ESMA states increased risk to investors due to renewed market volatility

The European Securities and Markets Authority (ESMA) has stated investors are facing “very-high market risk” due to renewed market volatility.

Following the release of its second Trends, Risks and Vulnerabilities (TRV) report, it has identified the asset management industry is at risk as they navigate potentially inflated asset valuations, subdued economic growth prospects, and flattering yield curves.

Additionally, the regulator claims that changed monetary policy expectations might boost investors’ risk appetite and reignite search-for-yield strategies, which would leave them vulnerable to volatility episodes and sudden shifts in market sentiment.

Credit risk and liquidity risk continue to be high, with isolated events indicating pockets of risk in the industry. The regulator also stated that “while the level of credit risk is stable, the deteriorating quality of outstanding corporate debt , the growth in leveraged loans and collateralised loan obligations should warrant attention of public authorities.”

Some of the other findings from ESMA include leveraged loans and collateralised loan obligations. Following simulations, it found uncertainties can impact the credit ratings of CLOs, potentially triggering forced sales from certain investors.

The regulator also used data collected under the EMIR framework to explore the use of derivatives by UCTIS equity funds. The tendency and frequency of the funds to trade derivatives is down to a large number of asset managers characteristics, such as fund family and fund family size, it said. Over time, currency risk and cash inflows appear to significantly influence them, which ESMA believes shows derivatives are used for transaction costs or risk reduction purposes.

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