Unpicking ESMA's market analysis

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Unpicking ESMA's market analysis

In April 2021 the European Securities and Markets Authority (ESMA) published its annual statistical report on the performance and costs of retail products. This wide-ranging document (over 100 pages long) makes for interesting reading, not only as a summary of the European investment landscape, but also to get some insight into the thinking of the European regulators.

The first comment that could be made is one of timeliness. The EUs political and regulatory machinery is known to be methodical rather than nimble, however to take over 15 months to compile and publish an annual report seems excessive and particularly unfortunate this year as it has not included anything of 2020.

The report centres around UCITS funds, Alternative Investment Funds (AIFs) and Structured Retail products. It states the approximate size of these three markets, Eur 4.5 Tn for UCITS, Eur 1Tn for AIFs and EUR 400m for structured products. This means that structured products make up around 7.5% of this total which is therefore a significant slice of the overall market.

The ESMA report contains high level analysis of the performance of each sector. It comments on the lack of readily available data for structured products, although it does later reference statistics from www.structuredretailproducts.com and others. ESMA notes that it has now created a database of submitted PRIIPs documents for structured retail products. This is a useful function for a regulator to perform in the era of digital based regulation both to provide market feedback and to shape future regulatory changes. It may also be revenue generating and the idea is similar to the European DataWarehouse initiative by the European Central Bank for collecting loan level data for Asset Backed Securities.

This article will concentrate on the structured products section of the report. These sections are interesting but do contain some inaccuracies and biased statements, such as the observation that “Moreover, unlike long-term investment products such as funds, many structured products may be designed for hedging purposes or to speculate on price movements over the period of months or years. Consequently, structured products should – as a general rule – not be regarded as long-term investments in the same way as funds.” This rather lazy comment overlooks the success that can be achieved by a diversified portfolio of regular investment in structured products and other assets. Given some of the other statements in the report it would be good for EUSIPA to contribute next year to help address this imbalance.

The report makes the high-level observation that capital at risk products have increased from 19% of the market in 2009 to 64% in 2018, which it correctly attributes to low interest rates which have made structuring capital protected products much harder. It also states that the number of products issued annually has increased even though total market size has remained roughly constant, leading to a lower average size per issue. It does not really comment why this has happened, which is down to a combination of technology improvements and automation making greater issuance easier, increased competition between distributors and often uncertain investment demand leading to distributors trying different product types to capture as much demand as possible.

The report uses some of the PRIIPs data it has started to collect to observe that for many structured products there is little difference between the moderate and favourable scenarios, unlike for funds for example. Although not stated in the report, this result is actually quite intuitive given that many structured products (Auto-calls, Reverse convertibles, Capped protected) deliberately aim to give fixed returns in flat to mildly positive scenarios and to control risk on the downside, meaning that both the moderate and positive scenarios will achieve their target returns.

The report also contains many interesting tables and charts showing investor trends over the last ten years in its statistical annex. This shows a number of themes, such as the mix of household assets which is very broadly stable, except for the decline in debt securities as rates have fallen. It also shows that the value and number of UCITS funds has increased over the last ten years, with the notable exception of France. Institutional usage of UCITS funds has increased from almost zero ten years ago and has kept pace with the increase in the number of retail funds.

One of the biggest growth sectors in the last ten years is that of Alternative Investment Funds (AIFs). Although it is still a small part of the retail market, one of the charts indicates that AIFs have almost as much AUM as Equity and Bonds. AIFs are mentioned elsewhere in the report, though with rather less detail than structured products. Various comments are made about availability of performance data for AIFs. This is caused in part by the fact that this sector has been slow to adopt the spirit of transparency envisaged by the AIFMD regulation which came into effect after the implosion of the asset class in the 2008 financial crisis.

Other important themes also get some attention, such as the rise in number of ESG funds and an indication of their favourable performance and cost levels. Brexit gets no direct mention although a table of UCITS domicile by country shows UK ahead of Ireland for both retail and institutional share classes. It will be interesting to see how this plays out in the next few years.

The whole paper ( which can be found here) is worth a look but I believe it would be better served by a more streamlined report, with data offered by download and a faster annual publication cycle to keep it relevant in today’s fast moving world.

Tags: Regulation Stress testing

A version of this article has also appeared on www.structuredretailproducts.com

Image courtesy of:     Guillaume Périgois / unsplash.com

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