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ESAs risk report

ESAs risk report

The Joint Committee (PDF 0.98 MB) of the three European Supervisory Authorities (EBA, EIOPA and ESMA) has published its latest review of cross-sectoral risk and vulnerabilities in the EU financial sector.

This review provides regulated firms with an indication of where supervisory attention may focus in the coming months, in addition to sector-specific risks.

The report focuses on four main cross-sectoral risks:

Valuation risk and sudden risk premia reversals

To some extent this risk crystallised in the first quarter of 2018, as the high equity prices and low volatility seen in much of 2017 gave way to equity price falls and significantly higher volatility. However, the Joint Committee sees continuing risks here related to valuations and the repricing of risk premia, which could have an adverse impact on profitability and asset quality across sectors.

Asset quality in the banking sector has recently improved and volumes of non-performing loans (NPLs) disposals are increasing. But NPLs remain high in some banks' balance sheets and require further action by banks and their supervisors.

Supervisory responses - these risks are already captured in EBA and EIOPA stress tests, while ESMA is developing its approach to stress testing in the asset management industry, including model-based stress simulations and liquidity stress testing, and developing guidelines for stress testing carried out by money market funds.

Brexit

Uncertainties around the terms of the UK's withdrawal from the EU still have the potential to expose the EU27 and the UK to economic and financial instability and to weaken market confidence, in particular if negotiations end in a disorderly fashion. The absence of a conclusive agreement on the withdrawal terms would be challenging for firms' operations and could affect the legal framework for financial services and hence the continuity of financial contracts.

Supervisory responses - the main focus here is on contingency planning for all potential challenges, including such as contract continuity and possible relocations. The Joint Committee highlights that the ESAs have published Opinions on some of these issues, which provide important guidance for financial institutions and national competent authorities.

Cyber

The Joint Committee highlights cyber risk as a “significant and highly escalating” threat to financial markets and their stability worldwide. They threaten data integrity and business continuity and are particularly dangerous because of their risk multiplier effect.

Similarly, risks related to virtual currencies have recently materialized, driven in part by extraordinary high levels of volatility and associated price falls.

Supervisory responses - continuing pressure on firms to improve fragile IT systems, to focus more on information security risks, and to address concerns about connectivity and outsourcing to third-party providers. EBA is developing Guidelines on the management of information and communication technologies risks for banks, and has issued guidance on the use of cloud service providers. ESMA is also launching a supervisory project on cloud computing. EIOPA is undertaking a survey on cyber risk, including the underwriting of cyber insurance.

Climate change

Climate change and the transition to a lower-carbon economy raise concerns about the quality and sustainability of investments across large parts of the financial sector, and have recently received increased attention from both national and international supervisory and regulatory bodies.

Supervisory responses - these remain very high level, including encouraging firms to take a more forward-looking approach to include sustainability risk in their governance and risk management frameworks, and to develop responsible, sustainable financial products.

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