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In my remarks today I would like to spend some time discussing the macro prudential supervision of the investment management sector, and in particular how the remaining vulnerabilities of Open-Ended Funds (OEFs) are being kept under close scrutiny at global level. In the EU important reforms are already underway to tackle the systemic risk posed by investment funds, in particular those arising from liquidity mismatch and excessive leverage.
I will start by presenting the recent market developments in the investment management sector and our views on current vulnerabilities. Then, I will continue by giving you an update on the ongoing regulatory agenda for the investment management sector at both international and European levels, with a particular focus on financial stability and macro prudential supervision.
Finally, I will explain how, at ESMA, we go about risk monitoring and what we expect market participants to do.
The macro-economic environment and trends in the investment fund market
I probably do not need to tell you that the current economic environment has been, and will remain for some time, uncertain. In the last few years, we have gone through a succession of unexpected crises of different nature, creating unprecedented challenges for asset managers, and the economy at large. As we were just emerging from the Covid-19 pandemic, the Russian invasion of Ukraine affected dramatically the risk environment of EU financial markets. At the same time, market participants have become increasingly concerned about a global economic slowdown, or even a recession in some jurisdictions. Recovery in EU financial markets faltered, volatility increased, and market corrections materialised.
Inflation has risen sharply since mid-2021, as pent-up demand from the pandemic returned and some key supply chains faced challenges. It reached its highest level since the early 1980s in the EU, up to 11.5 % on an annual basis, in October 2022. The war and the sanctions applied to Russia increased pressures on prices from resulting supply shocks in energy, food and other commodities. Higher energy prices, reaching 10-year highs, have particularly contributed to inflation, widely increasing input and distribution costs.
As a direct consequence, central banks tightened their monetary policies to reduce demand and bring inflation back down. Interest rates increased by 3.5 percentage points in the Euro Area (EA) over one year and 4.5 points in the US, with actual and anticipated monetary policy bringing yields to levels not seen in ten years. These developments create a new economic environment for markets in general and for the asset management sector in particular.
Asset managers need to adapt to this new reality, after operating for years in a low yield and low inflation environment.
In 2022, the assets under management of investment funds experienced their sharpest decline in the EU since the Global Financial Crisis (–11% in the EA, down to EUR 16tn). Equity funds especially declined by 17%, owing mainly to valuation effects as equity markets lost as much as 20%. Contrary to past episodes of market turmoil, the impact propagated across other assets classes, including bond funds, which declined by 16% and experienced significant performance-driven outflows. Beyond the fund sector, declining valuations impacted most segments of the market-based finance system, with a 60% decline in equity issuance and a 42% decline in corporate bond primary markets in the EU. In comparison, the total assets of the banking sector increased by 5.4%....
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