Wirecard Scandal Exposed Chinks in UK Safeguarding Rules
The accounting scandal at German payments company Wirecard
shook the global fintech sector this summer, but it also had a tangible impact
on the customers of UK fintech companies that had relied on Wirecard’s
services.
Years of dogged reporting by the Financial Times came to a
head in June, when Wirecard admitted that €1.9bn in cash was missing from its
balance sheet, prompting a collapse in its share price. In roughly a week the
company went from being valued at $14bn to filing for the German equivalent of
bankruptcy.
On 26 June, the Financial Conduct Authority froze Wirecard’s
UK arm, Wirecard Card Solutions Limited. This meant the firm could not dispose
of any assets or funds, could not carry out any regulated activities and had to
issue a statement on its website clarifying that.
The FCA’s intervention temporarily prevented thousands if
not millions of UK customers from accessing cash held in a number of financial
apps, including current account providers Curve, Pockit and U Account.
“The primary objective of these requirements was to protect
the electronic money funds of consumers in safeguarded accounts. It also had
the effect of preventing consumers from withdrawing and making payments with
those funds,” said the regulator in a statement.
After a few days, on 30 June, the finance watchdog allowed
Wirecard to resume its e-money and payment services.
But the disruption caused by the episode has put a dent in
the confidence of regulators and policymakers about the adequacy of so-called
e-money rules, which govern most fintech firms.
The FCA tightened rules for payments firms and e-money
issuers in early July, and later that month the All Party Parliamentary Group
(APPG) on Challenger Banks and Building Societies, led by Karen Bradley MP,
opened a probe into Wirecard’s collapse to establish whether a similar scenario
could unfold again in the UK’s fintech sector.
“Everybody was following the rules, and yet it still created
this mini-catastrophe,” said Simon Taylor, co-founder of the fintech
consultancy 11:FS. He added that “a lot of things just weren’t anticipated”.
Nigel Verdon, co-founder and chief executive of the
banking-as-a-service provider Railsbank, is in a good position to explain
exactly what was unexpected.
“One of the things that’s hampering the regulators here is
the client money safeguarding regulation is out of whack with the Companies Act
and insolvency regulation,” said Verdon.
The big issue, he explained, is contamination.
Under e-money rules in the UK, client money is supposed to
be ring-fenced so that if the issuing business goes down, customers’ funds will
be safe. But if one penny of non-customer money is found mixed in with client
funds when an e-money business goes pop, creditors can claim from the client
money pool, according to Verdon.
This would appear to chime with the FCA’s objective, when it
froze Wirecard Card Solutions, of protecting electronic money funds.
A second unforeseen kink in the e-money regime’s armour,
according to Verdon, is that if a company governed by those rules goes bust and
has kept poor records of the whereabouts of client money, the liquidator can
extract fees for figuring out where the money is from the client account.
“Which isn’t a great thing for client money!” said Verdon,
putting it mildly.
These vulnerabilities are all the more shocking because
fintech firms that operated under e-money rules in the UK have long trumpeted
the security of their customers’ cash.
Some had even gone so far as to suggest e-money is safer
than a bank account, on the basis that although banks benefit from the
protection of the Financial Services Compensation Scheme, they still lend out
deposits. E-money firms weren’t supposed to be able to touch customer funds.
In sum, people believed the scheme was watertight.
“It isn’t and never has been. That’s a key issue and the FCA
knows that,” said Verdon.
Verdon’s business, which had some overlap with Wirecard’s
business activities (the legitimate ones, that is), acquired Wirecard Card
Solutions in late August after emerging top of a competitive bidding process.
The bulk of Wirecard’s business was what is called card
acquiring, which in essence means payments processing. It is the card issuing
part of the business, which Verdon says is segregated, that Railsbank has
bought.
At the first session of the APPG on Challenger Banks and
Building Societies Wirecard inquiry, those giving evidence suggested that
certain firms had outgrown e-money rules – which were never intended to govern
companies with hundreds of thousands or even millions of customers.
11:FS’s Taylor pointed out, however, that the successes of
companies operating under these rules has “fundamentally changed the experience
for the consumer”.
That much can be seen from the sheer number of customers
that were affected by the regulator’s temporary freezing of the Wirecard’s UK
arm.
So, while there may be cracks in the regulatory framework
that governs most fintech firms, regulators will surely be cautious, while
mending them, not to stifle future innovation.
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