Red alert

Investors should brace for the threat of further market corrections amid high economic and financial vulnerabilities, says the European Securities and Markets Authority (ESMA) in a new report.

In its latest review of market trends, Europe’s financial markets regulator warned that overall risks remain high, and, with financial conditions tightening, certain risks could intensify.

“Contagion and operational risks are considered very high, as are liquidity and market risks,” ESMA said in its report. Credit risk is already high and expected to rise, “reflecting the growing concerns over public and corporate indebtedness.”

Additionally, the risks in securities markets and for the asset management sector was judged as very high, with the fund sector experiencing its largest decline in assets under management since the global financial crisis, due to both weak market performance and investor outflows.

“Financial markets remained remarkably stable in [the second half of 2022], despite the general volatile environment,” Verena Ross, chair of ESMA, said in a release. “Although economic sentiment has become more positive in early 2023, there is no room for complacency. ESMA is keeping the overall risk assessment across its remit at the highest level.”

She added that “the confluence of high risks … and fragile market liquidity may test the resilience of the financial system against possible future shocks.”

Capital market financing activity dropped sharply in 2022, ESMA said, as investor confidence weakened and credit standards tightened.

“Risks to infrastructures and to consumers both remain high, though now with a worsening outlook, while environmental risks remain elevated,” it said, noting that net-zero pledges have come under growing scrutiny, concerns about greenwashing have risen, and the effort to decarbonize the economy has been stunted by the energy crisis in Europe.

“Despite this, ESG markets continued to grow, with this trend showing resilience to broader market developments,” the report said.

While valuations have plunged in the crypto sector and crypto firms have been thrown into turmoil, there have been no signs of any spillover to the traditional financial industry or the real economy, the regulator said.