Risk Analysis & Economics - Markets Infrastructure Investors

The three European Supervisory Authorities (EBA, EIOPA and ESMA - ESAs) issued today their second joint risk assessment report for 2021. The report highlights the increasing vulnerabilities across the financial sector, the rise seen in terms of cyber risk and the materialisation of event-driven risks.

As the recovery begins, the appropriate phasing out of exceptional crisis measures plays a key role. Despite the positive outlook, the expectations for economic recovery remain uncertain and uneven across member states. Vulnerabilities in the financial sector are increasing, not least because of side effects of the crisis measures, such as increasing debt levels and upward pressure on asset prices. Expectations of inflation- and yield growth, as well as increased investor risk-taking and financial interconnectedness issues, might put additional pressure on the financial system.

The financial sector is also increasingly exposed to cyber risk. The financial sector has been hit by cyber-attacks more often than other sectors, while across the digital economy, cyber-criminals are developing new techniques to exploit vulnerabilities. Financial institutions will have to rapidly adapt their technical infrastructure in response to the pandemic, and the crisis has acted as a catalyst for digital transformation more generally.

Finally, the materialisation of event-driven risks (such as GameStop, Archegos, Greensill), as well as rising prices and volumes traded on crypto-assets, raise questions about increased risk-taking behaviour and possible market exuberance.

Concerns about the sustainability of current market valuations remain, and current trends need to show resilience over an extended period of time for a more positive risk assessment.

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

  1. financial institutions and supervisors should continue to be prepared for a possible deterioration of asset quality in the financial sector, notwithstanding the improved economic outlook;
  2. as the economic environment gradually improves, the focus should shift to allow a proper assessment of the consequences of the pandemic on banks’ lending books, and banks should adequately manage the transition towards the recovery phase;
  3. disorderly increases in yields and sudden reversals of risk premia should be closely monitored in terms of their impacts for financial institutions as well as for investors;
  4. financial institutions and supervisors should continue to carefully manage their ICT and cyber risks.

The ESAs also consider that policymakers, regulators, financial institutions and supervisors can start reflecting on lessons learnt from the COVID-19 crisis.


Notes to editors

The Joint Committee is the forum for cooperation between the European Banking Authority (EBA), European Securities and Markets Authority (ESMA) and European Insurance and Occupational Pensions Authority (EIOPA), collectively known as the ESAs.

Under the Joint Committee, the three ESAs cooperate regularly and closely to ensure consistency in their practices. In particular, the Joint Committee works in the areas of supervision of financial conglomerates, accounting and auditing, micro-prudential analyses of cross-sectoral developments, risks and vulnerabilities for financial stability, retail investment products and measures combating money laundering. In addition, the Joint Committee also plays an important role in the exchange of information with the European Systemic Risk Board.

Further information:

Solveig Kleiveland

Senior Communications Officer

   +33 (0)1 58 36 43 27

@   press@esma.europa.eu

The European Securities and Markets Authority (ESMA), the EU securities markets regulator, today publishes its second Trends, Risks and Vulnerabilities (TRV) Report of 2021. The Report highlights the continued rise in valuations across asset classes in an environment of economic recovery and low interest rates, the increased risk taking of investors and the materialisation of event risks such as GameStop, Archegos and Greensill.

ESMA continues to see elevated risks and fragile fundamentals, with an outlook for continued high risk and uncertainty over the sustainability of corporate and public debt as well as rising inflation expectations. Current market trends need to show their resilience over an extended period of time to allow for a more positive risk assessment. The extent to which these risks will materialise will critically depend on market expectations on the continuation of monetary and fiscal policy support, as well as on the pace of the economic recovery and on inflation expectations.

Increased risk-taking behaviour

Investor confidence has increased, linked to rising asset valuation and strong performance of retail investor instruments. A surge in retail trading since the onset of the COVID-19 pandemic has been driven by a range of factors, including innovation. New online and mobile trading platforms offer convenient, easy-to-use investment services, and zero-commission business models and gamified features may further attract consumers. These features can prompt investor protection concerns, as does the rise of trading encouraged by social media and online message boards.

Also, rising valuations across classes, massive price swings in crypto assets and event-driven risks observed amid elevated trading volumes raise questions about increased risk-taking behaviour and possible market exuberance.

Cloud outsourcing, credit ratings, green bonds: New evidence on key market developments

In addition to its risk monitoring, ESMA provides four in-depth articles looking at financial stability risks of cloud outsourcing, Credit Rating Agencies and green bonds:

  • Cloud outsourcing and financial stability risks: The article analyses the growing use of cloud service providers by financial institutions and how the concentration of those providers can create financial stability risks in case of outage.
  • COVID-19 and credit ratings: The analysis investigates how credit ratings evolved during the exceptional period of early 2020, exploiting ESMA’s RADAR database.
  • Market for small credit rating agencies in the EU: Using SupTech-related techniques and the CRAR database, the article assesses the network of CRAs and the concentration in the CRA market.
  • Environmental impact and liquidity of green bonds: In this article, ESMA investigates the CO2 emissions of green bond issuers, and then compares the liquidity of green and conventional corporate bonds.

The European Securities and Markets Authority (ESMA), the EU’s securities markets regulator, has today published its first Risk Dashboard (RD) for 2021 covering the first quarter of the year. The RD highlights that the main risk for EU financial markets remains that posed by a sudden risk reassessment, amid the general decoupling of securities prices from economic fundamentals, and is maintains its risk assessment at a very high level.

Valuations in EU financial markets for most market segments are now at or above pre-COVID-19 levels. They remain highly sensitive to events and volatility, as shown by the market movements related to Gamestop and the impact that a potentially slow roll-out of vaccines had on equity prices.

Fixed income valuations are now far above their pre-COVID-19 levels, in part due to continued monetary policy support. A sudden risk reassessment, amid the general decoupling of securities prices from economic fundamentals, remains the main risk for EU financial markets and ESMA therefore maintains its risk assessment. Credit risk is likely to increase further due to increasing corporate and public debt levels.

Looking ahead, ESMA anticipates a prolonged period of risk to institutional and retail investors of further – possibly significant – market corrections and sees very high risks across its whole remit. The extent to which these risks will further materialise will critically depend on market expectations on monetary and fiscal policy support as well as on the pace of the economic recovery.

RD 2 2021