ESMA praises European market resilience ahead highly risky 2024

“Looking ahead, markets are set to remain very sensitive and risks of market corrections continue to be high, given geopolitical and macro-financial uncertainty.”

The European Securities and Markets Authority (ESMA), the EU’s regulator and supervisor for financial markets, has released its inaugural risk monitoring report for 2024.

The report details the current key risk drivers in financial markets and covers structural developments and the status of key financial market sectors in the second half of 2023.

Fixed income, ESG, and Crypto

European corporates primarily accessed capital markets through fixed income and securitised products in the latter half of 2023. Equity markets saw modest improvement, but IPO activity remained low. Strong corporate bond issuance was observed, with debt sustainability being a significant risk, particularly in lower quality segments.

Growth in ESG investing and markets has plateaued recently. The ESG bond market grew slowly, with declining issuance volumes. SFDR Article 9 funds experienced net outflows, and outflows from SFDR Article 8 funds increased. Fund naming conventions played a role in differentiating these funds.

Crypto-asset valuations rose in 2023, buoyed by the US SEC’s approval of spot crypto ETFs in January 2024. However, total market capitalisation remains half of its 2021 peak. AI usage in finance is expanding, though dedicated AI investment instruments are limited.

Securities, asset management, geopolitical uncertainty

Equity valuations modestly increased in the second half of 2023, with contained volatility and wider bid-ask spreads. Fixed-income markets saw a general decline, with falling yields in sovereign and corporate bonds. Credit quality in high-yield non-financials, especially in real estate, continued to deteriorate.

EU fund performance and flows were volatile. Fixed income funds were preferred over equity funds, with money market funds attracting significant inflows. Risks stabilised but remained high, with concerns about real-estate fund asset valuations in a declining market.

Consumer sentiment was weak, impacted by geopolitical uncertainty and subdued growth, despite lower inflation. Bond holdings increased, and retail investment performance improved in the third quarter of 2023. Real estate exposures in retail AIFs pose risks.

Equity trading volumes decreased slightly year-on-year. Settlement fails stayed stable after a drop in the first half of 2023. Cyber incidents in the financial sector globally remain high but decreased in the third quarter.

“Risks of market corrections continue to be high”

Verena Ross, ESMA’s Chair, said: “At ESMA we are observing a financial system that has shown a high level of resilience. Looking ahead, markets are set to remain very sensitive and risks of market corrections continue to be high, given geopolitical and macro-financial uncertainty. In this context, maintaining trust in financial markets is of particular concern to ESMA, and key to achieving our mission to protect investors.

“Retail investors increasingly get their updates through social media, and we again stress the need to be aware of the risk of receiving false or misleading information through these media. All investors should verify the reliability and the quality of the information they use in their investment decisions. Financial stability and investors will be impacted by increased interest rates which are expected to remain higher for longer. This environment has a negative impact on credit quality and real estate valuations. Finally, greenwashing entails the risk of limiting the role finance can play in the transition to a more sustainable future.”