The draft of the German Retail Investors’ Protection Act (Kleinanlegerschutzgesetz) covers – as expected – also the regulation of Crowdfunding in Germany
The insolvency of the wind park issuing house Prokon had started a political discussion, whether a more strict regulation of the so called grey capital market (Grauer Kapitalmarkt) should be implemented. This was also the inition for a specific regulation of Crowdfunding in Germany.
Neither the federal minister of finance Dr. Wolfgang Schäuble nor the federal minister of justice Heiko Maas wanted to be accused of ignoring an endangerment of EUR 1.4 billion of German retail investors’ participation rights capital (Genussrechtskapital). Due to this fact, on 22 May 2014 they had issued a package of measures to improve the German Retail Investors’ protection (Maßnahmenpaket zur Verbesserung des Schutzes von Kleinanlegern) (we reported on this topic in our newsletter of 30 May 2014 – only available in German). Declared intention of this package was an improved investors’ protection of dubious and risky investment products.
Back then the federal government had realised that the intended measures would have tremen-dous consequences for Crowdfunding in Germany. Therefore, it was the official intention that as far as Crowdfunding is concerned, solutions shall be found which meet the requirements of young companies that are financed by Crowdfunding in consideration of the protection of investors.
If this intention is met can now be verified. On 28 July 2014 the first draft of the German Retail Investors’ Protection Act (Kleinanlegerschutzgesetz) (hereinafter referred to as the “Draft”) was published.
1 Extension of the scope of the German Investment Products Act (VermAnlG)
In Germany, there are three broad types of Crowdfunding: (1) Equity Crowdfunding: individuals make investments in return for a share in the profits or revenue generated by the company / project, (2) Lending Crowdfunding: lending money to a company or project in return for repayment of the loan and interest on the investment, (3) Donation or Reward Crowdfunding: the company’s / project’s funding is based on donations or non-monetary return. In case of Equity Crowdfunding and Lending Crowdfunding subordinated currently profit-participating loans (partiarische Nachrangdarlehen) are predominant in Germany.
Main topic of the Draft is the extension of the scope of the German Investment Products Act (VermAnlG). This in particular affects Crowdfunding and its regulation. To date subordinated profit-participating loans (partiarische Nachrangdarlehen) were not classified as investment products. According to the Draft they shall now – as well as all comparable investment products – be covered by the German Investment Products Act (VermAnlG). According to the legislative materials on the Draft the new regulation intends to avoid circumventions of investors’ protection contained in the German Investment Products Act (VermAnlG).
This extension of the scope of the German Investment Products Act (VermAnlG) was only a matter of time. Even for legal experts it was hard to distinguish silent partnerships (stille Beteiligungen) and debt participation rights (Genussrechte) from profit-participating loans (erfolgsabhängig verzinste partiarische Darlehen). It was hard to understand why silent partnerships and participation rights on the one side trigger the requirement to publish extensive prospectuses (that must be approved by the German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht “BaFin”)) while on the other side profit-participating loans (partiarische Darlehen) are completely unregulated.
2 Exception for Crowdfunding
In order to prevent the end of Crowdfunding in Germany the Draft provides for an explicit exception for this kind of funding.
The intended exception shall result in a less strict regulation. In particular, this light regulation provides for an exemption from the duty to publish a prospectus. According to the draft the exception for Crowdfunding applies if the following (cumulative) conditions are met:
- Total offering maximum: EUR 1 million;
- Offering of profit-participating loans or subordinated loans;
- Maximum investment per investor: EUR 10.000;
- Marketing via online platforms that need to obtain a license under the German Trade, Commerce and Industry Regulation Act (Gewerbeordnung), under the German Banking Act (Kreditwesengesetz) or the German Securities Trading Act (Wertpapierhandelsgesetz, WpHG).
Maximum EUR 1 million
From a German point of view the threshold of EUR 1 million seems to be a huge relief at first sight. Up to now only offerings of investments that do not exceed EUR 100.000 during 12 month were excluded from the prospectus requirement. However, on a European level according to the Prospectus Directive (2010/73/EU) a prospectus is not required for offerings that do not exceed EUR 5 million. Other European countries either adopted this threshold (e. g. Great Britain and Italy) or used this threshold as an orientation and – other than Germany – defined significantly higher values (the Netherlands and Sweden: EUR 2.5 million).
It remains an open question why the German government determined EUR 1 million and why Crowdfunding above this threshold shall not benefit from the lighter regulation. In our opinion this point should be revised in the further legislative procedure.
Limitation to profit-participating loans (partiarische Darlehen) or subordinated loans (Nachrangdarlehen) – no exception for Equity Crowdfunding
The same applies to the limitation of the exception to offerings of profit-participating loans and subordinated loans. The main reason for the use of these investments in the past was the lack of regulation. From an economic perspective, many Crowdfunding platforms preferred an equity-like investment. This can be learned from the structures of the profit-participating loans offered in Germany. Although these loans do (due to the nature of a loan) not cause liability for the losses of the project/company, the loans provide for a profit sharing. Thus the companies often promise interest rates, which depend e. g. on its profits or a possible exit return.
In general, it is understandable that the legislator wants to prevent circumventions of a regulation. However, the intended distinction between different forms of investment products does not make sense. Plattforms should be free to offer all kinds of investment products including equity under the lighter Crowdfunding regulation – and should not be limited to profit-participating loans or subordinated loans.
We assume that the legislator is not willing to define the term of “Crowdfunding”. Rather, he simply refers to the actual conditions of Crowdfunding in Germany. In doing so, the legislator ignores that this status quo neither has any economic reason nor is necessary due to the investors’ protection.
Maximum EUR 10.000
The limitation to a maximum investment of EUR 10.000 per investor and offering seems appropriate. As an alternative the allowed investment amount could be determined depending on the investor’s income and/or assets – comparable to the regulation in title III of the American JOBS Act.
The license requirement to operate a Crowdfunding platform is a necessary consequence if Crowdfunding investments are classified as investment products in terms of the German Investment Products Act (VermAnlG). In addition a licence under the German Trade, Commerce and Industry Regulation Act (Gewerbeordnung) should not overburden any (reliable) Crowdfunding platform.
3 Obligations for Crowdfunding (under the exception)
Under the aforementioned conditions there will be only a lighter regulation under the Crowdfunding regulation.
The essential relief of the intended exception will be the fact that no prospectus must be prepared. Due to fact that the costs of publishing a prospectus would have meant the end of most Crowdfunding in Germany, this appears to be the most important point.
Nevertheless, a number of requirements remain. Some of them appear to be not in line with the idea of Crowdfunding.
Investment Products Information Leaflet (Vermögensanlageninformationsblatt (VIB))
If an investor invests more than EUR 250, the company must provide the investor with a so called Investment Products Information Leaflet (Vermögensanlageninformationsblatt – hereinafter referred to as “VIB”). This is a highly formalised summary of the investment product on a maximum of three pages. The content is determined by law. In particular, the VIB must not contain any advertisement.
The preparation of a VIB is a manageable task within a Crowdfunding campaign in comparison to the preparation of an entire prospectus. In this context the legislator points out that the Crowdfunding platform is allowed to prepare the VIB without becoming the offeror of the investment product. However, the legislator remains silent with regard to possible liability consequences which may arise for the Crowdfunding platform if it prepares the VIB for the companies.
However, according to the current Draft the investors must sign the VIB and send it back to the company by ordinary mail. From an operational point of view, this means that the investor has to print the VIB, sign it and take it to the post office.
This anachronism is not compatible with the (internet-based) character of Crowdfunding at all. Crowdfunding is a phenomenon of the internet and takes place solely via the internet. An obligation to such a media discontinuity (printing and taking to the post office) may have a tremendous negative impact on the acceptance of Crowdfunding as a financing model.
Moreover, comparable investors’ protection can be easily achieved by an online confirmation of the investor. In this respect, it would be helpful, if the associations and parties concerned with Crowdfunding announce the need for a modification to the legislator. At least they should make sure that a transmission of a signed copy via email is sufficient.
Finally, the Draft significantly limits the possibilities to advertise investment products. At the current stage of the Draft, these changes are applicable to Crowdfunding to the full extend.
As far as the addressee is not a regulated company itself or prior consent to a transmission has been obtained, advertisement for investment products shall only be allowed via certain media. These are media, whose main topic is – at least inter alia – the presentation of economic topics. At the same time the advertisement has to be related to such presentation of economic topics. As a consequence, broadly based advertising campaigns, e. g. placarding or flyer advertisement in public, shall be prevented. Examples of allowed media shall be the business section of a daily newspaper or a news magazine. Promotional activities, “which cannot be related to any context of content due to their unspecific way of distribution and addressees” shall be prohibited in general. In our opinion, this might result in the prohibition of e. g. campaigns via Facebook, twitter or similar social networks (which are quite common currently).
The purpose of these limitations is that only persons are addressed who are willing to receive and comprehend economic information and who are expected to inform themselves by using detailed other product information. This is absolutely not in line with the concept of Crowdfunding. Crowdfunding intends to approach the broad public to shoulder funding of uprising enterprises by means of plenty of small investments.
In our opinion, this regulation hinders Crowdfunding platforms to reach the essential audience for Crowdfunding. Therefore, the exception for Crowdfunding should also preclude the requirements regarding advertisement.
Considering the aim of the German Retail Investors’ Protection Act (Kleinanlegerschutzgesetz), to protect investors from dubious and risky investment products, the intended exception, which is specifically tailored to Crowdfunding, is appreciated. It is certainly a positive signal that the legislator recognised the importance of this new kind of funding and is willing to grant Crowdfunding the possibility to establish in the market.
In order to do so, modifications to the current draft are necessary – in order to harmonize the regulation with the practical requirements of Crowdfunding – keeping in mind investors’ protec-tion. Adjustments to the current draft are required in particular in the following four fields:
- increase of the total offering maximum to over EUR 1 million,
- extension of the exception for Crowdfunding to all kinds of investment products,
- waiver of signing the VIB and
- exception from the new limitations of advertisement
If these issues are taken into account in the further legislative procedure, a new, successful regulation of Crowdfunding may be born in Germany.