Nervous markets: ESMA warns of risk of significant corrections

The European Securities and Markets Authority (ESMA) has warned that volatile markets pose ‘high risks’ to both institutional and retail investors, saying that further and ‘possibly significant’ market corrections could be in the pipeline.

With markets ‘remaining nervous’ and geopolitical tensions on the rise, the first trends, risks and vulnerabilities report of the year from the EU’s securities markets regulator warns that risks to investors remain high – and ESMA is particularly concerned about retail investors.

‘All investors should consider that the risk of market corrections remains acute,’ says Verena Ross, ESMA chair, in a statement. ‘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 [in the future].’

She adds that the rapid rise of retail investors into the markets – spurred by the growth of convenient and user-friendly mobile trading platforms – worries the regulator. ‘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 realizing the high risks involved,’ adds Ross.

ESG growth and concerns

For the first time, ESMA has included environmental risk as a category in its risk dashboard. ‘In addition, new risk indicators on climate-related disclosures, firms’ reputational risk and EU carbon markets are covered in the statistical annex,’ it notes.

Looking at sustainability risks, ESMA says 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. The regulator’s concern is with possible green asset overvaluation.

ESG concerns also feed into other areas such as equity. ESMA writes that generally, elevated price earnings ratios point toward potential overvaluation concerns. ‘Energy commodity prices were particularly volatile, highlighting the potential financial risks associated with the energy transition and Europe’s climate policy objectives,’ it adds.

Looking to asset management, the regulator notes that 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,’ it says.

ESMA also points to the risks around the crypto assets market, which it says reached new records with a peak of €2.6 tn ($2.95 tn) in November 2021. This was ‘fueled by investor appetite for riskier assets and growing institutional adoption,’ it says, adding that the rapid expansion of the asset class is causing concern over the resilience of business models as well as the ‘high product and market risks investors take’.

More broadly, ESMA notes that while the macro environment improved over the second half of last year, the economic outlook remains unclear – with the potential impact of any new Covid-19 wave also a concern.