The European Securities and Markets Authority (ESMA) published the second Trends, Risks and Vulnerabilities report of 2021. In addition to the risk assessment, the report discusses key trends, including those related to market-based finance, sustainable finance, and innovation. The report presents in-depth articles that focus on the financial stability risks of cloud outsourcing, market for small credit rating agencies in European Union, and the environmental impact and liquidity of green bonds.
The report notes that sustainable finance continues to expand in Europe, as reflected in the 20% growth of environmental, social, and governance (ESG) fund assets and the 40% increase in outstanding sustainable debt instruments outstanding from the end of 2020. Recent corporate announcements on "net zero" emission reduction targets mark a step forward but lack consistency and details. ESG equity benchmarks delivered a mixed performance relative to non-ESG indices while the equity valuation of clean energy firms increased markedly in two years, despite similar returns on equity to fossil fuel firms. Flows into ESG funds accelerated, with impact and environmental funds being the fastest-growing strategies. Green bonds continue to dominate the ESG bond market while social bond issuance has accelerated. Four firms—Sustainalytics, Cicero, Moody's Vigeo Eiris, and ISSOekom—account for 75% of the market share of green bond external reviews in European Union. Innovation can support sustainability by addressing ESG information gaps through green financial technology (fintech) solutions, but the environmental cost of one particular innovation—cryptocurrencies—is soaring. Meanwhile, decentralized finance continues to gain momentum and regulator engagement with fintech through innovation hubs and regulatory sandboxes is becoming mainstream across European Union, with benefits for both parties.
On of the four in-depth articles in the report analyzes the growing use of cloud service providers by financial institutions and how the concentration of those providers can create financial stability risks in case of outage. The article notes that high concentration in cloud service providers could create financial stability risks if an outage at a cloud service provider affects many of its clients, increasing the likelihood of simultaneous outages. Analysis using a stylized model calibrated with operational risk data suggests that cloud service providers 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 cloud service providers can best address systemic risks by strongly reducing incident resolution times, rather than incident frequency. In the model, using a backup, a cloud service provider successfully mitigates the systemic risk caused by cloud service providers. However, back-up requirements may need to be mandated, 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 cloud service providers.
Keywords: Europe, EU, Banking, Securities, Suptech, Fintech, Regtech, Sustainable Finance, ESG, Green Bonds, Cloud Service Providers, Operational Risk, ESMA
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