“There will be no such thing as a safe crypto-asset”

Interview with Verena Ross, Chair of the European Securities and Markets Authority, Supervision Newsletter

16 August 2023

The banking turmoil at the end of March prompted you to raise concerns about single-name credit default swap (CDS) markets. What risks do you see?

The events at the end of March confirmed that the single-name CDS market has limited trading activity and low liquidity. This means a small number of trades can have a large price impact, resulting in sharp changes in spreads. Since CDSs are commonly used as an indicator for credit risk, these movements can have consequences for wider investor sentiment and impact share prices and other financial markets.

We are therefore calling for additional transparency, not just in the opaque CDS market, but in other over-the-counter (OTC) derivatives markets too. These markets are global in nature, so we should be pushing to improve transparency and reduce data gaps in Europe, and also aiming for a globally coordinated approach under the aegis of the International Organization of Securities Commissions and the Financial Stability Board.

How does the post-trade transparency regime in the EU compare to the United States and the United Kingdom?

The Markets in Financial Instruments Regulation (MiFIR) introduced trade transparency requirements for OTC derivatives in the EU, including single-name CDSs, but actual transparency regarding trading activity remains very limited. This is for two main reasons. First, most transactions are only published after a significant delay. Second, the scope covered is ambiguous. In practice, only a small number of transactions are subject to the transparency regime at all. This stands in stark contrast to the approach in the United States, where the post-trade transparency regime covers a very broad range of OTC derivatives. Most transactions there are published in close to real time, even if participants are not required to disclose full details of large transactions.

A more ambitious transparency regime as part of the MiFIR review would make markets less opaque and participants better informed, ultimately strengthening the way markets function. It is also important to protect participants from negative market impacts by providing for rules on deferring the publication of trades, calibrated for each class of derivatives. We continue to argue for enhanced transparency in the CDS and other OTC derivatives markets – with appropriate tailoring where necessary at level 2.

One of your key priorities is to strengthen the resilience of central counterparties (CCPs) in the EU. What do you see as the main risks here, and how can these be addressed?

As part of our strategic priorities for 2023-2028 we have reiterated our commitment to helping enhance the stability and effectiveness of EU capital markets. This includes the resilience of the overall market infrastructure, including the CCPs. The ESMA CCP Supervisory Committee conducts an annual risk identification exercise which looks into this area. The Committee is uniquely placed to carry out the exercise, as it is composed of senior representatives of the 12 national competent authorities (NCAs) that supervise EU CCPs, as well as an independent chair and two independent members.

During the market turmoil following the COVID-19 lockdowns and the energy crisis, the surge in initial margins raised questions as to whether CCP margin models may have acted in a procyclical manner. In cooperation with the European System of Central Banks, we have proposed targeted changes to existing regulatory standards to better mitigate the potentially procyclical effects big step-changes in margin can have on clearing members and clients, as well as to prevent liquidity stress spreading to other parts of the financial system.

Another key priority for ESMA is to improve CCP resilience relating to operational risk. Having assessed exposure to critical third-party service providers for the first time as part of the 2022 CCP stress test, we are now focusing on preparations for the implementation of the Digital Operational Resilience Act (DORA).

The Markets in Crypto-Assets Regulation (MiCA) entered into force in June, with an implementation phase of 12-18 months. What key changes are you hoping will be introduced in crypto markets?

MiCA brings in a uniform regulatory framework across markets in the EU covering crypto-assets not currently regulated by existing financial services legislation. It will significantly change the current situation, which is a patchwork of national regimes ranging from the application of anti-money laundering provisions only to more developed standards not dissimilar to MiCA.

It introduces key provisions for entities issuing crypto-assets, offering them for trading, and/or providing investment advice, custody and other services in relation to crypto-assets. Among these, it is worth highlighting the authorisation and governance requirements applicable to crypto-asset service providers, disclosures in relation to crypto products and requirements aimed at ensuring the integrity of crypto markets. The new framework is intended to provide consumer protection, enhance market integrity and promote financial stability.

In the past these markets have been volatile and, in some cases, prone to fraud. MiCA should ensure that all companies providing services in relation to crypto-assets in the EU are uniformly regulated and supervised by their NCAs. Consumers will have more information about the products and the risks involved. It is important to remember that even with the implementation of MiCA, which is clearly a step forward, there will be no such thing as a safe crypto-asset. Consumers need to be aware that MiCA does not provide the same protection as for traditional financial products.

You are looking into sustainable investments and greenwashing. How can regulators and market participants stamp out inadvertently misleading claims?

Along with the other two European supervisory authorities (ESAs), we have been working on greenwashing over the past year. In the progress reports to the European Commission issued at the beginning of June the ESAs developed a common high-level understanding of greenwashing. This should serve as a shared reference point for market participants and regulators when addressing this phenomenon. We believe misleading claims can occur and spread both intentionally and unintentionally, and greenwashing can take place in relation to entities and products already within and still outside the scope of the EU regulatory framework.

Our progress report identified high-risk areas for greenwashing all along the sustainable investment value chain. One of our findings is the need for a more mature regulatory framework, and we are happy to provide further guidance where rules are found to be unclear. At the same time, market participants have an important duty to communicate sustainability information in a balanced manner, in line with the requirement to be fair, clear and not misleading. ESMA and the NCAs are committed to focusing on the continued risk of misleading claims and greenwashing.

You included climate risk in your stress test for the first time in 2023. How much progress have CCPs made in addressing and covering climate-related risks?

There is a key difference between our EU-wide exercise and the individual efforts made by CCPs in this area. Individual stress tests mostly focus on the specific CCP and its market environment. So far, we have seen CCPs mapping climate change risk to their existing risk categories, such as credit risk. Our EU-wide exercise assesses how climate risks can impact CCPs as a system as a whole, and the extent to which they are interconnected. As part of the 2023 stress tests we plan to collect a set of climate-related scenarios already developed by CCPs. This will give us an overview of how well prepared they are. Last year we invited stakeholders to give us their views; based on the input received, we designed a climate risk framework for the latest stress test. The results, including the climate-related risk aspects, are expected to be published in 2024.

I would also like to take this opportunity to point out how well the collaboration between ESMA and the ECB on this topic has been working. The exchange of ideas and information relevant for the climate component of the stress test has been very fruitful.

In addition, ESMA, the other ESAs, the ECB and the ESRB are actively collaborating on a wider consideration of climate risk for the financial sector. The Commission recognises the need to ensure the financial sector is resilient and has asked us to assess how far climate-risk related shocks could place significant stress on the financial system as a whole by 2030. This one-off scenario analysis is a major exercise, involving modelling that is both sectoral – in our case, focusing on investment funds – and cross-sectoral. We will report back to the Commission at the beginning of 2025.

Market participants argue that the European environmental, social and governance (ESG) framework is over-complex. Do you agree?

Integrating complex and multi-faceted environmental and social considerations into finance inevitably entails a certain level of complexity. Nevertheless, I agree we need to work together to make the EU framework more streamlined over the next few years.

The EU has been a global leader in regulating sustainable finance. Rules have evolved very rapidly since 2018. Fundamental elements are gradually falling into place, notably comprehensive sustainability reporting by companies as a result of the Corporate Sustainability Reporting Directive and the European Sustainability Reporting Standards. This will improve the data situation, which is currently still limited and very fragmented, with an impact along the whole sustainable investment value chain.

The Commission, legislators and the regulatory community all need to contribute to improving the practicality of the current EU framework, addressing inconsistencies across regulatory requirements and reducing complexity for investors. We need to make financial information concerning sustainability more comprehensible and comparable for investors. In general, we need to build investor trust to enable the financial sector to play its role in the transition to sustainable finance. This is reflected in the objective of enabling sustainable finance in our Strategy 2023-2028.