How to misplace €1.9 billion: Inside the Wirecard scandal
Monday 29th June 2020
In 2015, questions about the German financial services provider Wirecard AG started to arise. In 2016, short-sellers released a report accusing the firm of money laundering, corruption and fraud. In 2019, the Financial Times wrote a series of articles, exposing their accounting practices. Finally, on June 18th 2020, Wirecard admitted that the €1.9 billion in question “probably did not exist”, which has led to the loss of $8.3 billion in value in 3 days, the UK Financial Conduct Authority (FCA) freezing the activities of their subsidiary Wirecard Card Solutions Limited, and multiple cases being launched against not only their disgraced former CEO Markus Braun, but also against the auditing firm EY and the German Federal Financial Supervisory Authority (BaFin).
A failure on multiple fronts
Whilst the fault of the scandal undoubtedly lies within Wirecard and their rapid rise to the top of German markets, EY and BaFin played significant roles in facilitating the failure to disclose Wirecard’s shortcomings.
EY, the auditing company that was meant to be responsible for auditing Wirecard’s accounts, apparently failed to do so properly for 3 years. This is an astronomical failure on the part of the company, as a routine audit procedure could have uncovered the scandal that was occurring had they checked directly with Singapore’s OCBC Bank to confirm whether the money had entered the financial system. Instead, EY allegedly relied on documents and screenshots provided by a third-party and Wirecard employees. This follows a series of scandals that EY has been embroiled in, including a regulatory investigation into its oversight of NMC Health. More than 1,000 Wirecard investors have joined a class action seeking up to €1 billion in compensation from them, and the newspaper Der Spiegel recently reported that SoftBank also plans on suing the company over their role.
BaFin also significantly contributed – the most obvious example being the criminal complaints that they filed against FT journalists and short-sellers who had actively tried to expose Wirecard. It also banned short-selling against Wirecard, citing risks to the economy and market stability as their main concern. BaFin is Germany’s national financial regulator, and their role in the scandal could lead to a revision of how financial regulation is conducted within Germany. Currently, the statutory supervisory framework in Germany is based around principles as opposed to restrictive rules, which enables BaFin to exercise significant levels of discretionary powers on an individual case-by-case basis. Because Germany’s regulatory framework is based on EU directives, as it is an EU member state, there is the potential scope for this scandal to lead to an amendment on the current directives on capital requirements and on requirements for credit institutions and investment firms. This is not the first time that BaFin has been criticised for an ineffective response to financial wrongdoing as, in the past 10 years, Deutsche Bank, the only global financial institution in Germany, has been linked to financial malfeasance on multiple occasions – such as the $10 billion in sham Russian trades.
Carola Rinker, an economist and consultant specialising in accounting fraud, has cited a complex business model and trading in intangible assets as factors that may have hindered EY and BaFin from properly auditing the accounts and uncovering the scandal, but their previous failures speak volumes as to why the Wirecard issue has taken over 5 years to uncover since it was initially speculated about.
The implications of Wirecard moving into insolvency
With Wirecard unable to reach a deal with its lenders, the company is expecting to terminate loans amounting to €800 million on June 30th, and a further €500 million on July 1st. Customers using Wirecard’s subsidiary company, Wirecard Card Solutions Limited, have been assured that their money is safe as the FCA have frozen their assets. Fintech companies such as Curve and Pockit, who used the company to centralise finances, have released statements assuring customers that the suspension will be lifted and are working with the FCA to resolve the issue.
NN Pensii, Romania’s largest pension fund which serves 2 million Romanians, narrowly dodged disaster as they disposed of their stakes in the company just weeks before the scandal hit the news. This news has brought the fund under fire as reports have arisen questioning the fund manager’s decision to invest in foreign stocks as opposed to the local capital market. The Bucharest Stock Exchange remains largely underdeveloped as the Romanian Parliament has prevented the sales of stakes in big companies, an example being the recent hindrance of Hidroelectrica’s expected IPO.
Hedge funds who betted against Wirecard are estimated to have earned more than €1.5 billion in the week after Wirecard collapsed, making the significant profits after shorting the stock. Far more short-sellers are also predicted to have made significant gains after the revelation of the scandal.
What is a short-seller?
Short-sellers make money by betting against listed firms, by selling borrowed shares before buying them back later at a lower price. Over the past few years, they have played a significant role in uncovering financial fraud, such as the inflation of sales at Luckin Coffee and under-reporting of debt facilities at NMC Health.
