Wed, Feb 19, 2020

ESMA Finds Continued High Risks as Markets Remain Highly Volatile

The European Securities and Markets Authority (ESMA) published the first Trends, Risks and Vulnerabilities (TRV) report of 2020 since the ESA Regulation on January 1, 2020. 

ESMA identifies substantial risks and a weaker economic outlook as markets remain sensitive to geopolitical events. The risk outlook is stable; however, various risks are high, particularly in the securities markets and for retail investors. 

  • Market risk remained high in the second half of 2019, due to excessive asset valuations in the context of weaker growth prospects, looser monetary policy and uncertainties such as Brexit and US-China trade relations. Equity markets suffered volatility and bond spreads tightened in signs of continuing search-for-yield. Markets remained sensitive to events, seen in reactions to oil price shocks and the US repo squeeze;
  • Credit risk and liquidity risk remained high. Credit risk, remains elevated with deteriorating corporate debt quality and increasing risks of fallen angels (bonds being downgraded to below BBB) as the share of BBB-rated debt grows;
  • Consumer risks persist across investment products as market risks increase. Retail investors remained cautious, predominantly allocating savings to bank deposits:
  • Looking ahead, ESMA predicts weaker economic outlook and uncertainty over the impact of the coronavirus, global trade negotiations and Brexit.

Focus on Risks in Bonds, Bigtech and Short-termism

This TRV also takes an in-depth look at specific risk issues in three articles:

  • EU Funds Risk Exposure to Potential Bond Downgrades
    ESMA has simulated the impact of a wave of downgrades of fallen angels on bond funds and finds that the direct impact would moderately affect fund performance. Asset sales from bond funds would have a limited impact on asset prices, though EU bond funds could amplify shocks; 
  • Bigtech Implications for the Financial Sector
    This article reviews the importance of large technology firms (BigTechs) that increasingly offer financial services, utilizing their vast customer networks, data analytics and brand recognition. ESMA considers the impact of these firms and concludes that regulatory cooperation is needed to manage financial stability risks that could arise as BigTechs increase market concentration; and
  • Short-termism Pressures From Financial Markets
    ESMA considers the recent evidence collected by a survey on drivers of short-termism, conducted in response to the European Commission’s request to collect information on potential undue short-term pressures in financial markets. Survey results suggest that the misalignment of investment horizons and the remuneration of fund managers and executives could be a source of undue short-termism.


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