It just wouldn’t be a crisis without a proper corporate scandal.
You'll likely have heard and seen the headlines about German payments firm Wirecard, which filed for insolvency last week.
Initially, the story was that it had “misplaced” €1.9bn (£1.7bn) in cash. Now it seems the lost amount was somewhere around €3.5bn.
The firm’s chief executive Markus Braun quit and was arrested over the fraud allegations, while the chief operating officer Jan Marsalek went missing.
Meanwhile, the hunt for the missing billions came to a dead end in the Philippines, and management was forced to admit the money may not ever have existed.
The end came on 25 June when the company filed for insolvency, which was a surprise to creditors, who thought they were still in talks about further possible support.
Scandals of this size usually generate as much fear as they do publicity. Wirecard is the only firm in the history of the German Dax index to have gone bust.
The background to Wirecard
As of 17 June, according to Bloomberg data, the market capitalisation of Wirecard shares was €12.9bn, having peaked less than a year ago at over €24bn on 3 September.
Meanwhile Wirecard’s outstanding debt seems to be at least €3bn but, according to Reuters, probably stands at around €4bn.
Wirecard had a German deposit-taking retail bank that offered a high euro interest rate of 0.75 per cent (when others are nil or sometimes negative).
Yet these funds appear to be intact, so the German deposit insurance scheme shouldn't have to cover the funds.
There's no suggestion at this time that customers using Wirecard’s payment services have had their money stolen – buyers have paid, sellers have received the proceeds.
However, Wirecard’s cashflow may have been used to give the impression that the business itself had cashflow and cash of its own on the balance sheet.
So, this is about the alleged defrauding of investors; lenders, bond holders and equity holders.
Wirecard in the press
It may surprise you to note that negative stories surrounding Wirecard have been around since at least 2015.
The Financial Times published a series of articles on the company, with the allegations rising in seriousness all the way to late last year.
The FT pointed out that Wirecard’s profitability was entirely due to three particular Middle Eastern and Asian entities.
Another allegation from The Foundation for Financial Journalism pointed out that a 2015 purchase of Indian (and other) payment-processing companies had been channelled through a Mauritius fund.
It appeared that of the €340m paid by Wirecard, €285m did not go to the sellers. The implication was that the disparity went to some of Wirecard’s executives and friends.
Somehow, Wirecard deflected the stories.
Indeed, it managed to raise long-term debt in June 2018, arranging a €1.75bn revolving loan facility with a 2024 maturity.
Last year, it appeared €800m had been lent from the facility.
Remarkably, in September 2019, Wirecard received an investment-grade credit rating of Baa3 from Moody’s, and raised a five-year bond of €500m. It also got Softbank to fund a convertible bond of €900m.
It appears the revolving loan facility was drawn further by another €775m.
This was probably around the same time as KPMG published a report saying it could not verify €1bn in cash balances, could not trace hundreds of millions in cash advances to merchants, and questioned Wirecard’s acquisition accounting.
A high profile case
It's no surprise that cases like this come out when times are tough and companies are struggling.
But one case, even if extremely high profile, is manageable.
On the other hand, if this is symptomatic of a wider systemic issue, that presents serious problems for the financial system.
So, is Wirecard a case of one bad apple? Is it more serious, like the Enron scandal of 2001? Just how far does this go?
We suspect this will be seen as more of a one-off than a deeper directly systemic issue.
It may be that Wirecard’s management were able to use investors’ positive sentiment towards a rare and rising German fintech star in a particularly egregious way.
As with any bankruptcy claim, debt holders will have a bad time retrieving their capital. If fraud is proven, the chances of recovering anything at all are slim.
This highlights why one might prefer holding tech company equity over debt. Since tech companies have little in the way of physical assets, debt recovery can be extremely difficult.
Contrast this with the widespread issues in the lead-up to the global financial crisis.
Then, while many individuals in the system behaved badly, none were obviously breaking any law.
Technically, the financial institutions involved weren't obviously breaking the law either.
But they did enable a widespread mismanagement of culture and risks - and show willing in accepting dubious practices like accounting ‘tweaks’.
Returning to the present, there are certainly systemic and regulatory questions to be answered around the Wirecard collapse.
Moody’s will face a lot of criticism for its Baa3 rating of last year’s debt-raising.
The German financial regulator BaFin is also coming under intense scrutiny in the wake of the scandal.
There have been accusations that it ignored reports about accounting irregularities to protect what was seen as a domestic champion.
Following a police raid last year on Wirecard’s office in Singapore, BaFin banned investors from betting against its shares for two months – the first time such restrictions had been put on an individual stock in German history.
Shortly afterwards, the regulator filed a criminal complaint against two FT journalists who reported on the Wirecard allegations.
The role of accounting firms more generally is also on the radar.
In response to the Enron scandal, the Sarbanes-Oxley Act came into force with strict new rules for accountants, auditors and corporate officers.
Stringent record-keeping was supposed to follow from this but, 18 years after its passing, the fact there are still such cases suggests more needs to be done.
The biggest systemic issue involves the role of external auditing.
Wirecard’s auditors EY will be dreading the next few months. Already, EY faces the inevitable class action from investors.
For companies in general, and large companies in particular, the collapse in the number of skilled auditors presents a massive headache.
Auditor rotation is a regulatory requirement, and conflicts of interest mean there are none available. A shake-up of the industry is likely, with a potential rise in costs.
Active fund managers invested in Wirecard’s equity and bonds, and banks in the loans, will be asked quite how good their due diligence was.
We've asked our current active managers for a response, and are glad to report that none of them had any holdings in Wirecard.
Tracker-based portfolios inevitably did have some exposure, around 0.014 per cent in a typical balanced portfolio.
Then are those like Odey Asset Management founder Crispin Odey, who profited after shorting Wirecard shares.
The Wirecard episode may also affect how ready investors are to accept the high valuations of less transparent 'tech' companies.
But from what we have found out so far, there's little to suggest it poses significant systemic risks.
And if financial fraudsters are now more wary, so much the better.