Implications of the Wirecard fraud case on B2B payments

I speak to many executives in the B2B payment industry, and the conversation usually turns to the Wirecard fraud story at some point. Typically, the first question is: How could more than $2 billion go missing and the business run for years before it goes bust?

Wirecard was the darling German fintech. What went wrong?

It was founded in 1999, during the late stages of the dotcom boom as a payment processor to help websites collect credit card payments from customers.

The Financial Times did a great series on Wirecard’s history. In 2015, The Financial Times began publishing its “House of Wirecard” series on FT Alphaville, raising questions about inconsistencies in the group’s accounts. At the time of its collapse in June, Wirecard was processing payments for many known fintechs, including Payoneer, Curve and others, according to an article from Discover Curve. After the fall, businesses ranging from airlines to retailers to fintechs that relied on Wirecard to process payments saw funds frozen and had to quickly find alternatives.

For at least five years, we had the someone shouting the “Fraud!” alarm. And that someone happened to be The Financial Times, a reputable business news source. Unlike short sellers in the stock market who have various theses that they present for self-interest, there was some real investigating going on here.

Most of us only know what a fraud looks like after the fact. There are many large-scale fraud cases — what Dennis Kozlowski did with the Tyco book or what Bernie Ebbers did with WorldCom’s books. And of course, there is Enron, and perhaps the King of fraud: Dick Fuld at Lehman.

Wirecard somehow had more than $2 billion in Philippine banks — but it really didn't have it at all. Its auditors at EY missed it. The German regulators missed it. Funny how you can fool someone with a screenshot.

Many payment executives are concerned with wondering if there is another Wirecard fraud case out there. I believe in the payment space. Problems seem to be less about out-and-out fraud but more about mismanagement.

B2B payments are more complicated than B2C payments because of one tiny issue that tends to get overlooked: how hard reconciliation is.  With B2C, you don’t have this issue. B2C transactions take place face-to-face (or card non present), and you get your goods immediately or through e-commerce with the goods arriving within a day or two. B2B transactions have disputes, invoices, adjustments and other obstacles that make reconciliation much more complex.

When you multiply these transactions into the millions, there is a lot of money moving around.  And there is a huge resource shortage of auditors and regulators that deeply understand this space (i.e., the flow of money, the discrepancies, etc.). Bank auditors and the OCC (the U.S. Office of the Comptroller of the Currency) are good at bank audits. They know what to look for when it comes to assets, capital, loans, etc. But importantly, they know the right questions to ask. When it comes to Paytech and payment service providers, it’s just not that big of an area relative to banks.

Large corporations like Amazon or Uber can hire payment experts on staff, but small fintechs cannot. Marketplaces that are growing fast with global transactions and tons of disputes and chargebacks (especially now during the coronavirus pandemic) may find some hidden surprises.

Wirecard shed light about poor oversight from auditors and regulators over an industry that is both capital lite and asset lite. Add on the systematic risk brought on by COVID-19, and there is a real fear regulators may step in and over-regulate.

I think the Wirecard fraud debacle brought out several implications:

  • How will this impact future licensing arrangements in North America, the UK and EU?
  • How will regulations be managed if a holding company has various subsidiaries running different operations and moving money around via intercompany ledgers? For example, Wirecard AG had many subsidiaries, including Wirecard Card Solutions (UK), Wirecard Bank (Germany) and Al Alaam (UAE).
  • Will there be greater scrutiny of fintech’s outsourced arrangements?
  • What redundancy plans do fintechs need? How much extra will that cost? And how quickly can they be implemented?
  • With the growing interest in digital wallet products, in which money is part of a subledger of a true bank account, B2B customers need to better understand funds at risk.
  • Will this put some fintech B2B payment companies out of business?
  • Will regulators look to add some type of insurance plan ala FDIC or FSCS?

It wasn’t long ago that Wirecard replaced Commerzbank in the Dax 30 index, making it an eligible investment for pension funds. If we can't trust audit reports and bank regulators, who can we trust?

David Gustin runs Global Business Intelligence, a research and advisory practice focused on the intersection of payments, trade finance, trade credit and working capital. He can be reached at dgustin (at) globalbanking.com.

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