, which should facilitate finding the necessary information for the investor. Given document must be in a form that is easy to analyse and understand about the entire characteristic information about the applicant for the funding and the investment instrument offered to the public that is necessary for investors to make an informed assessment of, inter alia, the obligations of the applicant for funding the financial position, profits and losses, future prospects and the rights attaching to the investment instrument being offered. The ÜVIMS also sets requirements on the establishment clear procedures for timely resolution of customer complaints in their internal rules of procedure. The sector-specific risks will further be mitigated by the obligation to register the investment instruments at one central registrar, submission of regular reports to the EFSA (e.g., transactions report, statement of customers’ assets), audit of service provider’s annual accounts, set requirements for keeping customers’ funds, publishing the investing project, etc. Most importantly, by setting the licensing requirements, described below, the control over the regulated sector will increase – this way the regulatory authorities can check during and after the application process, who are actually eligible to provide the services and comply with the regulatory requirements.
The supervisory authority for the entities regulated under ÜVIMS will be the EFSA, who will grant the activity licenses. This activity license will be termless and not transferrable or expand to subsidiaries. The application evaluation time from receiving all the necessary documents will be 30 days (max. 60 days). For the application for activity license, a ranging list of documents must be provided, compared to the current application forms for such entities. These documents include: a business plan (for min. 3 years), a description of the organizational structure, internal accounting rules (or draft), the security policy or security rules, information on information technology systems and procedures, opening balance sheet, a statement of income, profits and cash flows, etc. A strong emphasis is put on the importance of the security of the systems and solutions used – during the evaluation processes the EFSA may even request an independent expert assessment of the applicant for authorization the technological solutions and cyber-security safeguards in use.
For comparison, Lithuania has passed the Law of Crowdfunding (LoC) already in 2016, which is applicable to contractual relationships the nature and purpose of which is identical with crowdfunding relationship (apart from charity and/or sponsorship). Meaning, a relationship where a project is funded by the funds of investors that are not related to the project and where the investors acquire creditor claims. The law covers funding transactions up to 5 million euros over 12-month period (project exceeding the threshold may only be governed by the Law on Securities). The LoC of Lithuania aims to be clear and simple to understand, as the main goal was to help SMEs to gather funding for their projects as obtaining funds in the form of loan was unlikely. According to Bank of Lithuania (supervisory authority for crowdfunding under LoC) approximately 40% of SME loan applications are rejected in Lithuania. The crowdfunding market of Lithuania has seen a rapid growth in the recent years.
The Estonian based service providers that have remained unregulated, due to absence of regulation, are obliged to obtain an activity license under the new regulatory regime – the deadline for this, is currently set to be 1 April 2022. The Regulation of Crowdfunding sets the deadline for 10 November 2022 as the final possible deadline – by then, the Member States need to have set licensing processes in place to allow crowdfunding companies can bring their activities into line with EU law.