jpmorgan global investment banks 2010-09-08

8/4/2019 JPMorgan Global Investment Banks 2010-09-08

1/176

Global Equity Research08 September 2010

Global Investment BanksInvestment Banking wallet outlook - all eyes on equityderivatives

Banks

Kian AbouhosseinAC

(44-20) 7325-1523

[email protected]

Delphine Lee(44-20) 7325-3971

[email protected]

J.P. Morgan Securities Ltd.

See page 172 for analyst certification and important disclosures, including non-US analyst d isclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm mhave a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making thinvestment decision.


2/176

2


Kian Abouhossein(44-20) [email protected]

Delphine Lee(44-20) [email protected]

Table of Contents

Key Takeaways.........................................................................3Equities business outlook matters .......................................10

IB revenue wallet trend - Equity Derivatives key driver ......10

Detailed growth rate discussion ...........................................16

Regulation: structural changes for the Equity Derivativesbusiness..................................................................................21

IB valuation .............................................................................44

Stock Selection.......................................................................47

Regulatory changes: impact analysis for the equities

business..................................................................................62

Structured Equity Products: towards the oligopoly............80

Flow equity derivatives ..........................................................98

Delta One products ..............................................................110

Convertibles..........................................................................124

Lyxor, an asset manager within the IB...............................128

Appendix I: How we estimate capital allocated to theequities business .................................................................134

Appendix II: Structured products........................................136

Appendix III: Flow equity derivatives..................................139

Appendix IV: Delta one products ........................................142

Appendix V: Detailed breakdown estimates ......................145

Credit Suisse Group.............................................................154

UBS........................................................................................155

Deutsche Bank .....................................................................156

Goldman Sachs ....................................................................157

Morgan Stanley.....................................................................158

BNP Paribas..........................................................................159

Socit Gnrale ..................................................................160

Valuation Methodology and Risks ......................................161

For Specialist Sales advice,please contact:

Nick Gough(44-20) 7325-9459

[email protected]

Oliver Doeltl(44-20) 7779 2187

[email protected]

Justine Shih(44-20) 7779 2149

[email protected]

Covering analysts for Barclays:

Carla Antunes da Silva(44-20) 7325-8215

[email protected]

Amit Goel, CFA(44-20) 7325-6924

[email protected]

Covering analyst forBank of America, Citigroup:

Vivek Juneja(1-212) 622-6465

[email protected]
mailto:[email protected]:[email protected]:[email protected]:[email protected]


3/176

3




Key Takeaways

Our analysis clearly illustrates the IB wallet is going ex growth, declining -4%

09-12E CAGR and to grow only 3% CAGR in 10E-12E.

The main catalyst for our base case ex growth revenue trend is that clean fixed

income revenues are likely to decline from the peak 2009 year by -22% in

2010E/09E and a further -4% CAGR in 2010-12E, accounting with 55% share for the

largest part of the $330bn IB revenue wallet in 2009.

So where is the IB revenue wallet growth going to come from?

In respect to IB product cycle in different economic stages, with the market

becoming more risk open, one should expect a shift to the next risky asset class to

drive IB revenues after 2009 being the best FICC trading year ever: Equities, in our

view.

In addition, there is no sign of innovation within the IB industry driving a new

IB revenue wallet super-cycle. One of the products offering potential long-term

growth is Insurance-linked-securities. However, following the structured credit crisis

we do not see client appetite to buy illiquid structured products. For details on

Insurance-linked securities, please refer to our note, Insurance Linked Securities:

The second leg of growth in the ABS market? published on 4 June 2007.

Hence, the key driver for growth in the IB wallet going forward has to be

equities. In particular, we focus on equity derivatives rather than highly

commoditized cash equity business as the key IB revenue driver considering its

higher long-term profitability, lower operating gearing, and more diverse business

mix.

Equity Derivatives the key determinator for IB wallet growth.

We analyse in detail the key sub-business segments within equity derivatives and

their potential IB revenues impact. We conclude equity derivative business is to

grow 9% CAGR 2010-2012E the fastest growth within all IB client flow

related businesses assuming 5% CAGR equity market performance in 10-12E.

The historic equity derivative revenue growth rates of c.15%p.a. are unlikely to

be achievable as clients operate with less leverage and demand relatively simple

structured products. More importantly regulation should be a trigger of structural

change in Equity Derivatives reducing profitability, with ROEs declining from 42%

to 22% in a 2011E sensitivity, mainly due to new capital rules accounting for 2/3rd

of change rather than revenue loss related regulation at 1/3rd. The regulatorychanges will lead to re-assessment of the business model in our view and structural

trend changes within the business wallet as we outline in detail in our report.

We expect Delta One to be a key growth segment in our view, accounting for

$10.7bn revenues wallet in 2009 with CAGR 9% 10-12E. These activities require

large scale operations to maintain significant size index-based portfolios and

competitive technology with the appetite and willingness to hedge at times long-

dated risk. Investment costs required for algorithmic trading are relatively high, and

equity finance activities are balance sheet intensive, as a result, we believe this

segment will remain dominated by the scaled players with strong balance sheets. In

Table 1: Clean IB revenue walletgoing ex-growth

%

CAGR 10E-12E

Fixed Income revenue -4%

Equities revenue 8%

IB revenue 12%

Total revenues 3%

Source: J.P. Morgan estimates.

Table 2: IB revenue cycle

Low RiskMoney Market FX Rates Credit Trading

Equity

Structuring

High Risk


Table 3: Global equity derivativesrevenues growth expectations

%

CAGR10E-12E

Structured products 10%Flow and listed deriv. 8%

ow Delta One 9%

ow flow equity derivatives 5%Convertible bonds 6%Equity deriv. ex prop 8%Prop trading/flow prop 14%Total equity deriv. Rev. 9%

https://mm.jpmorgan.com/servlet/PubServlet?skey=R1BTLTEyOTAwMC0w&Name=GPS-129000-0.pdfhttps://mm.jpmorgan.com/servlet/PubServlet?skey=R1BTLTEyOTAwMC0w&Name=GPS-129000-0.pdfhttps://mm.jpmorgan.com/servlet/PubServlet?skey=R1BTLTEyOTAwMC0w&Name=GPS-129000-0.pdfhttps://mm.jpmorgan.com/servlet/PubServlet?skey=R1BTLTEyOTAwMC0w&Name=GPS-129000-0.pdfhttps://mm.jpmorgan.com/servlet/PubServlet?skey=R1BTLTEyOTAwMC0w&Name=GPS-129000-0.pdf


4/176

4




addition we see material growth opportunities within ETFs at 20%p.a. The key

players are GS, SG and BNPP.

Within equity derivative structuring we expect retail business to remain

relatively slow and unlikely to reach peak volume levels at highly leveraged and risk

payoffs post the structuring crisis. However, strategic corporate business will

remain a material high growth segment in our view. We expect structuring to

grow from a 2009 wallet of $7.7bn by CAGR 10% 10-12E. Overall, due to difficult

to hedge risk and capital charges post Basel 2.5, IBs require scale in the structuring

business to generate acceptable ROEs over-the-cycle in our view leading to further

consolidation in this business segment. As a result, we expect the structured equity

derivatives industry to become more oligopolistic post regulatory changes. There are

business opportunities so and we remain surprised about competitors inability to

replicate a Societe Generale Lyxor-type structure. The key players are SG, BNPP,

DB and GS.

Our largest sub-segment business concern is regarding the equity derivative

flow business, becoming more cash equity-like with literally every IB now

focusing on expanding this business segment, with a 2009 wallet of $7.5bn and

CAGR 5% 10-12E. We witness overcapacity building up reducing spreads and

increasing operating leverage. In addition, with regulation increasing price

transparency the more commoditized equity derivative flow business is becoming

even more of a scale platform business with a strong IT infrastructure a key

differentiator. More importantly, the race to own high trading market share is key for

price discovery (i.e. liquidity provider) to optimize client facilitation business and

generate flow prop related revenues. Hence, the importance of flow prop as such will

not be diminished but becomes more vital in a continuously declining flow equity

derivative profitability world. We see flow prop as part of client facilitation business

in a more transparent equity derivative trading business. Overall, very few players (3-4) will be able to be liquidity providers in such a scale focused business and we are

concerned about the aggressive expansion strategy of all IBs including Tier II players

to build-up scale. Within flow equity derivative, there is the potential for some IBs to

close geographic gaps and grow the flow business aggressively, in particular French

and European Banks in the US, with ongoing structural growth in Asia. The player

by far being strongest in this segment is GS. We see the oligopolistic flow market

structure still uncertain with MS, UBS, DB and French Banks potential contenders in

our view.

Valuation ex revenue growth Why Buy IBs?

With the wallet unlikely to grow plus new regulations impacting IB ROEs, whyremain OW IBs over credit related banks?

We continue to prefer IBs over traditional credit banks, due to more attractive

valuation, higher cost flexibility, better capital levels as well as less revenue at

risk compared to low discounted expectations:

1. Current group valuations do not price in any growth: Investment Banks are

valued at 7x 2012E earnings on average, compared to historical peak valuations of

13x in 2000, currently accounting for no growth in the medium term with share

prices 27% below 2003 levels. Looking at group pre-tax, we still expect some growth

with 15% CAGR in 2010E-2012E, compared to 20% in 1999-2001E. Hence, IB

Table 4: Equity derivativesbusin esses net ROE pre and postregulatory changes

%

2011Epre

reguln.

2011Epost

reguln.Structuredproducts

27% 14%

Flow equityderivatives

29% 18%

Delta oneproducts

71% 40%

Convertibles 45% 30%Prop/flow prop 58% 24%Total equityderivatives

42% 22%


Figure 1: Averaged weightedspread on 28 significant series onISE

bps

0

5

10

15

20

25

30

Jan to Mar 08 May to Oct 09

Source: ISE

Table 5: Global Investment banks Group valuation vs. growth 2012E

x, %

P/BV PE Group

pre-tax10E-12E

GS 1.1 9.0 8%MS 0.9 7.5 23%UBS 1.3 7.6 22%CS 1.6 6.7 15%BNP 1.0 7.1 11%SG 0.9 6.2 27%Barc 0.8 7.5 13%DB 0.9 6.5 9%

Avg. 1.1 7.2 16%



5/176

5




valuations are already discounting a more negative earnings scenario than JPM is

expecting, offering share price upside potential in our view.

2. IB divisional valuation ex revenue growth offers upside even at 1x BV:

Valuing Investment Bank businesses at 1x BV would imply 15% upside. One of the

key reasons for the low valuation multiples for global investment banks is the lack of

growth in the IB revenue wallet only 3% CAGR growth in 2010E-2012E.

However, we already account for this in our valuation, where we assume SOP PE

multiples in the range of 5.5x-8.0x for the IB divisions of global investment banks.

The implied P/BV valuation for the IB divisions is 0.7x at current market prices. This

is well below our 1.1x p/BV estimate for IB businesses in our SOP valuations. Even

valuing the IB divisions at 1x BV would imply 15% upside.

3. In our view, regulatory risk for the overall Investment Banking business has

been discounted already - returns will be structurally lower than in the past,

declining from 20% to 12% on average in our estimates, due to OTC derivativesregulation and Basel changes for market risk and counterparty risk. Given the

political pressures in various geographies, we believe IB compensation reduction will

be a key driver of this road back to 15% ROE generation. Based on our estimates,

investment banks would need to reduce 2011E IB comp costs/head by -32% vs.

2009E. This would lead to structural reduction in comp ratio declining from 43% to

34% on average.

Within IB sector overweight position - what are the key IBs to own?

With the revenue wallet not growing much in the medium term as reflected in the PE

valuation, the Investment Banking business is becoming more like utilities with

growth just above GDP and lower long term ROE of 15% rather than 20% with

regulatory changes structurally reducing profitability. Even with cheap valuation and

market discounting a relative negative IB scenario, we prefer to own IBs that cansurprise in respect to EPS upside. In this scenario, we would prefer banks

which could offer potential upside through capital re-leveraging.

Our stock selection pecking order is for preference of US IBs now 1) Goldman

Sachs (OW), 2) Morgan Stanley (OW), 3) UBS (OW), 4) Credit Suisse (OW), 5)

Barclays (N), 6) Deutsche Bank (UW).

This reflects our preference for 1) well capitalized banks with the capacity to

buy back shares, 2) relatively resilient private banking exposure, 3) equity

gearing over fixed income within IB.

Table 6: Global investment banks Reaching 15% IB ROE 2011E byadjusting IB comp/head

%

ROE pre-regul ation 20.3%ROE post-regulation 12.1%IB comp ratio to reach 15% 34%

Cut in IB Comp/head11E/09E

-32%



6/176

6




1. Relative to European Investment Banks, US Investment Banks are better

capitalized, with: i) higher Basel 3 equity Tier I ratios of 12% on average compared

to 10% for European IBs, ii) Better leverage ratios with 7% vs. 4% for European IBson a comparable US GAAP basis, and iii) more conservative methodology in

calculating market risk than Europeans peers as discussed in our report Global

Investment Banks: Market RWA consistency questioned" on 6 July 2010. In

addition, it is worth noting US IBs have mainly clean mark-to-market balance

sheets unlike European peers, especially DB, BARC and SG operating with

significant IAS 39 reclassified structured credit exposures.

Whilst UBS and Credit Suisse capitalization levels are also relatively high with Basel

2 Core Tier I ratios of 14% and 11% respectively, both banks are unlikely to buy

back shares in the medium term as we believe that Swiss regulators will set the new

minimum level required at 16%. Unlike Swiss banks, we believe that US IBs

Goldman Sachs and Morgan Stanley could do a share buyback as early as 2012. We

estimate GS and MS have excess capital of $29bn and $18bn respectively, whichthey could use to repurchase shares.

2. Prefer Wealth Management exposure: UBS, CS: Private banking/brokerage

provides a source of relatively stable cash flow generation across the cycle, and

overall, remains one of the most profitable banking businesses with limited capital

consumption in our view. UBS and CS trade at 1.3x and 1.6x NAV ex own debt for

RoNAV of 19% and 25% respectively. Excluding the Wealth Management business

which we value at 10x PE, both banks would trade at 0.9x NAV for RoNAV of 17%

for CS and 13% for UBS.

3. Prefer equity gearing over fixed income: CS, UBS, MS. Within the more pure-

play IBs, we prefer banks with higher equity gearing as we see growth in IB revenues

coming from Equities. Credit Suisse and UBS are amongst the highest geared toequities accounting for c.35% of total Investment Banking revenues in 2011E. At

group level, equities account for 20% of group revenues for CS and 15% for UBS.

These banks are thus likely to benefit the most from any improvement in the equities

environment. Goldman Sachs and Morgan Stanley are also geared to equities which

accounts for c.30% of total IB revenues in 2011E, and 26% of group revenues for

GS, and 16% of group revenues for MS.

Table 7: Global Investment Banks:Basel 3 Equity Tier 1 and Core Tier1 ratios 2011E

%

Basel IIIEquity Tier

1 ratio

Core Tier 1ratio

GS 13.8% 13.8%CITI 12.8% 13.2%UBS 11.5% 14.0%MS 10.8% 10.8%CS 10.0% 11.0%BOA 9.2% 9.3%

BNP 8.4% 8.6%BARC 8.3% 9.4%SG 7.3% 7.9%DB 5.6% 7.3%

Avg. 9.8% 10.5%

Source: J.P. Morgan estimates, Company data.
https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-436229-0https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-436229-0https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-436229-0https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-436229-0https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-436229-0


7/176




Table 8: Summary wholesale and Investment B ank Valuation Table 2010E-2012E

Price TP RecNAV

2011ENAV

2012E

NAVex

owndebt

2010E

NAVex

owndebt

2011E

NAVex

owndebt

2012EPE

2011EPE

2012EP/NAV

11EP/NAV

12E

P/NAVex own

debt11E

P/NAVex own

debt12E

RONAV11E

UBS 18.2 22 OW 11.6 14.0 9.1 11.3 13.7 8.3 7.6 1.6 1.3 1.6 1.3 21.0% CSG 47.1 59 OW 26.2 31.1 21.0 24.9 30.0 7.9 6.7 1.8 1.5 1.9 1.6 22.9% DB 50.2 46 UW 50.5 56.4 44.9 50.4 56.3 6.8 6.5 1.0 0.9 1.0 0.9 14.6% Euro IBs - - - 7.8 7.0 1.5 1.3 1.6 1.3 20.0%

SG 44.4 58 OW 44.4 49.8 39.9 44.2 49.6 7.1 6.2 1.0 0.9 1.0 0.9 14.9% BNPP 53.4 65 OW 46.7 52.0 41.6 46.4 51.7 7.7 7.1 1.1 1.0 1.2 1.0 15.6% CASA 10.9 15 N 10.8 11.9 9.77 10.64 11.70 6.6 5.4 1.0 0.9 1.0 0.9 15.9% French Banks - - - 7.3 6.5 1.1 1.0 1.1 1.0 15.5%

Barclays 3.25 3.05 N 3.89 4.26 3.51 3.76 4.17 7.8 7.5 0.8 0.8 0.9 0.8 11.4% RBS 0.47 0.42 UW 0.51 0.55 0.51 0.51 0.55 28.9 11.0 0.9 0.9 0.9 0.9 1.0% HSBC 6.54 9.00 OW 7.26 8.25 6.35 7.13 7.84 9.4 7.6 1.4 1.2 1.4 1.3 16.0% UK Banks - - - 13.0 8.3 1.2 1.1 1.2 1.1 12.0%

GS 147.3 175 OW 125.5 140.6 110.1 124.7 139.9 9.3 9.0 1.2 1.0 1.2 1.1 13.5% MS 26.7 33 OW 27.4 30.8 23.6 26.8 30.2 7.7 7.5 1.0 0.9 1.0 0.9 13.4% US IBs - - - 8.8 8.5 1.1 1.0 1.1 1.0 13.5%

Total - - - 10.0 7.7 1.2 1.1 1.2 1.1 14.8%

Source: J.P. Morgan estimates, Company data. Priced from Bloomberg as of 3 Sept 2010.


8/176

8





9/176

9




Executive

Summary


10/176

10




Equities business outlook matters

2009 was the best year ever for Fixed Income, and we believe it is fair to say that

the record performance is unlikely to be repeated, given the exceptionally

favorable market conditions: high volatility levels, tightening credit spreads, and

low interest rates with the relatively steep yield curve and central banks pouring

liquidity in to the banking system.

Fixed Income accounted for 55% of total IB revenue wallet in 2009, with

equities accounting for only 27%. The question is then: Can the IB revenue

wallet grow from 2009 levels? Whilst the decline in Fixed Income has been well

anticipated, there are more uncertainties on the revenue outlook for equities in our

view.

More specifically, we believe the key question is whether equity derivatives which were previously seen as a growth area with over 15% revenue CAGR

can make up for the decline in Fixed Income and drive growth for the overall IB

wallet.

In this report, we attempt to i) gain a better understanding of the key product trends

within equity derivatives and provide an outlook for the overall revenue wallet,

ii) assess the risk from regulatory changes to profitability and business models, and

iii) give an overview of the future competitive landscape.

IB revenue wallet trend - Equity

Derivatives key driverWhere do we go from here? Sideways

Are the good old days of Investment Banking over? Total Investment Banking

revenues have grown +11% CAGR 1999-2009, with Fixed Income growing at an

impressive 17% CAGR whilst Equities increased 8% CAGR, on a clean basis

adjusted for writedowns and CVA. In our view, historical growth is unlikely to be

repeated in the medium term because of the more challenging outlook for fixed

income. We expect the IB revenue wallet to grow only 3% CAGR 2010E-12E, with

the decline in Fixed Income (-4%) more than offsetting the growth in equities (8%).

As illustrated in Figure 3 below, we forecast equities revenues to recover in 2011E-

12E to levels closer to 2009 following a challenging 2010. Revenue levels remain,however, 19% below 2007 peak. In Fixed Income, we expect 2012E revenues to be

27% below 2009 peak.

Figure 2: Split of the InvestmentBanking revenue wallet* 2009

FICC

55%Equities

27%

IB

18%

Source: J.P. Morgan estimates. * clean revenues

adjusted for writedowns, DVA and other non recurring

item, revenues for: GS, MS, DB, UBS, CS, BoA-ML,

Citi, Barc, SG and BNP.


11/176

11




Figure 3: Global Invest ment Banks Clean Investment Bank r evenues 1999-2012E

Rebased 1999 = 100

0

50

100

150

200

250

300

350

400

450

500

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010E 2011E 2 012E

Equities (LHS) F ixed Income (LHS) Investment Banking (LHS)

Source: J.P. Morgan estimates, company data. Note: clean IB revenues (Equities, FICC, Advisory & Underwriting) excluding

writedowns and DVA/own debt.

Fixed Income only one direction: down

Decline in Fixed Income revenues from the record 2009 has been well

anticipated in our view. We expect total fixed income wallet to decrease to $139bnin 2011E, down -23% from peak $180bn in 2009, with the decline mainly coming

from lower revenues in Rates, FX and prop/flow prop trading.


12/176

12




Figure 4: Glob al fixed incom e: revenue wallet of $180bn in 2009, $141bn in 2010E, $139bn in 2011Eand $131bn in 2012E

$ billion

39.933.3 34.5 33.7

57.7

43.1 39.435.7

28.3

22.220.7

19.2

20.6

18.218.9

19.2

9.5

7.88.1

8.7

24.0

16.117.2

14.5

0

20

40

60

80

100

120

140

160

180

200

2009E 2010E 2011E 2012E

Credit Rates CurrenciesCo mmo ditie s Eme rg ing Markets Pro p/flo w p ro p

Source: J.P. Morgan estimates. Notes: i) prop trading/flow prop both for cash and derivatives, ii) clean revenues excluding writedowns

and own debt valuation changes.

We expect Fixed Income revenues to decline -22% in 2010E vs. 2009E, on a

clean basis. The decline results from primarily from lower flow revenues:

We expect Fixed Income flow revenues to decrease -22% 2010E/09E as therecord performance in Rates reverses (-25% 010E/09E). We expect Rates

revenues to remain 39% above the relatively high 2007 level, but down -25%

however from the record 2009 year, as trading volumes and volatility levels

return to more normal levels and margins decline with increased competition.

Credit and FX revenues are also expected to be weaker with Credit down -17%

YoY and FX down -22% YoY in 2010E.

Prop/flow prop trading/hedge gains revenues in fixed income are expected todecline -33% in 2010E as the markets normalize and hedge gains of 2009E

should not be repeated. We note that once Volcker rules are applicable, pure prop

trading will be illegal for US firms.


13/176

13




Table 9: Global fixed i ncome: r evenue growt h 2009-2012E

%

2010E 2011E 2012E CAGR10E-12E 12E/09E

Credit -17% 4% -3% 1% -16%Rates -25% -9% -9% -9% -38%Currencies -22% -7% -8% -7% -32%Commodities -12% 4% 1% 3% -7%Emerging Markets -18% 4% 7% 6% -8%Prop/flow prop -33% 7% -16% -5% -39%Total Fixed Income -22% -1% -6% -4% -27%

Source: J.P. Morgan estimates. Note: prop trading/flow prop both for cash and equity derivatives.

Equities needs to drive IB wallet upwards

Total equities revenue wallet is expected to grow 8% CAGR from $70bn in

2010E to $81bn in 2012E. Industry revenues are however 3% lower than in 2009

due to the challenging 2010 when we expect equities revenues to decline -17%.

Figure 5: Global equities: revenue wallet of $85bn in 2009, $70bn in 2010E, $76bn i n 2011E and$81bn in 2012E

$ billion

22.218.4 19.3

20.5

6.4

5.8 6.36.9

14.9

12.413.2

13.9

30.3

27.3

29.3

31.8

10.8

6.4

8.1

8.4

0

5

10

15

20

25

30

35

40

45

50

55

60

65

70

75

80

85

90

2009E 2010E 2011E 2012E

Cash equities Electronic Prime Services

Equity derivatives Prop trading/flow prop


Within equities, equity derivatives (ex prop/flow prop) should remain the main

revenue driver with however a lower growth of 8% CAGR 10E-12E vs. c.15%

historically. We expect equity derivatives industry revenues excluding prop

trading/flow prop to grow from $30bn in 2009 to $32bn in 2012E, at a faster pace

than cash equities (5%) and prime services (6%).


14/176

14




Table 6: Global equit ies: r evenue growt h 2009-2012E

%

2010E 2011E 2012ECAGR

10E-12E2012E/2009E

Cash equities -17% 5% 6% 5% -8%Electronic -9% 8% 10% 9% 8%Prime Services -17% 6% 6% 6% -7%Equity derivatives -10% 8% 9% 8% 6%Equiti es ex prop -13% 7% 8% 7% 0%Prop trading/flow prop -41% 28% 3% 15% -22%Total equiti es revenues -17% 9% 7% 8% -3%


Equity derivatives wallet - back to peak level in 2012E tokeep wallet flat in base case

$38bn revenue wallet in 2012E, flat vs. 2009

The revenue outlook for equity derivatives will be more challenging in our view, and

the c.15% growth pa seen in the past is unlikely going forward. We expect the total

equity derivatives revenue wallet including prop trading/flow prop to decline -15% in

2010E from the very strong 2009 level of $37.5bn, mainly driven by reduced prop

trading and hedge gains decreasing by -38% YoY in 2010E. However, we forecast a

recovery with 11% YoY growth to $35.0bn in 2011E and a further 7% increase to

$37.6bn in 2012E.

Overall, revenue growth is half what it used to be +8% CAGR vs. +15% previously

however, we still expect solid growth in 2010E-12E, and our estimated 2012E

revenue level would be already broadly in line with 2007 level of $37bn.

Figure 7: Equity derivatives: revenue wallet 1996-2012$ billion

0

5

10

15

20

25

30

35

40

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012



15/176

15




The product mix has however significantly changed since 2007, with flow equity

derivatives and delta one accounting for $17bn or 50% of total industry wallet in

2011E, up from $14bn or 39% in 2007. On the other hand, structured productsrevenues have shrunk to $8bn or 22% of total, down from $12bn or 32% in 2007.

Figure 8: Equity derivatives: revenue wallet of $32bn in 2010E and $35bn in 2011E and $38bn in2012E

$ billion

10.012.0 12.5

7.7 7.1 7.7 8.4

5.5

6.6 6.9

7.56.3 6.7

7.0

6.5

7.8 8.210.7

9.910.8

11.84.0

4.6 2.3 4.4

4.04.1

4.55.0

6.3

-25.0

7.2

4.4

5.8

5.8

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35

40

45

2006 2007 2008 2009E 2010E 2011E 2012E

Structured products Flow equity derivatives Delta One products

Conver tibles Prop trading/flow prop

Source: J.P. Morgan estimates, company data. Notes: i) disclosures or reporting structures from the companies differ, e.g. delta one

products, program trading which are often part of cash equities; for comparability purposes, we have reclassified some of the revenues

from Prime Services/cash equities or Corporate Finance to equity derivatives; ii) our equity derivatives revenues include convertibles,

program trading, delta one, and prop trading revenues including flow prop; iii) structured products including corporate derivatives note

that we could be underestimating strategic derivatives/corporate derivatives revenues booked in Corporate Finance/Investment Banking;

iv) convertibles assuming half of the underwriting fees, with some banks having JVs with Corporate Finance, others with Fixed income

(credit trading).

Our cautious revenue outlook in equity derivatives results not only from the drop in

prop trading gains, but also from lower growth prospects in i) flow equity derivatives

with 5% CAGR 2010E-12E and ii) convertibles with 6%.

Table 10: Global equity derivatives weight ed average revenue growth in equity d erivatives 2009E-2012E%

2010E 2011E 2012E CAGR 09E-012E

CAGR 010E-012E

012E/09E

Struct ured prod ucts -7% 9% 10% 4% 10% 12%Flow and list ed derivatives -11% 8% 8% 1% 8% 3%

ow Delta One -8% 9% 9% 3% 9% 10%ow flow equity derivatives -16% 5% 5% -2% 5% -6%

Convertible bonds -10% 4% 8% 0% 6% 1%Equity derivati ves ex prop -10% 8% 9% 2% 8% 6%Prop trading/flow prop -38% 31% 0% -7% 14% -19%Total equity derivat ives revenues -15% 11% 7% 0% 9% 1%



16/176

16




Detailed growth rate discussion

Investment Banking revenue outlook: 3% growth 2010E-12E

We expect Investment Banking revenues to increase 3% CAGR from 2010E to

2012E, with the growth driven by Equities and Advisory & Underwriting. Fixed

Income has been the main IB revenue driver, accounting for c.55% of total IB

revenues on average in 2009. We however estimate Fixed Income revenues to

decline -1% in 2011E and a further -6% in 2012E.

Overall, we see a -4% CAGR in 2010E-12E in Fixed income, on a clean basis,

driven by i) lower flow revenues (down -3% CAGR 10E-12E) driven by volatility

and margin compressions in Rates and FX with increased competition, and ii) sharp

drop in prop trading and hedge gains (down -5%) as market conditions slowly

normalise. Note however that Fixed Income revenues are already down -22% in

2010E vs. peak 2009, and our estimates still assume volatility levels to remain higherthan in pre-crisis, hence, our Fixed Income 2012E revenue run rate is still 9% above

2007 level.

Equities faring better than fixed income

We expect total equities revenues to perform better, with the -17% decline in 2010E

followed by a 9% recovery in 2011E and 7% growth in 2012E. The equities revenue

wallet is growing +8% CAGR 2010E-12E, towards the 2009 level, compared to

fixed income revenues declining -4%. Overall, we estimate the 2012E revenue run

rate to stand 19% below 2007 peak level, but only 3% below 2009 which was the

second best year.

Table 11: Global Investment Banks weighted average revenue progressio n by busi ness 2008 -2012E

%

09/08 10E/09 11E/10E 12E/11E 09-012ECAGR

010E-012E

CAGREquity derivatives 8% -11% 8% 9% 2% 8%Cash equities incl electronic trading -16% -15% 5% 7% -1% 6%Prime Services -20% -16% 7% 9% -1% 8%Sub total flow -8% -13% 7% 9% 0% 8%Prop trading/hedge gain/loss/other -151% -39% 28% -2% -9% 12%Total Equiti es Clean Revenue 53% -17% 9% 7% -1% 8%

Structured Credit Trading 66% -20% 0% -2% -8% -1%Credit trading (incl. loans, bonds, CDS) 94% -16% 5% -3% -5% 1%Total Credit 87% -17% 4% -3% -6% 1%

Rates 70% -25% -9% -9% -15% -9%Currencies 24% -22% -7% -8% -12% -7%Commodities 8% -12% 4% 1% -2% 3%Emerging Markets Fixed Income 49% -18% 4% 7% -3% 6%Sub total flow 51% -20% -2% -4% -9% -3%Prop trading/hedge Gains/other -167% -33% 7% -16% -15% -5%Total Fixed Income clean revenues 165% -22% -1% -6% -10% -4%

Financin g & Advi sory clean revenues 13% -2% 12% 9% 7% 12%

Total IB clean revenues 83% -17% 4% -13% -4% 3%

Source: J.P. Morgan estimates. Notes: i) Weighted Average including UBS, CSG, GS, MS, BNP and SG only (BARC growth rates

distorted by the acquisition of Lehman businesses); ii) prop trading in equities include equity derivatives related prop trading/flow prop

revenues.


17/176

17




Equity derivatives still a key IB revenue growth driver

Within equities, equity derivatives remain the main revenue driver, with an 8%

CAGR 10E-12E compared to the 6% growth in cash equities and the 8% in primebrokerage. However, the pace of growth is much slower than historically, as equity

derivatives are becoming more commoditized and more similar to cash equities. In

addition, we see material hiring in equities and equity derivatives in particular

leading to ongoing margin pressure in flow revenues.

Several pockets of growth within equity derivatives: we still see areas ofgrowth in equity derivatives as no player has strengths in all products and

geographies, in particular, emerging markets, ETF, delta one and strategic

corporate derivatives.

Overcapacity and margin compression in flow equity derivatives: The flowequity derivatives business is becoming more like cash, with more commoditized

products and ongoing margin compression. Given the current attractive returns,we believe most players are unwilling to exit and all aiming to take market share

as the marginal cost of trade is minimal. The US business is particularly

competitive with the retail "click" business, but margins are also under pressure

in Europe with overcapacity building up.

Growth in equity derivatives is not what it used to be, however, longer term, we

still see higher growth potential as i) the asset class becomes less of a black box

and we expect clients to increase use of derivatives products, and ii) equity

derivatives is highly diverse in geographies and products with no players providing a

complete offering, which leave opportunities to close the gap.

Socit Gnrale for instance believes 10% revenue growth is possible in the

medium term. All players notably point to growth potential in i) flow equityderivatives in the US and delta one products with ongoing strong demand for liquid

products, algos and equity finance, and ii) strategic equity transactions.

We see several opportunities for the equity derivatives industry:

Top players in equity derivatives highlighted at our 17 Mar 2010 investorconference that institutional clients are back focusing on investments in equity

and absolute return,

The new regulatory framework raises capital requirements for financialinstitutions, but also increases the need for hedging solutions,

Emerging Markets are expanding with both local development and growing

interest from developed economies investors

Corporate clients and financial sponsors are cash rich, providing opportunities forstrategic transactions

In addition, the focus will be shifting progressively on equity derivatives rather than

cash equities as the key revenue driver considering its more diverse business mix

than the highly commoditized cash equities business (see our revenue split in

Table 12 below), as well as its lower operating gearing (see Table 13 below).


18/176

18




Table 12: Global Investment Banks Total equities r evenue wallet 2011E

$ million

SG BNP DB UBS CS GS MS BARC BOA-ML CITI Total Wallet

Total equi ties revenues 4,153 3,233 4,037 4,791 6,348 9,767 5,075 4,055 4,550 4,077 50,086 76,142ow cash equi ties 223 331 2,017 2,523 3,878 4,663 2,964 1,830 2,720 2,116 23,266 38,732

ow cash equities 172 57 923 1,053 1,389 1,599 720 488 1,314 960 8,675 19,278ow electronic 51 25 234 572 1,166 1,336 516 83 506 237 4,725 6,301ow prime brokerage 0 249 860 898 1,322 1,728 1,729 1,259 900 920 9,865 13,153

ow equi ty deri vati ves 3,315 2,553 1,560 1,712 1,913 3,605 1,393 1,819 1,408 1,436 20,715 29,269ow Structured products 1,550 945 604 424 691 910 306 616 324 311 6,683 7,681ow Flow equity derivatives 535 448 233 525 333 1,006 294 402 324 234 4,334 6,668ow Delta One products 1,063 945 532 540 648 1,169 646 545 475 443 7,006 10,778ow Convertibles 166 215 192 223 240 520 146 257 285 449 2,692 4,142

ow prop tradin g/flow prop 614 348 460 556 556 1,500 718 406 422 525 6,105 8,141

Source: J.P. Morgan estimates. Notes: i) disclosures or reporting structures from the companies differ, e.g. part of delta one products, program trading which are often part of cash equities; for

comparability purposes, we have reclassified some of the revenues from Prime Services/cash equities or Corporate Finance to equity derivatives; ii) our equity derivatives revenues include

convertibles, program trading, delta one, and prop trading revenues including flow prop; iii) structured products including corporate derivatives note that we could be underestimating strategic

derivatives/corporate derivatives revenues booked in Corporate Finance/Investment Banking; iv) convertibles assuming half of the underwriting fees, with some banks having JVs with Corporate

Finance, others with Fixed income (credit trading); v) prop trading/flow prop trading for both cash and derivatives.

Table 13: Global Investment Banks Equities businesses cost/income ratios 2011E

%

SG BNP DB UBS CS GS MS BARC BOA-ML CITI AverageStructured products 50% 55% 60% 72% 65% 53% 72% 72% 72% 72% 64%Flow and listed derivatives 55% 55% 60% 65% 60% 60% 58% 59% 61% 60% 59%

ow Delta One 50% 50% 55% 55% 55% 55% 55% 55% 55% 55% 54%ow flow equity derivatives 65% 65% 70% 75% 70% 65% 65% 65% 70% 70% 68%

Convertible bonds 50% 50% 50% 50% 50% 50% 50% 50% 50% 50% 50%Prop trading 35% 35% 40% 40% 40% 40% 40% 40% 40% 40% 39%Total equity derivativescos t/income 50% 52% 55% 61% 58% 54% 55% 59% 58% 55% 56%Cash equities 85% 85% 90% 90% 90% 90% 90% 90% 90% 90% 89%Electronic 85% 85% 90% 90% 90% 90% 90% 90% 90% 90% 89%Prime brokerage 55% 55% 55% 55% 55% 55% 55% 55% 55% 55% 55%Cash prop trading 35% 35% 40% 40% 40% 40% 40% 40% 40% 40% 39%Total equiti es cos t/inco me 52% 53% 65% 69% 69% 64% 63% 62% 70% 65% 63%





Finance, others with Fixed income (credit trading); v ) prop trading/flow prop trading for both cash and derivatives.

Macro assumptions for equities

Do not rely on equity markets recovery for IBs to re-rate

We see challenges in the macro-economic environment in the medium term and take

a cautious view on the 2010-12 revenue outlook given i) the increasing marginpressure in both cash and derivatives, ii) ongoing weak volumes with demand

dependent on market recovery, and iii) structurally lower risk appetite for higher

margin derivatives products and fewer opportunities for prop trading or hedging

gains.

Central scenario: 5-6% increase in equity markets values

In Figure 9 below, we show the correlation between Equity Index returns (taking

S&P 500 Total Returns Index as a proxy) and clean equity revenues. We have

estimated a conservative 5-6% upside in Equity markets in 2011E-2012E. Equities

could perform a bit better than our estimated 8% CAGR 10E-12E, especially if there


19/176

19




is a strong pick up in equity markets, and we would expect increased investor

appetite for equities as an asset class with the normalization of market conditions.

However, we would be reluctant to pay multiples for this.

Figure 9: Correlation betw een S&P 500 Total Returns Index and Equity revenues

y = 1.4x

R2 = 0.79

-60%

-40%

-20%

0%

20%

40%

60%

-50% -40% -30% -20% -10% 0% 10% 20% 30% 40%

S&P 500 Total Return Index (YoY change)

Clean

Equ

itiesrevenues

(Yo

Y

change

)

Source: Bloomberg, J.P. Morgan estimates, Company data.

Equity markets performance and hence Equity revenues are unsurprisingly dependent

on the global economic scenario, with some products particularly sensitive to the

interest rate environment. We show the interest rate forecasts from J.P. Morgan

economic research team and the economic forecasts from IMF in the tables below.

The interest rate environment is forecast to be generally stable, with no expectedchanges in the official interest rates for U.S. and Euro area till Q3 2011 as shown

in Table 14, although some tightening is expected in the Emerging market

economies. Low interest rate environment is negative for the economics of the

structured retail products business, and participation rates for investors are alsolower, hence any tightening in interest rates is going to have a positive effect on

the business in our view. Besides, steeper yield curves are also supportive for

swap trading desks.

Table 14: Interest rate fo recasts

%

Official Interest Rate Current Dec-10 Jun-11 Sep-11Global GDP-weighted average 1.75 1.82 1.97 2.02Developed GDP-weighted average 0.60 0.63 0.69 0.71Emerging GDP-weighted average 4.97 5.14 5.56 5.67United States Federal funds rate 0.125 0.125 0.125 0.125Euro area Refi rate 1.00 1.00 1.00 1.00United Kingdom Repo rate 0.50 0.50 0.50 0.50

Source: J.P. Morgan economic research estimates as of 3 Sept 2010.

Table 15: Long-term int erest rate forecasts

%

Sep-10 Dec-10 Mar-11 Jun-11US 2.7% 2.5% 2.5% 2.5%UK 2.9% 2.9% 3.0% 3.1%Euro Area 2.1% 2.2% 2.2% 2.3%

Source: J.P. Morgan estimates. Note: 10Y Govt. Bond Interest rate forecasts

We also provide a snapshot of the IMF GDP growth forecasts in Table 16 below,IMF forecasts US and Euro Area GDP growth at constant prices in 2012E of


20/176

20




2.40% and 1.81% respectively. Any further improvement in economic conditions

would positively impact the Equity businesses in our view and vice versa.

Table 16: IMF GDP growth f orecasts: Grow th Rate, constant pr ices

%

2010E 2011E 2012EUS 3.10% 2.55% 2.40%Euro Area 0.96% 1.49% 1.81%New Industrialized Asia 5.21% 4.93% 4.44%Developing Asia 8.70% 8.66% 8.57%

Source: IMF World economic outlook April 2010

Table 17: IMF: Inflation, average consumer pr ices; percent age change

%

2010E 2011E 2012EUS 2.1% 1.7% 2.0%Euro Area 1.1% 1.3% 1.5%New Industrialized Asia 2.3% 2.3% 2.4%Developing Asia 5.9% 3.7% 3.0%

Source: IMF World economic outlook April 2010. Note: For US - Inflation, average consumer prices

(Index, 2000 = 100)

Blue sky scenario 15% increase rather than 5-6%: additional $11bn for the

equities revenue wallet

Should equity markets increase by 15% rather than our 5%-6% base case scenario,we estimate that the equities revenue wallet would increase by an additional $11bn to

$92bn, equivalent to 21% growth 2012E vs. 2011E rather than 7% in our base case.

This would benefit equity-geared players most: UBS and CS with an estimated

additional 5%-6% revenues in the Investment Bank, but also GS, MS and SG.

Table 18: Global Investment Banks Sensitivity of Investment Banking and group numbers to a blue sky 15% increase in equity marketsvalues 2012E

$ million

SG BNP DB UBS CS GS MS B ARC Total / Av.Current assumptionEquity markets increase 5% 5% 5% 5% 5% 5% 5% 5% 5%Revenue growth 2012E vs. 2011E 3% 4% 6% 8% 8% 8% 8% 3% 7%

Total equities revenue 2012E 4,296 3,367 4,288 5,187 6,879 10,510 5,493 4,177 81,460

Blue sky assumptionEquity markets increase 15% 15% 15% 15% 15% 15% 15% 15% 15%Revenue growth 2012E vs. 2011E 10% 12% 19% 25% 25% 23% 25% 9% 21%Total equities revenue 2012E 4,584 3,634 4,792 5,977 7,941 11,994 6,329 4,420 92,098

Additional equities revenues 287 268 504 791 1,062 1,485 836 243 10,6% incr ease in equiti es revenues 6.7% 8.0% 11.7% 15.2% 15.4% 14.1% 15.2% 5.8% 13.1%% IB revenues 3.1% 1.7% 2.2% 5.5% 5.6% 4.5% 4.8% 1.1% -

Additional net earnings 2012E 100 88 116 181 237 376 217 67 % increase in IB net income 5.7% 2.5% 3.6% 4.2% 4.7% 4.0% 4.4% 1.5% -% EPS enhan cemen t 1.9% 1.0% 2.2% 1.9% 2.8% 3.7% 3.3% 1.2% -



21/176

21




Regulation: structural changes for the

Equity Derivatives businessIn our view, regulatory risk for the overall Investment Banking business has

been well flagged - returns will be structurally lower than in the past, declining from

20% to 12% on average in our estimates, and the negative impact from regulation has

been reduced with the less punitive versions of Basel 3 and US financial reform. For

more details, please refer to our Sept 2009 report Global investment banks:

Regulatory proposal analysis: Structural IB profitability decline.

Table 19: Global Investment banks 2011E ROE in the investm ent banks pre and post regul ation changes**

%

CS UBS DB GS MS BNP SG BARC Average

IB ROE 2011E 23.5% 22.7% 19.9% 23.4% 19.0% 19.2% 17.2% 17.8% 20.3%1. Clearing via CCP 1.6% 3.6% 2.4% 2.4% 1.8% 0.3% -0.2% 1.0% 1.6%2. Moving CDS to exchange trading -3.5% -3.6% -3.1% -2.4% -0.6% -0.5% -0.5% -1.4% -1.9%3. OTC post trade transparency -0.8% -1.0% -0.9% -0.8% -0.9% -0.5% -0.7% -0.8% -0.8%4. Prop trading proposed limits -1.9% -1.7% -1.7% -1.5% -1.1% -0.7% -0.7% -0.6% -1.3%5. Stressed VaR capital buffer -2.0% -1.2% -1.0% -2.0% -2.0% -0.9% -0.6% -1.2% -1.4%6. Incremental Risk Charge -2.8% -2.3% -2.2% -1.2% -0.8% -1.8% -1.3% -1.5% -1.7%5&6. Management guidance -3.8% -4.9% -4.0% -3.4% -4.8% 0.0% -3.5%7. Securitisation capital charge -1.0% -1.8% -1.1% -0.9% -0.7% -0.4% -0.7% -1.0% -1.0%8. Higher capital on non CCP clearing -2.3% -3.4% -2.5% -2.4% -1.9% -0.7% -0.9% -1.1% -1.9%9. Section 716 US reg - segregation IB 0.0% 0.0% 0.0% -2.8% -1.5% 0.0% 0.0% 0.0% -0.5%Total imp act -10.5% -11.2% -9.4% -9.6% -6.6% -5.4% -7.0% -5.8% -8.2%

Resul tin g IB ROE 13.0% 11.5% 10.5% 13.8% 12.4% 13.8% 10.2% 12.0% 12.1%

Source: J.P. Morgan estimates, Company data. Notes: i) Morgan Stanley Institutional Securities estimates, and ii) Goldman Sachs Global Capital Markets excluding any principal investment

revenues; iii) our ROE estimates are based on allocated capital as disclosed by the company or JPM alllocated capital (Tier I of 8%-11%); iv) For SG, we excluded provisions for legacy assets in

2011E, v) note that percentages cannot be added up as both numerators and denominators are changing. ** Proposed OTC derivatives regulation, higher market risk requirements from Basel 2.5,

Volcker limits for prop trading.

However, the risk for the equities business is underestimated in our view. Most

IB players have been relatively dismissive of the impact of regulation for the equities

business, with the common view that the bulk of regulatory changes would affect

Fixed Income businesses mainly. Whilst we would agree that returns in Fixed

Income businesses would decline more, we still see significant regulatory risk for the

equities business.

Regulation, a non issue for equities? Not exactly...

Returns in the equities business to almost halve

We estimate that ROE in the equities business will almost halve, declining from 42%

to 24% on average in 2011E. Whilst a 24% ROE remains attractive, the impact from

regulatory changes is far from being negligible. We would agree that the P&L impact

is relatively limited at -16% on average in our estimates; however, the increase in

capital requirements is understated in our view.
https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-323085-0https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-323085-0https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-323085-0https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-323085-0https://mm.jpmorgan.com/servlet/UserDocsHelperServlet?action=openpdf&docId=GPS-323085-0


22/176

22




Table 20: Global investment banks impact on ROE of the equities business from regulatory changes 2011E

%

SG BNP DB UBS CS GS MS BARC BOA-ML CITI Average

Equi ties ROE 58% 45% 34% 45% 46% 34% 41% 50% 35% 35% 42%OTC derivatives regulation & US financial reform1. Clearing via CCP 13% 9% 9% 8% 6% 6% 10% 9% 6% 4% 8%2. Moving derivatives to SEF trading -4% -4% -2% -3% -2% -2% -2% -3% -2% -1% -2%3. OTC post trade transparency -3% -2% -1% -1% -1% -1% 0% -1% -1% 0% -1%4. Volcker proposed limits on prop trading -4% -3% -3% -4% -5% -3% -3% -4% -3% -3% -3%5. Section 716 US reg 0% 0% 0% 0% 0% -2% -1% -1% -2% -2% -1%New Basel framework6. Stressed VaR capital buffer Basel -20% -14% -8% -8% -13% -9% -8% -13% -10% -14% -12%7. Incremental Risk Charge Basel -8% -7% -3% -4% -5% -1% -1% -2% -2% -3% -4%8. Securitisation 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%9. CVA -7% -5% -5% -5% -4% -3% -6% -5% -4% -2% -5%

Total imp act -29% -22% -13% -16% -20% -13% -13% -20% -15% -18% -18%

Resul tin g ROE 29% 23% 21% 28% 26% 21% 29% 30% 20% 16% 24%% change -50% -49% -38% -37% -44% -39% -31% -40% -42% -53% -42%

Source: J.P. Morgan estimates. Note: our ROE estimates are based on allocated capital at 10% of RWAs.

Increased capital requirements is the issue

For the equities business, the decline in ROE mainly comes from the increase in

capital requirements, more than the net income impact: we estimate a -16%

decline in equities net profits, which is more manageable than the 47% average

increase in RWAs.

-16% decline in equities net profits: The bulk of the negative earnings impactcomes from the Volcker limits on pure prop trading with an -8% impact. Note

that we have assumed that only pure prop trading revenues would fall within the

scope of these rules, i.e. only 5% of total equities revenues. Once Volcker rules

are applicable pure prop trading will be illegal for US firms. In addition to theVolcker rules, the OTC derivatives regulation moving standardized derivatives

to SEF/exchange trading would have an estimated negative impact of -6% on

net profits while we estimate the OTC derivatives post trade transparency

requirements would have a more limited negative impact of -2% on earnings.

Table 21: Global investment banks impact from regulatory changes on the equities business net profits 2011E

$ million

SG BNP DB UBS CS GS MS BARC BOA-ML

CITI Average

Equi ties net inc ome 1,447 1,059 926 1,098 1,415 2,476 1,319 1,111 969 1,001 12,822OTC derivatives regulation & USfinancial reform1. Clearing via CCP 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%2. Moving derivatives to SEF trading -7.0% -8.0% -4.6% -6.6% -4.4% -5.7% -4.3% -5.5% -5.2% -4.2% -5.6%

3. OTC post trade transparency -4.4% -3.7% -2.5% -2.0% -2.1% -1.8% -1.1% -2.5% -1.6% -1.4% -2.3%4. Volcker proposed limits on prop trading -6.2% -6.4% -8.5% -9.6% -9.8% -8.3% -8.1% -7.8% -9.9% -8.6% -8.3%5. Section 716 US reg 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%New Basel framework6. Stressed VaR capital buffer Basel 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%7. Incremental Risk Charge Basel 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%8. Securitisation 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%9. CVA 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

Total imp act -17.6% -18.2% -15.6% -18.2% -16.4% -15.7% -13.5% -15.8% -16.7% -14.1% -16%

Resultin g net inco me 1,192 867 782 899 1,183 2,086 1,141 935 808 859 10,752



23/176

23




47% increase in capital requirements for the equities business: the highercapital requirements mainly come from Basel 2.5 changes, Stressed VaR in

particular. CVA also increase RWAs by 12% in our estimates; however, thehigher requirements on non-CCP cleared equity derivatives should be more than

offset by the benefits from centralized clearing (-16% decline in RWAs).

Table 22: Global investment banks impact from regulatory changes on the equities business RWAs 2011E

$ million


CITI Average

Equi ties RWAs 25,009 23,633 27,331 24,604 30,623 73,277 31,870 22,099 27,455 28,724 314,625OTC derivatives regulation & US financialreform

0 0 0 0 0 0 0 0 0 0 0

1. Clearing via CCP -19% -16% -20% -15% -12% -14% -20% -15% -15% -10% -16%2. Moving derivatives to SEF trading 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%3. OTC post trade transparency 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%4. Volcker proposed limits on prop trading 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%5. Section 716 US reg 0% 0% 0% 0% 0% 5% 4% 2% 5% 7% 2%

New Basel framework 0 0 0 0 0 0 0 0 0 0 06. Stressed VaR capital buffer Basel 54% 48% 29% 22% 38% 34% 23% 36% 38% 69% 39%7. Incremental Risk Charge Basel 16% 18% 11% 10% 13% 2% 3% 5% 5% 8% 9%8. Securitisation 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%9. CVA 15% 13% 16% 12% 9% 11% 16% 12% 12% 8% 12%

Total impact 66% 62% 36% 29% 49% 38% 26% 40% 45% 82% 47%

Resul tin g RWAs 41,578 38,286 37,178 31,711 45,479 101,042 40,009 30,859 39,674 52,309 458,124


Equity derivatives not as glamorous

Equity derivatives returns more similar to cash equities

We estimate ROE in the equity derivatives business of 42% in 2011E pre regulatory

changes, slightly higher than the 39% ROE in cash equities and prime services.

However, post regulatory changes, estimated ROE in the equity derivatives businessdeclines by -47% to 22% on average, slightly below the 25% ROE in cash equities

and prime services.

Equity derivatives and prop trading are the most impacted by regulation within

equities businesses

The equity derivatives business including prop trading is more affected by regulation

which reduces ROE by -47%, compared to -35% for cash equities & prime services.

Prop trading/flow prop trading is the most affected with a decline of -58% forcash prop trading and -60% for prop equity derivatives. Post regulatory changes,

estimated returns in prop trading are less attractive at 24% for both cash equities

and equity derivatives, down from 58% previously. Note however that our

sensitivity analysis is based on 2011E estimates, but the impact from Volckerrules would only come post end 2012 and we would expect pure prop trading to

be scaled down closer to 2013. At 24% ROE, flow prop trading profitability

remains high, with a relatively flexible cost base, and should remain a core

business for IB market makers.

Equity derivatives is also more impacted relative to other businesses, with a -43% decline in ROE from 39% to 22% (excluding prop trading), due to the

additional regulations for derivatives (moving derivatives to SEF/exchange

trading, post trade transparency requirements, Section 716) which cash equities

does not have.


24/176

24




Table 23: Global Investment Banks Equities bu sinesses ROE

%

2009E 2011E Preregulation 2011E Postregulation Decline inROE 2011ECash equities 49% 43% 30% -31%Electronic 55% 54% 37% -31%Prime Services 43% 34% 24% -30%Prop trading cash 85% 58% 24% -58%Sub-total cash equities & Prime Services 49% 39% 25% -35%Equity derivatives 42% 39% 22% -43%Prop trading equity derivatives 73% 58% 24% -60%Sub-total equity derivatives 47% 42% 22% -47%Total equiti es 48% 41% 23% -42%


With the equity derivatives business being slightly more impacted by regulations,

large French banks equity derivatives houses are unsurprisingly a bit more affected

than peers, and cash equities houses and prime brokers UBS, Morgan Stanley andGoldman Sachs fare a bit better, we estimate.

Table 24: Global Investment Banks Equities businesses ROE pre and post regulatory changes 2011E

%SG BNP DB UBS CS GS MS BARC BOA-

MLCITI Average

Pre regulationCash equities 25% 25% 27% 62% 66% 38% 32% 29% 67% 47% 43%Electronic 22% 22% 28% 85% 70% 53% 57% 54% 65% 29% 54%Prime Services - 24% 29% 34% 41% 27% 45% 51% 30% 29% 34%Prop trading cash 77% - 60% 83% 80% 43% 73% 83% 54% 64% 58%Sub-total cash equities & PrimeServices

27% 24% 31% 44% 50% 33% 46% 50% 37% 33% 39%

Equity derivatives 56% 53% 32% 39% 39% 33% 29% 46% 30% 31% 39%Prop trading equity derivatives 77% 34% 60% 83% 80% 43% 73% 83% 54% 64% 58%Sub-total equity derivatives 59% 49% 36% 45% 42% 35% 37% 51% 34% 36% 42%Total equ iti es 58% 45% 34% 45% 46% 34% 41% 50% 35% 35% 41%

Post regulationCash equities 15% 15% 20% 47% 44% 28% 25% 20% 47% 26% 30%Electronic 13% 13% 20% 64% 46% 39% 45% 38% 45% 16% 37%Prime Services - 14% 21% 26% 27% 19% 36% 36% 21% 16% 24%Prop trading cash 31% - 24% 36% 23% 21% 37% 29% 17% 22% 24%Sub-total cash equities & PrimeServices

15% 14% 21% 31% 30% 22% 35% 34% 24% 18% 25%

Equity derivatives 29% 28% 21% 24% 22% 19% 19% 27% 17% 14% 22%Prop trading equity derivatives 31% 12% 24% 36% 23% 21% 37% 29% 17% 22% 24%Sub-total equit y derivatives 29% 24% 21% 26% 22% 20% 22% 27% 17% 15% 22%Total equi ties 29% 23% 21% 28% 26% 21% 29% 30% 20% 16% 23%

Decline in ROE

Cash equities -41% -40% -29% -24% -34% -27% -21% -29% -30% -44% -31%Electronic -41% -40% -29% -24% -34% -27% -21% -29% -30% -44% -31%Prime Services - -40% -29% -24% -34% -27% -21% -29% -30% -44% -30%Prop trading cash -60% - -60% -57% -72% -50% -49% -65% -68% -65% -58%Sub-total cash equities & PrimeServices

-44% -40% -33% -31% -41% -34% -24% -32% -34% -46% -35%

Equity derivatives -48% -47% -36% -37% -43% -41% -35% -41% -44% -54% -43%Prop trading equity derivatives -60% -65% -60% -57% -72% -50% -49% -65% -68% -65% -60%Sub-total equity derivatives -51% -50% -41% -42% -47% -43% -39% -46% -50% -58% -47%Total equ iti es -50% -49% -38% -37% -44% -39% -31% -40% -42% -53% -42%



25/176

25




OTC derivatives regulation + Basel = lower returns for equity derivatives

Compared to other equities businesses, equity derivatives is not only impacted by

Basel changes for market risk requirements, but also OTC derivatives regulation. Themain negative impact on returns for equity derivatives remains the higher market risk

requirements under new Basel 2.5 rules, with Stress VaR shaving off 12% from

ROE, and Incremental Risk Charge 4%. However, OTC derivatives regulation also

has a significant impact with -4% on average from moving OTC derivatives to

exchange/SEF trading and -2% from OTC post trade transparency requirements.

Equity derivatives also partly falls into the scope of Section 716 of the Dodd-Frank

bill in the US.

Table 25: Global Investment Banks Equity d erivatives busi nesses ROE pre and post regulatory ch anges 2011E

$ million


CITI Average

Equity derivatives ROE preregulation

59% 49% 36% 45% 42% 35% 37% 51% 34% 36% 42%

OTC derivatives regulation & USfinancial reform

0

1. Clearing via CCP 14% 12% 21% 18% 13% 12% 23% 19% 13% 8% 15%2. Moving derivatives to SEFtrading

-4% -4% -3% -6% -4% -3% -4% -5% -3% -3% -4%

3. OTC post trade transparency -3% -2% -2% -2% -2% -1% -1% -2% -1% -1% -2%4. Volcker proposed limits on proptrading

-4% -3% -4% -5% -4% -3% -5% -5% -4% -4% -4%

5. Section 716 US reg 0% 0% 0% 0% 0% -3% -2% -2% -3% -4% -2%New Basel framework6. Stressed VaR capital bufferBasel

-21% -16% -8% -8% -12% -9% -7% -13% -9% -15% -12%

7. Incremental Risk Charge Basel -8% -7% -4% -4% -5% -1% -1% -2% -2% -3% -3%8. Securitisation 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%9. CVA -8% -6% -8% -8% -7% -6% -9% -9% -6% -4% -7%

Total impact from regul ation -30% -24% -15% -19% -20% -15% -14% -23% -17% -21% -20%Equity derivatives ROE postregulation

29% 24% 21% 26% 22% 20% 22% 27% 17% 15% 22%

% decline -51% -50% -41% -42% -47% -43% -39% -46% -50% -58% -47%


Equity derivatives hit by both an increase in RWAs and a decline in earnings.

Similarly to cash equities & prime services, the equity derivatives business is

negatively impacted by the increase in capital requirements due to Basel changes,

with estimated 47% increase in RWAs. However, whilst cash equities & prime

services including prop trading only experience an estimated -7% decline in net

profits due to the impact of Volcker limits, we estimate net profits in equity

derivatives decline by -22% due to both OTC derivatives regulation and Volcker

limits on prop trading.

-22% decline in equities net profits: The bulk of the negative earnings impactcomes from i) the Volcker limits on prop trading and ii) moving OTC equity

derivatives to exchange/SEF trading, with both proposals reducing net profits by -

9%. Note that we have assumed that only pure prop trading revenues would fall

within the scope of these rules.

47% increase in capital requirements for the equities business: the highercapital requirements mainly come from Basel 2.5 changes, Stressed VaR in

particular (40% increase in RWAs). CVA also increase RWAs by 20% in our

estimates, however, the higher requirements on non-CCP cleared equity


26/176

26




derivatives is more than offset by the benefits from centralized clearing (-26%

decline in RWAs).

Table 26: Global Investment Banks Equity deri vatives busi nesses net inco me and RWAs pre and pos t regulatory c hanges 2011E$ million


CITI Total

Net inco me pre regulati on 1,418 972 546 587 648 1,411 598 621 505 572 7,879OTC derivatives regulation & USfinancial reform

0

1. Clearing via CCP 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%2. Moving derivatives to SEF trading -7% -9% -8% -12% -10% -10% -10% -10% -10% -7% -9%3. OTC post trade transparency -5% -4% -4% -4% -5% -3% -2% -4% -3% -2% -4%4. Volcker proposed limits on proptrading

-6% -7% -10% -11% -9% -7% -12% -10% -13% -11% -9%

5. Section 716 US reg 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%New Basel framework6. Stressed VaR capital buffer Basel 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%7. Incremental Risk Charge Basel 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

8. Securitisation 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%9. CVA 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

Total impact from regul ation -18% -20% -22% -27% -23% -20% -24% -25% -26% -21% -22%

Net inco me post regul ation 1,165 780 425 430 499 1,124 452 467 372 452 6,166

RWAs pre regu lation 23,947 19,970 15,059 13,090 15,311 40,742 16,286 12,292 14,935 15,798 187,431OTC derivatives regulation & USfinancial reform

0

1. Clearing via CCP -20% -19% -37% -28% -24% -25% -39% -27% -28% -18% -26%2. Moving derivatives to SEF trading 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%3. OTC post trade transparency 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%4. Volcker proposed limits on proptrading

0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

5. Section 716 US reg 0% 0% 0% 0% 0% 9% 7% 4% 9% 13% 5%New Basel framework6. Stressed VaR capital buffer Basel 54% 48% 29% 22% 38% 34% 23% 36% 38% 69% 40%

7. Incremental Risk Charge Basel 16% 18% 11% 10% 13% 2% 3% 5% 5% 8% 9%8. Securitisation 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%9. CVA 15% 15% 29% 22% 19% 20% 30% 21% 22% 14% 20%

Total impact from regulati on 66% 61% 32% 26% 46% 39% 25% 39% 46% 86% 47%

RWAs post regu lati on 39,770 32,223 19,943 16,496 22,347 56,769 20,339 17,041 21,804 29,419 276,151


Note that this could be a relatively pessimistic scenario for RWAs, as this does

not account for any potential RWAs reduction. Both DB and SG pointed to the

increased balance sheet flexibility since the start of the crisis. Both banks have

significantly reduced RWAs and balance sheet usage SG CIB cash assets down

38% end 2009 vs. Q2 07, and DB reduced its balance sheet and RWAs by c.60%

since peak levels in 2008.

Overall competitive landscape unlikely to change

Equity derivatives ROE still attractive at 22% in 2011E post regulatory changes

We expect regulatory changes currently being considered to make equity derivatives

returns less attractive than in the past, through the increased cost of capital, increased

margin compression and the end of pure prop trading. Whilst returns would no

longer be higher than in cash equities, they remain attractive at 22% in our view.

French equity derivatives houses Socit Gnrale and BNP Paribas remain

quite profitable relative to peers with average ROE of 27% in 2011E, despite the

higher impact from regulatory changes. We also expect Barcap, UBS, CS and


27/176

27




Morgan Stanley equity derivatives businesses to post attractive returns (22%-27%),

whilst Bank of America and Citi ROE would be lower at 17% and 15% respectively

post regulatory changes.

Table 27: Global Investment Banks equity derivatives business ROE pre and post regulation 2011E

$ million


CITI Total

Total equity derivatives revenues 3,919 2,902 1,882 2,046 2,136 4,355 1,895 2,123 1,704 1,830 24,791Costs -1,949 -1,513 -1,042 -1,241 -1,248 -2,339 -1,041 -1,254 -982 -1,013 -13,624Pre-provision profits 1,970 1,389 840 805 887 2,016 854 869 721 817 11,168Loan losses and other 0 0 0 0 0 0 0 0 0 0 0Pretax 1,970 1,389 840 805 887 2,016 854 869 721 817 11,168Net profits 1,418 972 546 587 648 1,411 598 621 505 572 7,879

Cost /income 50% 52% 55% 61% 58% 54% 55% 59% 58% 55% 56%Tax rate 28% 30% 35% 27% 27% 30% 30% 29% 30% 30% 30%

Pre-regulatory changesNet income 1,418 972 546 587 648 1,411 598 621 505 572 7,879

Allocated equity 2,395 1,997 1,506 1,309 1,531 4,074 1,629 1,229 1,494 1,580 18,743

ROE 59% 49% 36% 45% 42% 35% 37% 51% 34% 36% 42%

Post-regulatory changesNet income 1,165 780 425 430 499 1,124 452 467 372 452 6,166

Allocated equity 3,977 3,222 1,994 1,650 2,235 5,677 2,034 1,704 2,180 2,942 27,615

ROE 29% 24% 21% 26% 22% 20% 22% 27% 17% 15% 22%


Goldman Sachs and Socit Gnrale to remain the industry leaders

We expect regulatory changes to reduce revenues by -12% on average, with the

impact ranging from -11% to -15%. Regulation does not however structurally change

the competitive landscape in our view, with Socit Gnrale and Goldman Sachsremaining the industry leaders, still followed by BNP Paribas, Credit Suisse, Barcap

and UBS.

Whilst Socit Gnrale has long been the global leader in equity derivatives, we

estimate that Goldman Sachs generated the highest revenues in 2011E post

regulation with $3.8bn vs. $3.5bn for SG. SG remains the top structured products

house with an estimated $1.5bn of revenues equivalent to 20% market share, and GS

the dominant flow and delta one player with $2bn of revenues or 12% market share.

BNP Paribas remains a key equity derivatives player with estimated $2.6bn of

revenues in 2011E, with strong positions in structured products and delta one, whilst

Barclays, UBS and Credit Suisse still hold solid market share, generating about $1.7-

1.9bn of revenues, we estimate.


28/176

28




Table 28: Global Investment Banks equity derivatives revenues pre and post regulation 2011E

$ million

2011E revenues SG BNP DB UBS CS GS MS BARC BOA-ML CITI TotalPre-regulationStructured products 1,550 945 604 424 691 910 306 616 324 311 6,683Flow equity derivatives 535 448 233 525 333 1,006 294 402 324 234 4,334Delta one products 1,063 945 532 540 648 1,169 646 545 475 443 7,006Convertibles 166 215 192 223 240 520 146 257 285 449 2,692Prop/flow prop 604 348 322 334 223 750 503 304 295 394 4,076Total equi ty deri vati ves 3,919 2,902 1,882 2,046 2,136 4,355 1,895 2,123 1,704 1,830 24,791

Post regulationStructured products 1,469 896 572 402 655 863 290 583 307 294 6,332Flow equity derivatives 467 391 203 458 290 878 257 350 283 204 3,782Delta one products 984 874 492 499 600 1,081 598 504 439 410 6,480Convertibles 166 215 192 223 240 520 146 257 285 449 2,692Prop/flow prop 400 187 181 190 96 506 325 152 136 241 2,413Total equi ty deri vati ves 3,486 2,563 1,640 1,772 1,881 3,847 1,616 1,847 1,451 1,597 21,698

Impact from regulationStructured products -5% -5% -5% -5% -5% -5% -5% -5% -5% -5% -5%Flow equity derivatives -13% -13% -13% -13% -13% -13% -13% -13% -13% -13% -13%Delta one products -8% -8% -8% -8% -8% -8% -8% -8% -8% -8% -8%Convertibles 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Prop/flow prop -34% -46% -44% -43% -57% -33% -35% -50% -54% -39% -41%Total equity derivatives -11% -12% -13% -13% -12% -12% -15% -13% -15% -13% -12%





Finance, others with Fixed income (credit trading).

Regulation could however require banks to adapt theirbusiness mix

Structured products and prop trading most impaired by regulation

Whilst we expect overall returns in equity derivatives to remain attractive at 22%

post regulatory changes, the impact is differentiated by business. Within equity

derivatives, structured products and prop trading are the most impacted by

regulation, with an estimated -50% and -60% decline in ROE.

Prop trading/flow prop ROE declines the most, with ROE down from 58%to 24%, due to the higher market risk requirements, but also due to Volcker

limits on prop trading. In our sensitivity scenario, we have assumed that only

pure prop would be impacted, i.e. 5% of total equities revenues, but would be

partly offset by cost savings (40% cost/income ratio). Also note that Volcker

rules would only come into effect end 2012 at the earliest, and we would expect

banks to scale down prop trading closer to the new regulation starting date.Overall, at an estimated 24% ROE, flow prop trading remains however an

attractive business with good returns and flexible cost base, and we would expect

prop trading to remain core to IB market making businesses. As margin

compression continues to erode and returns are lower in flow businesses, we

believe the scale of the platform and risk management capabilities will be key to

generate client volumes and take market shares.

Structured products are also significantly impaired with ROE halving from27% to 14% on average post regulation, we estimate. This is mainly the result of

the increased capital requirements with RWAs increasing by 72% on average due

to Basel 2.5 changes, CVA, and Section 716 for US banks. Net profits also


29/176

29




decline by an estimated -16% on average, mainly due to the proposed OTC

derivatives post trade transparency requirements.

Flow equity derivatives ROE declines -36% from 29% to 18%, due to the-40% decline in net profits. We estimate that revenues could decline by -11%

mainly as a result of moving derivatives to SEF/exchange trading, without any

cost offset. Changes in capital requirements are less of an issue in our estimates,

as the higher market risk requirements are offset by the benefits from CCP

clearing. Overall, with ongoing margin compression and lower returns than in the

past, scale within flow and delta one become even more important in a cash

equity-like world to facilitate client flows and generate revenues by operating

with high price discovery level.

Delta one products remain the most profitable business within equityderivatives, despite the estimated -43% decline in ROE from 72% to 40% post

regulation. We estimate net profits decline by -16% and RWAs increase by 48%

on average, however, the business remains profitable due to the lowercost/income ratio and lower capital requirements pre regulation.

Table 29: Global Investment Banks Equity deri vatives busi nesses ROE

%

2009 2011E preregulation

2011E postregulation

Decline in ROE2011E

Structured products 25% 27% 14% -50%Flow equity derivatives 38% 29% 18% -37%Delta one products 72% 71% 40% -43%Convertibles 55% 45% 30% -32%Prop/flow prop 71% 58% 24% -60%Total equity derivatives 46% 42% 22% -47%

Source: J.P. Morgan estimates. Notes: i) disclosures or reporting structures from the companies differ, e.g. part of delta one products,

program trading which are often part of cash equities; for comparability purposes, we have reclassified some of the revenues from

Prime Services/cash equities or Corporate Finance to equity derivatives; ii) our equity derivatives revenues include convertibles,program trading, delta one, and prop trading revenues including flow prop; iii) structured products including corporate derivatives

note that we could be underestimating strategic derivatives/corporate derivatives revenues booked in Corporate Finance/Investment

Banking; iv) convertibles assuming half of the underwriting fees, with some banks having JVs with Corporate Finance, others with

Fixed income (credit trading).

Our estimates are conservative in our view, as our sensitivity analysis is based

on the pessimistic assumption that margins would not increase. In our view, IBs

would need to re-price transaction margins upwards to make up for part of the ROE

erosion, which we have not factored in the analysis.

Given the higher expected ROE decline in structured products due to regulation,

French banks are unsurprisingly a bit more impacted than peers with an estimated

-50% decline in ROE. However, we estimate Bank of America and Citigroup

profitability in equity derivatives would also decline significantly -54% on average,due to their higher operating leverage.

Potential adjustments to the business model to come

Whilst ROE in equity derivatives should remain attractive at 22% post regulation,

returns in some of the business lines are materially impacted in our view, notably

structured products, but also flow equity derivatives. This could lead equity

derivatives players to adjust their business models, reallocate capital and/or reduce

costs.


30/176

30




Structured products ROE halving to 14% only on average could leadsmaller players to exit the business. Return erosion is mainly due to the

increase in the cost of capital, as structured products are OTC derivativesproducts that are mostly not eligible for central clearing. Both related market

RWAs and counterparty credit RWAs are higher than for other equity derivatives

products. As smaller players in structured products generate less than 10% ROE

e.g. MS, BoA, Citi we believe that these banks could choose to exit the

business and reallocate capital to delta one products or other equities businesses.

With ROE declining to 18% on average, costs adjustments in flow equityderivatives could be required across the industry. Returns in Flow equity

derivatives are less impacted by regulation than structured products, as the

increased market risk requirements are partly offset by the benefits from CCP

clearing. However, regulation accelerates the pace of margin compression which

was already higher, and with overcapacity building up and all players investing in

flow businesses, ROE becomes less attractive at an estimated 18% vs. 29%

previously. As a result, the industry could adjust costs to offset the expected

-13% revenue impact from regulation.

Table 30: Global Investment Banks Equity d erivatives busi nesses ROE pre and post regulatory ch anges 2011E

%

2011E ROE SG BNP DB UBS CS GS MS BARC BOA-ML CITI AveragePre-regulatory changesStructured products 53% 42% 28% 23% 29% 20% 10% 30% 12% 11% 27%Flow equity derivatives 32% 36% 17% 28% 26% 37% 19% 34% 28% 19% 29%Delta one products 109% 100% 57% 72% 70% 52% 80% 83% 54% 49% 71%Convertibles 30% 40% 33% 47% 41% 35% 53% 59% 52% 78% 45%Prop/flow prop 77% 34% 60% 83% 80% 43% 73% 83% 54% 64% 58%Total equity derivatives 59% 49% 36% 45% 42% 35% 37% 51% 34% 36% 42%

Post-regulatory changes

Structured products 27% 21% 16% 13% 15% 11% 5% 15% 5% 4% 14%Flow equity derivatives 15% 19% 15% 15% 15% 30% 18% 21% 20% 8% 18%Delta one products 55% 51% 34% 45% 38% 32% 53% 49% 32% 23% 40%Convertibles 18% 24% 23% 36% 27% 26% 42% 42% 36% 44% 30%Prop/flow prop 31% 12% 24% 36% 23% 21% 37% 29% 17% 22% 24%Total equity derivatives 29% 24% 21% 26% 22% 20% 22% 27% 17% 15% 22%

Impact from regulationStructured products -49% -49% -44% -45% -47% -48% -49% -50% -55% -63% -50%Flow equity derivatives -51% -47% -13% -47% -44% -19% -3% -36% -29% -58% -37%Delta one products -50% -49% -41% -37% -45% -39% -34% -41% -42% -53% -43%Convertibles -41% -40% -29% -24% -34% -27% -21% -29% -30% -44% -32%Prop/flow prop -60% -65% -60% -57% -72% -50% -49% -65% -68% -65% -60%Total equity derivatives -51% -50% -41% -42% -47% -43% -39% -46% -

jpmorgan global investment banks 2010-09-08

Documents