An EU regulator has identified significant risks within EU financial markets, driven by external events and highlighted the potential for market corrections in a context of fragile liquidity and deteriorating credit conditions. The European Securities and Markets Authority its second risk monitoring report of 2024 on 29 August, emphasising the growing sensitivity of financial markets in the European Union.
Earlier in 2024, markets experienced reduced volatility and a resurgence in search-for-yield behaviour, particularly in riskier market segments, found Esma. This was seen as an indication of market optimism for a ‘soft landing’ in the economic landscape. However, recent developments underscored the continued vulnerability of markets, especially in response to changes in interest rates, worsening credit risks and political and electoral news. Esma reported that equity markets and other financial segments remained at high risk of correction.
Verena Ross, chair of Esma, in a press , noted the increasing market anxiety regarding economic prospects and political events. She pointed to the dip in equity valuations in early August and the market fluctuations surrounding recent European and French elections as evidence of this nervousness. Ross also underscored the importance of vigilant market monitoring and close cooperation with national authorities to manage these risks. She highlighted specific concerns in the fund sector, particularly around liquidity mismatches in real estate and the declining quality of assets linked to interest rates, credit risk and valuation issues.
Structural Developments
Esma’s report also provided insights into structural developments across key financial market sectors in the first half of 2024.
Market-based finance: Capital availability for European corporates through capital markets remained stable in 2024, despite challenging conditions for equity issuance. Initial public offering activity showed signs of recovery, while corporate bond issuance was strong in the first quarter but declined in the second. The report flagged the significant upcoming maturity wall for corporate bonds between 2024 and 2028, with corporate debt sustainability posing a considerable risk, especially within lower-quality segments.
Sustainable finance: The strong investor interest in sustainable investments observed in recent years has faced challenges, with green bond issuance slowing and sustainable funds experiencing outflows in the second half of 2023. Looking ahead, Esma indicated that the ability of firms to announce credible transition plans could influence investor willingness to support the green transition. Transition finance instruments could play a crucial role in this context.
Financial innovation: The crypto-asset market experienced a surge in the first half of 2024, driven by the approval of spot Bitcoin and Ether exchange-traded products (ETPs) in the United States, leading to a global market valuation of €2.2trn by the end of June--a 40% increase since the end of 2023. However, early August saw increased volatility and significant declines in crypto-asset valuations. Esma also noted the continued high concentration in both crypto-assets and crypto exchanges.
Market monitoring
In its analysis of securities markets, Esma observed that asset prices trended upwards with minimal volatility in early 2024, indicating market anticipation of future interest rate cuts. However, market volatility linked to elections in the EU during June and July, as well as a brief dip in global equity valuations in early August due to weaker-than-expected US economic indicators, reflected ongoing uncertainties. Corporate bond spreads, particularly for high-yield corporates, continued to narrow, despite a decline in the credit quality of high-yield non-financials, particularly in the real estate sector. This trend suggested a search-for-yield behaviour with potential underestimation of associated risks.
In the asset management sector, EU fund performance remained positive across categories, with inflows recorded in funds exposed to fixed income instruments, such as bond funds and money market funds. The increase in interest rates was mitigated by a broad perception of declining credit risk, as reflected in low credit spreads. However, the continued deterioration in the credit quality of bond fund portfolios, as measured by credit ratings, raised concerns about the potential for disorderly repricing of risky assets. Esma also highlighted ongoing liquidity risks and potential losses related to interest rate, credit risk, and valuation issues, with open-ended real estate funds remaining particularly vulnerable due to structural liquidity mismatches and downward pressure on valuations in housing markets.