(July 3): On June 18, Markus Braun, the CEO of beleaguered German FinTech firm Wirecard, walked into the criminal prosecutor’s office in Munich and surrendered himself. The 50-year-old Braun, an Austrian, co-founded Wirecard in late 1999 at the height of the dotcom bubble. After several pivots and acquisitions, Wirecard morphed into a key cog in the global financial transactions technology supply chain. Yet, for some years now, the payment firm has been embroiled in a massive accounting scandal and the subject of a long-standing investigation by a team of Financial Times reporters. Last week, Wirecard’s carefully constructed house of cards came tumbling down as it filed for bankruptcy.
Wirecard’s collapse comes just as the global FinTech sector is at an inflection point and set to drive major digital transformation in the financial services industry. Global FinTech revenues are expected to surpass US$265 billion ($369 billion) in 2025, according to a recent UBS report. Wirecard had been due to release its financial results for 2019 and the first quarter of 2020 on June 18. Instead, it admitted that it had “mischaracterised” its biggest business and that “previous financial statements may be inaccurate”. Auditor EY conceded that it could not find EUR1.9 billion ($3 billion), thereby unravelling the biggest accounting fraud since energy conglomerate Enron went belly up in 2002.
Accounting irregularities at Wirecard date back years. Essentially, it was pumping up its revenue numbers to please investors and keep its high-flying stock price airborne. Massaging revenues is one of the oldest tricks in the arsenal of fledgling digital firms. Wirecard just did it very well and successfully hid it for years. Given the complexity of the scam and the use of “third-
party” partners in Dubai, Singapore and Manila to inflate revenues, it is highly unlikely that Braun would have been able to pull it all off alone. Several other executives accused of inflating Wirecard’s balance sheets and deliberately misleading investors to boost its stock price are under investigation.
FinTech firms are entities at the intersection of finance and technology. A growing number of firms from those leveraging distributed ledger blockchain to those tackling algorithmic trading are upending financial services as we know it. By far, the hottest area is payments. The emergence of Covid-19 is helping to accelerate a transition to cash-light societies, driven by increased online spending as well as concerns around the cleanliness of cash. Once you build a scalable payments platform and you have persuaded people to adopt it, you can roll out the technology reasonably cheaply and make decent margins by taking a very small portion of each transaction.
Top FinTech disruptors such as US-based PayPal and Square are among the hottest tech stocks in the world. PayPal now boasts a market capitalisation of over US$200 billion, far more than that of Citigroup and Goldman Sachs combined. FinTech startups raised US$34 billion from 1,912 deals last year, down from US$40.8 billion through 2,049 deals in 2018, according CB Insights, a venture capital research firm.
One big driver of the FinTech boom has been the shifting of trust from century-old financial institutions to internet firms that did not exist a few years ago. Banks were once the most trusted brands and that trust was the biggest barrier to entry in banking. Now, people trust Alibaba and PayPal a lot more than HSBC or Wells Fargo.
Wirecard is a digital payment firm that had outsized exposure to e-commerce, which made it an alluring play for growth-hungry investors. If you were an investor in London, Paris or Frankfurt, and had missed the boat on getting a slice of Amazon.com or PayPal, you were buying into a FinTech promise that was Wirecard. At its height, Wirecard had a market capitalisation of nearly EUR26 billion, or more than that of Deutsche Bank, Germany’s
largest financial institution, or Swiss banking giant UBS at the time. Indeed, last year, according to Bloomberg, Wirecard was even seeking to merge with Deutsche Bank, which had the good sense to call the merger talks off.
At the apex of the payments supply chain are credit card firms like Visa, Mastercard and Japan’s JCB. Underneath them are in-store merchant acquirers and processors like
Global Payments and Fidelity National
Information Services, which acquired WorldPay last year. Next are online merchant acquirers and gateways like PayPal and Amsterdam-based Adyen. There are also point-of-sale terminal providers like Square. Many of the firms like Wirecard, PayPal and Square have a foot in several parts of the payments supply chain.
As a payment processor, Wirecard basically facilitated the relationship between the merchants selling the goods and the banks. Unlike other processors that grew gradually across Europe, Wirecard stood out because it grew exponentially — in emerging markets, particularly Asia and the Middle East. Three years ago, it purchased the merchant acquisition business of Citibank in Asia. So, if you own a store or restaurant in Singapore or Malaysia, you might get a Wirecard representative calling you to sell you the benefit of accepting Visa or Mastercard.
Merchant acquirers get a cut from the card issuer or the bank. Another part of Wirecard has lots of other fairly small customers, such as websites that generated revenues, and you could just pay online with a credit or debit card using third-party partners. Apparently, some of these third-party customers either did not exist, or if they did, were mere puppets of Wirecard. The German FinTech used third-party business partners in emerging markets, particularly in countries where it did not have a licence to operate. Most of the allegations against Wirecard are centred on those third-party partners, which were effectively posting fake revenues.
Wirecard’s dramatic rise and precipitous fall is likely to have major implications for Europe’s fledgling tech sector. The FinTech firm was seen as the shining star of the European tech sector, Germany’s “Great Tech Hope”, and praised as an example of the country’s ability to produce successful technology firms. Now, it has become a national embarrassment. While there are tech darlings outside the
US, notably China’s Alibaba, South Korea’s Samsung Electronics and Japan’s SoftBank, Nintendo and Sony, there are few in Europe that come anywhere near US giants such as Amazon.com or Apple, both of which are valued at over US$1 trillion.
Europe has many industrial technology firms, such as Siemens and Airbus, that are as good as, if not better than, their US counterparts, but nothing in the digital or consumer technology segment or e-commerce — a segment in which US tech giants dominate and continue to build on their huge lead against global competitors. The closest thing to a successful tech company in Germany is industrial software firm SAP, which has only recently started to transition to cloud services.
Because of what the eventual success of a giant FinTech firm could mean to Europe, the German establishment went to huge lengths to protect and defend Wirecard even as allegations against the firm mounted over the past two years. Instead of scrutinising the company, its management and its third-party partners in emerging markets, German regulators targeted short-sellers, whom they blamed for its growing problems.
Wirecard was the glimmer of hope for European tech investors. People in Germany wanted to believe in the Wirecard story. Many German retail investors lost a lot of money. Wirecard is to German retail investors what high-flying stocks such as Tesla or Netflix are to American mom-and-pop investors. German retail investors bet big on the stock, saw it climb 26-fold between 2010 and 2018, and are now seeing it unravel. Wirecard shares are down 94% from their peak two years ago.
Tighter regulation needed
Payment firms are in the business of trust. Once you are embroiled in a scandal, you lose the trust of your customers. Digitisation of payments is being accelerated in the aftermath of the Covid-19 pandemic to power the growth in e-commerce. Consumers are increasingly using digital wallets like Apple Pay or Google Pay or contactless tap-to-pay rather than cash or handing over a credit or debit card to the cashier for swiping. The irony of Wirecard’s collapse is that the post-pandemic era would have dramatically boosted its transaction volumes. Yet, because of the severity of the fraud, the lights are about to be switched off at its offices worldwide.
A big loser is Germany and its fledgling tech sector. The collapse of Wirecard has done tremendous damage to the country’s reputation as well as the reputation of
BaFin, the financial regulator. Clearly, Wirecard’s accounting fraud did not begin yesterday. It had been going on for years. The EU is now probing BaFin. There is also a need to look at the role of auditor EY not just in Germany, but elsewhere, including Singapore, whether it helped facilitate Wirecard in cooking its books for years.
Clearly, regulation of the sprawling global FinTech sector needs to be tightened up around the world. Until now, regulators have been reluctant to impose too many rules to rein in FinTech firms because they do not want to be seen to be stifling innovation and cutting-edge technology. I totally get it that governments in Asia want to help create an ecosystem that can spawn the next PayPal, Square or Stripe. Nobody wants to kill the goose that might lay golden eggs tomorrow. But the lesson from the Wirecard saga is that left to their own devices, FinTechs can and often do take advantage of loopholes and lax regulation.
Payment technology involves moving money belonging to you and me around the world. Consumer trust of traditional banks eroded over time and the 2008 financial crisis only accelerated the pace. Now Wirecard is threatening to dent the credibility of FinTechs as well.
Years from now, Wirecard will be seen as just a bump in the road for FinTechs. The financial services sector desperately needs cutting-edge technology to slash costs, become more efficient and user-friendly. Hopefully, the scandal will be a wake-up call for regulators and central banks to quickly put up adequate rules to protect our money. If regulators will not allow a licensed bank to mislead us, why allow FinTech players to do just that in the name of encouraging innovation?
Assif Shameen is a technology and business writer based in North America.