Estonia – on course to become the first fully regulated Fintech market?
Following the adoption of the most recent crowdfunding regulation by the European Parliament, Estonia is making efforts in implementing the new framework and going a step further.
A draft Crowdfunding and Other Investment Instruments Act that was recently published by the Estonian Ministry of Finance is expected to implement the EU crowdfunding regulation into Estonian law and, more significantly, it creates a legal framework regulating business activities related to issuing and trading cryptocurrencies and other novel financial instruments that have been so far unregulated. The act is expected to be adopted before the 10th of November 2021.
The new requirements for providing crowdfunding services
Up until now, there has been no unified framework for crowdfunding services in the European Union, which means that every country has established its own set of rules for services not covered by MIFID II. This lack of unified rules created obstacles for the provision of cross-border services and as a result, the current market share of European crowdfunding is negligible in comparison to the uniformly regulated markets like the USA and China.
Moreover, the existing regulations created active obstacles for growth, as any issuance of securities over 1mil euro calculated over a period of 12 months (in certain member states the threshold is increased up to 8 mil euro as an exception from the general rule from the prospectus regulation) were subject to prospectus obligations.
The new crowdfunding regulation tackles most of that by introducing a clear set of rules for all crowdfunding service providers in Europe. It clarifies the meaning of the term crowdfunding, which is now defined as “the matching of business funding interests of investors and project owners through the use of a crowdfunding platform” and which consists of either the facilitation of granting of loans or the placing of transferable securities.
As a result of the new regulation, such crowdfunding service can be provided only by service providers who obtain a license. The licenses will be issued by the relevant supervision authorities of the country where the service provider is established (in Estonia it will be done by the Financial Supervision Authority).
The list of documents required with the application for licensing will include but is not limited to: description of operational risks, description of service provider’s systems, resources, and procedures, a description of persons responsible for management and proof of their good reputation, etc.
Licensed crowdfunding service providers will have to adhere to certain obligations, including disclosing the loan default rates, assessing the abilities of the potential investor, and allowing for a pre-contractual reflection period for the investors.
A pre-contractual reflection period will last for four calendar days during which a prospective non-sophisticated investor may, at any time, revoke interest in the crowdfunding offer without giving a reason and without incurring a penalty. The businesses seeking funding on such crowdfunding services will have to publish a 6-pager document outlining the key investment information.
The regulation doubles the threshold at which preparation of a prospectus becomes obligatory (5 mil euro per year) for the project owners and allows for EU-wide passporting, meaning that a licensed crowdfunding service provider will be able to expand its licensed activities into any other EU state by notifying its home regulatory authority.
As a result, we should see more and bigger crowdfunding projects and platforms appear throughout Europe.
The secondary market on crowdfunding instruments offered via crowdfunding platforms will not allow for automated fulfillment of buy/sell orders, like with traditional stock exchanges. Instead, a service provider may choose to implement a system of bulletin boards.
A bulletin board will allow clients to advertise interest in buying and selling the instruments for crowdfunding purposes that were originally offered on respective crowdfunding platforms. With this system, there is no internal matching system, which makes the trades between investors manual.
In conclusion, the new rules should revitalize EU crowdfunding, help protect the investors and provide the long-needed legal certainty for the market.
Estonia’s plan to pull ahead
Despite being an important step towards harmonizing the rules within the Fintech sector, the EU regulation does not seek to achieve full regulation of the market, limiting its scope to regulating crowdfunding services. This means that services such as facilitating loaning through crowdfunding to consumers (Peer to peer or P2P loans) remain outside the scope of the regulation.
The Estonian legislator is preparing to provide solid regulation to all relevant areas of Fintech, including creating a framework for P2P consumer loans similar to the one applicable to business loans. This system would take into account the existing consumer law regulations and expand the already existing credit intermediary regulation for further investor protection.
With the EU regulation, there still exists a barrier for projects aiming to rise beyond 5 million euros, as at that point there is an obligation of drawing up a prospectus. Publishing of a prospectus must be preceded by a formal approval procedure with the relevant supervision authority, which in the case of Estonia can take up to 20 days.
The prospectus itself is a complicated piece of documentation the preparation of which demands a lot of time and resources. EU states can provide for simplified prospectus requirements for offerings up to 8 million Euros, but only some EU states have decided to use that possibility including, indeed, Estonia.
As a result, if a project decides to carry out a public offering of securities in the value between 5 to 8 million Euros, there will be an obligation to get approval for publishing a prospectus, but the requirements for such prospectus would remain more similar to those required from crowdfunding key investment information sheets, which are less detailed and presumably will be cheaper to prepare.
The EU regulation also does not touch upon the rapidly growing markets of cryptocurrency exchange/wallet/trading, which still remain virtually unregulated on the European level. Seeing their growing importance, Estonian legislator was among the first in the world to provide a framework for cryptocurrency-related activities.
Expanding on the acquired knowledge as one of the pioneering nations, Estonian legislator is planning to expand the existing framework applicable to cryptocurrency services by implementing many of the organizational requirements (e.g., risk management rules, reliability of management, etc.) that will become applicable to crowdfunding service providers.
These additions are expected to make these services more attractive to both users, who can expect better protection of their investments and more reliable services, and to European credit and financial institutions, who still viewed most cryptocurrency-related ventures as too risky even for conducting basic business.
In the last years, Estonia had seen numerous ICO-s (Initial coin offering) / TGE-s (token generation event). Such instruments are not regulated by the latest crowdfunding regulation, despite being a popular alternative to traditional investing.
So, Estonia is set to integrate the token offerings/generation events within the new crowdfunding framework with effectively the same obligations as any other crowdfunding offer.
The only cases not directly regulated by the new legislation will be the utility token, which is deemed sufficiently regulated by existing rules. With that cryptocurrencies will gain full recognition as a viable investment mechanism within the legal system.
The expected framework in Estonia is thus set to be unique as it will regulate every possible area of Fintech except non-commercial cases and utility tokens.
 Regulation (EU) 2020/1503, available at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32020R1503
Disclaimer: As of September 2021 the government has decided to implement the Crowdfunding Regulation separately from the originally suggested package. It is currently unclear whether the ideas described above will ever get implemented.« Back to articles