Germany is reforming financial regulation in the wake of Wirecard, should other countries follow suit?

The Wirecard debacle back in June was one of the biggest financial news stories of the year so far. It emerged that the payment processor had ‘lost’ around $1.9 bn in trust accounts just before it collapsed into insolvency, sending shockwaves around the sector.

It became clear that the stock market darling was heading for trouble when it delayed its latest financial results for the third time on June 18, and subsequently it came to light that the missing funds were probably down to fraud rather than an accounting error, leading to the arrest of former CEO Markus Braun.

A huge number of fintechs were affected by Wirecard’s collapse, including Pockit, Curve, FairFX, Soldo and ANNA, and although customers were swiftly reassured that their funds were not at risk, many were unable to access money for some weeks.

At first glance, the Wirecard scandal looked like a regulatory issue but as the situation unfolded, it started to look a bit more like a straightforward case of accounting fraud. Having said that, some regulatory weak points have emerged, and they have prompted the German regulator, BaFin, to take action.

What action is the German regulator taking?

BaFin has come under fire for allegedly failing to follow up on numerous media and analyst reports about suspected fraud at Wirecard. Prosecutors suspect that the fraud could date back as early as 2015 when the payment processing firm’s revenue was artificially inflated to try and deceive investors.

In response to the criticism, the German finance ministry has put forward a plan to beef up BaFin’s powers and those of APAS, Germany’s auditing regulator. The proposal would give BaFin ‘sovereign powers’, so that it could intervene ‘directly and immediately’ in public companies. In a statement, the Germany ministry said: “BaFin should have the right to carry out special audits of all capital market-oriented companies, including the right to access information from third parties, the ability to carry out forensic investigations and the right to inform the public about its auditing of balance sheets earlier than is currently the case.”

Part of the proposal also includes bolstering the powers of APAS, so it can impose tougher sanctions on any firms breaking the rule and forcing companies to replace their auditor every ten years.

The German ministry has also cancelled its contract with private sector body FREP, which was previously responsible for monitoring the financial reporting of the country’s listed companies. The new proposal also calls for BaFin to examine its organisational structure and review the way it is protecting consumer and shareholder rights.

Should other countries take action?

BaFin wasn’t the only regulator to come under fire about Wirecard – the FCA froze the accounts of the firm’s UK entity, leaving many consumers unable to access funds on a Friday afternoon. Some critics think that the UK regulator should have been placing closer scrutiny on Wirecard long before the situation came to a head and have called for a tightening in regulation. The FCA has prioritised regulation for fintechs, challenger banks and cryptocurrencies in its 2020/21 business plan, setting out intentions to engage with industry about artificial intelligence and strengthen anti-money laundering regulations, but is that enough?

Given that up to 90 per cent of card payments in the UK are served by just two merchant acquirers, some commentators have questioned whether the country needs a payments equivalent of the EU Bank Recovery and Resolutions Directive.

Is EU reform necessary?

In the wake of the scandal, there is a growing consensus that bulking up German regulation is not enough and a full EU reform is needed especially in terms of the supervision of financial reporting. In fact, the proposal from the German ministry calls for a transformation for the EU’s financial oversight body, ESMA, into a ‘European Securities and Exchange Commission’, which similarly to the Securities and Exchange Commission in the US, would have greater powers to demand information from listed companies.

Alternatively, a new specialised entity could be created to supervise financial reporting and placed under the direction of ESMA – similar to the way the Public Company Accounting Oversight Board operates under the SEC in the US.

There will always be objections to EU-wide reform as opposed to national supervisory changes, particularly where private companies and auditing are likely to come under greater scrutiny. 

However the $2.2 billion Wirecard scandal, has revealed some major gaps in the EU and German financial reporting and auditing processes – as well as demonstrating how quickly a fall from grace can happen. Major reform across most jurisdictions is probably important to restore and maintain faith in the burgeoning fintech sector, and the way that EU-wide legislation has been successfully applied to anti-money laundering regulation shows that is possible in other areas too.