ESMA warns EU financial markets risk at ‘very high level’

The European Securities and Markets Authority (ESMA) has published its Risk Dashboard for Q1 2021, classifying a “very high level” of risk amid the “general decoupling” of securities prices from economic fundamentals.

The report acknowledges that valuations in EU financial markets for most market segments are now at or above pre-COVID-19 levels and that markets remain “highly sensitive to events and volatility”.

Fixed income valuations are now far above their pre-COVID levels, in part due to continued monetary policy support, the ESMA says, and a sudden risk reassessment, amidst the aforementioned general decoupling, remains the main risk for EU financial markets.

Looking ahead, the ESMA says it anticipates a prolonged period of risk to institutional and retail investors of further – possibly significant – market corrections and sees very high risk across its whole remit.

The extent to which these risks will further materialise will critically depend on market expectations on monetary and fiscal policy support as well as on the pace of the economic recovery, the ESMA says.

Regarding the macroeconomic environment, the ESMA acknowledges that the European Commission economic forecast which predicts a stronger than anticipated recovery in the EU.

Economic growth is set to gather momentum in the summer as vaccination programmes progress and containment measures gradually ease. Nevertheless, the Authority states, the pace of recovery is projected to vary significantly across Member States.

The medium-term severity of this, especially in the presence of new COVID variants and potential delays in the roll-out of vaccination programmes, could also delay the easing of containment measures, the ESMA predicts, and the COVID-related economic impact could be more pronounced than anticipated.

Sustainability of Government support measures could also become a risk in the short to medium term, it predicts.

Regarding the low-interest-rate environment, the ESMA says that Monetary policy remained supportive of the economy, which is leading to “search-for-yield” behaviour and the decoupling of financial asset prices from fundamentals.

In terms of political risk, the ESMA presents a more optimistic outlook, with Brexit having been completed and with more economic and political predictably in the US, the Authority to identify a political and event risk assessment which remains stable.