ESMA Warns of Potential Sharp Market Correction Amid Elevated Valuations

European Securities Watchdog Flags Risk of Sharp Market Correction Amid Elevated Valuations

ESMA Identifies Market Risks and Emerging Threats

By Elizabeth Howcroft and Phoebe Seers

Valuation-Economic Gap Widens, Raising Correction Risks

PARIS, Sept 10 (Reuters) – The European Union’s financial watchdog said on Thursday that a widening gap between deteriorating macroeconomic conditions and buoyant market valuations could trigger a sudden market drop. Geopolitical tensions in the Middle East and rising energy costs are cited as key drivers of this divergence.

“Investor optimism continues to support elevated valuations despite mounting geopolitical tensions and a weakening economic outlook. The larger the gap becomes, the greater the risk of an abrupt market correction,” ESMA Chair Verena Ross remarked.

Operational and Cyber Risks Escalating Across Financial Markets

Heightened Vulnerabilities in Financial Infrastructure

The European Securities and Markets Authority reported that operational risks across financial markets have reached a very high and rising level. These risks are increasingly driven by growing cyber threats and advances in artificial intelligence that can discover and exploit vulnerabilities.

Crypto Market Volatility and Systemic Spillover Risks

Potential for Contagion to Broaden Financial System

ESMA reiterated its longstanding concern that shocks in crypto markets could spread to the broader financial system, reflecting the growing interconnectivity between digital assets and traditional finance.

Tokenised Equities Gaining Traction, Impact on Market Structure

While tokenised equities—crypto products based on equity derivatives—remain negligible relative to the global stock market, ESMA noted that adoption is accelerating and could influence market structure over time.

Prediction Markets Present Emerging Risks

Institutional Interest Amplifies Manipulation Risks

The regulator highlighted that growing institutional interest in fast‑growing prediction markets introduces new manipulation risks, as exchanges and investment funds seek partnerships in the sector.

Insider Trading and Detection Challenges Intensify

“Market manipulation and insider trading risks reach new levels in the context of prediction markets,” ESMA said. The use of crypto by users betting on real‑world events hinders detection and prevention of insider trading, wash trading, and coordinated manipulation.

“A growing number of incidents illustrates that prediction markets are rife with insider trading,” the report added.

(Reporting by Elizabeth Howcroft in PARIS and Phoebe Seers in LONDON; Editing by Kirstin Ridley and Alexander Smith)

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