The European Securities and Markets Authority (ESMA) has today published its first report on ‘Trends, Risks and Vulnerabilities’ in the European Union (EU) securities markets, alongside a new risk dashboard for Q412 which shows that systemic risk has decreased. The report says investment conditions in the EU improved in 2012, especially in the second half of the year, following the European Central Bank (ECB) decision to launch a bond buying scheme to support the euro.
The investment recovery, or at least the stopping of the rot, can be linked to the ECB’s announcement of Outright Monetary Transactions (OMT) last summer, says ESMA’s report, which alleviated pressure on euro area sovereign bond markets and reduced uncertainty among market participants. However, risk indicators in the Q4 dashboard remained at high levels. Among other factors, this was due to the on-going sovereign debt and banking crisis, which still required further action such as the details about the single banking union to be established to allay fears about a meltdown. Other factors in the present risk environment highlighted by ESMA include the realignment of risk assessments by corporate treasury investors and others, difficulties in funding risk, and the potential long-term implications of continued low interest rates – not to mention obstacles to orderly market functioning such as regulatory and non-compliance concerns.
The ESMA report on ‘Trends, Risks and Vulnerabilities’ looks at the performance of securities markets throughout 2012, assessing both trends and risks in order to develop a comprehensive picture of systemic and macro-prudential risks in the EU that can serve both national and EU bodies in their risk assessments. Their findings will have implications for corporate treasurers, banks and other financiers. By regularly looking into cross-border and cross-sector trends and risks both at the wholesale and retail level, ESMA’s report aims to contribute towards promoting financial stability and enhancing consumer protection, says the organisation which is placing quite a responsibility on its inaugural report here.
The report identifies the following key trends in EU securities markets:
- Securities markets: After a volatile first semester last year, financial market conditions in the EU in 2012 improved due to the ECB’s OMT announcement. However, sovereign bond markets continue to struggle.
- Collective investments: Asset managers benefited from easing markets, with total net asset values (NAVs) up to €8tn, compared to €7.4tn in 2011. The main beneficiaries were bond, hedge, real estate and exchange-traded funds (ETFs). Overall however, fund inflows remained volatile.
- Market infrastructures: Trading on EU venues and exchanges significantly decreased in 2012. The use of Central Counterparties (CCPs) however, increased, no doubt due to the impending new regulatory requirements concerning the centralisation of over-the-counter (OTC) trading: 60% of worldwide interest rate swaps (IRS) are now centrally cleared, and 10% of credit default swaps (CDS).
In addition to market trends and risks, ESMA monitors on an on-going basis market developments which may be considered as representing possible vulnerabilities. Its report on ‘Trends, Risks and Vulnerabilities’ therefore also looked at:
- Collateral concerns in financial markets: The collapse of unsecured markets during the financial crisis in 2008, as well as post-crash regulatory initiatives, have led financial market participants to increasingly rely on collateral as a means of mitigating counterparty risk. This has stimulated the demand for collateral and will be a familiar finding for corporate treasurers and other market participants. Additional demand for collateral will exceed the supply of available collateral in 2013-2014, says ESMA, especially as Basel III may make collateral comparatively scarcer. The Basel III capital adequacy rules are no doubt a key driver of this trend as banks and others seek to improve the strength of their capital bases. The delay to the liquidity coverage ratio (LCR) stipulations has, however, eased the immediate pressure somewhat.
- Hedge funds and prime brokers: Financial intermediation provided by hedge funds and prime brokers may be vulnerable to any negative impacts on the price of assets pledged as collateral, which may contribute towards the trend for scare collateral, reducing liquidity and ultimately hamper repo financing. The knock-on impacts for any treasurers or banks still foolishly relying on bank liquidity for lending purposes would be considerable.
Commenting on the inaugural ESMA report, Steven Maijoor, chair of the European Securities and Markets Authority, which was itself only set up after the disastrous 2008 crash, said: “ESMA’s risk analysis points to important first signs of easing in EU financial markets, but risks remain high and regulators, market participants and investors should remain vigilant about risks in the financial markets.
“This report provides a guide for securities regulators on those areas requiring regulatory focus in order to build on recent improvements in financial markets and to foster financial stability in the EU,” he added.
Quarterly Risk Dashboard
As part of its on-going market surveillance, ESMA will update its ‘Trends, Risks and Vulnerabilities’ report on a half-yearly basis, so it will be interesting to see how its next 2013 report sees the investment and risk picture for corporate investors. Its next quarterly risk dashboard is due out in the spring, however, and will provide a quicker risk overview for those still worried that the relative calm on EU financial markets, and in regard to eurozone crisis, will not last.
The key findings of the present Q4 2012 ESMA risk dashboard were as follows:
- Liquidity risk: In 2012, liquidity risk started to disperse across market segments and EU member states. Recent policy measures reduced liquidity risk in some segments, while others such as money market funds (MMFs) faced tightening liquidity. Within the sovereign bond market, however, liquidity risk remains significant, says ESMA.
- Credit risk: Overall EU issuance increased but was focused on high-risk assets. Banks and sovereigns exposed to high risk premia concentrated on shorter maturities. Should market conditions worsen, those issuers may face funding difficulties and substantial credit and rollover risks remain [for 2013].
- Market risk: Equity and bond markets showed signs of easing tension in 2012, starting from Q312. In particular, investors appeared to be less averse to risky bonds, found the ESMA risk dashboard.
- Contagion risk: EU sovereign bond markets remained mixed in 2012. Lower CDS exposures and increased risk perceptions by investors helped in mitigating market risks. Contagion risks remain high, however, for those countries, such as Spain or Greece, that still face high sovereign yields.
ESMA is an independent EU authority that was established on 1 January 2011 with a remit to enhance the protection of investors and promote stable and well-functioning financial markets in the EU. It works closely with the other European supervisory authorities responsible for finance and banking such as the European Banking Authority (EBA) and the European Insurance and Occupational Pensions Authority (EIOPA), plus the European Systemic Risk Board (ESRB), which makes up the triumvirate of new post-crash European regulatory bodies. ESMA’s trend reports and new risk dashboards and, therefore, likely to become key market indicators as to health or otherwise of the financial sector on the continent and a key guide to investors.
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