Down to the Wire: The Domino Effect That Led to the Collapse of Germany’s Fintech Poster Child

Published On February 16, 2021

Now that the dust has settled following Wirecard’s monumental collapse, Radar takes a look at exactly what went wrong and how regulators are changing to ensure the same mistakes can be avoided in the future. 

Founded in 1999, Wirecard set out to make online payments fast, safe and convenient. Piggybacking off the boom in e-commerce, the company grew rapidly, quickly becoming the leading light of Germany’s burgeoning fintech scene. 

Wirecard’s global aspirations became clear in 2010 when CEO Markus Braun made English the company’s official language. For the next four years, Wirecard acquired a number of smaller payment companies around the world with a particular emphasis on Asia. 

At its peak in September 2018, Wirecard had a valuation of US$28 billion (€24.6 billion) and became part of Germany’s DAX 30 index, placing it among esteemed company, such as Deutsche Bank, Allianz and Adidas. In an interview with Bloomberg at the time, Braun spoke confidently about how Wirecard would continue to capitalize on the growth of card payments around the world. 

However, just two years later, Wirecard became insolvent after admitting to one of the largest accounting frauds in post-war Germany.

The Fall from Grace 

For years, Wirecard was plagued by a series of serious allegations of accounting irregularities. In 2015, the Financial Times claimed there was a $300 million (€250 million) hole in Wirecard’s balance sheet. Another report in the same year by J Capital Research suggested that the company’s Asian business was significantly smaller than it claimed to be. In 2018, a whistleblower from the company’s Singapore office alleged that members of the finance team were part of a fraud referred to as “round-tripping”, which involved sending money to third-parties in India. 

Every time an accusation was made, the same thing happened: it was vehemently denied by Wirecard who claimed that the allegations were part of an ongoing conspiracy by a covert cabal of journalists and short sellers attempting to manipulate Wirecard’s share price for their own financial gain. 

In an attempt to protect the integrity of their brand, Wirecard enlisted an expensively assembled team of top London law firms, private investigators and consultants. In fact, by the time of Wirecard’s demise, the company was spending $158 million (£120 million) per year on what was loosely labelled as “advice”. 

Despite these high-profile allegations, investor confidence in Wirecard remained sky-high for two main reasons. Firstly, the company’s long-time auditor, EY, continued to give the company a clean bill of health. Secondly, Wirecard’s seemingly lucrative operations in Asia, overseen by Braun’s protege, fellow Austrian and COO Jan Marsalek, were generating a huge amount of revenue. Wirecard was outsourcing payment processing to third-parties in locations where it didn’t hold a license and the commission from these payments, said to total $2.1 billion (€1.9 billion), were being held in escrow accounts in the Philippines. 

The beginning of the end for Wirecard came in October 2019 when the Financial Times published an article that claimed that they had seen documents that proved Wirecard was inflating its profits in Dublin and Dubai. In response, Wirecard appointed KPMG to conduct a “special audit” to prove that the allegations were unfounded. In April 2020, KPMG published its report. 

As well as discovering that numerous contracts were often left unsigned and minutes weren’t being kept at meetings, auditors found that they could not substantiate Wirecard’s profits over the previous two years. 

Then, in June 2020, Filipino banks BPI and BDO informed EY that the amounts supposedly held by Wirecard in escrow accounts did not exist and that the documents presented by the company to prove its validity were “spurious”. Wirecard then admitted that the money probably didn’t exist, Braun resigned before being arrested on suspicious accounting and Jan Marsalek was suspended before fleeing the country. 

On June 25 2020, Wirecard filed for insolvency. 

The Role of Regulators 

Sadly, no one comes out of this story unscathed. EY is facing intense scrutiny into how, for over a decade as Wirecard’s auditor, it didn’t report any red flags despite overwhelming evidence that accounting irregularities were ongoing for a number of years. 

And then there is the German regulator BaFin. Whenever allegations were made against Wirecard, BaFin seemingly sided with Germany’s fintech poster child instead of investigating the company’s growing list of alleged malfeasances. 

In 2016, when a group of anonymous short sellers known as Zatarra published allegations of money laundering at Wirecard, BaFin investigated Zatarra for market manipulation. 

In January 2019, when the Financial Times published allegations about accounting irregularities at Wirecard’s Singapore office, BaFin investigated the Financial Times for market manipulation.

When Singapore police subsequently raided Wirecard’s office, BaFin imposed a two-month ban on short-selling after its share price dipped below $120 (€100) citing a “serious threat to market confidence.”

While this may look like a concerted effort to protect Wirecard at all costs, BaFin, to some extent, was hamstrung by its own legal remit. 

The regulator’s president, Felix Hufeld, has since argued that German capital markets laws left the agency no alternative but to act as it did.

BaFin lacked the legal authority required to investigate Wirecard in its entirety and instead oversaw only Wirecard Bank, a subsidiary of the group. 

What BaFin was able to do was refer the investigation to the Financial Reporting Enforcement Panel (FREP), a private sector organization that monitors the accounting practices of listed companies on behalf of the government. This happened in February 2019 following the Singapore allegations.

The only issue was that FREP had a measly annual budget of just $7.3 million (€6 million) per year and only 15 employees. Worse still, BaFin could not initiate its own investigation into Wirecard until FREP had published the results of its inquiry. When Wirecard filed for insolvency in June 2020, the FREP investigation was still underway and it was only afterward that they found the company’s financial statements were indeed inaccurate.

The Fallout and Future of German Regulation

Although the repercussions of the Wirecard scandal are likely to rumble on for some time, there has already been significant fallout.

Former EY partner Andreas Loetscher, who oversaw Wirecard’s audits, has been temporarily removed from his post as Deutsche Bank’s head of accounting after prosecutors launched a criminal investigation into potential violations of professional duties during Wirecard audits. He faces up to three years in jail if it can be proved that EY knew it was providing factually inaccurate audits.

In order to improve the effectiveness of the audit process, the finance ministry has proposed that large companies should switch auditors more frequently and that accountancy firms should clearly distinguish between their auditing function and consultancy business in order to remove any potential conflicts of interest.

With regards to BaFin, there are already plans underway to restructure the regulator after its reputation was left in tatters. Hufeld admitted that it “had not been effective enough” and a finance minister proposed that, “If we come to the conclusion that BaFin needs more money, more jobs and more competency, I will make every effort to ensure that this happens.” 

Since then, three key areas for reform have been identified. Firstly, BaFin will be given license to launch its own detailed investigations into any company at any time without having to wait for the outcome of a FREP probe.

BaFin is also assessing the creation of a new internal unit, much like the Asset Management Unit which was set up by the U.S. Securities and Exchange Commission in the wake of the 2009 financial crisis, that will pay special attention to institutions that pose significant regulatory risks.

Finally, the regulator will review its internal processes to ensure that information provided by whistleblowers is incorporated into its investigations in a way that helps to build a body of evidence instead of collecting disparate pieces of information that aren’t utilized to their full potential.

As is often the case with a scandal of this magnitude, reverberations are also being felt by the political elite. Even as the warning signs grew for Wirecard, Angela Merkel was lobbying on the company’s behalf as late as September 2019 on a trip to China. While the German Chancellor attested that she “had no knowledge” of Wirecard’s indiscretions and that, “It’s common practice, not only in Germany, to bring up the concerns of companies on foreign trips,” it is likely that the fallout from the Wirecard scandal will rumble on in the courts and the Bundestag for years to come.