Following the recent introduction of the new European Crowdfunding Regulation (ECFR), we sat down with our COO, Mihkel Stamm, to discuss its purpose, how it came about, and what implications it has for platforms like Estateguru, and our investor and borrower communities. As a company, Estateguru has been eagerly awaiting the introduction of this regulation, as it will bring unity across the European continent and allow us to offer our services in more countries even faster than ever before.
Can you provide us with some background information about how the regulation was first conceived, or how the need arose for them?
Crowdfunding itself has been on the scene for quite a long time, ten years or more. When you consider its origins, you’ll find most of the platforms emerged in the wake of the last financial crisis in 2007-2008.
Previously you could simply go to the bank, and make a deposit, and the bank would take your money and lend it out, either for consumer lending or real estate development. The interest that was earned on those investments, the bank took it for itself, as a profit or as an operational cost. If for some reason, financial or otherwise, you couldn’t secure a loan from the bank, you might have approached a high-net-worth individual and borrowed the money directly from them.
So after the crisis, Fintech became a hot topic, and the thinking was: the essence is there but let’s try to do some of the things better. Let’s make it more scalable and more user-friendly; let’s identify the deficiencies in traditional lending and see if we can improve on them. Can we provide a better user experience with apps and cheaper payment platforms? And then there were those who asked: what would happen if we brought a thousand people with a hundred euros each to lend together, on one platform and pool their funds for investment.
And it works well because it allows investors to have direct access to their returns. And although the customer now takes on the risk, the rewards are much greater because instead of a couple of percent of return, you can get the full return of 10 percent or 11 percent, or whatever the case may be. And it took off in the States, and then it went to the UK, but one area in Europe where it worked especially well, was the Baltic area. Estonia today for example is, per capita, one of the leading nations for crowdfunding in Europe.
The problem was that as it slowly picked up, the regulation didn’t follow so quickly. The authorities were still trying to get the banks to behave after the last crisis. But it became such a big phenomenon, so quickly, that soon the UK and some other countries published regulations aimed at protecting the retail investor.
So what do you think were the prime motivators in terms of pushing the regulators to act?
I think it was proactive. The regulators thought it was time to regulate it and not wait until it was too big and impossible to control. Then it also became a topic in Europe, and the thinking was that since there’s one common market it should be easy for businesses to open up in other areas, so if you get a banking licence you can use it freely in Europe, like a passport. So then they started to work on a pan-European crowdfunding licence which would allow companies to simply passport a business throughout Europe but due to the complexity of the issue and the range of jurisdictions, it took quite a long time.
How long has it been?
It has been a very long process, even longer than anticipated due to the Covid situation, but finally, in 2020 the ECFR was adopted and on the 11th of November 2021, the regulation became applicable across the European Union, whereas the existing market players were given a year to apply for their licences in their respective countries. As a company, you now have a choice, either you become regulated as a crowdfunding service provider or you try to find another licence but if you want to follow this business model you can’t if you’re not regulated.
Currently you can operate in one country but if you want to operate on a Pan European level, you need to first make sure you comply with the requirements in each and every European country. Under the ECFR, Pan European operations are made easier. So if you’re a Finnish company, for example, and you want to do business in Germany or France or wherever, you can now do so if you have the crowdfunding licence, because you can inform your regulator that you wish to operate in a country and they will let the regulators in that country know that a Finnish regulated company will start providing services in their jurisdiction. So the essence here is having one market and simpler processes for operating in different countries.
Another reason for the regulation is to provide more protection, especially for the ones who need to be protected and this means the investors or retail users who are not the typical financial entities. European regulators do everything in their power to ensure that fraudulent companies can’t steal from the retail customers and then move on to the next country. It’s meant to boost the business and the market, offer protection, and finally provide clarity.
Crowdfunding is a very specific regulated service so you can start off as a crowdfunding service provider and then move to the next level, for example by getting a licence to give investment advice or provide other investment services, or, if you want to take deposits, you would need a banking licence. So there are different levels you can choose as a business, and depending on what you want to do, you need to know the regulations you need to comply with.
As a business, how will these regulations affect Estateguru? We’ve obviously championed these regulations but what do they mean for us?
The main thing we want as a crowdfunding service provider is the faith of investors. Banks have long been regulated and that gives people the confidence to invest through them. We have always been transparent and done everything we can to follow the rules and protect our users. Our service requires customers to take risks related to their money, and for the customers to use our services, we need their trust and we have always done whatever we could to ensure that our investors have faith in us.
In Estonia, there weren’t any regulations until the ECFR came into force, but there was an Estonian umbrella organisation for Estonian Fintechs called FinanceEstonia who at one point formed a working group combining several Fintech market players who released an agreement of goodwill, the “Crowdfunding Best Practice”, which was entirely voluntary, which basically meant that the Fintech companies which applied it, promised to follow principles that were very similar to the crowdfunding related requirements in the UK, and now also to the current European regulation. Crowdfunding companies wanting to join the Best Practice had to apply for it and a separate committee established by FinanceEstonia reviewed the applications and either approved or rejected the applications. You had to provide information about your company and the steps you have taken to abide by the Best Practice.
There were also countries where there were full local regulations in place. So when we started to expand to different countries, one of the first things we looked at was whether there were regulations in place. The next step was to get the licence in the respective country. And consequently, we were the first company to be regulated in many European jurisdictions, from the UK to Finland, to Lithuania. Our aim was to ensure that we remained transparent and above board.
We have already done many of the preparations as a company; having customer checks in place, complaint handling protocols, appropriate marketing messages etc. So a lot of the preparatory work was already done, ahead of the introduction of the new regulation. There are new elements as well, but we have been actively preparing ourselves, so we welcome them. In Estonia, we have even contributed to the formation of these principles. A lot of effort has gone into devising them. Companies and organisations have worked with their local ministries to provide feedback to the European decision-makers. It was FinanceEstonia that officially provided feedback to the Ministry of Finance during the negotiations. There’s been a lot of collaboration and I think that’s the way it should be done. When you want to innovate, make room for the companies to evolve and see where it takes you, don’t just make decisions remotely and impose them. If you put measures in place that are too stringent, you can suffocate the industry.
Many in the industry have wanted these regulations, ourselves included, for the sake of clarity. The main problem was that local regulations were all different and although this may have suited companies providing services in one country, it did not work if your aim was to be pan-European. If you have a modern, technological business model, where you want to open a shop in one country, but your clients come from many different countries, it’s essential to have regulations that apply across the board. As we operate in different countries, we’ve contributed to this discussion through our representatives in all of them.
Who will be most impacted by the regulations?
As I’ve said, for us it’s a great thing because of the trust and the clarity it allows, but we are already an established company. Some of the smaller companies may find the new requirements frustrating, as their investors need to go through more onboarding protocols and meet specific requirements, so the user experience may suffer slightly, but the upside is that now the users have protections, and recourse in the event that they feel they have been defrauded.
Are there any other big changes we should mention?
The big focus is on providing consumer protections and protecting investors. There are clear rules, for example, about what information you need to publish about a project and how you handle complaints. You need to log them so they can be produced at the request of the regulators. There’s more clarity around conflict of interest. Who can lend and who you can lend to. There are better-defined criteria in regards to which deals fall under these regulations. This is quite flexible; different countries can determine the value of projects that fall under different regulations. How much can you lend with a particular licence? These values have now been clarified. There’s also the separation of investors into sophisticated and non-sophisticated categories, depending on defined criteria. The onus is on companies to understand their clients and provide safety nets and limits when necessary to ensure their investment experience is as safe as possible. There is for example a four-day cooldown period so you have time after making an investment decision to pull out if you are a non-sophisticated investor. There are also clear guidelines around how you can market your services and an emphasis on having a sustainable business plan that accounts for unexpected developments. These are some of the main points. The regulation and its delegated acts altogether are more than 100 pages, so we can’t cover all the minutia in this interview.
Understood. Thank you for summarising the essentials for us.