This article first appeared in The Edge Malaysia Weekly on June 29, 2020 - July 5, 2020

ON June 18, Markus Braun, the CEO of beleaguered German fintech firm Wirecard, walked into Munich’s criminal prosecutor’s office and surrendered himself.  A former management consultant at KPMG, Braun co-founded Wirecard in late 1999 at the height of the dotcom bubble. Now, he was throwing up his hands and admitting that he had no idea what had happened to US$2 billion (RM8.55 billion) of Wirecard funds that its auditors could not locate.

After several pivots and acquisitions, Wirecard had morphed into a key cog in the global financial transactions technology supply chain. Yet, for some years now, it 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, its carefully constructed house of cards came tumbling down. Unless a white knight appears, Wirecard is headed for bankruptcy within weeks.

The company’s spectacular 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 in 2025, implying an average annual growth rate that is more than three times faster than the broader global financial sector, according a recent report by Swiss bank UBS.

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 €1.9 billion or US$2 billion. Four days later, as CEO Braun was being arrested, Wirecard’s board admitted that the money in fact did not exist, thereby unravelling the biggest accounting fraud since energy conglomerate Enron went belly up in 2002.

Accounting problems at the German fintech firm date back years. Essentially, Wirecard was pumping up its revenue numbers to please investors and keep its high-flying stock price airborne. Given the complexity of the scam, it is highly unlikely that Braun would have been able to pull it all off alone. Prosecutors are now investigating several other executives accused of inflating Wirecard’s balance sheets and deliberately misleading investors to boost its stock price.

How long has scam  been going on?

The “missing” US$2 billion was supposed to have been held in escrow accounts in the Philippines, but the two banks that were supposed to be holding the accounts have since said they have no relationship with Wirecard, any of its subsidiaries or affiliates. Even the trustees that the company reportedly appointed to manage those accounts had never been clients of the two Manila-based banks, and the Philippine central bank said last week that money never entered the country or its banking system.

How long has this scam been going on? Hedge funds in Europe and the US have been shorting Wirecard stock for years, pointing to persistent accounting irregularities while German regulators repeatedly ignored their pleas to investigate the fintech firm. “People kept giving it the benefit of the doubt over and over when evidence was irrefutable that something was very wrong at Wirecard,” veteran short-seller Jim Chanos of Kynikos Associates said in a TV interview last week. Wirecard was Kynikos’ largest short position and the biggest position in its global hedge fund.

Fintech firms are the entities at the intersection of finance and technology. Once you build a scalable fintech platform and you have persuaded people to adopt it, you can roll the technology out reasonably cheaply and make decent margins by taking a very small portion of each transaction. Top fintech disruptors such as the US’ 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 Citigroup and Goldman Sachs combined.

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 lured into buying a fintech stock such as Wirecard. At its height, Wirecard had a market capitalisation of nearly €26 billion (RM125.1 billion), or more than Deutsche Bank, Germany’s largest financial institution, or Swiss banking giant UBS at the time. Indeed, two years ago, according to Bloomberg, Wirecard was even seeking to merge with Deutsche Bank, which had the good sense to call the merger talks off.

As a payment processor, Wirecard basically facilitated the relationship between the merchants selling the goods and the banks. Unlike other payment processors that grew gradually across Europe, Wirecard stood out because it grew exponentially — in emerging markets, particularly Asia and the Middle East.

Wirecard’s business comprises several parts. One chunk has customers for whom it processed payment transactions directly. Three years ago, Wirecard purchased the merchant acquisition business of Citibank in Asia. So, if you own a store or hotel 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 customers. Apparently, some of these third-party customers either did not exist, or if they did, they were actually doing whatever CEO Braun or his teammates told them to do. Wirecard used third-party business partners in emerging markets, particularly in countries where it did not have a licence to operate, as such effectively outsourcing the licensing to third-party operators.

Most of the allegations against Wirecard are centred on those third-party partners, who were effectively posting fake revenues. It is unclear just how complicit Wirecard’s top management was in the fraud, and if indeed they were not themselves directly involved in helping cook the books, when Braun and other Wirecard officials first realised that their third-party partners’ revenue numbers did not add up.

Blow to Europe’s fledgling tech sector

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 Group Holding, 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, Apple or Microsoft Corp, all of whom are valued at over US$1 trillion.

Europe, particularly Germany, 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 such as Amazon, Facebook and ­Google 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 93% from their peak two years ago.

So, what’s next? Watch what Wirecard’s lenders do. A consortium of banks, mostly German and European, has collectively lent just over US$2.3 billion to Wirecard. Unless it publishes audited annual results by June 30, the banks can call back those loans, and since the company has very little cash, the action would mean imminent bankruptcy. Effectively, Wirecard is at the mercy of its lenders and needs to convince them not to pull the plug.

Tighter regulation needed

It is highly unlikely that Wirecard will survive as a standalone entity. Fintech companies, particularly those focused on payments, are in the business of trust. Once you are embroiled in a scandal, you lose the trust of your customers. Still, there are many fintech companies that would be eager to look at parts of the Wirecard business they could add to their own portfolio.

Digitisation of payments is being accelerated in the aftermath of the Covid-19 pandemic to power e-commerce. Consumers are increasingly using digital wallets 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 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, according to several fintech executives in the US I talked to this past week.

Regulation of the sprawling global fintech sector needs be tightened up, not just in Germany but globally. Until now, regulators have been reluctant to impose too many rules to rein in fintech companies because they do not want to be seen to be stifling innovation and cutting-edge technology. Fintech involves moving money belonging to you and me around the world. Let’s hope the Wirecard scandal will be the wake-up call for regulators and central banks in Asia and globally to quickly put up adequate rules to protect our money. If regulators will not allow a licensed bank to cheat us, why allow fintech players to do just that in the name of encouraging innovation?

Assif Shameen is a technology writer based in North America

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