03, 2020 / 08:07 PM / by ESMA / Header Image Credit: Finance Magnates
The European Securities and Markets Authority (ESMA), the EU securities markets regulator, today publishes its second Trends, Risks and Vulnerabilities (TRV) Report of 2020. A webinar open to the public will be held on 9 September to present the report.
The Report analyses the impact of COVID-19 on financial markets during the first half of 2020 and highlights the risk of a potential decoupling of financial market performance and underlying economic activity, which raises the question of the sustainability of the current market rebound.
The TRV also highlights specific risks for financial stability and investors in relation to Collateralised Loan Obligations (CLOs) model risk, EU fund industry interconnectedness and spill overs, research unbundling and closet index funds costs and performance.
Continued very high risks across ESMA's remit
The COVID-19 pandemic, in combination with the valuation risks highlighted in ESMA's previous risk assessments, led to massive equity market corrections in Q1 while in Q2 markets witnessed a remarkable rebound, helped by public policy interventions in the EU and elsewhere.
The market environment however remains fragile, and ESMA maintains its risk assessment. It sees a prolonged period of risk to institutional and retail investors of further - possibly significant - market corrections and very high risks across the whole of ESMA's remit. The extent to which these risks will materialise will depend on two drivers: the economic impact of the pandemic, and additional external events in an already fragile global environment. The impact on EU corporates and their credit quality, and on credit institutions, are of particular concern, as are growing corporate and public indebtedness and the sustainability of the recent market rebound.
Decoupling between market performance and economic activity
The sustainability of the recent market rebound remains a concern. Equity markets have surged by 40% in the euro area since the trough reached in mid-March, almost back to pre-crisis levels, while the IMF expects GDP to drop by more than 10% in 2020, followed by a mild recovery of 6% in 2021.
Initial impact of COVID-19 on financial markets
During the reporting period for this TRV, ESMA saw the financial market go through three stages, each described in detail in this report: i) a liquidity and volatility period (mid-February - end-March) where markets, investment funds and infrastructures faced high levels of stress, ii) a rebound period (early to end-April) where markets grew swiftly on the back of policy actions and iii) a differentiation stage (starting early May), where credit and solvency risk came to the fore, as investors started to differentiate between issuers and asset classes amid ongoing deterioration of economic fundamentals.
Against the background of these events, regulators have monitored closely any threats to financial stability and taken measures to promote stability, investor protection and market integrity.
Focus on risks for financial stability and investors
This TRV also takes an in-depth look at specific risk issues in four articles: