Risk Analysis & Economics - Markets Infrastructure Investors

The European Securities and Markets Authority (ESMA), the EU’s securities markets regulator, today publishes the first Trends, Risks and Vulnerabilities (TRV) Report of 2022 and, in its outlook for 2022, continues to see high risks to institutional and retail investors of further, possibly significant, market corrections.

The pandemic’s resurgence at the end of 2021 and an uncertain economic and monetary policy outlook are leading market participants to revisit their growth and market expectations. Going forward, we continue to see high risks to investors of further – possibly significant – market corrections as markets remain nervous and geopolitical tensions are rising.

Verena Ross, Chair, said:

“All investors should consider that the risk of market corrections remains acute. This was demonstrated last year in two episodes of sell-offs largely driven by news first related to Evergrande and then to the resurgence of Covid-19. The markets remain highly volatile and ESMA sees growing uncertainty for investors going forward.”

“Retail investors are of particular concern to ESMA. Their participation in financial markets has increased substantially in recent years, with new investors taking advantage of the convenience and user-friendly features of mobile trading platforms. This diversification offers opportunities but also comes with risks, and ESMA remains concerned about risks to retail investors who buy assets with expectations of significant price growth, and without realising the high risks involved."

 

The Report’s main findings are:

Market environment: Macroeconomic conditions continued to improve through the second half of 2021, although the impact of a new wave of the pandemic on the economic outlook is unclear at this stage.

Securities markets: The increase in global equity prices continued, and while volatility remained low, elevated price earnings ratios pointed towards potential overvaluation concerns. Energy commodity prices were particularly volatile, highlighting the potential financial risks associated with the energy transition and Europe’s climate policy objectives.

Asset management: Investment fund markets continued to grow, particularly with inflows into equity funds. Risks remained elevated, both in terms of liquidity risk and credit risk, while higher inflation expectations raise new concerns in relation to duration risk. Funds investing in assets protected against inflation, such as commodity funds, benefitted from increased flows.

Sustainable finance: The growth of ESG markets remained steady as investors continued to increase their investments in sustainable products. ESG fund assets increased by 9% in the second half of 2021, while ESG bond markets grew by 19%. Concerns over possible green asset overvaluation lingered.

Financial innovation: Crypto Asset markets reached new records with a peak at EUR 2.6tn in November, fuelled by investor appetite for riskier assets and growing institutional adoption. Stablecoins and DeFI continued to expand rapidly, and with them concerns over the resilience of business models as well as high product and market risks investors take.

New in this edition

ESMA is for the first time including environmental risk as a category in the risk dashboard. In addition, new risk indicators on climate-related disclosures, firms’ reputational risk and EU carbon markets are covered in the statistical annex.

ESMA is also publishing the TRV Structural Market Indicators (SMIs), a collection of statistics that provide structural indicators on securities, markets, market participants and infrastructures for the EEA and EU, and by Member State. The SMIs provide transparency on the structure of EU securities and markets to supervisors, market participants and investors by using ESMA’s regulatory datasets. ESMA plans to update the published indicators and possibly expand the scope of the SMIs annually.

Risk Monitoring

Risk assessment focuses on important market risks that could harm ESMA’s objectives of investor protection, orderly markets and financial stability.  

ESMA monitors and assesses developments in the area of its competence and, where necessary, informs the European Parliament, the Council, the Commission, the other European Supervisory Authorities and the ESRB on a regular and, as necessary, on an ad hoc basis. ESMA continuously strengthens its capabilities to identify and assess risks to investors, orderly markets and financial stability in the EU.

The European Securities and Markets Authority (ESMA), the EU securities regulator, today publishes its fourth annual statistical report on the Alternative Investment Fund (AIF) sector. The report covers the 30 members of the European Economic Area (EEA30) and shows that the sector increased by 8% in 2020 to EUR 5.9trn in net assets from EUR 5.5trn in 2019

The main risk faced by the sector relates to a mismatch between the potential liquidity of the assets, and the redemption timeframe offered to investors. While at aggregate level this mismatch is unlikely to materialise, it indicates that AIFs with a liquidity deficit would face challenges if large redemptions were to occur. This is particularly the case for real estate funds and funds of funds.

Main findings:

  • The size of the EEA AIF market continued to expand to reach EUR 5.9tn in Net Asset Value (NAV) at the end of 2020, a 8% increase from 5.5trn in 2019. The growth of the EU AIF market results from the launch of new AIFs in 2020 and positive valuation effects;
  • Funds of Funds (FoFs) account for 15% of the NAV of EU AIFs, at around EUR 0.9tn (+4% compared with EUR 842bn in 2019). At the very short end, investors can redeem 40% of the NAV within one day, whereas only 14% of assets could be liquidated within this time frame. If large redemptions were to occur, AIFs would face challenges due to this liquidity mismatch;   
  • Real Estate Funds account for 13% of the NAV of AIFs, at EUR 766bn. They continued to grow in 2020 (+9% compared to 2019). RE funds are exposed mostly to illiquid physical assets which take time to sell, so liquidity risk in RE funds remains a concern;
  • Brexit – following the withdrawal of the United Kingdom (UK) from the EU, the size of the EEA30 Hedge Fund sector has declined to only EUR 89bn (2% of the NAV of all AIFs), from EUR 354bn in 2019 (including the UK). Leverage remains very high, particularly for some strategies highly reliant on derivatives;
  • Private Equity Funds account for 6% of the NAV of all AIFs, or EUR 363bn, and experienced the largest growth in 2020 (+29% compared with 2019). They follow a range of strategies and are almost exclusively sold to professional investors; 
  • Other AIFs account for 62% of the NAV of EU AIFs, at around EUR 3.7tn (+4% compared with 2019). The category covers a range of strategies, with fixed income and equity strategies accounting for 68% of the NAV and an additional residual category amounting to 29%. Other AIFs are mainly sold to professional investors, although there is a significant retail investor presence; and
  • EU Member States can allow non-EU asset managers to market alternative funds at national level under the National Private Placement Regime (NPPR), even though such funds cannot subsequently be passported to other Members States. The market for such non-EU funds is comparatively large: The NAV of non-EU AIFs marketed under NPPRs’ rules amounts to EUR 1.3tn, i.e. more than one-fifth of the AIF market. NPPR fund marketing is concentrated in a small number of Member States, and 99% of investors are professional investors.

ESMA will continue to report annually on its analysis.

 

Further information:

Solveig Kleiveland

Senior Communications Officer

   +33 (0)1 58 36 43 27

@   press@esma.europa.eu

 

*Statistics presented in this report cover the period following the withdrawal of the UK from the EU on 31 January 2020. Although EU law continued to apply to the UK until the end of the transition period on 31 December 2020, it was not possible to collect data covering this period, as year-end data for 2020 from the UK could not be transmitted in 2021 following its departure from the EU. Therefore, our statistics are constructed from data reports provided by entities authorised or registered in the Member States of the EEA post-Brexit. From this edition on we will only show statistics of the EEA/EU AIF market.