ESMA bolsters its monitoring of EU alternative investment funds

ESMA bolsters its monitoring of EU alternative investment funds

The European Securities and Markets Authority (ESMA), the esteemed financial markets watchdog of the EU, recently unveiled a comprehensive report spotlighting the market dynamics of the EU’s alternative investment funds (AIFs).

In a revealing segment of the report, ESMA casts a spotlight on the precarious standing of real estate (RE) funds. This particular focus is driven by a discernible downtrend in transaction volumes coupled with a downtrend in property values across various jurisdictions.

An added layer of complexity emerges with the existing liquidity mismatches within AIFs, a situation exacerbated by the significant presence of open-ended RE funds that boast daily liquidity options. This vulnerability takes on a systemic dimension in jurisdictions where the RE fund’s market share is notably substantial.

Broadening the scope to encompass the entire sector, ESMA’s findings paint a picture of a sector experiencing a slight contraction, with a 3% decrement bringing the total to EUR 6.8trn in 2022, accounting for 36% of the entire EU fund industry.

This downward adjustment in valuation is primarily attributed to the valuation losses sustained by funds with exposure to bonds and equities, a scenario precipitated by less-than-favourable market activities in 2022.

RE funds, in particular, find themselves at the crossroads of multifaceted risks, encompassing leverage concerns, market footprint, valuation inconsistencies, and liquidity mismatches. Meanwhile, the realm of hedge funds is not without its own set of challenges, with leverage remaining at elevated levels, potentially triggering significant market repercussions. However, a silver lining exists as most hedge funds maintain robust cash reserves, a strategic cushion against potential margin calls and a deterrent against forced sales.

The report also sheds light on the Liability-Driven Investment (LDI) funds, noting the continued prominence of the risks they introduce through their leveraged positions in the UK government bond market. Despite the precarious environment, the boundaries established post the intense market turmoil in September 2022 are deemed to still hold relevance and appropriateness.

In response to these multifaceted challenges, ESMA has detailed the array of measures deployed by regulatory authorities aimed at mitigating the identified risks. The authority remains committed to its financial stability mandate and pledges ongoing collaboration with National Competent Authorities (NCAs) to ensure a harmonised supervisory approach towards data reporting under AIFMD, enhancing its monitoring framework concerning market evolution and pivotal risk metrics such as leverage and liquidity.

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