TRV - esma.europa.eu

1 19 February 2020 ESMA50-165-1117 ESMA50-165-737 TRV ESMA report on Trends, Risks and Vulnerabilities No. 2, 2021 1 September 2021 ESMA50-165-1842 ESMA report on Trends, Risks and Vulnerabilities No. 2, 2021 2 ESMA report on Trends, Risks and Vulnerabilities No. 2, 2021 European Securities and Markets Authority, Paris, 2021. All rights reserved. Brief excerpts may be reproduced or translated provided the source is cited adequately. The reporting period for this report is 1 January 2021 to 30 June 2021, unless otherwise indicated. Legal reference for this report : Regulation (EU) No. 1095/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Securities and Markets Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/77/EC, Article 32 Assessment of market developments, including stress tests , 1.

2 The Authority shall monitor and assess market developments in the area of its competence and, where necessary, inform the European Supervisory Authority (European Banking Authority), and the European Supervisory Authority (European Insurance and Occupational Pensions Authority), the European Systemic Risk Board, and the European Parliament, the Council and the Commission about the relevant micro-prudential trends, potential risks and vulnerabilities. The Authority shall include in its assessments an analysis of the markets in which financial market participants operate and an assessment of the impact of potential market developments on such financial market participants. The information contained in this publication, including text, charts and data, exclusively serves analytical purposes. It does not provide forecasts or investment advice, nor does it prejudice, preclude or influence in any way past, existing or future regulatory or supervisory obligations by market participants.

3 The charts and analyses in this report are, fully or in part, based on data not proprietary to ESMA, including from commercial data providers and public authorities. ESMA uses these data in good faith and does not take responsibility for their accuracy or completeness. ESMA is committed to constantly improving its data sources and reserves the right to alter data sources at any time. The third-party data used in this publication may be subject to provider-specific disclaimers, especially regarding their ownership, their reuse by non-customers and, in particular, their accuracy, completeness or timeliness, and the provider s liability related thereto. Please consult the websites of the individual data providers, whose names are given throughout this report , for more details on these disclaimers. Where third-party data are used to create a chart or table or to undertake an analysis, the third party is identified and credited as the source.

4 In each case, ESMA is cited by default as a source, reflecting any data management or cleaning, processing, matching, analytical, editorial or other adjustments to raw data undertaken. ISBN 978-92-95202-50-4, ISSN 2599-8749, DOI , EK-AC-21-002-EN-N European Securities and Markets Authority (ESMA) Risk Analysis and Economics Department 201-203 Rue de Bercy FR-75012 Paris FRANCE ESMA report on Trends, Risks and Vulnerabilities No. 2, 2021 3 Table of contents Table of contents 3 Executive summary 4 Market monitoring 7 Market environment 8 Market trends and risks 10 Securities markets 10 Infrastructures and services 15 Asset management 22 Consumers 31 Market-based finance 36 Sustainable finance 44 Financial innovation 52 Risk analysis 62 Financial stability 63 Cloud outsourcing and financial stability risks 63 Financial stability 72 COVID-19 and credit ratings 72 Investor protection 82 The market for small credit rating agencies in the EU 82 Investor protection 95 Environmental impact and liquidity of green bonds 95 TRV statistical annex 107 List of abbreviations 108 ESMA report on Trends, Risks and Vulnerabilities No.

5 2, 2021 4 Executive summary Market monitoring ESMA risk assessment Risk summary EU financial markets continued their recovery during the first half of 2021 with valuations at or above pre-COVID-19 levels, as the global economic outlook improved, with COVID-19 vaccine roll-outs and amid sustained public policy support. Fixed income valuations, notably for HY corporate bonds are now far above their pre-COVID-19 levels in a context of increasing corporate and public debt. Increased risk-taking behaviour has led to volatility in equity ( GameStop related market movements) and crypto asset markets, as well as to the materialisation of event-driven risks such as in the case of Archegos or Greensill. Going forward, we expect to continue to see a prolonged period of risk to institutional and retail investors of further possibly significant market corrections and see very high risks across the whole of the ESMA remit.

6 Current market trends will need to show their resilience over an extended period of time for a more positive risk assessment to be made. The extent to which these risks will materialise will critically depend on market expectations on monetary and fiscal policy support, as well as on the pace of the economic recovery and on inflation expectations. ESMA remit Risk categories Risk drivers Level Outlook Level Outlook Outlook Overall ESMA remit Liquidity Macroeconomic environment Securities markets Market Interest-rate environment Infrastructures and services Contagion Sovereign and private debt markets Asset management Credit Infrastructure disruptions Consumers Operational Political and event risks Note: Assessment of the main risks by risk segments for markets under ESMA s remit since the last assessment, and outlook for the forthcoming quarter.

7 Assessment of the main risks by risk categories and sources for markets under ESMA s remit since the last assessment, and outlook for the forthcoming quarter. Risk assessment is based on the categorisation of the European Supervisory Authorities (ESA) Joint Committee. Colours indicate current risk intensity. Coding: green =potential risk, yellow=elevated risk, orange=high risk, red=very high risk. Upward-pointing arrows indicate an increase in risk intensity, downward-pointing arrows a decrease and horizontal arrows no change. Change is measured with respect to the previous quarter; the outlook refers to the forthcoming quarter. ESMA risk assessment based on quantitative indicators and analysts judgement. Market environment: The economic outlook continued to improve in 1H21, reflected in further improved gross domestic product forecasts and despite a remaining high degree of uncertainty concerning the ongoing economic impact of the COVID-19 pandemic.

8 However, rising valuations across asset classes, massive price swings in cryptoassets and event-driven risks observed in 1H21 amid elevated trading volumes raise questions about increased risk-taking behaviour and possible market exuberance. Rising commodity prices and volatility have contributed to increased concerns about inflation expectations, even though the medium-term outlook for EU inflation remains subdued. In a context of continued accommodative monetary policies and fiscal support, concerns around the profitability of banks and insurers, as well as elevated corporate and government debt levels, continue to weigh on the medium-term economic outlook. Securities markets: In 1H21 equity markets rallied on expectations of economic recovery, with share valuations in the EU recovering from the March 2020 drop .

9 Heterogeneity in performance across EU countries and sectors continues to persist, with financial sector share performance catching up. Fixed-income markets continued to show elevated valuations amid continued monetary policy support and improving economic outlooks. Inflation concerns in the US started a global bond sell-off, which had some spillover effects in the EU with a slight increase in most EA sovereign yields. High-yield corporate bonds continued to gain market value at a brisk pace highlighting continued search-for-yield behaviour. A surge in commodity prices can be attributed to economic recovery and expectations of an inflation upswing. Infrastructures and services: Equity trading volumes in European venues increased significantly compared to 2H20, partially due to the relocation of EEA share trading linked to the share trading obligation.

10 Central clearing volumes increased for products subject to clearing. Settlement activity also ESMA report on Trends, Risks and Vulnerabilities No. 2, 2021 5 increased, while settlement fails remained more frequent than before the pre-COVID-19 crisis for equities, and slightly above 2H20 levels across security types. Finally, a transition to new benchmarks, including the euro short-term rate ( STR) is underway, with a stable STR rate fixing, and increasing volumes, notably on interest-rate swap markets. Credit rating agencies continued to improve their outlook, with ratings drift starting to return to pre-pandemic levels for most products, though commercial mortgage-backed securities (CMBS) continued to experience significant downgrades early in 2021. Fallen angels continued to decrease, but a growing share of BBB-rated debt in corporates and structured finance shows ongoing vulnerability to future stresses.