The international crowdfunding market has seen incredible growth over the last seven years. In fact, in 2010 the overall funding raised via this method hadn’t even hit the $1 billion mark, and in the seven years between then and 2017 we have seen around $50 billion invested in the global crowdfunding market. It is the debt-based method of crowdfunding, where investors expect to see a financial return on their investment, that has dominated the growth in funding, raising over 80% of this overall $50 billion since 2010.
Though the market has seen remarkable growth it has slowed down slightly over the last year or so. However, this specific method of funding has still garnered great political and economic attention globally. In fact, a reason that this could be the case is due to the fact that the market is completely dominated by two parties; the US and the EU, who have raised $25.8 billion and $16.9 billion respectively, of the $50 billion between 2010 – 2017.
Though the EU does have a large share of the crowdfunding market, there is an issue. When the EU’s crowdfunding market is broken down country per country, it is clear that the UK completely dominates the EU market, with 88% of the funds raised between 2010-2017 coming through the UK. This is, of course, not the best news for the EU, with the UK expected to leave the bloc in October 2019, meaning the EU will lose a huge share of the crowdfunding market.
Of course, there may be arguments that suggest that if the UK loses its strong collaboration with the rest of the EU, then there may be less investment and therefore crowdfunding in the UK. However, crowdfunding typically is a local source of finance, with most investors funding ventures in the same country they are located due to the fact that they have much more knowledge on the political, economic and legal situation. Therefore, the UK leaving the EU is likely to not have a huge effect on the level of crowdfunding market share that the UK has, but will hugely, and potential detrimentally, impact the EU’s collective market share. Therefore, with Brexit likely to happen in October 2019, it is important for the EU that they look at ways to discourage the localisation of crowdfunding, and encourage more cross-border activity.
One way in which cross-border activity could be stimulated is by improving the current regulatory framework around crowdfunding. This is something that the EU Commission has been looking in to, and in fact in March 2018 proposed a new framework centrally focused around crowdfunding. Before this proposal, cross-border activity in the crowdfunding market was only possible for platforms authorised under the Markets in Financial Instruments Directive (MiFID). However, most platforms perceive such an authorisation as too costly and burdensome, and thus choose to obtain authorisation under national regulatory frameworks. This did not change with the implementation of the MiFID 2 in January 2018, as it was still not specifically tailored towards the needs of crowdfunding platforms.
The EU Commission’s proposal however, does have a more specific approach towards crowdfunding and attempts to give investors greater protection, encourage cross-border activity and act as an exemption from the restrictive MiFID 2 regulation. However, in my research with my colleague Dmitry Chervyakov, we identified at least three major shortcomings of the EU Commission’s new framework that need to be addressed in order to decrease localisation and promote the growth of EU markets outside of the UK.
Firstly, the new framework proposal needs to have a precise and transparent legal explanation of crowdfunding activities. Currently this is not the case, meaning that there is still legal confusion both for investors and firms which discourages cross-border activity because smaller, more localised firms do not have sufficient knowledge of other countries legal regimes. If a consistent and clear legal framework for crowdfunding is implemented across the EU, then all firms and investors would have the legal knowledge to partake in cross-border activity.
Secondly, the framework must have a clearer and more authoritative stance on investor protection. Under the current proposed framework, if a platform provider is dissatisfied with a potential investor, the only step they are able to take is to issue a warning, however this does not necessarily prevent a potential investor from funding a project, despite the platform provider’s concerns. To ensure both investors and firms have protection when participating in the crowdfunding market, there needs to be more rigorous vetting of potential investors through a ‘qualified investor test’. This would ensure that all investors who fund firms and their ventures through crowdfunding can prove that they have the necessary knowledge, and that they are adequate to contribute to the crowdfunding market.
And finally, the proposed framework is too restrictive for investors. Currently, it has a maximum threshold investment, restricting investors to only $1 million per project, over a 12-month period. Although only 15% of EU crowdfunding investors between 2010-2017 were over this proposed threshold of $1 million, this 15% amounted to around half of the actual funding in the EU crowdfunding market – a huge share. This clearly shows that large investments, over this proposed threshold are vital for the EU market if it wants to thrive, and employing this threshold could drastically cut substantial funding in the EU market. Therefore, the cap should be raised to $5 million per project to ensure the EU doesn’t miss out on this substantial level of funding.
The introduction of a proposed framework for crowdfunding regulation in Europe certainly addresses some of the current issues investors and firms experience when participating in the crowdfunding market. However, it does not go far enough and there are still some shortcomings in the framework that must be addressed if the EU wants to stimulate as much potential growth as possible in the crowdfunding market. If the UK is to leave the EU in October 2019, then it is important that these shortcomings are addressed as soon as possible.
Jörg Rocholl is President and Professor of Finance at ESMT Berlin. He is also the EY Chair in Governance and Compliance and his research interests are in the areas of Corporate Finance, Corporate Governance, and Financial Intermediation.
