11 November 2020: A peer review report issued by the European Securities and Markets Authority has highlighted important deficiencies in the German supervision of Wirecard’s financial reporting. The findings feed into a broader reflection on the state of the EU’s supervisory architecture.

Requested by the European Commission, the European Securities and Markets Authority’s (ESMA) 189-page report provided an analysis of the events leading up to the collapse of Wirecard and the German supervisory response in the area of financial reporting, covering the period from 1 January 2015 to 25 August 2020. It did not directly address other regulated areas, including market abuse, short selling, auditing and corporate governance rules. 

The report focused on the two-tier system in place whereby FREP (Financial Reporting Enforcement Panel) intervenes in the first instance by reviewing issuers’ financial reports (with the cooperation of the issuer) but BaFin (Bundesanstalt für Finanzdienstleistungaufsicht) can intervene in a second instance in specific cases. Both FREP and BaFin are designated competent authorities in Germany under the EU Transparency Directive.

While ESMA does not have direct supervisory powers in the area of financial reporting, it has a role in promoting the consistent application of legislation and in encouraging supervisory convergence in enforcement practices. The report, carried out by a committee composed of experts from national competent authorities and ESMA, is the first one to be fast-tracked and focused on only one jurisdiction and one issuer.

Deficiencies, inefficiencies and impediments

The report identified deficiencies relating to independence, market monitoring and examination procedures.

• While both BaFin and FREP have adequate numbers of professionally skilled and trained staff in place, the report raised questions over the independence of BaFin from the Ministry of Finance arising from the frequent, detailed reporting to the Ministry in the Wirecard case, sometimes before actions were taken. Questions were also raised over potential conflicts of interest of BaFin employees given insufficient data on their shareholdings, raising doubts on the robustness of BaFin’s internal controls.
• There were important deficiencies in market monitoring by both BaFin and FREP, particularly given FREP’s non-selection of Wirecard’s 2015, 2016 or 2017 financial reports for examination, despite growing international media attention as well as Wirecard’s risk profile. BaFin did not request that FREP examine Wirecard reporting during the 2016 to 2018 period.
• Where FREP did examine Wirecard’s financial reports, the report also found shortcomings, including failures to appropriately address areas material to the business as well as a more thorough examination of media and whistle-blowing allegations. The analyses performed by FREP (level of professional scepticism, timeliness of examination procedures, assessment of disclosures) and their documentation were also insufficient.

Legal and procedural impediments to the effectiveness of the German supervisory system in the area of financial reporting were also documented in the report. 

• BaFin and FREP are not aligned in their perception of each other’s role in addressing fraud in financial reporting – as well as with regards to the limitations and possibilities they have in the two-tier supervisory system.
• There is a high hurdle for both bodies to notify the public prosecutor where there are suspicions of criminal activity relating to financial reporting. Consequently, BaFin and FREP may not have the necessary powers to request information from auditors and other relevant parties or to exchange information with the Audit Oversight Body. This issue had already been flagged by ESMA in 2017.
• The strong confidentiality regime binding both BaFin and FREP may also hinder the exchange of information between them, as well as with other relevant bodies.
• BaFin was not “put in the position” to assess FREP’s examinations and to determine whether it should have taken over from FREP. This was due to a lack of precise and substantive information provided to BaFin from FREP – as well as the requirement to meet the hurdle of ‘substantial doubts’ before BaFin can take over an examination.
• The report also documented instances of lack of coordination and inefficiencies in the exchange of information between relevant teams in BaFin. 

The report included a series of recommendations to address the identified shortcomings. 

What happens next?

Presenting the report, Steven Maijoor, outgoing ESMA chair, noted that the ESMA Board of Supervisors will reflect further on the issues raised and provide a further response before the end of the year.

The Commission said it will assess the findings of the report and whether there may be legal issues relating to the European supervisory framework that need addressing. The Capital Markets Union Action Plan, issued in September, also includes a commitment to assess the implications of the Wirecard collapse and the potential need to enhance the single rulebook for capital markets and to consider stronger supervisory coordination, if not direct European-level supervision.

German Finance Minister Olaf Scholz is reported to have said that he does not consider the ESMA report as ‘something critical’ and that the recommendations are in line with the reform plans being discussed in Berlin.

 Read the full report here.