On 3 October 2022, the European Securities and Markets Authority (ESMA), published the second Trends, Risks and Vulnerabilities (TRV) Report of 2022. The Russian war on Ukraine against a backdrop of already-increasing inflation has impacted the risk environment of EU financial markets, with overall risks to ESMA’s remit remaining at its highest level.

During the first half of 2022 financial markets saw uncertain recoveries, increasing volatility and likelihood of market corrections. Separately, crypto-markets saw large falls in value, stressing again the very high-risk nature of the sector. ESMA has been following these developments closely for several years, because of their risks to consumer protection, and outlines in this report the latest understanding of crypto-assets’ risks and transmission channels to financial markets.

ESMA notes that, at present, crypto-assets are not integrated to traditional markets. In future, this could change. Continuous monitoring of the crypto-asset market and its interaction 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.

MiCA is set to regulate crypto-assets, by setting regulatory requirements for the public offer, marketing and the provision of services related to them. In addition, MiCA includes provisions to prevent market abuse involving crypto-assets.

MiCA provides that issuers of stablecoins will need to be licensed and have in place a robust and segregated reserve of assets to achieve sustainability and organic growth. The final text of MiCA is expected to be published in the Official Journal in spring 2023, and will enter into force 12-18 months thereafter.

The rise of trading volumes for crypto-assets has been bolstered by the emergence of specialised crypto-asset trading platforms with sizes and volumes that now rival some of the smaller established stock markets. But the key difference is that most trading platforms found in crypto markets operate outside of any regulatory oversight.

The overall risk to ESMA’s remit remains at its highest level. Operational risks are now considered very high, like liquidity and market risks. Credit risk stays high but is expected to rise. Risks to infrastructures and to consumers are soaring, while environmental risks remain elevated. Looking ahead, the confluence of risk sources continues to provide a highly fragile market environment, and investors should be prepared for further market corrections.

ESMA’s TRV Report can be found here.