Russian Ukraine conflict concept

Already elevated, financial market risks have only grown amid persistent inflation, rising market volatility and heightened geopolitical risk, according to the European Securities and Markets Authority (ESMA).

In its latest risk assessment report, the European securities markets regulator said market risks are at the highest level. The outlook has only deteriorated due to Russia’s invasion of Ukraine and the imposition of economic sanctions, which occurred after ESMA’s previous risk report was issued.

“The invasion and subsequent political and economic developments have since profoundly impacted the risk environment of EU financial markets,” it said.

In particular, the invasion and the response in the form of sweeping sanctions has driven valuation issues for funds and investors with exposures to Russian assets, it noted.

“There has been significant asset repricing, with riskier assets falling in value (particularly equities, corporate bonds and emerging market debt),” it said.

At the same time, growing inflationary pressures and rising inflation expectations have led to a “growing likelihood of far-reaching rebalancing of portfolios as investors adjust to the new environment.”

Higher inflation is also depressing real returns, “which could lead investors to even higher risk-taking,” the report said.

“In the short term, political event risk remains very high and a key risk driver,” the report said. “Since the invasion, the frequency and intensity of shock events has risen, with potential for further unanticipated developments.”

New shocks would likely further increase market, credit and liquidity risks, it noted.

While not as impacted by factors such as the invasion and inflation, crypto asset values have also declined in lockstep with the mainstream financial markets, the ESMA noted.

“The collapse of [stablecoin] Terra illustrates the acuteness of confidence effects in cryptoasset markets and the risks attached to so-called stablecoins in the absence of a sufficiently robust business models and financial engineering,” it said.

Finally, the report said that cyber risk is still very high and remains a key concern for financial markets, “as attacks targeting infrastructures and firms could be very disruptive.”