Risk Analysis & Economics - Markets Infrastructure Investors

The European Securities and Markets Authority (ESMA), the EU securities markets regulator, today updates its risk assessment to account for the impacts on financial markets of Russia’s invasion of Ukraine and the deteriorating economic environment.

The risk to ESMA’s overall remit remains at the highest level, with political event risk, surging inflation and jumps in market volatility negatively impacting the outlook.

Risk assessment June 2022

Following the invasion and the resulting sanctions, funds and investors with exposures to Russian assets have faced substantial valuation issues. There has been significant asset repricing, with riskier assets falling in value (particularly equities, corporate bonds and emerging market debt).

Prices of commodities and related derivatives have jumped sharply and are adding to pre-existing inflation pressures. This has led to increasing market expectations of higher interest rates and growing likelihood of far-reaching rebalancing of portfolios as investors adjust to the new environment. Finally, cyber risk is very high currently and remains a key concern for financial markets, as attacks targeting infrastructures and firms could be very disruptive.

ESMA also observes that crypto assets have experienced sharp falls in value, showing the importance of the recently published ESAs joint warning on crypto assets reminding consumers of the highly volatile and speculative nature of many crypto markets.  The collapse of Terra illustrates the acuteness of confidence effects in crypto-asset markets and the risks attached to so-called stablecoins in the absence of a sufficiently robust business models and financial engineering.

The European Securities and Markets Authority (ESMA), the EU’s securities markets regulator, is today publishing a study showing how regulatory reporting data can be used to identify risks in derivatives markets, such as occurred in the case of Archegos.

In the study, ESMA finds that the build-up of exposures by Archegos, a US family office whose collapse in March 2021 resulted in more than USD 10bn in losses, can be seen in data reported under the European Market Infrastructure Regulation (EMIR). The high level of concentration and the associated risks posed by the firm are also visible.

These findings show how regulatory data collected under EMIR can be used to monitor leverage and concentration risk arising in derivatives markets, and could foster the development of early warning indicators by supervisory authorities to track different types of risk.

Next steps

This article is an ex-post analysis of a relevant financial market event and aims to foster further financial stability analysis, as well as to feed into ongoing work on using EMIR, and other regulatory datasets, to identify and monitor risks, including at the international level by the European Systemic Risk Board and Financial Stability Board.

Background

In March 2021, the default of Archegos, a US family office, led to large losses for some global banks. Archegos was able to accumulate large leveraged exposures on equities by entering into derivatives transactions with banks. When the price of the underlying stocks started to decline, the firm was unable to meet variation margins, resulting in the liquidation of the stocks by the banks.

Further information:

Solveig Kleiveland
Senior Communications Officer
Tel: +33 (0)1 58 36 43 27
Email: press@esma.europa.eu

The three European Supervisory Authorities (EBA, EIOPA and ESMA - ESAs) issued today their first joint risk assessment report for 2022. The report highlights the increasing vulnerabilities across the financial sector as well as the rise of environmental and cyber risks.  

Russia’s invasion of Ukraine and its economic consequences have aggravated the outlook for growth and inflation and brought heightened market volatility. Market resilience will critically depend on the ability of markets and financial institutions to deal with the economic consequences of the Russian invasion of Ukraine, and to withstand changes in public policy support on the monetary or fiscal side without material disruptions.

Some of the risks emerging during 2021 and highlighted in the report were amplified by Russia’s invasion of Ukraine. The EU economy was on track for a strong recovery from the crisis caused by the Covid-19 pandemic and the financial sector largely proved resilient. However, the recovery appears to have been hindered by new waves and variants of the virus, concerns regarding inflation risk, rising commodity prices and heightened geopolitical risks.

Additional vulnerabilities and risks for the financial system have built up over time. Financial markets remain vulnerable to changes in market sentiment, particularly if financial conditions tighten unexpectedly due to inflation pressures. In the real estate sector, persistent price increases and higher borrowing by households have increased risks. At the same time, the financial sector is increasingly exposed to environmental risks and risks stemming from digitalisation.

In light of the risks and uncertainties, the ESAs advise national competent authorities, financial institutions and market participants to take the following policy actions:

  1. Financial institutions should be prepared for further potential negative implications stemming from geopolitical tensions and ensure compliance with the sanctions regimes put in place both at the EU and at global levels;
  2. Financial institutions and supervisors should prepare for a possible deterioration of asset quality in the financial sector;
  3. The impact of further increases in yields and sudden reversals in risk premia on financial institutions and investors should be closely monitored;
  4. Retail investors are of particular concern, and supervisors should monitor risks to retail investors seeing that their participation in financial markets has increased substantially in recent years;
  5. Financial institutions should further incorporate ESG considerations into their business strategies and governance structures; and
  6. Considering the elevated level and frequency of cyber incidents, financial institutions should strengthen their cyber resilience and prepare for a potential increase in cyberattacks.

Pages