Mon. Aug 10th, 2020

Planet Compliance

Innovation & Regulation in Finance

A Regulator’s Nightmare – A German FinTech Fairytale

6 min read

The Wirecard story is many things – one of them a prime example of a regulator’s struggle with innovation.

Another chapter in the compendium of corporate fraud

Imagine you run a seemingly successful company and from one day to the other you have to admit that a quarter of your assets actually do not exist. Sounds like a story right out of the Bernie Madoff playbook, doesn’t it?

Next thing you know your stock price crashes and wipes out first more than 80% to consolidate somewhere around 3% what it was worth only two weeks ago.

You get arrested and your days as an acclaimed CEO of a billion-dollar company are definitely over while the firm files for bankruptcy. Welcome to the Wirecard nightmare! It is an unbelievable tale of a company that rose from the ashes of the dot-com bubble to establish itself as one of the few European FinTech unicorns to rival Silicon Valley’s success stories only to show alarming similarities to another American business story, the Enron scandal, one of the biggest audit failures in history with more than $60 billion in assets and the downfall of Arthur Andersen, then one of the big five accounting firms.

 

Worrying similarities

Now as then shareholders, politicians and regulators wanted to believe in a story that was too good to be true. Then and now, red flags had appeared long before the eventual collapse and rumors were ignored. Though that is in the case of Wirecard not entirely true: after all, the German financial watchdog BaFin had been shoring up the company against evil short-sellers that had smelled blood in the water and circled their prey.

 

I want to believe

In February 2019, the German Bundesanstalt für Finanzdienstleistungsaufsicht (or BaFin / the Federal Financial Supervisory Authority) issued a general administrative act prohibiting establishing and increasing net short positions in shares of the embattled German FinTech wonder. When reports appeared of accounting and contract irregularities at its Singapore unit, Wirecard’s stock price immediately got under pressure and the German regulator responded. Citing the company’s importance and connections to more than 200 international payment networks as well as contracts with major credit card companies, BaFin stated that the attacks on Wirecard posed a risk to market integrity in Germany and the trust in fair and efficient price determination.

The Financial Times had referred to documents that were describing potential fraud and money laundering at the German payments firm with a senior executive at the firm suspected of forging and backdating contracts.

Still, the German regulator stood by its belief that this was a temporary and unjustified assault on the country’s most precious FinTech success story.

The Germans weren’t alone though. Whenever the regulatory authority of a EU member state issues a short selling ban, it is reviewed by the European Securities and Markets Authority (ESMA). That was the case, too, with regard to the Wirecard measures and ESMA issued an official opinion agreeing to an emergency net short position ban, on net short positions in Wirecard shares under the Short Selling Regulation.

Furthermore, the activity would have been a clear violation of securities laws in Singapore and now its regulator MAS equally faces questions about its practices.

A Brave New World

Little more than a year and a global pandemic later and everything is under examination and the eventual fallout is difficult to predict. The industry speculates about what might happen with the remains of the once proud Fintech giant. There are likely to be criminal proceedings against various decision makers of the company. Another interesting aspect will be the impact this scandal will have on the firm’s auditor: Ernst & Young may have been aware or has had serious concerns on the practices at Wirecard for years and still signed off on its annual accounts. Will it face a similar fate as its former peer among the Big 5? Will this result in a serious review of the way the remaining four operate? Only time will tell.

One of the first questions that will be answered might be the future of BaFin’s first officer, Felix Hufeld. BaFin, unlike other regulatory authorities, cannot be considered at the forefront of FinTech innovation and continuously shows caution when it comes to promoting innovation in Europe’s largest economy. Safety first appears to be the governing credo and still all caution seems to have been abandoned in the case of Wirecard. The German government has so far backed the head of its regulator and the organization itself, but pressure is building up and some of the details surfacing don’t paint a very flattering picture. In an article with Bloomberg, Hufeld said that with regard to the “complete disaster we’re looking at”, “it starts with looking at complete failure of a senior management, despite many, many hints to discover the facts”.  He said that “it goes on to the scores of auditors who couldn’t dig up the truth and it goes on with a whole range of private and public entities including my own who have not been effective enough to prevent something like that happening.” Which, in turn, raises the question where BaFin was during this time and why it had not felt compelled to dig deeper. This week, he defended the agency by telling a closed-door session of the Bundestag’s finance committee that BaFin only oversaw Wirecard Bank. Still, not everything is as straightforward as Hufeld would like it to be. Only yesterday, BaFin was compelled to issue a statement that clarified some of his statements in front of the finance committee regarding Wirecard’s regulatory status. At the same time, German newspaper FAZ discovered gaps in the anti-money laundering oversight of the company that raise serious concerns.

 

What next for…?

Is it enough to safe his head and what will be the consequences for his organization?

The head of hedge fund Odey Asset Management, Crispin Odey, apparently is planning to sue the German financial regulator for millions of pounds after it banned short-selling on Wirecard last year. It is only going to increase the scrutiny Hufeld and the agency have come under. Many aspects will remain subject of speculation like whether BaFin wanted to believe in its fallen FinTech hero to compensate for the criticized lack of innovation in Germany until it was too late.

Whatever may come out or not, whatever the consequences will for the different stakeholders in this nightmare, it is story that demonstrate the difficulties of the authorities dealing with regulating innovation and how to strike the right balance. Albeit a story that has gone horribly wrong.

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