Wirecard – a case of misguided industrial policy?

In light of the Wirecard scandal, Dr Tobias Dieler, Lecturer in Finance, discusses what exactly could have caused the fintech giant’s fall from grace, and how much policy-makers and financial regulators have to answer for.


Wirecard was one of the few German companies offering services in mobile payments, e-commerce, and digitisation of financial technology on a global scale. The fintech company not only captured the attention of investors but also inspired hope in politicians that finally, a German fintech star had been born. After nearly two decades of rapid growth, at its highest point, in 2018, Wirecard was worth about USD 26 billion, had a reported transaction volume of USD 125 billion, and that same year, was also admitted into the leading German stock index, DAX. This meant they were on par in terms of creditworthiness with companies like BMW, Siemens, Lufthansa and other members of Germany’s lead index.

And so, the natural question arises as to how, only two years later, this very same company could go into administration.

Although the investigation is still in its early stages, and many of the facts remain unclear, it would seem the explanation behind this historic event – the insolvency of a DAX company – may lie in the toxic interplay between Wirecard’s corporate culture, accounting firms’ nonchalant scrutiny, and German industrial policy and regulation.

In recent years, there have been a number of significant events which point in the direction of fraudulent behaviour by Wirecard’s senior executive management. In January 2019, the wider public gained its first insight into Wirecard executives’ financial conduct when Financial Times’ journalist Dan McCrum published an article about falsification of accounts, money laundering and round-tripping in the company’s Asia-Pacific operations. Towards the end of 2019 and the beginning of 2020, EY and KPMG found irregularities in Wirecard’s books and refused to approve their financial reports. Then, in June 2020, Bavarian authorities issued arrest warrants for two members of Wirecards’ senior executive management.

There is a fairly high bar in terms of economic crimes leading to arrest warrants. Prosecutors are usually required to have relatively solid proof to support their allegations, and the monetary value of the offenses must be considerable. In this instance, the central piece of evidence seems to have been a missing cash amount of about USD 2 billion on a Philippine bank account.

Around the time of these arrests, insiders at Wirecard went on record to make similar accusations to those that appeared in the Financial Times article from early 2019, and since going into administration on 25 June, more evidence has arisen which seems to suggest that the missing USD 2 billion is only the tip of the iceberg. In fact, in the firm’s final days it became clear that there had been reports of financial wrongdoings from as early as 2014. This begs the question as to what extent the accounting firms responsible for Wirecard’s financial reports could, or should, have known about its potential fraudulent behaviour.

This commentary could end here and conclude that Wirecard and, in particular, its senior management, was blindsided by greed, ambition and empire building, and that this ultimately went unchecked due to the lax scrutiny of their accounting firms. While this may hold a degree of truth, the Wirecard case also highlights Germany’s, and potentially many other countries’, flawed industrial policy.

While markets around the world are becoming more connected, governments still want to establish their national champions in each industry. Whether through direct or indirect subsidies, through trade bans, tariffs, industry standards or permissive law enforcement, these national champions are, to some extent, shielded from international competition. To understand Germany’s regulatory response, it is helpful to firstly acknowledge the situation with regards to German industries. While there are a few strong German firms which are leaders in their fields, there is a sense that Germany is lagging behind in the development of Tech companies with the potential to become industry leaders in the same way. Wirecard was a welcome exception to the rule within an underdeveloped German Tech industry.

Germany’s regulatory response to the first indications of financial wrongdoing at Wirecard was very mild to say the least. In response to the Financial Times article, the German financial conduct authority, BaFin, temporarily suspended short sales of Wirecard’s stock to “protect shareholders”. A short sale ban is a delicate decision for the regulator. It reduces an investor’s incentive to ensure they are sufficiently informed before investing into a stock, to some extent, hoping that the regulator will limit their losses if the firm’s value drops. At the same time, a ban on short sales can prevent fire sales which would otherwise destroy firm value.

Striking the balance in this trade-off is not an easy task. BaFin came out in favour of a short sale ban. And while this might have been the optimal policy response, there no or hardly any follow-up investigation into the accusations against Wirecard by BaFin.

After preventing the potential fire sale, BaFin should have put all its efforts into the investigation of Wirecard’s financial behaviour. Instead BaFin decided to take action against the journalists from the Financial Times for market manipulation. It eventually took ambitious regional prosecutors from Bavaria to investigate Wirecard’s finances, and the question should be asked whether BaFin, the German regulator ultimately responsible, was unable to detect financially unsound behaviour, or whether it simply did not want to.

The Wirecard case follows a tradition of German regulators turning a blind eye to their own financial corporations. Deutsche Bank has been involved in various scandals over the last two decades and did not face serious repercussions in Germany. Instead, it was required to pay its largest fines in the US. Similarly, after poor performance in the aftermath of the Financial Crisis in 2008, Commerzbank was partially nationalised. Today, many still regard this as a breach of EU subsidy and competition rules. Keeping weak financial institutions afloat or not enforcing market rules not only costs taxpayer money, but also lowers competitive pressure and hence decreases service quality for the consumer.


Glossary

Short sales
Investors who do not own an asset sell the asset. How does it work? Investors borrow the asset, sell it in the market, hoping for a price decrease so that when they have to return the borrowed assets, they can buy them back at a lower price than what they sold them for, thus making a profit. A short sale in practice does not require to ever own the asset but only pays out the difference between sale and purchase price minus a fee for the security lender. An investor who short sells an asset therefore needs relatively little money in comparison to owning the asset. With a short sale an investor can therefore trade a fairly large amount of assets with relatively little money. That is why short sales are considered to reinforce price downward spirals.

Fire sales
When shareholders sell a large amount of assets the asset price decreases. The price decrease may trigger other shareholders to sell. Through this mechanism a price downward spiral may occur. The asset price eventually ends up below the fundamental value of the firm.


About the author

Dr Tobias Dieler is a Lecturer in Finance at the University of Bristol. His research focuses on the Microeconomics of Financial Markets. In particular, on institutional aspects such as the division/integration of commercial bank and investment bank, the role of a CCP in money markets and the effect of differential liquidity needs in asset trade.

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