Topical Analysis

2024

▸ Real estate markets – Risk exposures in EU securities markets and investment funds

Recent macroeconomic shifts, such as elevated inflation and rapidly rising interest rates, coupled with global growth deceleration, have put real estate markets under particular stress. We explore the current exposures in EU securities markets and the asset management sector to the rising risks in real estate markets. First, there has been a broad-based decline of the main equity and bond real estate indices, as along with increased trading activity and securities lending activity for real estate corporations. Lower valuations were also observed for listed real estate firms and real estate investment trusts, this may also be in the context of an increase in leverage of real estate firms over the past five years. Second, next to credit institutions, particularly banks, investment funds are important investors in the sector. They also belong to the main counterparties of some real estate firms in derivatives and securities financing transactions. Real estate-related securities are also found to be used as collateral. Real estate alternative investment funds have seen significant growth in the past five years (+375% to EUR 1.5tn AuM). Finally, real estate firms have mainly domestic focus with few prominent players and low cross border-exposures (except for securities financing transactions). Going forward, interest rate risk can be expected to continue to shape real estate market exposures; credit risk indicators for real estate companies have started to show signs of deterioration; liquidity mismatches remain the key vulnerability for real estate funds.

2023

▸ Evolution of EEA share market structure since MiFID II

Since the launch of the EU capital markets union initiative, new legislative and non-legislative proposals have aimed at fostering a single market for capital in the EU. These regulatory proposals, together with other external events including mergers, have shaped the integration and competition level of trading platforms. Making use of regulatory data, this article presents the evolution of the European share market microstructure from 2019 to 2022, with a specific focus on the impact of the UK’s withdrawal from the EU, given its pivotal role in equity markets. The important decrease in trading volumes observed after 2021 was accompanied by four main changes: a decrease in the number of infrastructures trading shares, even though they remain elevated; a new distribution of trading, both by market type and by country, with a concentration of trading in a few EU countries; the relocation of domestic trading for many European countries; and the increased specialisation of venues. Confirming the transfer of volumes in a few countries, share trading remains highly concentrated on a few trading venues after the UK’s withdrawal.
 

▸ The August 2022 surge in the price of natural gas futures

This paper investigates the record surge in prices on European natural gas markets in August 2022. It looks at the main market, the Dutch TTF, and finds CCP margins rose and fell with prices and volatility in line with expectations, with margin calls met on time. There were no signs of reductions in positions in TTF contracts in our data, with TTF positions in fact slightly higher during this period. The OTC share also did not change significantly during the March and August 2022 market events. In terms of trading behaviour, it finds highly inelastic demand, reflected in only slightly lower traded volumes from a year previously, despite prices being many times higher. This was likely driven by the need to replenish reserves for the winter given the drop in Russian pipeline supply. End-clients in EU member states also accumulated net long positions through the month. At points in the month there was positive correlation between volumes and prices, indicative of demand rising with prices. Demand also focused primarily on futures for delivery in the autumn/winter period. Different trading patterns are discernible among the largest end-clients. Some gas producers were significantly net short across maturities, showing their role in bringing supply to the market. Electricity utilities also showed two patterns, a first group who were long on maturities for winter delivery while short on others, and a second group that tended to build long positions across maturities, sometimes building positions rapidly, thus more liable to fuel price increases and reduce liquidity. Non-end clients, financial entities that act as clearing (and exchange) members, generally accumulated net short positions serving strong demand from end-clients.

▸ The EU securitisation market – an overview

This article provides an overview of the EU securitisation market based on the data ESMA receives under Regulation (EU) 2017/2402 (securitisation regulation, or SECR). The SECR requires the reporting of public securitisation data, including on underlying exposures and investor reports, through registered securitisation repositories from 30 June 2021. Overall, the size of the European securitisation market has decreased significantly since the Global Financial Crisis which at the end of 2010 amounted to EUR 2tn for ABS, CDO and MBS. At the end of 2022, there were 390 individual securitised products outstanding in the EU as reported to the registered securitisation repositories, amounting to EUR 540bn. 54% of these outstanding amounts were linked to residential mortgages, followed by automobile loans (16%), loans to SMEs (15%) and consumer loans (12%). 86% of the outstanding was originated in the five largest markets, namely FR (25%), DE (21%), IT (17%), ES (13%), and NL (10%). The scope of Regulation (EU) 2017/2402 is limited to public securitisation deals issued after 1 January 2019 and does not cover earlier issuances. The overall market including pre-2019 securitisations is significantly larger, as suggested by industry reports such as AFME’s estimate of EUR 700bn of EU ABS. The market coverage of the ESMA reporting will increase as we approach the maturity of the pre 2019 deals, although private securitisation will remain out of scope.

▸ EU natural gas derivatives markets: risks and trends

Natural gas derivative markets came into the spotlight after the Russian invasion of Ukraine, as prices soared amid high volatility and a significant deterioration of liquidity. This article uses regulatory data to provide an overview of the structure and functioning of EU natural gas derivatives markets which complements other analyses published in recent months. The focus is on the assessment of risks for financial stability rather than detailed monitoring. Overall, the annual turnover on EU futures exchanges reached EUR 4,150bn in 2022, and open positions of EU counterparties amounted to around EUR 500bn as the end of 2022. The market is characterised by a high degree of concentration of market participants active in clearing and trading activity, and some energy firms hold relatively large derivative positions. In that context, liquidity and concentration risks are among the main vulnerabilities identified, along with data fragmentation and data gaps. The recent migration of some of the activity from exchangetraded to over-the counter derivatives trading, possibly related to lower margin requirements, raises concerns due to more limited transparency and more bespoke margin and collateral requirements in that market segment.

2022

▸ A framework to assess operational resilience

The operational resilience of financial entities that play a critical role in the financial system is key to financial stability. In this article, we present a novel approach to assess operational resilience for financial entities providing time-critical services. These tools provide the means for supervisors to measure and test different aspects of financial entities’ operational resilience in a standardised and comparable manner and can be adapted to different types of financial institutions for which continuous operations is expected. We present an application of those tools in the context of the fourth ESMA CCP stress test.

▸ Parsing prospectuses: A text-mining approach

The EU Prospectus Regulation sets out strict requirements on how issuance prospectuses for securities like shares and bonds should be drafted and presented. Because of the importance of these documents for investors, it is useful to understand how actual prospectuses match up with these specific requirements. We aim to contribute to this question by applying natural language processing techniques to a unique dataset consisting of all prospectuses approved under the Prospectus Regulation between end-November 2020 and January 2022. After evaluating 593,000 pages of text, we find that prospectuses from issuers in the EU can pose challenges for those intending to use them: they contain substantial repetition of text, include broken hyperlinks, may present generic and imprecise risk factors, and may include unclear language regarding availability of working capital. In addition, we find statistical evidence that longer prospectuses, all else being equal, contribute to greater divergence among rating agency assessments of credit risk. This suggests that an abundance of material can present a challenge for even specialised readers to identify information that is key to assessing the product. Our findings are a contribution to assessing the content of issuance prospectuses by means of text mining, i.e. an advanced analytical technique which enables the enormous volumes of text that prospectuses entail to be more comprehensively assessed. Our study also illustrates the effectiveness of text mining as a supervisory technology tool.

▸ Leverage and derivatives – the case of Archegos

In March 2021, the default of Archegos, a US family office, led to large losses for some global banks. Archegos was able to accumulate large exposures to and leverage on equities by entering into derivatives transactions with bank counterparties. When the price of the underlying stocks started to decline, the firm was unable to meet variation margins, resulting in the liquidation of the stocks by the counterparty banks. In this article, we use EMIR data to analyse Archegos positions and show that it is possible to track the steep increase in concentrated exposures that the family office undertook in February and March 2021. Our findings show how regulatory data collected under EMIR can be used to monitor leverage and concentration risk in derivatives markets.
 

2021

▸ COVID-19 and credit ratings

This article investigates how credit ratings evolved during the exceptional circumstances of early 2020, exploiting ESMA’s extensive RADAR database of credit rating actions, which covers not only EU ratings but also a large number of non-EU ratings. It shows that corporate and sovereign ratings were downgraded rapidly following the onset of the pandemic, with non-financial corporates particularly affected. Underlying this were strong impacts on businesses in sectors particularly vulnerable to declining economic activity, such as the energy, and consumer cyclicals sectors. Sovereign ratings experienced downgrades in bursts, with many of these occurring with the first and second waves of the pandemic, though the extent of downgrades varied greatly by jurisdiction. In structured finance products, commercial mortgage-backed securities appear by far the most affected, with persistent downgrades reflecting the ongoing challenges to the performance of commercial mortgages. Collateralised loan obligations, a concern before the pandemic, also experienced a wave of downgrades during summer 2020, but otherwise appear to have been relatively resilient, with senior tranches largely unaffected.

▸ The market for small credit rating agencies in the EU

In Europe, the three largest CRAs have for years had an overall market share of more than 90 %. EU legislators sought to reduce this imbalance 10 years ago by supporting the use of small CRAs in Europe. This article applies SupTech-related techniques to take stock of market conditions since then, using a unique dataset containing all EU ratings issued and outstanding since 2015 (when the CRA Regulation’s reporting requirement entered into force), covering EUR 20 tn worth of EU financial products and nearly 6 000 issuer ratings. Using network analysis techniques, it is clear that the landscape for small CRAs at the EU level is a challenging one: small CRAs are used almost exclusively in local single-rating markets (the ‘periphery’), and are locked out of the larger ‘core’ market (of issuers seeking more than one rating for their products or themselves). This larger market is shared almost exclusively among the three largest CRAs, and the associated industry-wide Herfindahl-Hirschman Index (HHI) levels are consistently at levels usually deemed to be “highly concentrated”. Lastly, the article introduces a simulation exercise for alternative legislative rules designed to boost competition in EU markets for credit ratings. Strengthening legislative requirements to make use of small CRAs when seeking an additional rating for a product or issuer is associated with an average reduction in overall EU CRA industry concentration of roughly 40 to 55 %, leading to HHI levels that are no longer “highly concentrated” from a competition perspective.

2020

▸ Model risk in CLOs

The benefits of securitisation depend on its ability to effectively engineer and limit credit risk. This article explores the approaches to modelling CLO credit risk adopted by the three main CRAs. It discusses the differences and some limitations in approaches and how these might potentially affect credit ratings’ accuracy. Finally, it sets the discussion in the context of some of the recent developments in the leveraged loan and CLO markets, including those stemming from COVID-19. Together, these make clear the importance of sensitivity analysis to identify model and credit rating limitations and how the transparency of these is key to informing investors’ reliance on ratings.

2019

▸ DVC mechanism – impact on EU equity markets  

We provide evidence on the impact of MiFID’s DVC mechanism on European equity markets in the first six months of its application. The DVC mechanism introduces limits on the amount of transactions executed in dark pools and aims to protect the price discovery process in equity markets. We find that, overall, for equities, most of the trading is executed in lit markets. We also analyse the impact of the DVC mechanism on market liquidity in lit markets, building on a set of market liquidity indicators. The results are mixed. For equities banned by the DVC mechanism, market liquidity in lit markets improved in terms of tightness, breadth and depth (measured by bid ask spreads, turnover, and the Amihud index), while it worsened when measured by the turnover ratio and average trade size. 

▸ Leveraged loans, CLOs – trends and risks

Recent years have seen a significant pickup in the issuance of leveraged loans and collateralised loan obligations (CLOs) in the US and the EU. The surge in issuance occurred against a backdrop of looser underwriting standards, higher indebtedness of borrowers and compressed credit spreads. This article provides an overview of the leveraged loans and CLO markets in the EU. In particular, we assess exposures of the EU fund industry to leveraged loans and CLOs, which remain limited at the current juncture. In addition, the article uses a simulation analysis to show how model uncertainty can impact the credit ratings of CLOs, and potentially trigger forced sales from some types of investors.

2018

▸ Enhancing transparency of EU securitisations

The EU Securitisation Regulation includes a number of due diligence and monitoring requirements for investors. ESMA is tasked with developing draft transparency technical standards that will assist investors in fulfilling these obligations, in line with its investor protection mandate. At the same time, securitisation capital requirements are also changing, with important implications for the types of transactions to be observed in the future. This article uses a loan-level and tranche-level dataset of 646 securitisations to simulate the securitisation features that can arise when originators seek to use securitisation as part of their capital management exercises. The draft ESMA disclosure templates can assist investors in fulfilling their due diligence and monitoring tasks to better understand the risks and aspects of these instruments.

▸ Monitoring volatility in financial markets

Market volatility, and its potential to undermine financial stability as well as to impose unexpected losses on investors, is a subject of concern for securities market regulators. Relatively low or high levels of volatility increase the likelihood of stress in financial markets. Low yields and low volatility characterised the two years between February 2016 and January 2018. In February 2018 equity market volatility spiked as markets globally were affected by a strong correction. The main drivers of the long period of low volatility are related to lower equity return correlation, a low interest rate environment and searchfor-yield strategies, and stable macroeconomic and corporate performances. A prolonged period of low volatility may lead to a more fragile financial system, promoting increased risk-taking by market participants driven by the use of VaR models and, more recently, by the growth of volatility targeting strategies. While the AuM of these products may be considered still quite small, the number of products is sufficiently broad to become a key factor driving volatility spikes, like those that occurred in the first week of February 2018.

2024

▸ Assessing risks posed by leveraged AIFs in the EU

This article contributes to ESMA’s financial stability objective by presenting the AIFMD Art. 25 framework and the results of the risk assessment performed by ESMA and NCAs in 2023, based on the end of 2022 AIFMD data. One focus of the 2023 risk assessment are the risks posed by real estate (RE) funds. It finds that RE funds pose low risks on an individual basis, due to their limited use of leverage or size in most jurisdictions, but could be more systemically relevant in jurisdictions where groups of funds own a large share of the RE market on aggregate. This is the case in Ireland where the Central Bank of Ireland (CBI) imposed leverage limits for those funds.

2023

▸ Stress testing MMFs in the EU – First evidence from fund reporting

Money market funds (MMFs) are investment funds that invest essentially in money market instruments issued by banks, governments or corporates. They especially serve as short-term liquidity providers to banks, and as cash management vehicles for institutional investors and large corporates, which use them as an alternative to bank deposits. As such, MMFs play a systemically important role as they interconnect money markets, banks and institutional investors. Therefore, any disruption affecting the MMFs may impact various parts of the financial system, potentially with negative implications for financial stability. To help assess and manage the related risks, the EU’s MMF Regulation (MMFR) of 2017 introduced requirements in terms of stress testing. The Regulation requires MMFs to put in place sound stress testing processes as part of their internal risk management. In addition, they are required to assess the impact of common risk parameters and report the results to their national authorities and ESMA.

This article presents the results of the stress tests, as per the methodology and parameters included in the ESMA Guidelines implemented in 2021. The scenario draws lessons from the stress episode affecting MMFs in March 2020 in the context of a deep, but non-lasting, global recession caused by the COVID-19 pandemic. The results show that both liquidity and credit risks could have a detrimental impact on MMFs, with concerns regarding the capacity of LVNAV funds in particular to maintain their stable value. Finally, despite a calibration reflecting the intensity of the March 2020 stress episode, the different redemption and macro scenarios show the capacity of MMFs to meet redemption requests. This first evidence will inform future enhancements of the MMF stress testing framework, scheduled in 2023.

2022

▸ Fund performance during market stress – The Corona experience

In this article we analyse the performance of actively managed equity UCITS relative to their market benchmark indices, between 19 February 2020 and the end of June 2020. This is a period characterised by a strong market downturn between February and March 2020 (first wave of COVID-19), followed by a fast recovery of equity prices in April and a stabilisation at elevated levels in May and June. The COVID-19 crisis offers the opportunity to test the hypothesis that active equity UCITS outperform their benchmarks during stressed market conditions. We also investigate the performance of passive equity UCITS versus their own benchmarks. The main findings show that for the sample of funds considered active funds, net of ongoing costs, did not on average outperform their related benchmarks in the period considered. More than half of the active UCITS analysed underperformed their benchmarks during the stressed period (between 19 February and 31 March) and more than 40% during the post-stress period (between 1 April and 30 June). Moreover, results show a partial ability of active funds to generate abnormal positive net returns, especially during the period analysed and in the case of larger funds.

2021

▸ Fund stress simulation in the context of COVID-19

 During the COVID-19-related market stress in 1Q20, investment funds faced a significant deterioration of liquidity in some segments of the fixed income markets combined with large-scale investment outflows from investors. In May, the ESRB issued a recommendation to ESMA requesting a focused supervisory engagement with investment funds exposed to asset categories that were affected by the liquidity stress. This joint supervisory exercise between ESMA and the NCAs took the form of a data-driven assessment of the impact of the liquidity crisis on funds, and an assessment of funds’ preparedness for future shocks, involving STRESI exercises under several assumptions. This article presents the results of the stress simulation: while funds have been resilient to the market stress, the fund simulation also highlights existing vulnerabilities. In its response to the ESRB, ESMA concluded that funds needed to enhance their preparedness.

2020

▸ Interconnectedness in the EU fund industry

The COVID-19 turmoil has highlighted the risks of market-wide stress, not least for investment funds. This article assesses the connectedness among EU fixed-income funds. Our empirical results suggest high spillover effects, indicating that funds exposed to less liquid asset classes are more likely to be affected by shocks originating in other markets than funds invested in more liquid assets. Alternative funds are found to be the main transmitters of shocks, while high yield (HY) and corporate bond funds were net shock receivers during the COVID-19 market stress.

▸ Vulnerabilities in money market funds

The acute market stress period of March 2020 showed that EU money market funds remain vulnerable to liquidity risk on their asset and liability sides. This article identifies a series of structural risks. The evidence related to these risks can serve as input to the currently ongoing discussions on MMF regulatory reforms. On the asset side, non-public debt MMFs have very high and concentrated exposures to private money markets that have low liquidity, making MMFs highly vulnerable to a symmetric liquidity shock as in March 2020. Regulatory constraints might also make some MMFs more vulnerable to runs from investors, as a result of concerns related to redemption fees and gates, or of tight constraints on NAV deviations. Finally, MMF ratings also add to the constraints on managers, by restricting their eligible assets and by penalising the use of liquidity management tools provided in the Money Market Fund Regulation (MMFR).

2020

▸ Costs and performance of potential closet index funds

Closet indexing’ refers to the situation in which asset managers claim to manage their funds in an active manner while in fact tracking or staying close to a benchmark index. Panel regressions using annual fund-level data for the period 2010-2018 suggest that investors face lower expected returns from closet indexers than from a genuinely actively managed fund portfolio. At the same time, potential closet indexers are only marginally cheaper than genuinely active funds. Overall, the net performance of potential closet indexers is worse than the net performance of genuinely active funds, as the marginally lower fees of potential closet indexers are outweighed by reduced performance.

▸ EU fund risk exposures to potential bond downgrades  

This case study focuses on the impact of a potential credit shock on the EU fund industry. We simulate the effects of a wave of downgrades of BBB-rated corporate bonds (fallen angels) on bond funds, amid a rise in risk aversion. Overall, the direct impact would moderately affect fund performance with no significant performance-driven outflows. Similarly, asset sales from bond funds in response to the shock would only have a limited and non-systemic impact on asset prices. However, it also shows that in this scenario EU bond funds could amplify shocks coming from passive funds, especially non-EU ETFs.

2019

▸ MMFs in the EU – new stress-testing requirements

MMFs play an important role in the EU money market by connecting investors investing in short-term liquid products with governments and institutions that are in need of short-term funding. The new EU MMFR aims at increasing the resilience of the sector by addressing the issues identified, such as the “first-mover advantage”. The Regulation introduces new stress-testing requirements, as part of fund risk management and regulatory disclosure. ESMA will design common parameters and scenarios to coherently capture the risks of the sector. Stress test results will be reported to ESMA and the National Competent Authorities (NCAs).

▸ Net performance of active and passive equity UCITS

In this article we analyse the cost and performance of EU equity UCITS funds, distinguishing between active and passive investment management, and ETFs. In particular, we investigate the gross and net relative performance of actively and passively managed funds with respect to their prospectus benchmark. The main results show that on an aggregate basis, active funds have underperformed in past years passive funds and ETFs, in net terms, as well as their benchmarks; ongoing costs had the largest impact on performance. The top 25% actively managed equity UCITS outperformed passively managed UCITS before and after costs, as well as their benchmarks. However, the group of top 25% actively managed equity UCITS change over time, such that there is only limited opportunity for investors to pick consistently outperforming actively managed equity UCITS.

▸ Use of derivatives by UCITS equity funds

We investigate the use of derivatives by EU UCITS equity funds, based on regulatory data on derivatives collected under the EU EMIR framework. Our results indicate that the tendency and frequency of EU UCITS equity funds to trade derivatives is to a large extent embedded in asset managers’ characteristics, such as fund family and fund family size. On the contrary, we find that on the individual fund level the investment strategy, size, geographic focus, base currency, or domicile of the fund play a minor role. Over time, cash inflows as well as currency risk seem to have a significant and robust influence, which suggests that derivatives are used for transaction cost or risk reduction purposes. Our analysis does not find strong indications that derivatives are primarily used for speculative or window-dressing purposes by UCITS equity funds.

2018

▸ Drivers of CDS usage by EU investment funds

As part of ongoing efforts to improve the monitoring of derivatives markets, this article investigates the drivers of credit default swaps usage by UCITS investment funds. We present several important findings: only a limited number of funds use CDS; funds that are part of a large group are more likely to use these instruments; fixed-income funds that invest in less liquid markets, and funds that implement hedge-fund strategies, are particularly likely to rely on CDS; and fund size becomes the main driver of net CDS notional exposures when these exposures are particularly large. This article also explores the bond-level drivers of funds’ net single-name CDS positions. We find that CDS positions on investmentgrade sovereign bonds – most of which are from emerging market issuers – tend to be larger. The analysis finally sheds some light on tail-risk from CDS for funds: directional strategy funds that belong to a large group are the most likely to have sell-only CDS exposures, exposing them to significant contingent risk in case of default of the underlying reference entity. Similarly, a number of funds use CDS to build unhedged credit exposure to US non-bank financial issuers.

2024

▸ Social media sentiment: Influence on EU equity prices

On social media platforms, investors are nowadays able to share information, opinions and views at a large scale in real time. The quality and validity of information shared by individuals in that way cannot be taken for granted. In this respect, social media posting differs fundamentally from journalism: specialised financial media are held accountable for the accuracy of the information they report.  

This is not necessarily the case for social media. The impact of social-media information in securities markets is, therefore, a growing market and public policy concern. Increasing social media interactions and related sentiment among investors influence the collective investor behaviour with potential effects on financial market dynamics. This comes with notable risks for retail investors raising investor protection concerns. It may also involve wider market movements with systemic implications, increasing financial stability concerns.  

Against this background, this article investigates the influence specifically of social media activity and sentiment on stock prices. The main findings identify only a transitory effect of social media sentiment on stock excess returns. Positive social media sentiment seems to be correlated with higher returns in the very short-term.  

In this sense, information spreading on social media platforms may affect investor trading choices and may amplify daily market movements. However, price overreaction typically does not last more than one day and is only transitory. This points to the risk of investors excessively relying on social media news whose truthfulness and accuracy is difficult to verify.  

With this analysis, we cast a first light on the market impact of social-media information in the EU. Other transmission channels and market impacts are likely to exist, and more analytical work and monitoring need to be undertaken to obtain a fuller picture of the risks for individual investors and markets at large.

2022

▸ Key Retail Risk Indicators for the EU single market

Monitoring retail risks aims to provide policymakers and supervisors with the information they need to better protect investors. ESMA has a longstanding mandate in this regard and regularly publishes Trends, Risks and Vulnerabilities (TRV) analysis and indicators on consumers. Underscoring the importance of such work, ESMA recently received an additional, explicit mandate to develop retail risk indicators (RRIs). Building on the existing TRV analysis, this article proposes a conceptual framework that defines key terms, considers how to measure risks practically and identifies sources of risk to consumers. Within this framework the set of RRIs should aim to reflect market developments, especially the rise of online- or mobile-based retail trading. Based on regulatory data this article presents a first selection of possible RRIs. These highlight risks around inexperienced investors, use of digital tools by younger investors and spikes in overall trading during periods of market stress.
 

2020

▸ MiFID II research unbundling – first evidence 

This article analyses the impact on EU sell-side research of the MiFID II Research Unbundling provisions that require portfolio managers to pay for the research they obtain. In the past, concerns have been raised, based primarily on survey data, that the new rules could have detrimental effects on the availability and quality of company research in the EU. In order to provide a more detailed, data-based contribution to inform this discussion, we examine a sample of 8,000 EU listed companies between 2006 and 2019, and do not find material evidence of harmful effects from these rules. The introduction of MiFID II has not led to a significant difference in the number of analysts producing Earnings per Share (EPS) estimates (‘research intensity’). Recent increases in the number of companies no longer being covered by research analysts (‘research coverage’) appear to be a continuation of a long-term trend. The quality of research has been steadily improving in recent years. SMEs do not appear to be disproportionately affected in terms of research intensity, research coverage, and research quality. The descriptive findings in this article are consistent with the emerging data-based academic literature on the impact of the MiFID II research unbundling provisions and are complemented by a forthcoming ESMA econometric study. Further assessment of the impact of the MiFID II research unbundling provisions on subsets of the EU market for research, such as the impact on sponsored research, will be interesting avenues for further study.

2019

▸ Retail AIFs – heterogeneity across the EU

This article provides an overview of the EU market for Alternative Investment Funds (AIFs) sold to retail investors. It presents the first EU-wide analysis of the structure of the retail AIF market, drawing from data collected as the result of the reporting obligation set out in the Directive on Alternative Investment Fund Managers (AIFMD). Overall, the size of AIFs sold to retail investors accounted for 18% of the AIF market in terms of net asset value (NAV) in 2017. Potential risks related to liquidity transformation and liquidity mismatch are analysed. 2017 data suggest no significant signs of liquidity mismatch for AIFs held exclusively by retail clients. The article also describes the heterogeneity across the EU regarding the distribution of retail AIFs which falls under national law.

2018

▸ Structured Retail Products – the EU market

Structured products sold to retail investors in the EU are a significant vehicle for household savings. Certain features of the products – notably their complexity and the level and transparency of costs to investors – warrant a closer examination of the market from the perspective of investor protection. Breaking down the EU market geographically into national retail markets reveals a very high degree of heterogeneity in the types of product sold, although among the vast array of different structured products available to retail investors each market is concentrated around a small number of common types. Changes in typical product characteristics are not uniform across national markets. Analysis both at an EU-wide level and in the French, German and Italian retail markets suggests, however, that the search for yield has been a common driver of several changes observed in the distribution of product types.

2024

▸ Impact investing – Do SDG funds fulfil their promises?

Impact investing – i.e., investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return – attracts growing interest from investors. It is, thus, important for the sustainable finance work of ESMA and forms part of a specific workstream on greenwashing, as impact investing – while essential for progressing on the EU’s sustainability objectives – may be prone to misleading, inaccurate or unsubstantiated claims. Impact investing – and ESG investing overall – have a key role to play in achieving sustainability objectives, thus the topic requires particular attention to ensure that products and strategies that aim to foster such objectives stand true to their claims. Impact claims are often based on well-known sustainability frameworks, including the United Nations Sustainable Development Goals (SDGs), which are a significant pillar of the international development agenda. Here specifically, these impact claims suggest a positive contribution to the fulfilment of the SDGs. Their achievement requires substantial financial resources, which can, at least partly, be sourced from private sector actors through the issuance of dedicated financial products. Increasing investor appetite for sustainable financial products has boosted the growth of investment funds claiming to contribute to achieving the SDGs (SDG funds). This article proposes and summarises a methodological approach towards identifying SDG funds and assessing the extent to which their holdings align with their claims by bringing together a unique set of different data sources. Our results highlight some of the challenges in assessing real-world impact claims and show that SDG funds do not significantly differ from non-SDG counterparts or ESG peers regarding their alignment with the United Nations SDGs. This raises questions as to whether funds claiming to contribute to the SDGs are actually fulfilling their promise to investors. 

2023

▸ The financial impact of greenwashing controversies

The transition to a low-carbon economy requires trust in the commitment and ability of companies to adapt their business operations to help deliver climate-related objectives. However, greenwashing risks undermining this trust by sapping consumer and investor confidence, underlining the importance of monitoring and tackling the problem. This article explores the role that ESG controversies can play in supporting these efforts. While greenwashing-related controversies do not provide accurate information on the scale or frequency of greenwashing occurrences, they are important from an investor protection angle since they reflect public perceptions of greenwashing, which may lead to reputational issues for the firms involved. We document that the number of greenwashing controversies involving large European firms increased between 2020 and 2021 and tended to be concentrated within a few firms belonging to three main sectors, including the financial sector. We also investigate the impact of greenwashing controversies on firms’ stock returns and valuation and find no systematic evidence of a relationship between the two. The results suggest that greenwashing allegations did not have a clear financial impact on firms and highlight the absence of an effective market-based mechanism to help prevent potential greenwashing behaviour. This underscores the importance of clear policy guidance by regulators and efforts by supervisors to ensure the credibility of sustainability-related claims.

▸ Dynamic modelling of climate-related shocks in the fund sector

Identifying vulnerabilities of the investment fund sector in climate stress scenarios is of vital importance given the sector's size in the financial system and its crucial role financing the green transition. In line with recent ESMA mandates in this regard, this article outlines a first approach to dynamically modelling the impact of asset price shocks from adverse scenarios involving climate-related risks. A given set of asset price shocks is the core input to the model, which comprises static impacts – the immediate price impact on funds’ direct and indirect asset holdings – plus dynamic impacts, such as inflows and outflows by investors and portfolio rebalancing by managers. The present analysis focuses on the direction and sequencing of dynamic impacts, showing that dynamic responses can exacerbate falls in total fund assets due to outflows following an initial shock. Portfolio rebalancing, in contrast, only affects the sensitivity of fund valuations to subsequent shocks. The article concludes by discussing the sensitivity of the results and possibilities for further research.

▸ The European sustainable debt market – do issuers benefit from an ESG pricing effect?

Issuance of sustainable-labelled debt has soared over the last years, benefitting from an increasing investor appetite for financial products that contain a sustainability element. At the same time, research suggests that sustainable-labelled debt issuers may benefit from a pricing advantage, the so-called ‘greenium’, which is often attributed to investor’s willingness to forego returns in exchange for the sustainability element of the financial product they are investing in. However, existing evidence has not been conclusive so far regarding the existence of a definite pricing advantage, and it further focuses mainly on green bonds only. This article expands the analytical work to all environmental, social and governance (ESG) bond types and identifies a set of key factors potentially causing the greenium. The topic is thereby relevant to several of ESMA’s mandates. It directly adds to the understanding of investor preferences for sustainable finance, it helps to investigate any pricing distortions between comparable debt instruments that might impact market stability if they unravel, and, finally, it contributes to ESMA’s strategic priority of monitoring ESG market developments and assessing new financial instruments. In terms of findings, our analytical results cannot confirm the existence of a systematic and consistent pricing advantage for any ESG bond category. Furthermore, we find that in the past, issuers of ESG bonds benefitted from pricing premiums based on their issuer characteristics and that issuers’ public sustainability commitments do not impact the pricing of their bonds

▸ ESG names and claims in the EU fund industry

Finance plays a key role in supporting the transition to a more sustainable economy. To achieve this, investor confidence and trust in the accuracy of ESG disclosures is necessary. With this in mind, greenwashing has become a major concern for policymakers around the world. Focussing on EU investment funds, we construct and exploit several unique datasets to examine the basis for these concerns. Using a novel dataset with historical information on 36,000 funds managing EUR 16 trillion of assets, we find that funds increasingly use ESG related language in their names, and that investors consistently prefer funds with ESG words in their name. We then analyse the extent of ESG language across funds’ regulatory documentation and marketing material, using a dataset of more than 100,000 documents available at the end of 2022. We find evidence of the fund industry adapting its ESG communication depending on the type of document – regulated or unregulated. Our findings support recent efforts by policymakers to ensure that EU funds’ names and disclosures accurately reflect their activities.

2022

▸ EU Ecolabel: Calibrating green criteria for retail funds

The EU Ecolabel is an EU-wide label awarded to green products and services. A version of the label for retail financial products has been considered as an option to help retail investors make informed investment decision on the sustainability features of investment products. In this article we test three key Ecolabel criteria on a sample of 3 000 sustainability-oriented UCITS equity funds with EUR 1 trillion in assets under management. Using fund portfolio holdings and proxy data, we find that only 16 funds (0.5 % of our sample) meet the proposed minimum portfolio greenness threshold of 50 % and exclusion requirements. These findings highlight the trade-off between the stringency and feasibility of the Ecolabel requirements. The article further illustrates the impact of different threshold calibrations on the number of eligible funds and potential volumes of green finance channelled through Ecolabel funds. The analysis does not prejudge any policy developments or decisions regarding an EU Ecolabel for financial products.

▸ The drivers of the costs and performance of ESG funds

Investment funds that include environmental, social and governance (ESG) features have grown rapidly over the last years. ESMA recently determined that ESG equity undertakings for collective investment in transferable securities (UCITS), excluding exchange-traded funds, were cheaper and better performers in 2019 and 2020 compared to non-ESG peers. The reasons behind this relative cheapness and outperformance of ESG funds are of particular interest. Understanding the cost and performance dynamics may bring insights for the overall fund industry on how to make funds more affordable and profitable for retail investors. This study builds on past analyses by assessing whether portfolio composition can help to understand the cost and performance differentials between ESG and non-ESG funds. It identifies several differences between the two categories of funds, with ESG funds being more oriented toward large caps and developed economies, and it demonstrates that these factors are correlated with lower ongoing costs. However, even after controlling for fund characteristics and differences in portfolio exposures, ESG funds remain statistically cheaper and better performing than non-ESG peers between April 2019 and September 2021. Further research is thus needed to identify the other factors driving these cost and performance differences.

▸ Monitoring environmental risks in EU financial markets

Regulators and supervisors have started to incorporate environmental risks, especially those stemming from climate change, and their potential implications for the financial system into their work. The objective of this article is twofold: first, to depict how environmental risks can be expected to impact EU securities markets and their participants; and second, to lay out ESMA’s approach to integrating environmental risks in the risk assessment and monitoring framework. In light of ESMA’s financial stability, investor protection and orderly market objectives, and given the unique nature of climate risks and the challenges they entail for risk monitoring purposes, we propose to integrate climate risk as a new risk category alongside the existing liquidity, market, credit, contagion and operational risk categories. This risk category is intended to capture physical and transition risk drivers and their mitigants, in addition to the potential risks associated with green finance. As part of this framework, at the current juncture we identify three core risks to ESMA’s objectives stemming from climate change: abrupt changes in market sentiment, greenwashing and weather-related hazards.

▸ Text mining ESG disclosures in rating agency press releases

Investor interest in sustainable finance has grown exponentially in recent years. With this in mind, some credit rating agencies (CRAs) have sought to become more transparent as to how environmental, social, and governance (ESG) factors are integrated into their credit ratings. To ensure a consistent level of transparency for investors on ESG issues, on 30 March 2020 ESMA began to apply Guidelines for how and when CRAs’ considerations of ESG factors are disclosed in credit rating press releases. This article assesses the implementation of these Guidelines, as also envisaged in the European Commission’s Renewed Sustainable Finance Strategy. We apply natural language processing techniques to a unique dataset of over 64,000 CRA press releases published between 1 January 2019 and 30 December 2020. We find that the overall level of ESG disclosures in CRAs’ press releases has increased since the introduction of the Guidelines. However, there is clearly room for further improvement: the level of ESG disclosures differs significantly across both CRAs and ESG factors (especially environmental topics). Moreover, we observe divergences in CRAs’ disclosures even for rated entities that are highly exposed to ESG factors, relative to their sector peers.

2021

▸ Environmental impact and liquidity of green bonds

The European green bond market is attracting a growing number of corporate issuers, which has implications for the environmental impact of these instruments and their liquidity. This article first investigates the carbon dioxyde emissions of green bond issuers. We show that, between 2009 and 2019, energy firms, utilities and banks that issued a green bond were much more likely to disclose emissions data, and they have on average reduced their carbon intensity to a larger extent than other firms – confirming the view that green bonds act as a signal of firms’ climate-related commitments. We then compare the liquidity of green and conventional EUR corporate bonds from green bond issuers using proxy indicators. Green bond liquidity appears to be tighter, but the differential with conventional bonds has remained small and broadly constant during the COVID-19 turmoil, suggesting no particular vulnerability for the green segment of the corporate bond market.

▸ Fund portfolio networks: a climate risk perspective

Within the European financial sector, investment funds are more exposed to climate-sensitive economic sectors than banks, insurers and pension funds. However, few investment fund climate-related financial risk assessments have been conducted. This article provides a first attempt to fill this gap, using a data set of EUR 8 trillion of European investment fund portfolio holdings. Funds whose portfolios are tilted towards more polluting assets (brown funds) distribute their portfolio over a larger number of companies than funds with cleaner portfolios (green funds). This apparent diversification hides a concentration risk: brown funds are more closely connected with each other (have more similar portfolios) than green fund portfolios, which tend to ‘herd’ less (have less similar portfolios to those of other green funds). This suggests that widespread climate-related financial shocks are likely to disproportionately affect brown funds. A preliminary climate risk scenario exercise confirms this: besides total system-wide losses of EUR 152 billion to EUR 443 billion, most brown funds’ losses range from about 9 % to 18 % of affected assets, in contrast to green funds’ losses, which usually range from 3 % to 8 %. In addition, brown funds have more systemic impact: they contribute more to total system-wide losses (by virtue of their greater interconnections within the fund universe) than green funds. These findings provide support for ongoing EU regulatory and supervisory initiatives on sustainable finance.

▸ ESG ratings: Status and key issues ahead

As sustainable investing gains traction, ESG ratings are growing in importance for investors and issuers, while gaining attention from global media. This article describes the market for ESG ratings, including types of ratings and key providers, and presents several use cases. In the absence of a regulatory framework, several issues and risks reduce the potential benefits of these ratings. The lack of a common definition and of comparability, together with transparency issues, could be ultimately detrimental to the transition towards a more sustainable financial system. To illustrate the impact of these issues on investors, our analysis focuses on the specific case of ESG benchmark construction

2020

▸ Short-termism pressures from financial markets

Short-termism in finance refers to the focus placed by market participants on short-run profitability at the expense of long-term investments, a tendency that political initiatives such as the EU’s action plan on financing sustainable growth seek to limit. The recent empirical evidence collected by ESMA sheds some light on commonly discussed drivers of short-termism. In particular, our findings suggest that the misalignment of investment horizons in financial markets and the remuneration of fund managers and executives that rewards short-term profit seeking could be potential sources of short-termism. Improvements in the availability and quality of ESG disclosure could serve to promote more long-term investment decisions by investors.

2024

▸ Crypto assets: Market structures and EU relevance

2023

▸ Decentralised Finance: A categorisation of smart contracts

First introduced on the Ethereum blockchain in 2015, smart contracts have become the backbone of decentralised finance (DeFi). Smart contracts are computer programmes stored on the blockchain and run when predetermined conditions are met. They are designed to facilitate financial transactions among blockchain users, without the need for trusted intermediaries that characterises traditional finance. Owing to their open-source nature, smart contracts have been claimed to be a major source of financial innovation. Nonetheless, they bring with them enormous technological complexity. Regulators and supervisors need to understand and monitor this complexity to systematically evaluate the risks to investors and financial stability stemming from DeFi. By discerning different categories of smart contracts, this article represents a first step in this direction. Building on on-chain data and using the topic model proposed by Ibba et al. (2021), we implement a categorisation of smart contracts on the Ethereum blockchain, define five major smart contract categories, and monitor their relative incidence over time. We note a major difference in terms of smart contracts heterogeneity between the first and the second surge in smart contract deployment (occurring in 2017–2018 and in 2021–2023, respectively), reflecting the increased complexity of smart contracts and the adoption of more sophisticated protocols that have come to characterise DeFi.

▸ Decentralised Finance in the EU: Developments and risks

Decentralised finance (DeFi) has attracted attention from investors and regulators, as the latest and arguably most innovative development in the crypto area. This article assesses the development of DeFi, its distinctive features, and the risks it raises to ESMA’s objectives, with a view to informing the future review of the markets in crypto-assets regulation (MiCA). It highlights that although investors’ exposure to DeFi remains small overall, there are serious risks to investor protection, due to the highly speculative nature of many DeFi arrangements, important operational and security vulnerabilities, and the lack of a clearly identified responsible party. DeFi does not represent a meaningful risk to financial stability at this juncture, considering its small size, but this is something that requires monitoring as the phenomenon continues to evolve quickly. Looking at one specific type of DeFi application, namely decentralised exchanges, the article shows that they purport to eliminate important pain points in the trading of crypto-assets but bear their own flaws and challenges. While market integrity in DeFi and crypto-asset markets is still under-researched, due to important data gaps and the technicalities involved, the article shows that DeFi has spawned new market manipulation issues and techniques, such as maximal extractable value and flash loan attacks, that the industry needs to address.

▸Artificial intelligence in EU securities markets

The use of artificial intelligence (AI) in finance is under increasing scrutiny from regulators and supervisors interested in examining its development and the related potential risks. This article contributes by providing an overview of AI use cases across securities markets in the EU and assessing the degree of adoption of AI-based tools. In asset management, an increasing number of managers leverage AI in investment strategies, risk management and compliance. However, only a few of them have developed a fully AI-based investment process and publicly promote the use of AI. In trading, AI models allow traders, brokers, and financial institutions to optimise trade execution and post-trade processes, reducing the market impact of large orders and minimising settlement failures. In other parts of the market, some credit rating agencies, proxy advisory firms and other financial market participants also use AI tools, mostly to enhance information sourcing and data analysis. Overall, although AI is increasingly adopted to support and optimise certain activities, this does not seem to be leading to a fast and disruptive overhaul of business processes. A widespread use of AI comes with risks. In particular, increased uptake may lead to the concentration of systems and models among a few ‘big players’. These circumstances warrant further attention and monitoring to continue ensuring that AI developments and the related potential risks are well understood and taken into account.

2022

▸ Crypto-assets and their risks for financial stability

Crypto-assets have gained increasing attention due to their rapid growth and so has the interest around their implications for the traditional financial system – including financial stability. ESMA has been following these developments closely for several years, including because of their risks to consumer protection, and outlines in this article the latest understanding of crypto-assets’ risks and transmission channels to financial markets. While some sources of risk are well understood from traditional markets, others are novel and linked to the product design, technological development, or the complex infrastructures built around crypto-assets. We find that, at present, crypto-assets are still small in size and their interlinkages to traditional markets are limited. In future, this situation may change as market growth can occur suddenly and risk transmission is possible through various channels. Continuous monitoring of the crypto-asset market and its interconnectedness with the wider financial system is required to assess newly emerging threats in a timely manner, while regulations such as the EU proposal “Markets in Crypto-Assets” (MiCA) should be implemented swiftly to mitigate already identified risks.

2021

▸ Cloud outsourcing and financial stability risks

The growing use of cloud service providers (CSPs) by financial institutions can provide benefits to individual firms and the financial system. However, high concentration in CSPs could create financial stability risks if an outage in a CSP affects many of its clients, increasing the likelihood of simultaneous outages. Analysis using a stylised model calibrated with operational risk data suggests that CSPs need to be significantly more resilient than firms to improve the safety of the financial system. In financial settings where only longer (multi period) outages cause systemic costs, the results suggest that CSPs can best address systemic risks by strongly reducing incident resolution times, rather than incident frequency. In the model, using a back-up CSP successfully mitigates the systemic risk caused by CSPs. Backup requirements may need to be mandated however, as the systemic risk is an externality to individual firms. Finally, there is a clear need for detailed data on outages by financial institutions and CSPs.

▸ 54 000 PRIIPs KIDs – how to read them (all)

This article presents the results of an ESMA pilot exercise to apply natural language processing techniques on a unique dataset of c. 54 000 Key Information Documents that describe structured retail products produced under the Packaged Retail Investment and Insurance-Based Products Regulation. The techniques involved include measuring linguistic richness and semantic uncertainty, as well as sentiment analysis. This work – an application of SupTech – aims to illustrate how these techniques can produce useful measures for European supervisors, policymakers and risk analysts. Information extracted from text opens up new possibilities for supervisory assessments, for example with respect to information completeness and to legal requirements that a document be comprehensible to investors. In addition, text-based information is uncorrelated with (i.e. complementary to) numerical information, which can help policymakers determine if the legislation is working as intended. Lastly, text-based information can identify new sources of financial risks to investors.

2020

▸ BigTech – implications for the financial sector

Several large technology firms (BigTechs) now offer financial services, taking advantage of their vast customer networks, data analytics and brand recognition. However, the growth of BigTech financial services varies by region, reflecting differences in existing financial services provision and regulatory frameworks. Prospective benefits include greater household participation in capital markets, greater transparency and increased financial inclusion (although some individuals may be excluded). On the risk side, the high level of market concentration typically observed in BigTech may get carried into financial services, with potentially adverse impacts on consumer prices and financial stability. The crosssectoral and global nature of the business strengthens the case for comprehensive cooperation among relevant regulators.

• Guidelines on outsourcing to cloud service providers

2019

▸ RegTech and SupTech – change for markets and authorities

Regulatory and supervisory technologies are developing in response to various demand and supply drivers. On the demand side, regulatory pressure and budget limitations are pushing the market towards an increased use of automated software to replace human decision-making activities. This trend is reinforced by supply drivers such as increasing computing capacity and improved data architecture. Market participants are increasingly using new automated tools in areas such as fraud detection, regulatory reporting and risk management, while potential applications of new tools for regulators include greater surveillance capacity and improved data collection and management. With these new tools come challenges and risks, notably operational risk. However, with appropriate implementation and safeguards, RegTech and SupTech may help improve a financial institution’s ability to meet regulatory demands in a cost-efficient manner and help regulators to analyse increasingly large and complex datasets.

• Advice on legislative improvements relating to ICT risk management requirements in the EU financial sector; 
• Advice on the case for a coherent EU-wide cyber resilience testing framework for significant market participants and infrastructures within the whole EU financial sector.

2018

• Joint ESA’s Warning on Virtual Currencies

2017

• Statements on Initial Coin Offerings
• DLT report

Economic reports and working papers provide rigorous analytical work addressing issues relevant to ESMA, providing a topical complement to our continuous risk monitoring, and conceptual and empirical evidence to inform policy-making and supervision.

• ESMA Working Papers
• ESMA Economic Reports​