[Editor’s note: This is a guest post from Ryan Weeks, formerly with Dow Jones and AltFi, covering fintech. This is part three of a four part series (here is part one and part two) he is writing for us on the UK fintech market in the run-up to LendIt Fintech Europe.]
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.