The European Securities and Markets Authority (Esma), the EU’s securities markets regulator based in Paris, said on Tuesday that it continues to see high risks to institutional and retail investors of further, possibly significant, market corrections.
Esma is particularly concerned about the increased participation of retail investors in Europe’s financial markets. The number of retail investors in financial markets has increased substantially in recent years as new investors hoped to take advantage of the convenience and user-friendly features of mobile trading platforms.
Presenting its latest “Trends, Risks and Vulnerabilities Report”, Esma said it continues to see “high risks to investors of further – possibly significant – market corrections as markets remain nervous and geopolitical tensions are rising.”
Correction risk ‘remains acute’
“All investors should consider that the risk of market corrections remains acute,” said Verena Ross, Esma’s chair, in a press release.
“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.”
Diversification comes with risks
“Retail investors are of particular concern to Esma,” Ross said. “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.”
In its report, the Paris-based regulator noted that macroeconomic conditions continued to improve during the second half of 2021, although the impact of a new wave of the pandemic on the economic outlook is unclear at this stage.
In securities markets, the increase in global equity prices continued, and while volatility remained low, elevated price earnings ratios pointed towards potential overvaluation concerns, Esma said. Energy commodity prices were particularly volatile, highlighting the potential financial risks associated with the energy transition and Europe’s climate policy objectives.
Liquidity, credit risks ‘remain elevated’
Addressing asset management, Esma noted that 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.
In sustainable finance, “concerns over possible green asset overvaluation lingered,” said Esma. The growth of ESG markets remained steady as investors continued to increase their investments in sustainable products. ESG fund assets increased by 9 percent in the second half of 2021, while ESG bond markets grew by 19 percent.
Crypto asset markets reached new records with a peak at 2600 billion euro in November, fuelled by investor appetite for riskier assets and growing institutional adoption. Stablecoins and DeFI, or Decentralised Finance, continued to expand rapidly, and with them concerns over the resilience of business models as well as high product and market risks investors take.
Environmental risk as new category
Esma said that it has added, for the first time, environmental risk as a category in its risk dashboard because climate change has potential implications for the financial system. In addition, new risk indicators on climate-related disclosures, firms’ reputational risk and EU carbon markets are covered in the statistical annex.
Esma said it wanted to depict how environmental risks can be expected to impact EU securities markets and their participants, while laying out its approach to integrating environmental risks in the risk assessment and monitoring framework.
This risk category is intended to capture physical and transition risk drivers and their mitigants, said Esma, in addition to potential risks associated with green finance. As part of this framework, Esma has identified three core risks stemming from climate change: abrupt changes in market sentiment, greenwashing and weather-related hazards.
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