Trend Sight 2022

Trend Sight 2022 4 November 2021

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Introduction Summary 01 Trends 03 Investment Behavior of Execution-Only Investors 02 Risk Maps Page 3 Page 11 Page 33 Page 61 Page 5

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In Trend Sight, the AFM addresses important trends and associated risks in the financial sector. Trend Sight provides substantive background, depth, and coherence regarding relevant supervisory topics. Early detection and understanding of changes in the sector contribute to an effective, forward-looking, and preventive supervisory approach. In this way, we fulfill our mission to strengthen ourselves for fair and transparent financial markets and contribute to sustainable financial well-being. Trend Sight addresses developments in areas such as the macro-economy, digitalization, and sustainability. Based on the identified trends, we describe important issues within our supervision and, where possible, provide directions for solutions. New in this edition of

Introduction

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Trend Sight are the risk maps for the four AFM supervisory areas, which can be found in Chapter 2. In these risk maps, the main risks per supervisory area are clarified from their interaction with the trends from Chapter 1. The behavior of execution-only investors receives special attention in this edition (Chapter 3). Agenda 2022 Trend Sight contributes to determining the AFM's supervisory priorities. The concrete implications of the trends and risks for the AFM's supervisory activities are elaborated in the Agenda 2022, which will be presented at the beginning of 2022.

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Chapter 1: Trends Annually, the AFM conducts an environmental analysis of trends that influence our supervision. These trends are briefly described below. Macro-economic Climate The peak of the corona crisis seems to be over, but the pace of economic recovery remains shrouded in uncertainty. Nevertheless, financial markets are optimistic. This is reflected in high equity valuations. However, recently rising inflation expectations may cause a tempering of sentiment. Due to the persistently low, sometimes even negative, interest rates, the search for yield continues. As a result, prices of more risky assets are rising. For individuals, the effect of low interest rates is visible in a strong increase in the number of investors. Summary

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Here, a point of attention is that individual investors, in their search for alternatives to saving, are turning to investment products whose risks they do not assess well. Low interest rates make it attractive for companies to incur debt. Additionally, increased equity valuations and credit growth make financial markets more vulnerable to overvaluation and abrupt market shocks. And thus to the emergence of risks regarding financial stability. Finally, due to the long-term low interest rates, the profitability and solidity of financial institutions, primarily insurers, remain a point of attention. The return on investments remains low, while long-term liabilities are increasing. This can also create a tension field in the careful handling of customer interests and the sustainable design of the business model. Housing, Work, and Pension The Dutch housing market remains overheated. On the rental market, supply structurally fails to meet demand. High house prices and the high debts incurred when buying a home make households vulnerable to setbacks. First-time buyers especially seem to be putting all their eggs in one basket to buy that coveted first home. In doing so, they risk borrowing unreasonably large amounts. To prevent households from getting into too much debt, it is important that loan norms are applied carefully. The high degree of flexibilization of the Dutch labor market puts pressure on the income security of a large group of workers. And it is precisely these flexible workers who were hit hard by the corona crisis. This underscores the need for households to maintain sufficient financial reserves to be resilient against economic shocks. In the new pension system, participants have more personal responsibility. The new pension system, for which an agreement was reached in the summer of 2020 and which will enter into force no later than 2027, will consist of premium schemes with largely variable benefits. This can have a significant impact on the level of the pension. The transition to the new system is a large and complex process in the coming years. The vulnerable financial position of pension funds makes the transition to the new system particularly challenging. Digitalization Data are increasingly forming the core of business processes for both traditional financial parties and new entrants. Data are an important means to improve service provision and profitability. The increasing use of data also brings risks. Points of attention include ensuring high data quality and handling personal data lawfully and carefully. Securing data and the resilience of IT infrastructure against cyberattacks require continuous attention. The trend of outsourcing digital business processes makes financial enterprises more vulnerable to disruptions by their service providers. The importance of Big Tech for the financial sector is increasing. The technological solutions offered by Big Tech provide ease of use but also harbor risks. From the perspective of investors and consumers, protecting customer data requires constant attention. Additionally, concentration risks are emerging because financial institutions are dependent on only a few platforms offered by Big Tech, for example for cloud services. There is currently no regulation to structurally counter these risks. The trend of outsourcing digital business processes makes financial institutions more vulnerable to incidents at their service providers. Investors and consumers are also affected by this.

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Investing in crypto-assets is taking off. Due to, among other things, the high volatility of valuation, investing in crypto-assets is risky. In response to the turbulent development of the crypto market, European regulation is in the making, the Markets in Crypto-Assets Regulation (MiCAR), which creates obligations for both issuers of crypto-assets and crypto-service providers. Internationalization The regulatory framework for the AFM is largely determined internationally. For 2022, several important European legislative tracks are on the agenda, on which the AFM will provide input, among others, in the ESMA context. Furthermore, supervisory convergence as the next step in European cooperation is having an increasing influence on our work. Now that market parties can easily become active in multiple member states and markets due to digitalization, and markets are increasingly cross-border, supervisory convergence is becoming increasingly important. Due to Brexit, many new supervised enterprises have established themselves in the Netherlands. These are primarily parties active in capital markets, such as large trading platforms, proprietary traders, benchmark parties, and managers of investment funds. The Netherlands has thereby become one of the most important trading centers for equities in Europe. Due to the increasing international character of Dutch equity platforms, other types of financial products are also traded in Amsterdam. For example, SPACs (Special Purpose Acquisition Companies) and derivatives, such as CO2 emission rights. Furthermore, the financial services market is operating increasingly internationally. This is manifested, among other things, in the large number of foreign financial service providers offering their services in the Netherlands via a European passport. This brings advantages, including an increase in the diversity of offerings, but also disadvantages, such as the increase in malicious providers. This strengthens the need to intensify cooperation with foreign supervisors. Sustainability Climate objectives will largely determine the social agenda for the coming decades. Efforts to reduce the CO2 intensity of our economy can translate, among other things, into stranded assets and have adverse effects on our prosperity. The financial sector must respond to this by adequately pricing these effects into their assets and financing models. Furthermore, corporate reporting is facing increasingly stringent requirements regarding sustainability information. Financial enterprises play an important role in the sustainability transition by mobilizing capital for sustainable investments and steering towards sustainability aspects in the business operations of companies. This creates a tension field. Financial enterprises are increasingly being called upon regarding their role in the sustainability transition. In doing so, parties must provide transparency regarding their sustainability objectives based on existing regulations. At the same time, legislation and regulation have not yet crystallized. For example, sustainability definitions and reporting standards are still under development. Meanwhile, the inflow of new capital into sustainable investments is growing rapidly. With this growth, attention to the risk of greenwashing also increases. This concerns the concern that raised expectations regarding the sustainability content of investments are not sufficiently met. Integrity Money laundering and other financial crime undermine the integrity of the financial-economic system. The government and citizens are concerned about this form of crime. Trust in the financial sector can also be damaged if companies, consciously or unconsciously, become involved in malicious practices. Financial institutions play an important gatekeeper function in preventing criminals from bringing illegally obtained wealth into the financial system or using the financial system to carry out illegal activities.

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Supervisory Landscape ‘Less market, more state’. Both politics and the public are increasingly rallying behind this adage. Increasing public expectations regarding the resolution of social problems by an active government may translate into similar expectations of parties in the financial sector and the decisiveness with which supervisors address malpractices. One sector undergoing a change process is the accounting sector. In the report of the Commission for the Future of the Accounting Sector, recommendations were made aimed at sustainably delivering high quality and thereby regaining the justified trust of stakeholders. Part of these recommendations has been translated into a legislative proposal that was consulted on in the summer of 2021. The new pension system and the new supervisory tasks arising from it have significant consequences for AFM supervision. For the AFM, the system change means an expansion of tasks. For example, the new Pension Act includes new tasks for the AFM regarding supervision of the determination of the risk preference of the participant population and introduces requirements in the area of choice guidance. Markets are becoming increasingly cross-border, leading to more European supervisory coordination. This applies both to the traditionally internationally intertwined capital markets and to financial services and consumer markets. As a result, European influence on the priorities of national supervisors is growing.

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Chapter 2: Risk Maps The risk maps in Chapter 2 provide an overview of important risks per supervisory area. The risk maps make it clear how the developments outlined in Chapter 1, such as low interest rates, digitalization, and sustainability, impact risks within the four AFM supervisory areas: financial services, capital markets, asset management, and financial reporting and accounting organizations. Below, some risks are highlighted per supervisory area; for the full overview, reference is made to Chapter 2. The risk map for financial services highlights, among other things, the pension transition. This system change requires a complex, far-reaching transition affecting millions of households. Furthermore, attention is drawn to how the macro-economic climate and digitalization impact retail investing. The risk map reveals concerns regarding possible corrections on strongly risen equity markets, the increasingly low-threshold access to (risky) investment products, and the rich breeding ground for investment fraud. There is also attention paid to the pressure on the accessibility of financial services. As clarification, the results of an exploration into the relationship between financial services and Dutch people with a migration background are included. For capital markets, further digitalization and internationalization are important drivers of risks. Special attention is given to the efficient functioning of markets, which is under pressure due to growing trading outside traditional platforms, which can lead to a decrease in general transparency regarding prices and transactions. Another risk is inadequate data quality and accessibility of data for market players. As a result, the market is not fully or incorrectly informed about, for example, the nature, valuation, or price of a financial product. The risk of market disruption by trading algorithms and the role social media can play as a coordination platform for market manipulation are also addressed. Within the asset management supervisory area, the strategic repositioning of parties requires attention. Especially for smaller asset management parties, it is a challenge to address this sufficiently vigorously. The risks of outsourcing are also addressed. As the chain becomes longer and dependencies increase, this can lead to less secure controlled and honest business operations. Furthermore, we extensively explain how the increased demand for sustainable financial products affects the sector and how the lack of standardized, reliable data on sustainability performance increases the risk of greenwashing. For accounting organizations, much dynamism stems from the change process aimed at strengthening the structure of the sector and supervision. Special attention is paid to developments that put the relevance of traditional financial reporting and auditing under pressure. This concerns, among other things, a changing information need at the end-user and new, digital possibilities for reporting. Furthermore, attention is paid to the increasing attention for fraud throughout the reporting chain. A new area gaining strong relevance is the reporting and auditing of non-financial information (including sustainability information). New rules and standards are being developed for this, the application of which must be guided properly.

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Chapter 3: Investment Behavior of Execution-Only Investors The number of investing Dutch people has increased strongly in the past two years. Reasons for this include, among other things, low interest rates and the ease with which consumers can start investing. Most investors choose execution-only service provision, where they are responsible for the transactions and the portfolio themselves. The AFM has conducted research among retail investors in the execution-only channel. Below, the findings of this research are described; for the full research, reference is made to Chapter 3. In this publication, we provide insight into various characteristics of these investors, such as age, gender, and invested assets. Furthermore, the research provides insight into their reported behavior, such as the number of transactions and the degree of diversification. For example, we see that almost one-third of investors make periodic deposits. This reduces the risk that they purchase their entire portfolio at a market peak, thereby improving the risk-return ratio of their portfolio. The AFM focused this research on the suboptimal behavior of investors. We know from various scientific studies that making investment decisions does not always go well. For example, investors tend to trade too much and thereby incur unnecessary costs, diversify too little across different instruments or geographic regions, or purchase unnecessarily risky products. This suboptimal behavior worsens the outcome for the investor, due to higher costs or more risk in the portfolio than necessary. The research shows that 32% of investors exhibit suboptimal behavior. This can be a problem if there is a high chance that someone needs the money, now or in the future. For example, because they have a small buffer or because they are investing for a goal for which they will depend on the invested assets in the future. Approximately 12% of investors have a high chance of needing the assets and exhibit suboptimal behavior. We view this group as vulnerable, because the financial well-being of these investors may be jeopardized by their suboptimal behavior. The AFM did not look into the causes of this behavior in this research. In 2022, the AFM will investigate to what extent investment companies influence investors' behavior, what effect that has, and what can be improved therein to benefit sustainable financial well-being for their clients.

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The peak of the corona crisis seems to be over. After a long period of lockdowns that held society and the economy in their grip, vaccination campaigns are bearing fruit. Although not all restrictive measures are gone, the path to recovery seems definitively set. The economic damage has turned out to be less than expected at the height of the crisis. It is expected that the initiated economic recovery in the Netherlands will continue in 2022.1 The extensive support measures from the government have played an important role in dampening the economic damage. Due to a good starting position and the extensive crisis measures, the global financial system has remained resilient to the consequences of the pandemic so far. 1 CPB. 'Macro Economic Forecast 2022', September 2021. 01 Trends

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Financial institutions have thus far continued to fulfill their role, and credit provision to companies and households has remained at level. Although the prospects are positive, economic development remains surrounded by much uncertainty. The corona crisis leaves structural changes in financial services. Particularly relevant is the acceleration in digitalization due to the lockdowns. And especially the acceleration in online remote work and (related to that) the accelerated transition to online service provision. For the financial sector and our supervision, this acceleration means that issues around cyber security and privacy protection are becoming even more important. Another concrete manifestation of this development is the accelerated closure of bank branches in the past year, which has led to social concern regarding the accessibility and inclusivity of the financial sector. Against the backdrop of this broader social context, this chapter describes trends that influence AFM supervision. This chapter first describes a number of macro-developments in the areas of economy, housing, work, and pension (paragraphs 1.1 and 1.2). Then, it zooms in on three trends that are changing the financial sector at high speed: digitalization (1.3), internationalization (1.4), and sustainability (1.5). Paragraph 1.6 addresses a theme receiving much social attention: the integrity of the financial sector. Paragraph 1.7 discusses how the trends influence the position of the AFM within the broader supervisory landscape. 2 European Commission, Eurostat. 3 Central Bureau of Statistics. 4 CPB. 'Macro Economic Forecast 2022', September 2021. 5 On September 23, 2021, the Amsterdam stock exchange index AEX closed above 800 points for the first time in its history. This stands in great contrast to the level of 389.60 that the AEX noted on March 16, 2020, as the low point of the corona crisis. 1.1 Macro-economic Climate Although the peak of the corona crisis seems to be over, the pace of economic recovery remains shrouded in uncertainty. The spread of the coronavirus among the global population and the subsequent lockdown measures have slowed the real economy worldwide. This led to a GDP contraction of 6.3% in the eurozone2 and a contraction of 3.8% of the Dutch economy3 in 2020. For many countries, including the Netherlands, this was the largest economic contraction since the Second World War. However, the contraction remained relatively limited due to the provision of financial support packages by governments and interventions by central banks. Nevertheless, it remains uncertain how large the blow will be to the economy once financial support from the government, for example for self-employed individuals without employees (zzp’ers), falls away and bank moratoria expire. For now, the CPB estimates that the GDP of the Netherlands will grow by 3.9% in 2021 and by 3.5% in 2022.4 Financial markets have been optimistic about economic recovery for a long time, but recently rising inflation expectations are causing a tempering of sentiment. In March 2020, when the far-reaching consequences of corona became visible worldwide, stock prices fell sharply, and the volatility of global equity markets reached record levels. Interventions from central banks and governments made this dip in market sentiment short-lived. The sentiment among investors recovered, and risk appetite increased strongly. This resulted in rising equity valuations. Since the spring of 2020, equity markets have shown an upward trend, reaching record levels5 (see Figure 1, left graph). The stimulation of the

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economy by central banks and governments and the recent economic recovery also lead to rising inflation expectations. This causes the sentiment among investors to be somewhat tempered. Also, risk-free interest rates are rising slightly worldwide (see Figure 1, right graph). Nevertheless, real financial conditions remain ample. Other factors that can negatively influence sentiment are the strongly risen energy prices and uncertainty regarding the possible global spillover of vulnerabilities in the Chinese economy. If the rise in energy prices proves to be structural, it will also have an impact on the real economy. Due to ample financial conditions, the search for yield continues, and prices of more