EU flags waving in front of European Parliament building. Brussels, Belgium

European financial regulators are warning industry firms to prepare for declining asset quality and the risk of market corrections, among other threats.

In their first joint risk assessment this year, Europe’s securities, banking and pension regulators warned that a resurgence in Covid-19 infections in the first quarter of 2021 has intensified economic uncertainty.

While the initial distribution of vaccinations “provides a crucial anchor for medium-term expectations,” the regulators said that disruptions in the rollout due to insufficient production, delivery delays and mutations of the virus “are weighing heavily on short-term recovery prospects.”

Yet this uncertainty has not been reflected in “asset valuations and market volatility,” the regulators said, noting that they have generally recovered to pre-crisis levels.

This represents “a continued risk of decoupling of valuations from economic fundamentals,” they said, and poses a risk of “possible further market corrections.”

As a result, the regulators advised policymakers, financial institutions and market participants to prepare for a decline in asset quality, the risks of a prolonged low interest rate environment, and to ensure adequate risk pricing.

They also called on firms to remain conservative in paying dividends and engaging in share buybacks, and suggested that investment funds step up preparations for potential redemption spikes and valuation shocks.