Wirecard collapse will likely lead to overhaul of EU Financial Services Regulation

On 25 June 2020 Wirecard, the German payment processor and financial services provider filed for insolvency after the once high-flying company revealed a multi-year fraud which led to a EUR 1.9 billion hole in its accounts. Wirecard’s failure is expected to give rise to big losses for its creditors and the company’s regulators have come in for criticism. In comments made to reporters last week Valdis Dombrovskis, the EU Commissioner for Financial Stability, Financial Services and the Capital Markets Union set out that the EU “will assess how to improve the relevant EU rules so these kinds of cases can be detected”. 

On 25 June 2020 Wirecard, the German payment processor and financial services provider, filed for insolvency following an earlier announcement that EUR 1.9 billion in cash was missing from its accounts. Its CEO Markus Braun was arrested by German Authorities and questions have been raised with regards to the role of the company’s regulators and auditors. Felix Hufeld, the head of Germany’s Federal Financial Supervisory Authority (“BaFin”) described the issue as a “complete disaster”, and a “shame for Germany”. Germany’s economy minister, Peter Altmaier, said that “We would have expected such a situation anywhere in the world, but not in Germany”.

The announcement and insolvency filing followed allegations of accounting malpractice that had trailed the company for years. The Financial Times (“FT”) originally reported on Wirecard in 2015, questioning why the company kept paying large sums in advance of deals completing, why millions were being spent on struggling Asian businesses and why accounts filed in Singapore did not match reports filed in Germany.

Following several similar reports and publications, BaFin’s initial reaction was to file a criminal complaint against two FT journalists and several short-sellers for market manipulation. BaFin also announced that it would temporarily ban short-selling of Wirecard stock (a first for an individual stock) without embarking on any examination of the substance of the allegations.

Eventually however, the reports and concerns about Wirecard’s business proved remarkably prescient. On 18 June 2020, EY, the company’s auditors, announced that EUR 1.9bn was missing from the company’s accounts. EY had failed to verify that the funds in question were held by a Singaporean bank, as alleged by the company in the preceding three years financial years. The company’s insolvency filing followed a week later.

The Wirecard case is noteworthy for many reasons, not least because it demonstrated failures in three safeguards all designed to protect EU investors: regulations and corporate governance requirements should have ensured proper accounting procedures within Wirecard, EY should have verified the accuracy of the company’s accounts, and supervisory work by regulatory authorities not only failed to identify issues but instead moved in the other direction by banning short-selling in the stock. In his comments to reporters last week Mr Dombrovskis referred to these failures and set out that “Wirecard’s failure potentially raises issues at all three levels of defence and this is why we are now looking at those issues comprehensively to draw all lessons that need to be launched and take necessary actions”.

Further to an examination of the role of audit committees announced by Mr Dombrovskis to see whether stronger EU rules in this area are required, the European Securities and Markets Authority (“ESMA”) has announced that it will launch an assessment of the supervisory response by BaFin and Financial Reporting Enforcement Panel (“FREP”), Germany’s accounting watchdog. ESMA’s assessment will focus on whether their own “Guidelines on the Enforcement of Financial Information” were applied by BaFin and FREP. These guidelines were published by ESMA in 2014 and apply to all competent authorities within the EU that undertake enforcement of financial information under the Transparency Directive.

Ultimately, the reviews might lead to changes in the way that fintech firms are regulated throughout the EU. Wirecard began life as a company processing electronic payments and acquired a banking license in 2006. Crucially, this hybrid model of banking and non-banking operations made its financial statements harder to compare with those of its peers in either industry and helped persuade investors to rely on adjusted versions of its financial statements. Furthermore, as BaFin was only required to regulate the banking operations of Wirecard’s business, its hybrid structure meant that BaFin did not have the authority to investigate the company’s core business and its accounting practices.

The German government has already sought to address this latter weakness as it has announced that it will terminate its contract with FREP and will give the power to launch investigations into companies’ financial reporting to BaFin. Ultimately, due to the scale and nature of Wirecard’s collapse, changes such as this might only be the tip of the iceberg with several more changes in financial services regulation throughout the EU potentially following. Watch this space.

If you have any questions or comments about financial services or fintech regulation, the Investment Services and Funds team at Chrysostomides may be able to assist you. Please do not hesitate to contact us.