How Wirecard’s fall is likely to impact the FinTech industry

Kumar Kartikeya Prakash and Akash Srinivasan

It is not uncommon for media’s exposé to make headlines, but Financial Times’ persevered watch on Wirecard AG (Wirecard) revealed one of the biggest accounting frauds in the world. Wirecard provides payment solutions, software for digital payments and fraud prevention systems to large companies such as FedEx and KLM, and acts as a card issuer and sponsor for several FinTech companies, globally.

Founded initially as a payments processor for online gambling and adult websites, Wirecard grew exponentially over the years to become Europe’s FinTech success story and Europe’s biggest competitor to the Silicon Valley giants.

On June 22, Wirecard announced that €1.9 billion had disappeared from its balance sheet. This led to a 98 percent fall in its share price and the arrest of its former CEO, Markus Braun, on the ground of suspected falsification of accounts and money laundering. Since 2009, EY had been involved as the company’s auditors and in late 2019, KPMG was appointed to carry out a special audit, which highlighted certain gaps in verifying Wirecard’s profits.

Regulatory Oversight?

This incident raised concerns over how BaFin, Germany’s financial regulator, dealt with the situation, despite multiple investor complaints and whistle-blower allegations over the years. Public sources indicate that measures undertaken were unsatisfactory.

However, one may note that the regulatory framework precludes BaFin from investigating on its own. Instead, the Financial Reporting Enforcement Panel (FREP), a private institution and Germany’s accounting watchdog, has the right to conduct the first probe over such allegations. Unusually, the FREP’s relationship with the government is contractual, rather than statutory, and is under the scanner now.

Impact on Indian FinTech

Wirecard’s scandal brings to the fore several complexities that could concern the Indian FinTech industry. Some of them are:

Payment chains consist of several companies that are inter-dependent, but do not always compete with each other. The India’s FinTech industry is built on inter-dependence, where the smaller players are more dependent on the larger ones for sustenance and growth, and such failures can have alarming repercussions on the financial system. For instance, when the United Kingdom ordered the suspension of Wirecard UK’s regulated activities, it caused panic as several FinTechs were dependent on Wirecard for debit card issuance and e-money licensing, and were struggling to find new suppliers and card issuers.

In India, such an incident could lead to suspension of accounts and consequent blockage of cash flow, severely impacting the services of several FinTech businesses.

While reports don’t indicate that customers’ money was compromised, such an incident nevertheless causes severe trust deficit among stakeholders — customers, investors and merchants. It will slow funding and collaborations and hamper the growth of the industry.

Even card networks such as Visa and MasterCard may suspend their affiliations with such faltering companies, causing disruptions to their card issuing and settlement functions.

While the Payment and Settlement Systems Act, 2007 (PSS Act) requires payment processors to store customers’ money only in a prescribed escrow account, any wrongdoing in this regard may have a bigger impact on the payments processing eco-system, causing a systemic risk.

Given the repercussions of inter-dependence and potential loss of trust, FinTech companies may want to reduce their dependence on the big players — this, however, may be counterproductive. Typically, such a move to harbour critical aspects in-house is costly and time consuming, given the regulatory requirements, and will eventually cause a drag on business.

Indian Regulatory Framework

While accounting frauds are not uncommon in India, over time, there has been increased emphasis on regulatory oversight and better corporate governance. The Companies Act, 2013, contemplates the establishment of the National Financial Reporting Authority to regulate accounting and auditing standards for certain class of companies (in addition to the scrutiny of the Institute of Chartered Accountants in India, as generally applicable).

Payments system participants are governed by the PSS Act and the regulations framed by the Reserve Bank of India. Also, financial institutions are governed by the Prevention of Money Laundering Act, 2002, which seeks to monitor and punish money laundering and prescribes reporting obligations for suspicious transactions.

To conclude, while regulations may imply safeguards, it is up to the industry players to instil and increase stakeholders’ confidence in the growth story of the FinTech and payments industry.

Kumar Kartikeya Prakash is Principal Associate and Akash Srinivasan is Associate, Khaitan & Co. Views are personal.