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European Crowdfunding Regulation (EU) 2020/1503 – European Crowdfunding Service Provider Regulation – ECSPR) provides a harmonized regulatory framework for service providers operating crowdfunding platforms. The ECSPR entered into force on 10 November 2021.
In this article, we will address how the crypto industry is treated under the ECSPR. We will cover the basics of the regulation, including its scope and whether crypto tokens are subject to the regulation and if so, whether they qualify as loans, transferable securities or permitted instruments for crowdfunding purposes under the ECSPR. In addition, the article examines whether special features apply to security tokens issued through crowdfunding.
ECSPR basics
ECSPR regulates crowdfunding services. Crowdfunding services can be described as the matching of business financing interests of investors and project owners using a crowdfunding platform through any of the following activities:
- facilitating loan approval;
- placing without firm commitment on the basis of transferable securities and approved instruments for crowdfunding purposes issued by project owners or special purpose companies, and receiving and transferring client orders in connection with these transferable securities and accepted instruments for crowdfunding purposes.
There is a requirement for a license to provide crowdfunding services, as well as certain rules of conduct for those involved in crowdfunding.
However, the application of ECSPR is limited. In particular, it does not apply:
- to crowdfunding services provided to project owners who are consumers; and/or
- if the crowdfunding offer has a fee of more than 5 million euros ($5.4 million) calculated for a period of 12 months.
Are crypto tokens even covered by the ECSPR?
Recital (15) of the ECSPR makes a statement about crypto tokens when it relates to initial coin offerings. It states that: “Although Initial Coin Offerings (ICOs) have the potential to finance small and medium-sized enterprises, innovative start-ups and expansions and can accelerate technology transfer, their characteristics are significantly different from the crowdfunding services regulated by this Regulation.”
However, this does not mean that all crypto tokens fall outside the scope of the ECSPR. On the one hand, both German versions (“Ausgabe neuer virtueller Krypto-Token”) and the French version (“offres initiales de jetons”) are somewhat ambiguous.
The English version, on the other hand, doesn’t talk about crypto tokens, but refers to an “initial coin offering”, which is a common term in the market. ICOs are usually associated with the issuance of utility tokens or currency tokens, not just any type of token. In contrast, the issuance of security tokens is called a security token offering (STO).
Based on the language used in the ECSPR, it therefore seems obvious that only (tokens associated with) ICOs should be exempted from the provisions of the ECSPR, while (tokens subject to) the WTO may largely fall under its regulation. This interpretation is further supported by the indication that the characteristics of ICOs are significantly different from those of crowdfunding, while security tokens have similarities with crowdfunding. Therefore, it cannot be argued that investment instruments are excluded from the scope of the ECSPR simply because they are crypto tokens.
Crypto tokens as loans?
In general, the ECSPR applies to crowdfunding services. This includes credit brokerage activities. ECSPR defines loans as “an agreement by which the investor places at the disposal of the project owner an agreed amount of money for an agreed period of time, and by which the project owner undertakes an unconditional obligation to return that amount to the investor, together with the calculated interest, in accordance with the repayment plan in installments”.
Thus, tokens can fall under the ECSPR if they are considered a loan. Utility tokens and currency tokens are generally structured in such a way that they do not fall under the concept of a loan. This is because they usually do not include an obligation to repay and/or claim interest. Typically, utility tokens are structured in such a way that the acquirer receives the good or service, but does not return the amount paid. Similarly, currency tokens are not typically structured like loans.
Crypto tokens as transferable securities?
The placement or brokerage of transferable securities generally qualifies as crowdfunding services, which fall under the ECSPR. For the definition of transferable securities, the ECSPR refers to MiFID II which, in turn, defines transferable securities as “those classes of securities that are negotiable on the capital market, with the exception of payment instruments, such as:
- shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depository receipts for shares;
- bonds or other forms of securitized debt, including certificates of deposit related to such securities;
- any other security which gives the right to acquire or sell any such transferable security or which gives rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures.”
Both utility tokens and currency tokens are typically structured in such a way that they do not fall under the concept of transferable securities. They do not embody security-like rights, such as dividend or interest claims and membership rights.
Security tokens regularly fall under the concept of transferable securities. They are usually standardized, transferable and represent bonds or other forms of debt that authorize repayment and claim interest.
We see many different token structures in the market. In most cases, a case-by-case assessment is recommended.
Crypto tokens as permitted instruments for crowdfunding purposes?
In addition, the placement or mediation of approved instruments for crowdfunding purposes qualifies as a crowdfunding service.
The ECSPR defines accepted instruments for crowdfunding purposes as “in relation to each Member State, shares of a private limited liability company that are not subject to restrictions that would effectively prevent their transfer, including restrictions on the manner in which those shares are offered or advertised to the public”.
Whether it is possible to issue shares of a private limited company in the form of crypto tokens is a matter of relevant local laws. For example, in Germany, shares of a German limited liability company (GmbH) may not be issued as security tokens on the blockchain because they are subject to strict formal requirements.
All equity/equity tokens related to the German GmbH use a structure that is likely to qualify them as transferable securities (and therefore not as approved instruments for crowdfunding purposes).
What special features apply to security tokens issued through crowdfunding?
As a rule, if crypto tokens qualify as transferable securities, their issuance is subject to the preparation and publication of a securities prospectus in terms of the Prospectus Regulation (Regulation (EU) 2017/1129). According to the exemption from the Securities Prospectus Law, the preparation of a securities information sheet may also be sufficient. These obligations change if security tokens are issued through crowdfunding under the ECSPR.
The obligation to publish a prospectus under the Prospectus Regulation will not apply if the offer is made by an authorized crowdfunding service provider and if a threshold of less than EUR 5 million ($5.4 million) is reached. However, under the ECSPR, there is a requirement to issue a Key Information Sheet (KIS). The content of the KIS should closely follow the standards set in the ECSPR.
Authors:
Dr. Michael Juenemann, Johannes Wirtz, LL.M. and Timo Foerster
Bird & Bird LLP
Financial Services EMEA Regulators and Government
