In its 2018 Annual Report, Wirecard, a German Fintech organisation, claimed to be “a global technology group that supports its customers and partners in accepting electronic payments from all sales channels [and in] the issuing of payment instruments”. The report additionally said that “[t]he uniform platform approach and seamlessly integrated value added services such as data analytics, customers loyalty programmes and digital banking services support customers and partners of Wirecard to successfully master the challenge of digitalisation”. In response to ESMA (2019), it “connected to more than 200 international payment networks (banks, payment solutions, card networks), which resulted in 34,000 customers from various industries, and offered its services in over 100 transaction currencies”.
Determine 1 Bank card funds
Supply: Barba Navaretti et al. (2020).
Wirecard acted as an acquirer of cost transactions (most of them on-line), working as an middleman between retailers and their banks on the one hand, and prospects, their card issuers, and their banks on the opposite (Determine 1). The corporate additionally supplied a bunch of associated technological companies. Buying actions had been carried out both instantly, with licensed subsidiaries comparable to Wirecard Bank AG in Germany and Wirecard Card UK within the UK, or by licensed third-party acquirers, largely in Asia. Technological companies had been provided primarily by on-line platforms, which, in response to Wirecard’s claims, had been instrumental in implementing an efficient danger administration of a posh community of cost transactions.
The share of revenues coming from largely unregulated cost and danger administration actions was substantial, accounting for 3 quarters of Wirecard’s whole revenues in 2018. Solely 1 / 4 of income was coming from buying and issuing companies (that are regulated). Because it turned out – largely from a radical investigation by the Monetary Instances began in 2015, and by the auditing carried out by KPMG (KPMG 2020) – a big share of Wirecard revenues and income, particularly in Asia, seemed to be cast by a community of firms not directly managed by Wirecard’s administration, which falsified paperwork and cash flows (McCrum, 2020). In the long run, it may floor that €1.9 billion of alleged reserves, supposedly held in escrow accounts in Asia, had been non-existent.
With the good thing about hindsight, it’s clear that the kind of actions carried out by Wirecard had been normal routine cost companies, and Wirecard’s default had nothing to do with the alleged technological complexity of its operations. In different phrases, chapter didn’t occur due to undetected issues or mismanagement of the expertise. Extra merely, Wirecard’s Fintech standing created a display screen of presumed complexity, hindering the eye of overseers and financiers, and probably enabling a level of complacency on the a part of home authorities unwilling to thwart the expansion of a ‘national champion’.
Regardless of resembling an accounting fraud of the extra classical sort, Wirecard’s default raised many considerations on the dearth of ample oversight of Fintech firms. The shortcoming of authorities to detect the fraud in a distinguished and well-known firm is, to a big extent, the results of regulatory loopholes. There’s concern that this may go away room for future transgressions. Certainly, there was neither complete and built-in oversight of Wirecard actions nor ample vetting of its accounting practices. There was additionally a scarcity of efficient oversight and enforcement of accounting and auditing practices. However what is basically lacking in regulation and supervision of Fintechs?
Investor and buyer safety
We argue in a latest paper (Barba Navaretti et al. 2020) that to know how totally different authorities can cooperate in regulating and supervising Fintech firms, it is very important distinguish between investor and buyer safety.
The purpose of investor safety is to ensure that the customers of funds supplied by third events provide clear, dependable, and immediate info on their decisions. Within the case of monetary intermediaries and cost companies suppliers, buyer safety goals as a substitute at guaranteeing the value of deposits, which is essential as a result of they’re de facto an nearly excellent substitute for cash.
In Wirecard’s case, investor safety failed in its position, and financiers will definitely incur important losses. In distinction, prospects had been left nearly unscathed by the default. Nevertheless, even when it didn’t occur this time, Wirecard’s enterprise model and its regulation and supervision left a lot of loopholes which could have led to critical issues for its prospects beneath totally different circumstances. If the unregulated technological companies supplied by Wirecard to retailers, shoppers, and third-party acquirers had failed, these would have suffered important losses. For instance, not with the ability to make or settle for a cost carried out utilizing a card causes liquidity issues, which may probably flip into solvency issues, ultimately resulting in monetary instability. Regulatory oversight of Fintechs is subsequently of the utmost significance.
The challenges of overseeing Fintech actions
Immediately, banks and conventional monetary establishments are a ‘comfort zone’ for regulators and supervisors, which have substantial expertise of find out how to present safety to traders and prospects, and assure stability. The arrival of Fintech has opened up largely unchartered territories, not just for entrepreneurs, but additionally for skilled supervisors and regulators (Barba Navaretti et al. 2018).
A key problem is the massive quantity (and kind) of various gamers which have already emerged, and the massive quantity that may emerge. It’s helpful to determine not less than 4 kinds of operators partaking within the monetary innovation course of and classify them with their particular angle in the direction of monetary innovation (Ehrentraud and Garcia 2020).
‘Enhancers’ are operators that carry out some key technology-based exercise in monetary markets, typically by ‘vertical unbundling’ of a few of the actions carried out at totally different vertical levels of the value chain. Enhancers typically depend on new and efficiency-enhancing applied sciences, comparable to synthetic intelligence (AI) and machine studying (ML). This was the case of many technological subsidiaries of Wirecard group.
‘Unbundlers’ are new specialised monetary operators, coming into in particular segments historically served by all-round monetary establishments. They carry out horizontal unbundling, separating companies to remaining customers that conventional monetary establishments would provide as a bundle (comparable to cost and credit score service), both totally in-house or by outsourcing some actions (e.g. Satispay).
‘Pursuers’ are conventional monetary operators that ‘catch up’ adopting new applied sciences, typically by the acquisition of a Fintech start-up. An instance of this horizontal unbundling is the acquisition by of the Fintech start-up WePay by JP Morgan Chase in 2017.
‘BigTech’ are massive firms that function platforms in non-financial markets, comparable to business-to-consumer platforms (an instance being Amazon) or social networks (an instance being Fb). BigTech corporations are recognized to enter monetary markets, bundling monetary and non-financial companies on their platforms.
The very presence of those numerous kinds of operators in monetary markets typically makes current rules insufficient and supervision extra complicated. To beat these issues, it’s essential to determine a set of key steps that ought to be addressed inside a brand new regulatory framework.
The oversight of Fintech actions: Key steps
When regulating Fintechs, it’s essential to steadiness the effectivity positive factors of technological innovation within the monetary trade with the attainable further dangers created for its stakeholders (Amstad 2020). In our paper, we recognized a set of key steps to this purpose:
1. Keep away from regulatory arbitrage. Regulators lagging behind fintech companies developments ought to be prevented. This can assist to make sure a degree taking part in area between Fintech firms and conventional companies. Regulators also needs to be sure that entities finishing up the identical exercise comply with the identical units of guidelines (nonetheless they carry them out).
2. Perceive clearly what Fintechs do and what their enterprise models are. Regulators want to know the supply of profitability and the potential enhancing or disruptive impression of Fintech actions, in addition to how they work together with different elements of monetary and non-financial markets. Sandboxes (the place observing Fintechs develop their concepts) are helpful on this respect, so long as they don’t create unhealthy hyperlinks between the regulators and the regulated.
3. Mix the oversight of entities with the oversight of actions. Unbundled monetary actions ought to be supervised independently of the type of incorporation adopted by the corporate and independently of the opposite actions that it performs in parallel. This ought to be finished with out compartmentalising the oversight of monetary markets. In any other case, loopholes may emerge for firms with a posh and complex internet of actions, comparable to Wirecard, beneath totally different regulatory and supervisory regimes. The proposal of the European Fee – which grants ample oversight powers with respect to technological third-party suppliers additionally inside the identical group – strikes exactly on this course (European Fee 2020).
4. Grasp the expertise utilized by Fintechs. On the core of Fintech enlargement lies a set of comparatively latest applied sciences that permit for higher info extraction from information. It ought to be clear that these applied sciences are solely instruments to carry out normal monetary actions which, up till now, had been carried out by different means. For an efficient and protected deployment of AI in monetary markets, supervisors and regulators will need to have the power to watch and assess the precise behaviour and functioning of those algorithms. Regtech and Suptech (i.e. using AI within the implementation of regulation and supervision) are attention-grabbing developments on this respect, however are unlikely to utterly substitute extra conventional oversight approaches.
5. Know the worldwide image and harmonise and coordinate internationally guidelines and oversight of Fintechs. Fintech gamers, particularly these unbundling and specialising in slim segments, have proven a pure tendency for cross-border actions. This broad geographic span of enterprise actions requires a coordinated motion of regulators and supervisors, definitely in Europe (and, hopefully, extra broadly). Coordination, info sharing agreements, and harmonisation of oversight requirements is critical worldwide (and is a needed ingredient of Europe’s Capital Market Union).
It is not uncommon when new kinds of issues come up to suggest new authorities to handle the problem. The historical past of the EU isn’t resistant to this tendency. We see no want for a brand new regulatory physique overseeing Fintechs in Europe to ensure that the important thing steps outlined above to be carried out. The goals of regulation are unchanged, unbiased on whether or not operations are carried out by Fintechs, conventional companies, or a mix of the 2. With respect to investor safety, Wirecard’s case requires stronger nationwide authorities, elevated worldwide harmonisation, coordination and cooperation, and direct and sound supervision of auditing corporations. In truth, that is needed for all listed corporations. As for buyer safety, efficient regulation and supervision of Fintechs is barely attainable with a radical understanding of their enterprise model and of the applied sciences that they use. However, in each instances, European authorities ought to be put within the place of creating a harmonised and coordinated framework for regulating Fintech, which can then be exercised by nationwide authorities.
Amstad, M (2019), “Regulating fintech: Ignore, duck type, or code”, VoxEU.org, 21 March.
Barba Navaretti, G, G Calzolari and A F Pozzolo (2018), “FinTech and banks”, VoxEU.org, 01 March.
Barba Navaretti, G, G Calzolari and A F Pozzolo (2020), “What are the wider supervisory implications of the Wirecard case?”, European Parliament Suppose Tank, PE 651.384.
Castro, R, G L Clementi, G and G MacDonald (2004), “Investor protection, optimal incentives, and economic growth”, The Quarterly Journal of Economics 119(3): 1131-1175.
Ehrentraud, J and D Garcia (2020), “Managing the winds of change: policy responses to fintech”, VoxEU.org, 19 April.
ESMA (2019), “Opinion on a proposed emergency measure by BaFin under Section 1 of Chapter V of Regulation (EU)”, No 236/2012, 70-146-19.
European Fee (2020), “Proposal for a Regulation of the European Parliament and of the Council on digital operational resilience for the financial sector and amending Regulations (EC)” No 1060/2009, (EU) No 648/2012, (EU) No 600/2014 and (EU) No 909/2014, 24 September.
KPMG (2020), “Report concerning the independent special investigation, Wirecard AG”, Munich, April.
Mc Crum, D (2020), “Wirecard and me”, Monetary Instances, 03 September.