EU Regulators Issue Market Risk Warnings On Brexit And Cyber-security

In a report issued on Thursday (12 April), the European Supervisory Authorities (ESAs) - encompassing securities and markets regulator ESMA, banking regulator the EBA and insurance and pensions regulator EIOPA - reiterated concerns about the risks posed to retail investors by the rise of cryptocurrencies.

It said: "virtual currencies can raise significant consumer protection issues [such as] extreme volatility and bubble risk, the lack of a robust secondary market, operational disruptions as well as the lack of price transparency."

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The ESAs issued a similar joint statement on 12 February, which focused on the risks of buying and trading virtual currencies, and financial products exposing consumers directly to virtual currencies.

In addition, the 12 February warning highlighted the specific risks associated with the un-regulated status of cryptocurrencies.

The joint committee report on Risks and vulnerabilities in the EU financial system focuses on the second half of 2017, over which time despite "the overall EU macroeconomic environment continued to improve" key risks persisted.

Risk premia reversal

Despite the improved economic outlook, the potential for sudden risk premia reversals, whereby abruptly increasing yields could lead to losses across asset classes and generate substantive volatility in asset prices, remain "imminent", according to the report.

ECB data shows retail consumers are affected by a repricing of risk premia through their portfolio holdings, with EU households' exposure to globally listed equities amounted to €950bn in the third quarter of 2017, while they held €1,890trn in investment fund shares.

The report said: "Significant market turmoil resulting in negative portfolio returns can reduce household consumption, via wealth effects or realised losses".

The ESAs said national regulators must continue to use stress testing as a crucial tool for the management of systematic risk", focusing on banks, CCPs, insurance and pensions, and, in the future, asset managers.

In 2017 equity prices rose by 10%, after remaining flat in 2016, supported by the improved macroeconomic environment and "accommodative monetary policies", the report said.

The ESAs believe these conditions "fuelled concerns of possible asset overvaluation, while low volatility "reflects to some extent expectations of continued monetary policy support" and, as a result, the "relative absence of market reaction to adverse events" has also potentially increased investor complacency and "the probability of sudden risk repricing".

The report added this may have contributed to sudden return of global equity market volatility in February 2018, where the S&P 500 lost 4.1% in one day and the VIX jumped to around 40%, its highest level in several years.

It warned this kind of volatility "may increase in the future".

Brexit

The ESAs also reiterated concerns about the risks associated with the UK's departure from the EU, which have "the potential to expose the EU27 and the UK to economic instability and to weaken market confidence, in particular if negotiations end in a disorderly fashion".

For regulated firms, counterparties, investors and consumers, the report said it is essential they "prepare appropriate mitigating actions in a timely manner, to prepare for the UK's withdrawal from the EU".

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The report also noted concerns about Brexit-driven relocations, adding "common EU efforts to ensure a consistent EU supervisory approach to potential relocations of financial institutions are necessary to protect the integrity of the Single Market".

It added: "A range of further issues may arise, including the restructuring of legal entities and possible portfolio transfers.

"In the short term, UK's withdrawal from the EU may also affect access of EU 27 households and corporates to financial services provided in the UK and it may affect market confidence.

"This has potential implications on market liquidity and risk premia, and the risk of further adverse feedback loops."