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Global Equity Research
08 March 2011
Global Investment Banks
Regulatory Arbitrage series: OW European over USIBs
BanksKian Abouhossein
AC
(44-20) 7325-1523kian.abouhossein@jpmorgan.com
Jerzy Kot
(44-20) 7325-9729 jerzy.s.kot@jpmorgan.com
Amit Ranjan
(44-20) 7325-4780amit.x.ranjan@jpmorgan.com
Delphine Lee
(44-20) 7325-3971delphine.x.lee@jpmorgan.comJ.P. Morgan Securities Ltd.
See page 78 for analyst certification and important disclosures, including non-US analyst disclosures.
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 mayhave a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
 
 2
Global Equity Research
08 March 2011Kian Abouhossein(44-20) 7325-1523kian.abouhossein@jpmorgan.com
Table of Contents
Regulatory Arbitrage II: EU compensation analysis – favorsGlobal IBs over EU IBs, winners AM & HFs.........................42
Regulatory Arbitrage III: Section 716, pushing part ofderivatives out of the US depositary bank...........................62
Section 716 – pushing part of derivatives business out ofthe US depositary bank..........................................................64
 
 3
Global Equity Research
08 March 2011Kian Abouhossein(44-20) 7325-1523kian.abouhossein@jpmorgan.com
Portfolio Snapshot
Following our two reports on Volcker limits and EU compensation rules, wecomplete our Regulatory Arbitrage series today with our analysis of the third keyregulatory issue opposing the US vs. Europe: Section 716 of the Dodd-Frank bill.
Relative to US Investment Banks, European IBs are overall “winners” fromregulatory arbitrage opportunities
, based on our analysis of the three keyregulatory issues: 1) Volcker prop trading limits, 2) EU compensation rules, 3)Section 716 or swap push out provision.Regulating IB comp structures has been a key element of financial reform in Europeto limit risk taking, while in the US the approach is more direct through the Volcker rule and the segregation of part of the derivatives activities from the bank. Thefinancial implications of changes in EU compensation structures are significantly lessmaterial for European IB profitability than the two key constraints for US IBs in theDodd-Frank bill – Volcker limits (Section 619) and to a lesser extent the swap pushout rules (Section 716).
Hence, European IBs could benefit from regulatoryarbitrage opportunities and gain market shares in market making and some of the derivatives activities.
 
Volcker rule could hit not only US IB ‘pure’ prop trading but also their marketmaking activity earnings.
European IBs would be the relative “winners” asVolcker rule provisions are unlikely to be implemented by the EU/Swiss.
 
EU compensation rules could threaten the competitiveness of EuropeanInvestments Banks as employers, through higher bonus retention anddeferral rates, however, the rules only affect the top 200-400 employees.
 
 
Section 716 or the swap push out provision requires the segregation of someof the derivatives activities from the banking entity
. In our universe all major European banks (except from HSBC) will be unaffected whilst US banks wouldhave to set up a new swap entity to comply with Section 716.
We remain OW IBs over traditional credit banks, which in our view havelimited earnings momentum, and stick to our preference for European IBs overUS IBs, with the Swiss banks as our top picks ticking all the right boxes
.
Ourpecking order is UBS, CSG, MS, BNPP, SG, BARC, GS and DB.
 
European IBs continue to trade at more attractive multiples compared to USIB peers
. Despite recent underperformance of US IBs, US IBs still trade at 1.1xtangible book value 2012E, vs. European IBs at 0.9x NAV (excluding the WM business at 10x PE).
 
We prefer Swiss IBs’ business mix and equity gearing
, with i) relativelyresilient private banking exposure at average 32% of 2012E earnings, and ii)equity gearing over fixed income within IB – we expect equities revenues togrow 8% CAGR 10E-12E vs. fixed income to decline -3%.
 
European IBs could benefit from regulatory arbitrage opportunities
: We believe that the tougher Volcker and swap push out rules in the Dodd-Frank billfor US IBs could represent a material revenue opportunity for European IBs.

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