JPMorgan Global Investment Banks 2010-09-08

Global Equity Research
08 September 2010
Global Investment Banks

Investment Banking wallet outlook - all eyes on equity derivatives
Banks Kian Abouhossein
AC
(44-20) 7325-1523 kian.abouhossein@jpmorgan.com
Delphine Lee
(44-20) 7325-3971 delphine.x.lee@jpmorgan.com J.P. Morgan Securities Ltd.
See page 172 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 may have 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.
Kian Abouhossein (44-20) 7325-1523 kian.abouhossein@jpmorgan.com Delphine Lee (44-20) 7325-3971 delphine.x.lee@jpmorgan.com
Global Equity Research 08 September 2010
Table of Contents
For Specialist Sales advice, please contact: Nick Gough
(44-20) 7325-9459 nick.c.gough@jpmorgan.com
Key Takeaways .........................................................................3 Equities business outlook matters .......................................10 IB revenue wallet trend - Equity Derivatives key driver ......10 Detailed growth rate discussion ...........................................16 Regulation: structural changes for the Equity Derivatives business..................................................................................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 the equities 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
Oliver Doeltl
(44-20) 7779 2187 oliver.doeltl@jpmorgan.com
Justine Shih
(44-20) 7779 2149 justine.shih@jpmorgan.com
Covering analysts for Barclays: Carla Antunes da Silva

(44-20) 7325-8215 carla.antunes-silva@jpmorgan.com
Amit Goel, CFA

(44-20) 7325-6924 amit.x.goel@jpmorgan.com
Covering analyst for Bank of America, Citigroup: Vivek Juneja

(1-212) 622-6465 vivek.juneja@jpmorgan.com
Key Takeaways
Table 1: Clean IB revenue wallet going ex-growth
% CAGR 10E12E Fixed Income revenue Equities revenue IB revenue Total revenues
Source: J.P. Morgan estimates.
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 regulatory changes 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 longdated 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
3
-4% 8% 12% 3%
Table 2: IB revenue cycle

Low Risk Money Market FX Rates Credit Trading Equity Structuring High Risk
Table 3: Global equity derivatives revenues growth expectations

% CAGR 10E-12E 10% 8% 9% 5% 6% 8% 14% 9%
Structured products Flow and listed deriv. ow Delta One ow flow equity derivatives Convertible bonds Equity deriv. ex prop Prop trading/flow prop Total equity deriv. Rev.
addition we see material growth opportunities within ETFs at 20%p.a. The key players are GS, SG and BNPP.
Table 4: Equity derivatives businesses net ROE pre and post regulatory changes
% 2011E pre reguln. 27% 29% 71% 45% 58% 42% 2011E post reguln. 14% 18% 40% 30% 24% 22%
Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives
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 (34) 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.
Figure 1: Averaged weighted spread on 28 significant series on ISE

bps
30 25 20 15 10 5 0 Jan to Mar 08 May to Oct 09
Source: ISE
Table 5: Global Investment banks Group valuation vs. growth 2012E

x, % P/BV GS MS UBS CS BNP SG Barc DB Avg. 1.1 0.9 1.3 1.6 1.0 0.9 0.8 0.9 1.1 PE 9.0 7.5 7.6 6.7 7.1 6.2 7.5 6.5 7.2 Group pre-tax 10E-12E 8% 23% 22% 15% 11% 27% 13% 9% 16%
Valuation ex revenue growth Why Buy IBs?

With the wallet unlikely to grow plus new regulations impacting IB ROEs, why remain 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
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.
Table 6: Global investment banks Reaching 15% IB ROE 2011E by adjusting IB comp/head
% ROE pre-regulation ROE post-regulation IB comp ratio to reach 15% Cut in IB Comp/head 11E/09E
20.3% 12.1% 34% -32%
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 derivatives regulation 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 can surprise 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 7: Global Investment Banks: Basel 3 Equity Tier 1 and Core Tier 1 ratios 2011E
% Basel III Equity Tier 1 ratio 13.8% 12.8% 11.5% 10.8% 10.0% 9.2% 8.4% 8.3% 7.3% 5.6% 9.8% Core Tier 1 ratio 13.8% 13.2% 14.0% 10.8% 11.0% 9.3% 8.6% 9.4% 7.9% 7.3% 10.5%
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 IBs on 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, which they 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 pureplay 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 to equities 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.
GS CITI UBS MS CS BOA BNP BARC SG DB Avg.
Source: J.P. Morgan estimates, Company data.
Table 8: Summary wholesale and Investment Bank Valuation Table 2010E-2012E

NAV ex own debt 2010E 9.1 21.0 44.9 39.9 41.6 9.77 3.51 0.51 6.35 110.1 23.6 NAV ex own debt 2011E 11.3 24.9 50.4 44.2 46.4 10.64 3.76 0.51 7.13 124.7 26.8 NAV ex own debt 2012E 13.7 30.0 56.3 49.6 51.7 11.70 4.17 0.55 7.84 139.9 30.2 P/NAV ex own debt 11E 1.6 1.9 1.0 1.6 1.0 1.2 1.0 1.1 0.9 0.9 1.4 1.2 1.2 1.0 1.1 1.2 P/NAV ex own debt 12E 1.3 1.6 0.9 1.3 0.9 1.0 0.9 1.0 0.8 0.9 1.3 1.1 1.1 0.9 1.0 1.1 RONAV ex own debt gain 11E 21.6% 26.2% 15.4% 21.6% 15.0% 15.7% 16.1% 15.6% 11.4% 1.0% 16.0% 12.0% 13.5% 13.7% 13.6% 15.1% RONAV ex own debt gain 12E 19.2% 25.5% 14.5% 20.2% 15.3% 15.3% 17.9% 15.9% 11.0% 6.4% 17.7% 14.0% 12.4% 12.5% 12.4% 15.5%
UBS CSG DB Euro IBs SG BNPP CASA French Banks Barclays RBS HSBC UK Banks GS MS US IBs Total
Price 18.2 47.1 50.2 44.4 53.4 10.9 3.25 0.47 6.54 147.3 26.7 -
TP 22 59 46 58 65 15 3.05 0.42 9.00 175 33 -
Rec OW OW UW OW OW N N UW OW OW OW -
NAV 2011E 11.6 26.2 50.5 44.4 46.7 10.8 3.89 0.51 7.26 125.5 27.4
NAV 2012E 14.0 31.1 56.4 49.8 52.0 11.9 4.26 0.55 8.25 140.6 30.8
PE 2011E 8.3 7.9 6.8 7.8 7.1 7.7 6.6 7.3 7.8 28.9 9.4 13.0 9.3 7.7 8.8 10.0
PE 2012E 7.6 6.7 6.5 7.0 6.2 7.1 5.4 6.5 7.5 11.0 7.6 8.3 9.0 7.5 8.5 7.7
P/NAV 11E 1.6 1.8 1.0 1.5 1.0 1.1 1.0 1.1 0.8 0.9 1.4 1.2 1.2 1.0 1.1 1.2
P/NAV 12E 1.3 1.5 0.9 1.3 0.9 1.0 0.9 1.0 0.8 0.9 1.2 1.1 1.0 0.9 1.0 1.1
RONAV 11E 21.0% 22.9% 14.6% 20.0% 14.9% 15.6% 15.9% 15.5% 11.4% 1.0% 16.0% 12.0% 13.5% 13.4% 13.5% 14.8%
RONAV 12E 18.8% 22.5% 13.7% 18.8% 15.3% 15.2% 17.7% 15.7% 10.9% 6.4% 17.5% 13.9% 12.4% 12.3% 12.4% 15.1%
Core Tier 1 2011E (%) 14.0% 11.0% 7.3% 11.3% 9.1% 8.6% 9.4% 9.0% 9.4% 9.3% 11.5% 10.6% 13.9% 12.2% 13.4% 10.7%
Source: J.P. Morgan estimates, Company data. Priced from Bloomberg as of 3 Sept 2010.
Executive Summary
9
Equities business outlook matters

Figure 2: Split of the Investment Banking revenue wallet* 2009
IB 18%
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.
FICC Equities 27% 55%
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.
IB revenue wallet trend - Equity Derivatives key driver

Where 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 2011E12E 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.
10
Figure 3: Global Investment Banks Clean Investment Bank revenues 1999-2012E

Rebased 1999 = 100
500 450 400 350 300 250 200 150 100 50 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E Equities (LHS) Fix ed Income (LHS) Inv estment 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 $139bn in 2011E, down -23% from peak $180bn in 2009, with the decline mainly coming from lower revenues in Rates, FX and prop/flow prop trading.
11
Figure 4: Global fixed income: revenue wallet of $180bn in 2009, $141bn in 2010E, $139bn in 2011E and $131bn in 2012E
$ billion
200 180 24.0 160 9.5 140 120 28.3 100 22.2 80 57.7 60 43.1 39.4 35.7 20.6 16.1 7.8 18.2
Credit Commodities
Rates Emerging Markets
Currencies Prop/flow prop
17.2 8.1 18.9 20.7 14.5 8.7 19.2 19.2
40 20 0 2009E 2010E 2011E 2012E 39.9
33.3
34.5
33.7
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 the record 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 to decline -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.
12
Table 9: Global fixed income: revenue growth 2009-2012E

% 2010E Credit Rates Currencies Commodities Emerging Markets Prop/flow prop Total Fixed Income -17% -25% -22% -12% -18% -33% -22% 2011E 4% -9% -7% 4% 4% 7% -1% 2012E -3% -9% -8% 1% 7% -16% -6% CAGR 10E-12E 1% -9% -7% 3% 6% -5% -4% 12E/09E -16% -38% -32% -7% -8% -39% -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 in 2011E and $81bn in 2012E
$ billion
90 85 80 75 70 65 60 55 50 45 40 35 30 25 20 15 10 5 0 6.4
Cash equities Equity derivatives

10.8
Electronic Prop trading/flow prop
Prime Services
8.4 8.1 6.4
30.3 29.3 27.3
31.8
14.9 12.4 5.8 13.2
13.9
6.3
6.9
22.2
18.4
19.3
20.5
2009E
2010E
2011E
2012E
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%).
13
Table 6: Global equities: revenue growth 2009-2012E

% 2010E -17% -9% -17% -10% -13% -41% -17% 2011E 5% 8% 6% 8% 7% 28% 9% 2012E 6% 10% 6% 9% 8% 3% 7% CAGR 10E-12E 5% 9% 6% 8% 7% 15% 8% 2012E/ 2009E -8% 8% -7% 6% 0% -22% -3%
Cash equities Electronic Prime Services Equity derivatives Equities ex prop Prop trading/flow prop Total equities revenues
Equity derivatives wallet - back to peak level in 2012E to keep 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
40
35
30
25
20
15
10
0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
14
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 products revenues 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 in 2012E
$ billion
Structured products
45 40 35 30 25 20 15 10 5 0 -5 -10 -15 -20 -25 -30 2006 2007 2008 -25.0 5.0 4.0 6.5 5.5 10.0 6.6 6.9 6.3 4.6 7.8 2.3 8.2
Flow equity derivatives Prop trading/flow prop
Delta One products
Convertibles
7.2 4.4 10.7 4.4 4.0 9.9 6.3 7.1
5.8 4.1 10.8 6.7 7.7
5.8 4.5 11.8
7.5 12.0 12.5 7.7
7.0 8.4
2009E
2010E
2011E
2012E
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 weighted average revenue growth in equity derivatives 2009E-2012E
% 2010E Structured products Flow and listed derivatives ow Delta One ow flow equity derivatives Convertible bonds Equity derivatives ex prop Prop trading/flow prop Total equity derivatives revenues
Source: J.P. Morgan estimates. 15
2011E 9% 8% 9% 5% 4% 8% 31% 11%
2012E 10% 8% 9% 5% 8% 9% 0% 7%
-7% -11% -8% -16% -10% -10% -38% -15%
CAGR 09E012E 4% 1% 3% -2% 0% 2% -7% 0%
CAGR 010E012E 10% 8% 9% 5% 6% 8% 14% 9%
012E/09E 12% 3% 10% -6% 1% 6% -19% 1%
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 higher than 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 progression by business 2008 2012E
% 09/08 Equity derivatives Cash equities incl electronic trading Prime Services Sub total flow Prop trading/hedge gain/loss/other Total Equities Clean Revenue Structured Credit Trading Credit trading (incl. loans, bonds, CDS) Total Credit Rates Currencies Commodities Emerging Markets Fixed Income Sub total flow Prop trading/hedge Gains/other Total Fixed Income clean revenues Financing & Advisory clean revenues Total IB clean revenues 8% -16% -20% -8% -151% 53% 66% 94% 87% 70% 24% 8% 49% 51% -167% 165% 13% 83% 10E/09 -11% -15% -16% -13% -39% -17% -20% -16% -17% -25% -22% -12% -18% -20% -33% -22% -2% -17% 11E/10E 8% 5% 7% 7% 28% 9% 0% 5% 4% -9% -7% 4% 4% -2% 7% -1% 12% 4% 12E/11E 9% 7% 9% 9% -2% 7% -2% -3% -3% -9% -8% 1% 7% -4% -16% -6% 9% -13% 09-012E CAGR 2% -1% -1% 0% -9% -1% -8% -5% -6% -15% -12% -2% -3% -9% -15% -10% 7% -4% 010E012E CAGR 8% 6% 8% 8% 12% 8% -1% 1% 1% -9% -7% 3% 6% -3% -5% -4% 12% 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. 16
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 prime brokerage. 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 of growth 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 flow equity 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 equity derivatives 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 investor conference that institutional clients are back focusing on investments in equity and absolute return, The new regulatory framework raises capital requirements for financial institutions, 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 for strategic 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).
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Table 12: Global Investment Banks Total equities revenue wallet 2011E
$ million SG Total equities revenues ow cash equities ow cash equities ow electronic ow prime brokerage ow equity derivatives ow Structured products ow Flow equity derivatives ow Delta One products ow Convertibles ow prop trading/flow prop 4,153 223 172 51 0 3,315 1,550 535 1,063 166 614 BNP 3,233 331 57 25 249 2,553 945 448 945 215 348 DB 4,037 2,017 923 234 860 1,560 604 233 532 192 460 UBS 4,791 2,523 1,053 572 898 1,712 424 525 540 223 556 CS 6,348 3,878 1,389 1,166 1,322 1,913 691 333 648 240 556 GS 9,767 4,663 1,599 1,336 1,728 3,605 910 1,006 1,169 520 1,500 MS 5,075 2,964 720 516 1,729 1,393 306 294 646 146 718 BARC 4,055 1,830 488 83 1,259 1,819 616 402 545 257 406 BOAML 4,550 2,720 1,314 506 900 1,408 324 324 475 285 422 CITI 4,077 2,116 960 237 920 1,436 311 234 443 449 525 Total 50,086 23,266 8,675 4,725 9,865 20,715 6,683 4,334 7,006 2,692 6,105 Wallet 76,142 38,732 19,278 6,301 13,153 29,269 7,681 6,668 10,778 4,142 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
% Structured products Flow and listed derivatives ow Delta One ow flow equity derivatives Convertible bonds Prop trading Total equity derivatives cost/income Cash equities Electronic Prime brokerage Cash prop trading Total equities cost/income SG 50% 55% 50% 65% 50% 35% 50% 85% 85% 55% 35% 52% BNP 55% 55% 50% 65% 50% 35% 52% 85% 85% 55% 35% 53% DB 60% 60% 55% 70% 50% 40% 55% 90% 90% 55% 40% 65% UBS 72% 65% 55% 75% 50% 40% 61% 90% 90% 55% 40% 69% CS 65% 60% 55% 70% 50% 40% 58% 90% 90% 55% 40% 69% GS 53% 60% 55% 65% 50% 40% 54% 90% 90% 55% 40% 64% MS 72% 58% 55% 65% 50% 40% 55% 90% 90% 55% 40% 63% BARC 72% 59% 55% 65% 50% 40% 59% 90% 90% 55% 40% 62% BOA-ML 72% 61% 55% 70% 50% 40% 58% 90% 90% 55% 40% 70% CITI 72% 60% 55% 70% 50% 40% 55% 90% 90% 55% 40% 65% Average 64% 59% 54% 68% 50% 39% 56% 89% 89% 55% 39% 63%
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.
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 margin pressure 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
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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 between S&P 500 Total Returns Index and Equity revenues
Clean Equities revenues (YoY 60% 40% change) 20% 0% -20% -40% -60% -50% -40% -30% -20% -10% 0% 10% 20% 30% 40% y = 1.4x R 2 = 0.79
S&P 500 Total Return Index (YoY 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 expected changes 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 also lower, 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 forecasts
% Global Developed Emerging United States Euro area United Kingdom Official Interest Rate GDP-weighted average GDP-weighted average GDP-weighted average Federal funds rate Refi rate Repo rate Current 1.75 0.60 4.97 0.125 1.00 0.50 Dec-10 1.82 0.63 5.14 0.125 1.00 0.50 Jun-11 1.97 0.69 5.56 0.125 1.00 0.50 Sep-11 2.02 0.71 5.67 0.125 1.00 0.50
Source: J.P. Morgan economic research estimates as of 3 Sept 2010.
Table 15: Long-term interest rate forecasts

% US UK Euro Area Sep-10 2.7% 2.9% 2.1% Dec-10 2.5% 2.9% 2.2% Mar-11 2.5% 3.0% 2.2% Jun-11 2.5% 3.1% 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
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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 forecasts: Growth Rate, constant prices
% US Euro Area New Industrialized Asia Developing Asia 2010E 3.10% 0.96% 5.21% 8.70% 2011E 2.55% 1.49% 4.93% 8.66% 2012E 2.40% 1.81% 4.44% 8.57%
Table 17: IMF: Inflation, average consumer prices; percentage change

% US Euro Area New Industrialized Asia Developing Asia 2010E 2.1% 1.1% 2.3% 5.9% 2011E 1.7% 1.3% 2.3% 3.7% 2012E 2.0% 1.5% 2.4% 3.0%
Source: IMF World economic outlook April 2010
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 markets values 2012E
$ million SG Current assumption Equity markets increase Revenue growth 2012E vs. 2011E Total equities revenue 2012E Blue sky assumption Equity markets increase Revenue growth 2012E vs. 2011E Total equities revenue 2012E Additional equities revenues % increase in equities revenues % IB revenues Additional net earnings 2012E % increase in IB net income % EPS enhancement
BNP 5% 4% 3,367 15% 12% 3,634 268 8.0% 1.7% 88 2.5% 1.0%
DB 5% 6% 4,288 15% 19% 4,792 504 11.7% 2.2% 116 3.6% 2.2%
UBS 5% 8% 5,187 15% 25% 5,977 791 15.2% 5.5% 181 4.2% 1.9%
CS 5% 8% 6,879 15% 25% 7,941 1,062 15.4% 5.6% 237 4.7% 2.8%
GS 5% 8% 10,510 15% 23% 11,994 1,485 14.1% 4.5% 376 4.0% 3.7%
MS 5% 8% 5,493 15% 25% 6,329 836 15.2% 4.8% 217 4.4% 3.3%
BARC 5% 3% 4,177 15% 9% 4,420 243 5.8% 1.1% 67 1.5% 1.2%
Total / Av. 5% 7% 81,460 15% 21% 92,098 10,637 13.1% -
5% 3% 4,296 15% 10% 4,584 287 6.7% 3.1% 100 5.7% 1.9%
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Regulation: structural changes for the Equity Derivatives business

In 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 investment banks pre and post regulation changes**
% IB ROE 2011E 1. Clearing via CCP 2. Moving CDS to exchange trading 3. OTC post trade transparency 4. Prop trading proposed limits 5. Stressed VaR capital buffer 6. Incremental Risk Charge 5&6. Management guidance 7. Securitisation capital charge 8. Higher capital on non CCP clearing 9. Section 716 US reg - segregation IB Total impact Resulting IB ROE CS 23.5% 1.6% -3.5% -0.8% -1.9% -2.0% -2.8% -3.8% -1.0% -2.3% 0.0% -10.5% 13.0% UBS 22.7% 3.6% -3.6% -1.0% -1.7% -1.2% -2.3% -4.9% -1.8% -3.4% 0.0% -11.2% 11.5% DB 19.9% 2.4% -3.1% -0.9% -1.7% -1.0% -2.2% -4.0% -1.1% -2.5% 0.0% -9.4% 10.5% GS 23.4% 2.4% -2.4% -0.8% -1.5% -2.0% -1.2% -0.9% -2.4% -2.8% -9.6% 13.8% MS 19.0% 1.8% -0.6% -0.9% -1.1% -2.0% -0.8% -0.7% -1.9% -1.5% -6.6% 12.4% BNP 19.2% 0.3% -0.5% -0.5% -0.7% -0.9% -1.8% -3.4% -0.4% -0.7% 0.0% -5.4% 13.8% SG 17.2% -0.2% -0.5% -0.7% -0.7% -0.6% -1.3% -4.8% -0.7% -0.9% 0.0% -7.0% 10.2% BARC 17.8% 1.0% -1.4% -0.8% -0.6% -1.2% -1.5% 0.0% -1.0% -1.1% 0.0% -5.8% 12.0% Average 20.3% 1.6% -1.9% -0.8% -1.3% -1.4% -1.7% -3.5% -1.0% -1.9% -0.5% -8.2% 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.
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Table 20: Global investment banks impact on ROE of the equities business from regulatory changes 2011E
% SG Equities ROE OTC derivatives regulation & US financial reform 1. Clearing via CCP 2. Moving derivatives to SEF trading 3. OTC post trade transparency 4. Volcker proposed limits on prop trading 5. Section 716 US reg New Basel framework 6. Stressed VaR capital buffer Basel 7. Incremental Risk Charge Basel 8. Securitisation 9. CVA Total impact Resulting ROE % change 58% 13% -4% -3% -4% 0% -20% -8% 0% -7% -29% 29% -50% BNP 45% 9% -4% -2% -3% 0% -14% -7% 0% -5% -22% 23% -49% DB 34% 9% -2% -1% -3% 0% -8% -3% 0% -5% -13% 21% -38% UBS 45% 8% -3% -1% -4% 0% -8% -4% 0% -5% -16% 28% -37% CS 46% 6% -2% -1% -5% 0% -13% -5% 0% -4% -20% 26% -44% GS 34% 6% -2% -1% -3% -2% -9% -1% 0% -3% -13% 21% -39% MS 41% 10% -2% 0% -3% -1% -8% -1% 0% -6% -13% 29% -31% BARC 50% 9% -3% -1% -4% -1% -13% -2% 0% -5% -20% 30% -40% BOAML 35% 6% -2% -1% -3% -2% -10% -2% 0% -4% -15% 20% -42% CITI 35% 4% -1% 0% -3% -2% -14% -3% 0% -2% -18% 16% -53% Average 42% 8% -2% -1% -3% -1% -12% -4% 0% -5% -18% 24% -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 impact comes 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 the Volcker 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 Equities net income OTC derivatives regulation & US financial reform 1. Clearing via CCP 2. Moving derivatives to SEF trading 3. OTC post trade transparency 4. Volcker proposed limits on prop trading 5. Section 716 US reg New Basel framework 6. Stressed VaR capital buffer Basel 7. Incremental Risk Charge Basel 8. Securitisation 9. CVA Total impact Resulting net income
BNP 1,059 0% -8.0% -3.7% -6.4% 0% 0% 0% 0% 0% -18.2% 867
DB 926 0% -4.6% -2.5% -8.5% 0% 0% 0% 0% 0% -15.6% 782
UBS 1,098 0% -6.6% -2.0% -9.6% 0% 0% 0% 0% 0% -18.2% 899
CS 1,415 0% -4.4% -2.1% -9.8% 0% 0% 0% 0% 0% -16.4% 1,183
GS 2,476 0% -5.7% -1.8% -8.3% 0% 0% 0% 0% 0% -15.7% 2,086
MS 1,319 0% -4.3% -1.1% -8.1% 0% 0% 0% 0% 0% -13.5% 1,141
BARC 1,111 0% -5.5% -2.5% -7.8% 0% 0% 0% 0% 0% -15.8% 935
1,447 0% -7.0% -4.4% -6.2% 0% 0% 0% 0% 0% -17.6% 1,192
BOAML 969 0% -5.2% -1.6% -9.9% 0% 0% 0% 0% 0% -16.7% 808
CITI 1,001 0% -4.2% -1.4% -8.6% 0% 0% 0% 0% 0% -14.1% 859
Average 12,822 0% -5.6% -2.3% -8.3% 0% 0% 0% 0% 0% -16% 10,752
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47% increase in capital requirements for the equities business: the higher capital requirements mainly come from Basel 2.5 changes, Stressed VaR in particular. CVA also increase RWAs by 12% in our estimates; however, the higher 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
SG Equities RWAs OTC derivatives regulation & US financial reform 1. Clearing via CCP 2. Moving derivatives to SEF trading 3. OTC post trade transparency 4. Volcker proposed limits on prop trading 5. Section 716 US reg New Basel framework 6. Stressed VaR capital buffer Basel 7. Incremental Risk Charge Basel 8. Securitisation 9. CVA Total impact Resulting RWAs
BNP 23,633 0 -16% 0% 0% 0% 0% 0 48% 18% 0% 13% 62% 38,286
DB 27,331 0 -20% 0% 0% 0% 0% 0 29% 11% 0% 16% 36% 37,178
UBS 24,604 0 -15% 0% 0% 0% 0% 0 22% 10% 0% 12% 29% 31,711
CS 30,623 0 -12% 0% 0% 0% 0% 0 38% 13% 0% 9% 49% 45,479
GS 73,277 0 -14% 0% 0% 0% 5% 0 34% 2% 0% 11% 38% 101,042
MS 31,870 0 -20% 0% 0% 0% 4% 0 23% 3% 0% 16% 26% 40,009
BARC 22,099 0 -15% 0% 0% 0% 2% 0 36% 5% 0% 12% 40% 30,859
25,009 0 -19% 0% 0% 0% 0% 0 54% 16% 0% 15% 66% 41,578
BOAML 27,455 0 -15% 0% 0% 0% 5% 0 38% 5% 0% 12% 45% 39,674
CITI 28,724 0 -10% 0% 0% 0% 7% 0 69% 8% 0% 8% 82% 52,309
Average 314,625 0 -16% 0% 0% 0% 2% 0 39% 9% 0% 12% 47% 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 business declines 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% for cash 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 Volcker rules 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.
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Table 23: Global Investment Banks Equities businesses ROE

% 2009E Cash equities Electronic Prime Services Prop trading cash Sub-total cash equities & Prime Services Equity derivatives Prop trading equity derivatives Sub-total equity derivatives Total equities
49% 55% 43% 85% 49% 42% 73% 47% 48%
2011E Pre regulation 43% 54% 34% 58% 39% 39% 58% 42% 41%
2011E Post regulation 30% 37% 24% 24% 25% 22% 24% 22% 23%
Decline in ROE 2011E -31% -31% -30% -58% -35% -43% -60% -47% -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 and Goldman Sachs fare a bit better, we estimate.
Table 24: Global Investment Banks Equities businesses ROE pre and post regulatory changes 2011E
% SG Pre regulation Cash equities Electronic Prime Services Prop trading cash Sub-total cash equities & Prime Services Equity derivatives Prop trading equity derivatives Sub-total equity derivatives Total equities Post regulation Cash equities Electronic Prime Services Prop trading cash Sub-total cash equities & Prime Services Equity derivatives Prop trading equity derivatives Sub-total equity derivatives Total equities Decline in ROE Cash equities Electronic Prime Services Prop trading cash Sub-total cash equities & Prime Services Equity derivatives Prop trading equity derivatives Sub-total equity derivatives Total equities
BNP 25% 22% 24% 24% 53% 34% 49% 45% 15% 13% 14% 14% 28% 12% 24% 23% -40% -40% -40% -40% -47% -65% -50% -49%
DB 27% 28% 29% 60% 31% 32% 60% 36% 34% 20% 20% 21% 24% 21% 21% 24% 21% 21% -29% -29% -29% -60% -33% -36% -60% -41% -38%
UBS 62% 85% 34% 83% 44% 39% 83% 45% 45% 47% 64% 26% 36% 31% 24% 36% 26% 28% -24% -24% -24% -57% -31% -37% -57% -42% -37%
CS 66% 70% 41% 80% 50% 39% 80% 42% 46% 44% 46% 27% 23% 30% 22% 23% 22% 26% -34% -34% -34% -72% -41% -43% -72% -47% -44%
GS 38% 53% 27% 43% 33% 33% 43% 35% 34% 28% 39% 19% 21% 22% 19% 21% 20% 21% -27% -27% -27% -50% -34% -41% -50% -43% -39%
MS 32% 57% 45% 73% 46% 29% 73% 37% 41% 25% 45% 36% 37% 35% 19% 37% 22% 29% -21% -21% -21% -49% -24% -35% -49% -39% -31%
BARC 29% 54% 51% 83% 50% 46% 83% 51% 50% 20% 38% 36% 29% 34% 27% 29% 27% 30% -29% -29% -29% -65% -32% -41% -65% -46% -40%
BOAML 67% 65% 30% 54% 37% 30% 54% 34% 35% 47% 45% 21% 17% 24% 17% 17% 17% 20% -30% -30% -30% -68% -34% -44% -68% -50% -42%
CITI 47% 29% 29% 64% 33% 31% 64% 36% 35% 26% 16% 16% 22% 18% 14% 22% 15% 16% -44% -44% -44% -65% -46% -54% -65% -58% -53%
Average 43% 54% 34% 58% 39% 39% 58% 42% 41% 30% 37% 24% 24% 25% 22% 24% 22% 23% -31% -31% -30% -58% -35% -43% -60% -47% -42%
25% 22% 77% 27% 56% 77% 59% 58% 15% 13% 31% 15% 29% 31% 29% 29% -41% -41% -60% -44% -48% -60% -51% -50%
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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. The main 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 derivatives businesses ROE pre and post regulatory changes 2011E
$ million SG Equity derivatives ROE pre regulation OTC derivatives regulation & US financial reform 1. Clearing via CCP 2. Moving derivatives to SEF trading 3. OTC post trade transparency 4. Volcker proposed limits on prop trading 5. Section 716 US reg New Basel framework 6. Stressed VaR capital buffer Basel 7. Incremental Risk Charge Basel 8. Securitisation 9. CVA Total impact from regulation Equity derivatives ROE post regulation % decline
BNP 49%
DB 36%
UBS 45%
CS 42%
GS 35%
MS 37%
BARC 51%
59% 0 14% -4% -3% -4% 0% -21% -8% 0% -8% -30% 29% -51%
BOAML 34%
CITI 36%
Average 42%
12% -4% -2% -3% 0% -16% -7% 0% -6% -24% 24% -50%
21% -3% -2% -4% 0% -8% -4% 0% -8% -15% 21% -41%
18% -6% -2% -5% 0% -8% -4% 0% -8% -19% 26% -42%
13% -4% -2% -4% 0% -12% -5% 0% -7% -20% 22% -47%
12% -3% -1% -3% -3% -9% -1% 0% -6% -15% 20% -43%
23% -4% -1% -5% -2% -7% -1% 0% -9% -14% 22% -39%
19% -5% -2% -5% -2% -13% -2% 0% -9% -23% 27% -46%
13% -3% -1% -4% -3% -9% -2% 0% -6% -17% 17% -50%
8% -3% -1% -4% -4% -15% -3% 0% -4% -21% 15% -58%
15% -4% -2% -4% -2% -12% -3% 0% -7% -20% 22% -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 impact comes 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 higher capital 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
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derivatives is more than offset by the benefits from centralized clearing (-26% decline in RWAs).
Table 26: Global Investment Banks Equity derivatives businesses net income and RWAs pre and post regulatory changes 2011E
$ million SG Net income pre regulation OTC derivatives regulation & US financial reform 1. Clearing via CCP 2. Moving derivatives to SEF trading 3. OTC post trade transparency 4. Volcker proposed limits on prop trading 5. Section 716 US reg New Basel framework 6. Stressed VaR capital buffer Basel 7. Incremental Risk Charge Basel 8. Securitisation 9. CVA Total impact from regulation Net income post regulation RWAs pre regulation OTC derivatives regulation & US financial reform 1. Clearing via CCP 2. Moving derivatives to SEF trading 3. OTC post trade transparency 4. Volcker proposed limits on prop trading 5. Section 716 US reg New Basel framework 6. Stressed VaR capital buffer Basel 7. Incremental Risk Charge Basel 8. Securitisation 9. CVA Total impact from regulation RWAs post regulation
BNP 972 0% -9% -4% -7% 0% 0% 0% 0% 0% -20% 780 19,970 -19% 0% 0% 0% 0% 48% 18% 0% 15% 61% 32,223
DB 546 0% -8% -4% -10% 0% 0% 0% 0% 0% -22% 425 15,059 -37% 0% 0% 0% 0% 29% 11% 0% 29% 32% 19,943
UBS 587 0% -12% -4% -11% 0% 0% 0% 0% 0% -27% 430 13,090 -28% 0% 0% 0% 0% 22% 10% 0% 22% 26% 16,496
CS 648 0% -10% -5% -9% 0% 0% 0% 0% 0% -23% 499 15,311 -24% 0% 0% 0% 0% 38% 13% 0% 19% 46% 22,347
GS 1,411 0% -10% -3% -7% 0% 0% 0% 0% 0% -20% 1,124 40,742 -25% 0% 0% 0% 9% 34% 2% 0% 20% 39% 56,769
MS 598 0% -10% -2% -12% 0% 0% 0% 0% 0% -24% 452 16,286 -39% 0% 0% 0% 7% 23% 3% 0% 30% 25% 20,339
BARC 621 0% -10% -4% -10% 0% 0% 0% 0% 0% -25% 467 12,292 -27% 0% 0% 0% 4% 36% 5% 0% 21% 39% 17,041
1,418 0 0% -7% -5% -6% 0% 0% 0% 0% 0% -18% 1,165 23,947 0 -20% 0% 0% 0% 0% 54% 16% 0% 15% 66% 39,770
BOAML 505 0% -10% -3% -13% 0% 0% 0% 0% 0% -26% 372 14,935 -28% 0% 0% 0% 9% 38% 5% 0% 22% 46% 21,804
CITI 572 0% -7% -2% -11% 0% 0% 0% 0% 0% -21% 452 15,798 -18% 0% 0% 0% 13% 69% 8% 0% 14% 86% 29,419
Total 7,879 0% -9% -4% -9% 0% 0% 0% 0% 0% -22% 6,166 187,431 -26% 0% 0% 0% 5% 40% 9% 0% 20% 47% 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
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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 SG Total equity derivatives revenues Costs Pre-provision profits Loan losses and other Pretax Net profits Cost/income Tax rate Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE
BNP 2,902 -1,513 1,389 0 1,389 972 52% 30% 972 1,997 49% 780 3,222 24%
DB 1,882 -1,042 840 0 840 546 55% 35% 546 1,506 36% 425 1,994 21%
UBS 2,046 -1,241 805 0 805 587 61% 27% 587 1,309 45% 430 1,650 26%
CS 2,136 -1,248 887 0 887 648 58% 27% 648 1,531 42% 499 2,235 22%
GS 4,355 -2,339 2,016 0 2,016 1,411 54% 30% 1,411 4,074 35% 1,124 5,677 20%
MS 1,895 -1,041 854 0 854 598 55% 30% 598 1,629 37% 452 2,034 22%
BARC 2,123 -1,254 869 0 869 621 59% 29% 621 1,229 51% 467 1,704 27%
3,919 -1,949 1,970 0 1,970 1,418 50% 28% 1,418 2,395 59% 1,165 3,977 29%
BOAML 1,704 -982 721 0 721 505 58% 30% 505 1,494 34% 372 2,180 17%
CITI 1,830 -1,013 817 0 817 572 55% 30% 572 1,580 36% 452 2,942 15%
Total 24,791 -13,624 11,168 0 11,168 7,879 56% 30% 7,879 18,743 42% 6,166 27,615 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 Sachs remaining 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 $1.71.9bn of revenues, we estimate.
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Table 28: Global Investment Banks equity derivatives revenues pre and post regulation 2011E
$ million 2011E revenues Pre-regulation Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives Post regulation Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives Impact from regulation Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives SG 1,550 535 1,063 166 604 3,919 1,469 467 984 166 400 3,486 -5% -13% -8% 0% -34% -11% BNP 945 448 945 215 348 2,902 896 391 874 215 187 2,563 -5% -13% -8% 0% -46% -12% DB 604 233 532 192 322 1,882 572 203 492 192 181 1,640 -5% -13% -8% 0% -44% -13% UBS 424 525 540 223 334 2,046 402 458 499 223 190 1,772 -5% -13% -8% 0% -43% -13% CS 691 333 648 240 223 2,136 655 290 600 240 96 1,881 -5% -13% -8% 0% -57% -12% GS 910 1,006 1,169 520 750 4,355 863 878 1,081 520 506 3,847 -5% -13% -8% 0% -33% -12% MS 306 294 646 146 503 1,895 290 257 598 146 325 1,616 -5% -13% -8% 0% -35% -15% BARC 616 402 545 257 304 2,123 583 350 504 257 152 1,847 -5% -13% -8% 0% -50% -13% BOA-ML 324 324 475 285 295 1,704 307 283 439 285 136 1,451 -5% -13% -8% 0% -54% -15% CITI 311 234 443 449 394 1,830 294 204 410 449 241 1,597 -5% -13% -8% 0% -39% -13% Total 6,683 4,334 7,006 2,692 4,076 24,791 6,332 3,782 6,480 2,692 2,413 21,698 -5% -13% -8% 0% -41% -12%
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).
Regulation could however require banks to adapt their business 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 from 27% 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
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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 equity derivatives, 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 lower cost/income ratio and lower capital requirements pre regulation.
Table 29: Global Investment Banks Equity derivatives businesses ROE
% 2009 Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives 25% 38% 72% 55% 71% 46% 2011E pre regulation 27% 29% 71% 45% 58% 42% 2011E post regulation 14% 18% 40% 30% 24% 22% Decline in ROE 2011E -50% -37% -43% -32% -60% -47%
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.
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Structured products ROE halving to 14% only on average could lead smaller players to exit the business. Return erosion is mainly due to the increase in the cost of capital, as structured products are OTC derivatives products 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 equity derivatives 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 derivatives businesses ROE pre and post regulatory changes 2011E
% 2011E ROE Pre-regulatory changes Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives Post-regulatory changes Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives Impact from regulation Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives SG 53% 32% 109% 30% 77% 59% 27% 15% 55% 18% 31% 29% -49% -51% -50% -41% -60% -51% BNP 42% 36% 100% 40% 34% 49% 21% 19% 51% 24% 12% 24% -49% -47% -49% -40% -65% -50% DB 28% 17% 57% 33% 60% 36% 16% 15% 34% 23% 24% 21% -44% -13% -41% -29% -60% -41% UBS 23% 28% 72% 47% 83% 45% 13% 15% 45% 36% 36% 26% -45% -47% -37% -24% -57% -42% CS 29% 26% 70% 41% 80% 42% 15% 15% 38% 27% 23% 22% -47% -44% -45% -34% -72% -47% GS 20% 37% 52% 35% 43% 35% 11% 30% 32% 26% 21% 20% -48% -19% -39% -27% -50% -43% MS 10% 19% 80% 53% 73% 37% 5% 18% 53% 42% 37% 22% -49% -3% -34% -21% -49% -39% BARC 30% 34% 83% 59% 83% 51% 15% 21% 49% 42% 29% 27% -50% -36% -41% -29% -65% -46% BOA-ML 12% 28% 54% 52% 54% 34% 5% 20% 32% 36% 17% 17% -55% -29% -42% -30% -68% -50% CITI 11% 19% 49% 78% 64% 36% 4% 8% 23% 44% 22% 15% -63% -58% -53% -44% -65% -58% Average 27% 29% 71% 45% 58% 42% 14% 18% 40% 30% 24% 22% -50% -37% -43% -32% -60% -47%
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Structured equity derivatives products: towards the oligopoly

The structured equity derivatives products industry is likely to remain competitive, with players competing for a much reduced revenue wallet and lower growth than in past. Industry wallet of $7.7bn in 2011E, 39% below 2007 peak of $12.5bn We expect industry revenues to increase 8% in 2011E vs. 10E, back to 2009 levels. However, at an estimated $7.7bn, the revenue pool is much smaller than in the past and we do not expect 2007 peak levels to be achieved in the medium term. Although the crisis led some players (e.g. Natixis, CASA) to exit or reduces their ambitions, the industry is more concentrated than in the past with the top five players accounting for 61% or $4.7bn of the total wallet in 2011E. 10% revenue growth vs. 15% pa pre-crisis We expect revenues in structured product to reach a low in 2010E, following a -45% decline in 2009E and -7% in 2010E, but to recover in 2011E-12E with a 10% CAGR. Overall, with the weak 2010E, this would imply 4% CAGR 2009-2012E for the industry, broadly in line with SGs expectation of moderate growth between 3% and 6%. We expect more limited revenue growth going forward and estimate 7%-10% growth p.a. in the next few years, compared to 15% pre-crisis, as demand for complex and riskier products is likely to remain weak in the medium term. The retail business is however slowly recovering with improved volumes and still relatively resilient margins, but most importantly, we see more growth potential in the Corporate business (Strategic Transactions) and the Institutional business, with solid demand from pension funds, insurance companies and banks. Profitability materially impaired by regulation So far, all players continue to invest in structured products, where ROE is expected to improve from 25% in 2009 to 27% in 2011E in our estimates, and it is business as usual. We however see material risk to profitability, with ROE estimated to almost halve to just 14% post regulatory changes. As a result, some smaller players could opt to exit the business to free up capital for more profitable businesses in our view, and this could benefit the large players which have long been committed to the business. With an even more oligopolistic industry, margin compression might be slower than in flow businesses, which would help protect returns at decent levels for large players. In our view, the structured products industry is likely to remain very concentrated due to i) relatively high barriers of entry both in terms of risk management and investment costs, ii) higher regulatory capital requirements and lower returns, assuming limited margin re-pricing. Industry still dominated by large players SG, BNP, GS, CS and BARC We expect Socit Gnrale and BNP Paribas to remain the largest structured equity derivatives houses, with 2011E revenues of $1.5bn to $0.9bn respectively and ROE above 20% even after regulatory changes, as they both benefit from scaled platforms, higher efficiency levels and large distribution networks.
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Deutsche Bank, CS and BARC also have strong positions with revenues of $0.60.7bn and ROE of about 15% in 2011E. Tier 2 players Morgan Stanley, Bank of America and Citi with returns below 10% in 2011E could potentially consider exiting a business which will require i) more RWAs (both market risk and counterparty risk) and ii) more capital against the RWAs as a significant part of their business will fall within the scope of Section 716.
Table 31: Global Investment Banks structured equity derivatives summary P&L 2011E
$ million SG Structured products Costs Pre-provision profits Loan losses and other Pretax Net profits Cost/income Tax rate Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE 1,550 -775 775 0 775 558 50% 28% 558 1,050 53% 500 1,858 27% BNP 945 -520 425 0 425 298 55% 30% 298 709 42% 263 1,231 21% DB 604 -363 242 0 242 157 60% 35% 157 558 28% 136 867 16% UBS 424 -305 119 0 119 87 72% 27% 87 369 23% 70 543 13% CS 691 -449 242 0 242 177 65% 27% 177 612 29% 150 979 15% GS 910 -482 428 0 428 300 53% 30% 300 1,466 20% 266 2,504 11% MS 306 -221 86 0 86 60 72% 30% 60 606 10% 49 974 5% BARC 616 -443 172 0 172 123 72% 29% 123 409 30% 100 670 15% BOAML 324 -234 91 0 91 64 72% 30% 64 549 12% 52 985 5% CITI 311 -224 87 0 87 61 72% 30% 61 574 11% 49 1,263 4% Total 6,683 -4,016 2,667 0 2,667 1,884 64% 30% 1,884 6,902 27% 1,636 11,873 14%
Source: J.P. Morgan estimates. Notes: i) disclosures or reporting structures from the companies may differ, ii) structured products including corporate derivatives note that we could be underestimating strategic derivatives/corporate derivatives revenues booked in Corporate Finance/Investment Banking.
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Flow equity derivatives: the reign of cash-equity-like providers?

In our view, the flow equity derivatives industry could become even more competitive than it is already with i) more players competing for a revenue wallet that is not really growing, and ii) increased margin pressure and operating leverage with the overcapacity building up. Industry wallet of $6.7bn in 2011E, 11% below 2009 level of $7.5bn With the significant losses in equity derivatives in 2008, most players have been refocusing on flow businesses, leading to increased competition since 2009 for a smaller wallet. We expect the global revenue pool in flow equity derivatives (excluding delta one) to decline -16% in 2010E vs. 2009E, but revenues should recover 5% pa in 2011E-12E. The industry is however more competitive than in structured products, with more players and a smaller revenue wallet $6.7bn in 2011E vs. $7.7bn for structured products. In flow equity derivatives, the top 5 players account for $2.9bn or 44% of total revenue wallet in 2011E in our estimates. 5% revenue growth vs. 15%-20% pre-crisis Revenue growth is likely to become more challenging going forward, and we estimate revenue growth of 5% p.a. vs. 15%-20% previously, mainly as a result of margin compression on increased competition and expansion of electronic trading. In our view, the flow equity derivatives business is likely to evolve towards a "cash" model with high and low touch segments. Margin pressure is the key issue Flow equity derivatives revenue growth is lower than in the past mainly as a result of margin compression. Bid-offer spreads widened during the Q4 08 market dislocation, however, they have declined to lower levels than pre-crisis for the most liquid and transparent products, as illustrated in the figures below.
Figure 10: Bid-offer spreads
%
Figure 11: Averaged weighted spread on 28 significant series on ISE

Bp
35 30 25 20 15 10 5 0 Jan to Mar 08 Apr 08 to Apr 09 May to Oct 09
Source: J.P. Morgan analysis on Eurex data.
Source: ISE.
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Long term growth opportunities There is clearly room for all the players to grow as no business model is perfect in terms of product and geographical coverage. We see the US as the most obvious gap for most of them, with most players investing in US flow. The key question mark remains whether European players with smaller presence in the US, weaker client relationships, and smaller cash equities and/or prime brokerage platforms, can be successful in expanding in the US. All players also see Asia as another potential growth driver for flow businesses, notably warrants. but overcapacity feeding into the margin pressure We are however concerned by the overcapacity building up in equity derivatives with the recent investment spending spree. The IB industry has become more concentrated post the financial crisis and collapse/exit of several players. The large players all gained some market shares and partly benefited from the reversal of the 2008 losses. In Equities, the large players remain Goldman Sachs with $12bn of revenues in 2009 and Credit Suisse with $7bn in the top league, followed by Citi, BoA, MS, UBS, SG, and DB with $4.5bn-$5.5bn, as illustrated in Table 32 below. However, except for Goldman Sachs, none of the players provides a complete offering in all areas within equities, equity derivatives in particular, with most of them having revenue gaps and some areas of strengths. As a result, we believe there is still room to grow, and all players are piling up investments, mainly in flow businesses.
Table 32: Global Investment Banks split of total equities revenues 2009E
$ million SG Total equities revenues ow cash equities ow cash equities ow electronic ow prime brokerage ow equity derivatives ow Structured products ow Flow equity derivatives ow Delta One products ow Convertibles ow prop trading/flow prop 4,913 266 211 55 0 3,508 1,563 685 1,074 186 1,139 BNP 2,367 331 71 25 235 2,435 859 501 859 215 -398 DB 4,563 2,379 1,120 250 1,009 1,729 609 341 564 215 455 UBS 4,769 2,895 1,271 600 1,023 1,528 350 500 475 203 346 CS 7,339 4,446 1,617 1,200 1,629 2,038 700 411 661 266 856 GS 12,030 5,246 1,813 1,400 2,033 3,828 928 1,150 1,200 550 2,956 MS 4,908 3,015 765 500 1,750 1,380 300 300 630 150 513 BARC 4,198 1,889 507 60 1,322 1,889 600 450 550 289 420 BOAML 4,901 2,851 1,400 451 1,000 1,450 350 300 500 300 600 CITI 5,372 2,672 1,212 260 1,200 1,500 300 250 450 500 1,200 Total wallet 84,682 43,529 22,192 6,401 14,936 30,370 7,717 7,520 10,713 4,421 10,782
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, vi) clean revenues adjusted for exceptional items and DVA.
The issue is that overcapacity is building up in flow equity derivatives, with all players aiming to take market share in a business which is becoming commoditized. Margins are under pressure both in the US which also has a well developed retail market for listed derivatives, and in Europe where the relatively large OTC business is moving progressively on exchange. Hirings have picked up again since end H1 09 across most businesses in Investment Banking, as banks address staff turnover (e.g. UBS), rebuild or expand in flow businesses where they see attractive growth prospects. Equities businesses are among the most in demand.
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In New York, 6,900 financial industry positions were added from end Feb to June 2010 (according to the New York State Department of Labor - see Figure 12 below). Whilst financial jobs at 429,100 in June 2010 are still well below the peak level in Aug 2007, the trend is clearly up. Goldman Sachs group headcount increased by 2,900 since end June 09, of which 1,600 in 2010 so far. In equities, expansion in emerging markets is the key growth opportunity as GS does not have any product gap in our view. Across the IB division, we estimate GS has increased front office headcount by 150 in Brazil, 100 in Russia, 100 in Dubai, 200-300 in China in 2009. Credit Suisse hired over 1,800 staff in the investment bank since end June 09. In equities and prime services, CS repositioned its businesses to focus on liquid flow quant strategies and client flow in convertibles. The group aims to consolidate its top 3 market share in prime services, has growth plans in listed derivatives and delta one, and intends to expand its flow and corporate footprint in equity derivatives whilst building up scale in APAC. UBS Investment Bank hired over 1,200 staff since end June 09, and has been recruiting in equities (c.167 in 2009, of which 76 new MDs and EDs). UBS intends to leverage UBS Wealth Management for both cash equities and equity derivatives. Deutsche Bank staff levels increased by c.550 since end June 09, however less than 5% of the staff investment is related to equities. In equities the investment is focused on closing the gap in cash equities and prime services in Asia and the US, and in equity derivatives the focus is on three main areas: 1) US flow derivatives trading (targets Top 3 by volume end 2011), 2) strategic transactions in Asia and Latam, and 3) db-x in Turkey and Korea.
Figure 12: Number of employees in Financial activities in New York City
Thousands
480 470 460 450 440 430 420 410 Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10
Table 33: Headcount changes

Goldman Sachs group Morgan Stanley group Credit Suisse IB UBS IB Deutsche Bank IB Jefferies group Macquarie group Royal Bank of Canada group Nomura group end June 10 34,100 62,926 20,600 16,552 10,608 2,821 14,657 70,812 26,374 end June 09 31,200 62,215 18,800 15,324 10,060 2,307 12,740 66,748 25,626 Increase 2,900 711 1,800 1,228 548 514 1,917 4,064 748
Source: Company reports, J.P. Morgan estimates. Notes: i) end Mar data for Macquarie and Nomura, ii) end April data for Royal Bank of Canada, iii) Deutsche Bank CB&S staff numbers do not include all IB headcount as part of it is booked in the corporate center.
Source: New York State Department of Labour.
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Table 34: Summary - Hiring in Equities

Bank HSBC Nomura Morgan Stanley Barclays Capital Details on Hiring in Equities Added about 400 staff in its global banking and markets (GBM) investment bank arm in the first half 2010, with about 50 of those part of the equities build-up In March 2009, Nomura had roughly 1,000 total employees in the U.S., but boosted that number to about 1,600 in March 2010. The firm plans to have 2,000 in the region by March of next year. The firm doubled its U.S. equities revenue producing staff in the last fiscal year. Added to its London-based equities business in recent months, with several senior hires in electronic trading and equity derivatives. Barclays has been one of the biggest European hirers in the past 18 months and has built its London business to match the investment banking operations it acquired in North America from Lehman Brothers. The bank is still a recruiter and is continuing to grow its advisory and equities business, with the hire of more M&A bankers and capital markets staff. Macquarie Group agreed a deal to acquire the cash equities business of German private bank Sal. Oppenheim. Under the agreement more than 50 staff will join Macquarie on completion of the transaction. This is in addition to more than 90 staff from Sal. Oppenheims equity derivatives and structured products business, which Macquarie acquired in a separate transaction last December. Cash equities traders and salespeople are among the most in demand talent for investment banks, with a large amount of hiring also taking place in back office roles such as risk management, accounting and product control, according to headhunters. Source HSBC adds 400 investment bankers, builds up equities, Reuters , Aug 2, 2010 UPDATE: Nomura Hires Americas Head Of International Trading, WSJ, 12-Aug-10 Bank hiring: the sector breakdown, Efinancial News, 16 Feb 2010 A guide to which investment banks are hiring, and where, Efinancial News, 22 Feb 2010 Bank hiring: the sector breakdown, Efinancial News, 16 Feb 2010
Macquarie Group
Investment Banks
Bank hiring: the sector breakdown, Efinancial News, 16 Feb 2010
Source: Press articles.
Returns wont be what they used to be Whilst we believe the impact from regulation is not as negative as for structured products, we still see ROE declining by -40% on average to 18% in 2011E, mainly on additional margin compression. We estimate revenue erosion of -11% in flow equity derivatives, with no assumption of cost offsets. An ROE of 18% remains attractive; however, returns are still significantly lower than the 27% 2011E preregulation or the 38% achieved in 2009. With high margin compression and lower returns, we believe that cost reduction could become necessary if equity market conditions and hence revenue outlook do not improve. Flow equity derivatives is becoming more commoditized, more similar to cash equities, but compared to cash equities, the business still needs much more capital. The new reign of cash equity-like liquidity providers? Industry is likely to be dominated by large players providing liquidity in a similar fashion as in cash equities. In our view, winners in flow equity derivatives will be players with the scale to provide liquidity. The dynamic of the business has changed with increased price/choice transparency for clients, pure prop will be limited, and efficient market making has become more important to generate improved returns. As a result, we see scale and being at the center of the flow as key to be successful. Goldman Sachs remains the leader in the flow equity derivatives segment with estimated revenues of $1bn in 2011E and ROE of 30% post regulatory changes. In our view, GS benefits from its strong cash equities business and institutional/corporate client franchise, as well as expertise in electronic trading SIGMA X is the largest broker dealer ATS (Alternative Trading System, also referred to as dark pools) in the US. GS is followed by Socit Gnrale and UBS with estimated revenues of $0.5bn and ROE of 15% in 2011. Both SG and UBS enjoy strong market shares in Europe where both groups have been able to leverage their corporate
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relationships, however, in the US, SG lacks presence and does not have the institutional relationships from the US brokers' cash equities businesses. BNP Paribas and Barclays are also large flow equity derivatives players, with an estimated $0.4bn of revenues and ROE of 19% and 21% respectively in 2011E. Barclays benefits from former Lehman's presence in the US, whilst BNP Paribas has more presence in Europe.
Table 35: Global Investment Banks flow equity derivatives summary P&L 2011E
$ million Flow equity derivatives Costs Pre-provision profits Loan losses and other Pretax Net profits Cost/income Tax rate Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE SG 535 -348 187 0 187 135 65% 28% BNP 448 -291 157 0 157 110 65% 30% DB 233 -163 70 0 70 45 70% 35% UBS 525 -393 131 0 131 96 75% 27% CS 333 -233 100 0 100 73 70% 27% GS 1,006 -654 352 0 352 246 65% 30% MS 294 -191 103 0 103 72 65% 30% BARC 402 -261 141 0 141 101 65% 29% BOA-ML 324 -227 97 0 97 68 70% 30% CITI 234 -164 70 0 70 49 70% 30% Total 4,334 -2,274 1,100 0 1,100 777 68%
135 425 32% 0 86 554 15%
110 307 36%
45 273 17%
96 344 28%
73 276 26%
246 659 37%
72 382 19%
101 298 34%
68 247 28%
49 259 19%
27%
70 368 19%
26 180 15%
47 320 15%
42 284 15%
157 520 30%
46 252 18%
64 298 21%
39 200 20%
28 357 8%
18%
Source: J.P. Morgan estimates. Note: i) disclosures or reporting structures from the companies may differ from our split of equities and equity derivatives revenues and P&L; ii) flow equity derivatives include options, vol trading and warrants, excluding delta one products.
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Delta one attractive growth and returns

Benefiting from the flight to more liquid and transparent products Delta one products are the area of growth, with strong client volume growth, good margins and untapped potential in emerging markets. With macroeconomic uncertainties and technological innovations, delta one products and algo trading have expanded in the past few years. Most players have high ambitions in ETF where volumes are expected to grow further by 20% pa, e.g. SG aims to double its ETF business (32bn of AuM end 2009, 21% market share). Industry wallet of $10.8bn in 2011E, back to peak 2009: We estimate the total delta one revenue wallet to amount to $11bn in 2011E, back to 2009 levels after a challenging 2010 (-8% YoY). The industry is relatively concentrated with the top 5 players accounting for 41% or $4.5bn of revenues in 2011E. 9% revenue growth: Delta one is one of the fastest growing businesses within equity derivatives, and we estimate revenues to grow 9% CAGR 2010E-12E, driven by volume growth in ETF, equity swaps and certificates, with limited margin compression. 40% ROE business: Delta One is also the most profitable business with ROE of 40% in 2011E in our estimates post regulation, despite the -43% decline in returns from 71% due to the 48% increased in capital requirements. Competing on technology and balance sheet Large players to stay large In our view, the delta one products segment could remain relatively concentrated. Delta one trading desks generate most revenue through a variety of high frequency trading strategies related to relative value trading, index arbitrage, and equity finance operations. These activities require large scale operations to maintain significant size index-based portfolios and competitive technology. 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 Europe, the largest players in delta one products include Socit Gnrale with $1.1bn of revenues globally in 2011E, BNP Paribas $0.9bn, and Goldman Sachs. In the US, the large cash equities players, Goldman Sachs with $1.2bn of revenues globally, Morgan Stanley $0.6bn lead the industry. Key for US players is the client relationship with institutionals, hedge funds and corporates, as well as the leverage with cash equities and prime brokerage.
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Table 36: Global Investment Banks delta one derivatives summary P&L 2011E
$ million SG Delta One products Costs Pre-provision profits Loan losses and other Pretax Net profits Cost/income Tax rate Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE 1,063 -532 532 0 532 383 50% 28% 383 350 109% 325 596 55% BNP 945 -473 473 0 473 331 50% 30% 331 331 100% 281 548 51% DB 532 -292 239 0 239 156 55% 35% 156 273 57% 130 384 34% UBS 540 -297 243 0 243 177 55% 27% 177 246 72% 148 325 45% CS 648 -357 292 0 292 213 55% 27% 213 306 70% 178 463 38% GS 1,169 -643 526 0 526 368 55% 30% 368 703 52% 307 957 32% MS 646 -356 291 0 291 204 55% 30% 204 255 80% 170 322 53% BARC 545 -299 245 0 245 175 55% 29% 175 210 83% 146 296 49% BOAML 475 -261 214 0 214 150 55% 30% 150 275 54% 125 392 32% CITI 443 -244 199 0 199 139 55% 30% 139 287 49% 116 509 23% Total 7,006 -3,753 3,253 0 3,253 2,295 54%
71%
40%
Source: J.P. Morgan estimates. Note: 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.
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Convertibles refinancing needs to support growth

The convertibles business has recovered well from the losses in 2008. Despite the challenging 2010, we expect further growth in the next few years with increased refinancing needs. Despite the increased capital requirements, convertibles remain profitable at 30% ROE in 2011E post regulation. Industry wallet of $4.1bn in 2011E, 6% below 2009: We estimate the convertibles revenue wallet to amount to $4.1bn in 2011E, improving towards 2009 levels. The industry is also relatively concentrated with the top 5 players accounting for 42% or $1.8bn of revenues in 2011E. 6% CAGR revenue growth 2010E-12E: convertibles valuations have recovered from the end 2008 lows and are now back to pre-crisis peak levels. In our view, revenues from market making will be more challenging from these levels, however, refinancing needs are expected to increase, and the revenue outlook should improve we estimate a relatively conservative 6% CAGR growth in 2010E-12E. 30% ROE business: Convertibles is also a reasonably profitable business with ROE of 30% in 2011E in our estimates post regulation, despite the -32% decline in returns from 45% due to the 48% increased in capital requirements. Industry dominated by GS, Citi and BoA: The convertibles market is much larger in the US compared to Europe or Asia, and unsurprisingly, US players GS, Citi and BoA dominate the market with estimated revenues of $0.3-0.5bn in 2011E, as they leverage their corporate relationships, sizeable fixed income platform and solid positions in listed options.
Table 37: Global Investment Banks convertibles summary P&L 2011E
$ million Convertibles Revenues Costs Pre-provision profits Loan losses and other Pretax Net profits Cost/income Tax rate Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE SG 166 -83 83 0 83 60 50% 28% 0 60 200 30% 0 60 341 18% 75 313 24% 62 269 23% 82 228 36% 88 324 27% 182 698 26% 51 121 42% 92 218 42% 100 274 36% 157 356 44% 948 3,141 30% 75 189 40% 62 191 33% 82 172 47% 88 214 41% 182 513 35% 51 96 53% 92 155 59% 100 192 52% 157 201 78% 948 2,124 45% BNP 215 -107 107 0 107 75 50% 30% DB 192 -96 96 0 96 62 50% 35% UBS 223 -112 112 0 112 82 50% 27% CS 240 -120 120 0 120 88 50% 27% GS 520 -260 260 0 260 182 50% 30% MS 146 -73 73 0 73 51 50% 30% BARC 257 -129 129 0 129 92 50% 29% BOA-ML 285 -142 142 0 142 100 50% 30% CITI 449 -224 224 0 224 157 50% 30% Total 2,692 -1,346 1,346 0 1,346 948 50%
Source: J.P. Morgan estimates. Notes: i) disclosures or reporting structures from the companies may differ; ii) convertibles revenues estimates assuming half of the underwriting fees, with some banks having JVs with Corporate Finance, others with Fixed income (credit trading).
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Prop trading/flow prop scale in flow will be key

We expect returns in prop trading to decline sharply post regulation, with an estimated ROE decline of -43%. The prop business is the most affected by regulations with the largest impact coming from the increased capital requirements and the Volcker rules. Note however that our sensitivity analysis is on 2011E, but Volcker rules will only be effective from 2013 the earliest, and we would expect banks to scale down prop trading closer to the new rule effective date. 2011E revenues 19% below 2009: Investment Banks prop revenues benefited in 2009 from very favorable market conditions, and we expect prop and hedge gains to decline to more normalized levels. Following the -38% decline in 2010 on more challenging equity markets with high levels of volatility, correlation and drop in dividend expectations in Q2 10, we expect a 31% recovery in 2011E. Overall, we estimate 2011E run rate to remain 19% below 2009. 24% ROE in 2011E post regulation: we expect ROE to decline by -40% from 58% to 24% on higher market risk requirements with 49% overall increase in RWAs and 40% net profits impact from Volcker rules. Note that: i) we have assumed only pure/segregated prop trading would be affected about 5% of total equities revenues, ii) our prop/flow prop estimates for Goldman Sachs do not include revenues from Goldman Sachs Principal Strategies (GSPS) which we have not forecast in our total equities revenues in 2010E-12E more generally, we do not forecast revenues for Principal Investments, GSPS and SSG (Special Situations Group), although these revenues accounted for 10% or $3.5bn of total firm revenues on average over the past 5 years. At 24% ROE, flow prop trading remains an attractive business segment with good returns and flexible cost base, remaining core to IB market makers which take risk on behalf of clients. As the dynamic of the client business has changed, market making becomes more important to generate acceptable ROE. Equity derivatives is becoming more cash-like and hence, scale in flow and ability to take risk with the appropriate risk management capabilities will be key. With price-choice transparency for clients increasing, being centre of the flow is important to be successful in market making/flow prop trading.
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Table 38: Global Investment Banks prop trading (including flow prop) summary P&L 2011E
$ million Prop trading/flow prop Costs Pre-provision profits Loan losses and other Pretax Net profits Allocated equity Cost/income Tax rate ROE Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE SG 604 -211 393 0 393 283 369 35% 28% 77% 0 283 369 77% 0 194 628 31% 91 763 12% 70 296 24% 83 234 36% 42 185 23% 212 997 21% 136 366 37% 65 222 29% 57 329 17% 101 458 22% 1,053 4,478 24% 159 461 34% 126 210 60% 146 177 83% 97 122 80% 315 733 43% 211 290 73% 130 157 83% 124 231 54% 165 259 64% 1,756 3,010 58% BNP 348 -122 226 0 226 159 461 35% 30% 34% DB 322 -129 193 0 193 126 210 40% 35% 60% UBS 334 -134 200 0 200 146 177 40% 27% 83% CS 223 -89 134 0 134 97 122 40% 27% 80% GS 750 -300 450 0 450 315 733 40% 30% 43% MS 503 -201 302 0 302 211 290 40% 30% 73% BARC 304 -122 182 0 182 130 157 40% 29% 83% BOA-ML 295 -118 177 0 177 124 231 40% 30% 54% CITI 394 -158 236 0 236 165 259 40% 30% 64% Total 4,076 -1,583 2,494 0 2,494 1,756 3,010 58%
Source: J.P. Morgan estimates. Notes: i) disclosures or reporting structures from the companies differ from our split of equity derivatives revenues, flow prop and pure prop would often be part of the different businesses; ii) Goldman Sachs estimates excluding Goldman Sachs Principal Strategies (GSPS), as a result, the impact for GS from Volcker limits is in line with peers. Should GSPS be included, the impact from Volcker rules and regulation on prop/flow prop would be the highest for GS.
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IB Valuation and stock selection

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IB valuation
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 pretax, we still expect some growth with 15% CAGR in 2010E-12E, compared to 20% in 1999-2001E. The IB sector is currently trading at 6.9x 2012E P/E on average for European IBs and 7.3x 2012E P/E for US IBs, reflecting low growth expectations. We estimate pre-tax earnings growth of 13% CAGR 2010E-12E for US IBs and slightly higher for European IBs with 16% CAGR however our growth rates for Europeans are distorted by i) UBS which is still in a turnaround mode in 2010 and ii) SG which is still cleaning its legacy assets portfolio in 2010-11E. Adjusted for these banks, our 10E-12E CAGR estimates for the European IBs are 12% on average. This compares to the 12.8x PE valuation for European IBs with growth expectations of 23% back in 2000, or the 13.3x for US IBs for 15% growth expectations. In our view, current valuations account for very low growth expectations.
Table 39: Global Investment Banks Current valuation & growth vs. historical peak
$ million Price (local ccy) 47.1 50.0 18.2 53.4 44.4 325 3.91 147.3 13.5 26.7 Market Cap ($m) 54,866 40,001 68,601 82,491 42,672 60,432 349,063 113,287 79,615 135,457 37,243 365,601 Current valuation & growth Group PE 12E Group pretax CAGR 10E-12E 6.7 15% 6.5 9% 7.6 22% 7.1 11% 6.2 27% 7.5 13% 6.9 16% 6.6 9.0 6.0 7.5 7.3 8% 8% 23% 13% Historic "peak" valuation & growth 2 yr fwd PE 1999-2001E 13.9 15.6 14.4 10.3 11.3 11.7 12.8 16.3 14.2 8.6 14.1 13.3 21% 39% 11% 27% 23% 13% NA NA 9% 15% Performance 2003-2010YTD -1% -25% -54% 3% -35% -37% -25% -92% 38% -69% -49% -43%
Credit Suisse Deutsche Bank UBS BNP Paribas Socit Gnrale Barclays European IB Citigroup Goldman Sachs Bank of America Morgan Stanley US IB
Source: J.P. Morgan estimates, Company data, Bloomberg (priced as of COB 3 Sept 2010).
IB divisional valuation 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-12E. However, we already account for this in our valuation, as shown in Table 40, where we assume SOP PE multiples in the range of 5.5x-8.0x for the IB divisions of global investment banks.
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Table 40: Global Investment banks SOP multiples for the IB division 2012E
x, % IB P/BV GS MS DB CS UBS SG BNP BARC Avg. 1.8 1.0 0.7 1.2 1.1 0.6 0.9 1.3 1.1 IB PE 7.5 7.5 7.5 6.5 5.5 8.0 8.0 7.8 7.3 IB earnings 10E-12E 2% 8% 0% 14% 25% 15% 1% 1% 8%
At current prices, IB businesses implied P/BV at 0.7x vs. 1.1x in our SOP valuations The implied P/BV valuation for the IB divisions is 0.7x at current market prices, as shown in Table 42 below. This is well below our 1.1x p/BV estimate for IB businesses in our SOP valuations. Socit Gnrale, BNP Paribas and UBS have the lowest implied P/BV of 0.3x on average, compared to our SOP estimates of 0.9x. Credit Suisse and Morgan Stanley with average implied P/BV of 0.7x for IB businesses vs. 1.1x in our SOP estimates look relatively cheap, while Deutsche Bank CB&S division has an implied P/BV of 0.8x, higher than our estimated 0.7x in our SOP valuation. 15% upside to current prices with IB at 1x book value In our SOP, we value Investment Banking businesses at 1.1x BV. However, the IB businesses are valued at 0.7x BV at current share prices. Even valuing the IB divisions at 1x BV would imply 15% upside. Socit Gnrale would have the highest upside of 54% to current prices, followed by BNP Paribas and Morgan Stanley with 25% upside on average Goldman Sachs and Barclays would have downside of 14% and 25% respectively to current prices, if we value their IB division at 1x BV, rather than the average 1.5x that we have in our SOP valuations. Valuing their IB businesses at 1x would however be too pessimistic in our view given the relatively high returns on higher capital base accounting for conservative market risk calculations. 44% downside to current prices with IB at zero Valuing the IB business at zero would imply 44% downside on average for Global Investment banks. However, based on history, this is only a likely event in a capital at risk crisis such as the structured credit crisis or EM crisis - which we view as an unrealistic scenario at this point.
Table 41: Global Investment Banks - SOP divisional multiples

x Retail EM retail Investment Bank Asset Mgt Private Banking
SOP PE 8.0x-9.5x 8.5x-10x 5.5x-8.0x 8.5x-9.5x 9.0x-10x
Table 42: Global Investment Banks - P/BV of the SOP Investment Banking division and sensitivity to group valuations 2012E
Local currency per share Goldman Sachs 147.3 175 114 62 1.8 7.5 64.6 1.3 64.6 126 -14% 62 -58% Morgan Stanley 26.7 33 20 13 1.0 7.5 19.7 0.7 19.7 33 24% 13 -50% Deutsche Bank 50.2 46 36 9 0.7 7.5 51.8 0.8 51.8 61 21% 9 -82% Credit Suisse 47.1 59 26 33 1.2 6.5 22.2 0.7 22.2 55 16% 33 -31% UBS 18.2 22 6 16 1.1 5.5 5.6 0.3 5.6 22 21% 16 -10% Socit Gnrale 44.4 58 19 39 0.7 8.0 29.1 0.2 29.1 68 54% 39 -12% BNP Paribas 53.4 65 24 42 0.9 8.0 26.0 0.5 26.0 68 27% 42 -22% Barclays 3.3 3.0 2.7 0.4 1.3 7.8 2.1 1.4 2.1 2.4 -25% 0.4 -88% Average 1.1 7.3 0.7 15% -44%
Current share price SOP TP group SOP Value for the Investment Bank Implied SOP value rest of the group P/BV IB PE IB BV/share IB Implied P/BV of IB at current prices SOP value IB at 1x BV Implied SOP group Upside SOP group with IB at 0 Upside
Source: J.P. Morgan estimates, Bloomberg. Priced from Bloomberg as of COB 3 Sept 2010. Note: Barclays SOP based on 2011E earnings
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Low IB valuations despite more manageable regulatory changes

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 derivatives regulation and Basel changes for market risk and counterparty risk. We believe the negative impact from regulation has however been reduced in June/July 2010 with the less punitive versions of Basel 3 and US financial reform (Dodd-Frank Wall Street Reform and Consumer Protection Act).
Table 43: Global Investment banks 2011E ROE in the investment banks pre and post regulation changes**
% IB ROE 2011E 1. Clearing via CCP 2. Moving OTC der. to exchange trading 3. OTC post trade transparency 4. Volcker proposed limits 5. Stressed VaR capital buffer 6. Incremental Risk Charge 5&6. Management guidance 7. Securitisation capital charge 8. Higher capital on non CCP clearing 9. Section 716 US regulation Total impact Resulting IB ROE CS 23.5% 1.6% -3.5% -0.8% -1.9% -2.0% -2.8% -3.8% -1.0% -2.3% 0.0% -10.5% 13.0% UBS 22.7% 3.6% -3.6% -1.0% -1.7% -1.2% -2.3% -4.9% -1.8% -3.4% 0.0% -11.2% 11.5% DB 19.9% 2.4% -3.1% -0.9% -1.7% -1.0% -2.2% -4.0% -1.1% -2.5% 0.0% -9.4% 10.5% GS 23.4% 2.4% -2.4% -0.8% -1.5% -2.0% -1.2% -0.9% -2.4% -2.8% -9.6% 13.8% MS 19.0% 1.8% -0.6% -0.9% -1.1% -2.0% -0.8% -0.7% -1.9% -1.5% -6.6% 12.4% BNP 19.2% 0.3% -0.5% -0.5% -0.7% -0.9% -1.8% -3.4% -0.4% -0.7% 0.0% -5.4% 13.8% SG 17.2% -0.2% -0.5% -0.7% -0.7% -0.6% -1.3% -4.8% -0.7% -0.9% 0.0% -7.0% 10.2% BARC 17.8% 1.0% -1.4% -0.8% -0.6% -1.2% -1.5% 0.0% -1.0% -1.1% 0.0% -5.8% 12.0% Average 20.3% 1.6% -1.9% -0.8% -1.3% -1.4% -1.7% -3.5% -1.0% -1.9% -0.5% -8.2% 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.
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 reprice transaction margins upwards to make an acceptable ROE, which we have not factored in the analysis. IBs need to demonstrate that they can achieve a 15% ROE in the long run, as so far, cost management has been disappointing, e.g. Credit Suisse, Goldman Sachs and Barclays in H1 10. Although regulatory changes should significantly decrease IB returns, most investment banks could still achieve a 15% IB ROE in our analysis. 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. Credit Suisse and UBS would have to make less adjustments: they would have to cut IB comp per head by only -16% on average in 2011E compared to 2009E. Both banks would have the highest IB comp ratio with 45% and 40% respectively.
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GS, MS, Barclays and Deutsche Bank would have resulting IB comp ratio of 34% on average. Goldman Sachs would have to reduce costs by -40% and payout only 36% comp ratio, however, the group would remain competitive as IB comp/head would remain one of the highest in the industry. Socit Gnrale and BNP would have to reduce IB comp by -50% and -43% respectively, and both banks would have to run IBs with extremely low comp ratios - below 30%, which is unrealistic in our view. If our scenario for returns happens, we believe that i) the business model would have to be adapted or they would have to consider exiting the business or opt for an agency model as opposed to a full service broker.
Table 44: Global investment banks Reaching 15% IB ROE by adjusting IB comp/head
Credit Suisse -19% 45% 15.0% UBS -14% 40% 15.0% Deutsche Bank -29% 37% 15.0% Goldman Sachs -40% 36% 15.0% Morgan Stanley -33% 33% 15.0% BNP Paribas -43% 29% 15.0% Socit Gnrale -50% 19% 15.0% Barclays -27% 31% 15.0% Average -32% 34% 15.0%
Cut in IB Comp/head 2011E vs. 2009E Resulting IB comp ratio* IB ROE
Source: J.P. Morgan estimates, Company data. For Barclays, please note the compensation ratio in 2009 was significantly lower on a clean basis due to significant writedowns.
Stock Selection
Prefer US IBs vs. European IBs
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 with regulatory changes structurally reducing profitability. In this scenario, we would look prefer banks which could offer potential upside through re-leveraging. Relative to European Investment Banks, US Investment Banks are better capitalized, with: Higher Basel 3 equity Tier I ratios of 12% on average compared to 10% for European IBs, Better leverage ratios with 7% vs. 4% for European IBs on a comparable US GAAP basis, and even under preliminary Basel 3 proposals, we estimate 6% Basel equity Tier I leverage ratio vs. 3% for European IBs, More conservative methodology in calculating market risk than European peers US IBs mostly use the standardized approach for calculating market RWAs whilst European IBs use the internal-model based approach, which tends to be more favourable, even under new Basel 2.5 rules. For more details on market RWA issues, please refer to our report Global Investment Banks: Market RWA consistency questioned" on 6 July 2010. Cleaner balance sheet assets as US IBs do not have significant loan book exposure, marked-to-market their structured credit risk assets unlike European IBs many of which have reclassified trading assets to the loan book to avoid mark-to-market losses. Regulatory risk over-discounted in our view, as the Dodd-Frank bill has already been signed off, and US banks have limited impact from Basel 3. Whilst
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there are still numerous rule making to come with a few uncertainties remaining, we believe that the bulk of US financial regulation has already been priced in. With higher capitalisation levels, new Basel 3 minimum requirements are less of an issue for US IBs vs. European IBs which have lower capitalization levels or do not yet meet the new standards, and should hence be more sensitive to regulatory issues in our view. US IBs have underperformed European IBs by -8% over the past three months, which is undeserved in our view given their better capital position and the higher potential for re-leveraging. We expressed in report Global Investment Banks: Market RWA consistency questioned" on 6 July 2010 our preference for US IBs at similar valuation as Europeans but better risk profiles, and reiterate our stance. 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, which they could use to repurchase shares. Assuming both banks use all their excess capital for a share buyback, they would remain well capitalised with Basel III equity Tier1 ratios of 9.9% and 9% respectively in 2012E post the assumed buyback.
Table 45: Global Investment Banks: Split of allocated Capital 2012E
Local currency million, % Goldman Sachs Allocated capital Investment Bank Other businesses Unallocated Total Unallocated Capital as % of current Mkt. cap Investment Bank Other businesses Unallocated Total 40,331 13,498 29,476 83,305 37% 48% 16% 35% 100% Morgan Stanley 29,337 5,275 18,500 53,112 50% 55% 10% 35% 100% Deutsche Bank 34,466 8,242 -12,455 30,253 -40% 114% 27% -41% 100% Credit Suisse 27,293 5,638 5,883 38,814 11% 70% 15% 15% 100% UBS 22,083 8,407 16,670 47,160 24% 47% 18% 35% 100% Socit Gnrale 21,371 19,012 -4,791 35,592 -14% 60% 53% -13% 100% BNP Paribas 30,969 29,209 7,213 67,391 11% 46% 43% 11% 100% 11% Average
Source: J.P. Morgan estimates. Priced from Bloomberg as of COB 3rd September, 2010.
We run a sensitivity scenario assuming US IBs use their respective excess capital to buy back shares at current share price, in Table 46 below. We conclude that both GS and MS look cheap on both earnings and P/TBV multiples with a share buyback done at or below BV. GS would trade at 6.2x 2012E earnings, 1.1x NAV for an RoNAV ex own debt of 17%, whilst MS would be trading at 4.8x 2012E earnings, for an RoNAV ex own debt of 17%.
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Table 46: US IBs solid capital position even in a share buyback scenario
$ million, % Capital Surplus Current Market Cap Share Buyback Buyback as % Market Cap Old EPS New EPS % change Risk weighted Assets Basel III Equity Tier 1 (old) Basel III Equity Tier 1 (new) Basel III Equity Tier 1 (old) Basel III Equity Tier 1 (new) Old NAV/share New NAV/share Old RoNAV ex own debt New RoNAV ex own debt PE (old) PE (new) P/NAV (old) P/NAV (new)
Source: J.P. Morgan estimates, priced from Bloomberg 3rd Sep 2010 (intraday).
GS 29,051 75,555 29,051 38% 16.40 23.46 43% 542,732 82,878 53,827 15.3% 9.9% 139.3 135.6 11.8% 17.3% 8.9 6.2 1.0 1.1
MS 18,500 35,874 18,500 52% 3.58 5.55 55% 386,434 53,112 34,612 13.7% 9.0% 30.2 32.2 11.8% 17.2% 7.4 4.8 0.9 0.8
Bottom-up stock picking

Our pecking order is 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 capitalised banks with the capacity to buy back shares, 2) relatively resilient private banking exposure, 3) equity gearing over fixed income within IB.
Table 47: US IBs and Swiss banks preferred stocks
Capital Goldman Sachs Morgan Stanley UBS Credit Suisse Socit Gnrale BNP Paribas Barclays Deutsche Bank
Leverage X
X X X X
Business Mix (prefer Private Banking exposure) X X -
IB revenue mix (prefer Equity gearing) X X X X
1) Prefer well capitalised banks with the capacity to buy back shares: GS, MS We would seek exposure to banks with high levels of capitalization, enabling them to improve returns for shareholders - we believe that US Investment Banks Goldman Sachs and Morgan Stanley could buy back shares, unlike their European peers which
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are less well capitalised or Swiss peers which are subject to demanding requirements and have to build up capital. Based on Basel III Equity Tier I, US Investment banks remain the highest capitalised banks within Global Investment Banks, with Basel III equity Tier I of 12% on average compared to 10% for European IBs. In Table 48 below, we show Global Investment Banks Tier I ratios under the latest Basel III proposals. On average, we estimate that Core Tier I ratios decline by c.80bp on average from 10.5% to 9.8% due to Basel III. GS and MS remain amongst the best capitalised banks with average Basel III Equity Tier 1 ratios of 13.8% and 10.8% respectively end 2011E. We estimate that both banks have significant excess capital - $29bn for GS and $18bn for MS which they could use to buy back shares. UBS and CS remain well capitalised in our analysis with Basel III equity Tier 1 ratio of 11.5% and 10% respectively end 2011E. Note that we do not account for any dividend payouts for UBS in 2010E-012E, whilst we still estimate DPS of SF2.00 in 2010E-012E for CS. Both banks have excess capital SF6bn for CS and SF17bn for UBS but they are unlikely to buyback shares as the Swiss regulator will require 16% Core Tier I ratio in the medium term. Significant capital deficits at Barclays and Deutsche Bank: Barclays and Deutsche Bank Basel III Equity Tier 1 ratios look relatively low vs. other IB peers, with 5.6% for DB and 8.3% for Barclays end 2011E. We estimate capital deficits of 7.0bn for Barclays and 12bn for DB, compared to our minimum capital required based on our divisional capital allocation. For details on our allocated capital calculation, please refer to our note Global Investment Banks: Market RWA consistency questioned: DB downgrade to UW, upgrade GS to OW published on 6 July 2010. French Banks BNP Paribas and Socit Gnrale Basel III equity Tier I ratios are also relatively low vs. Global IB peers, at 8.4% and 7.3% respectively. However, French banks benefit from a better business mix with a higher gearing to more stable retail activities which require less capital over the cycle.
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Table 48: Global Investment Banks: Basel III Equity Tier 1 ratio 2011E
local ccy millions, %
2011E Tier 1 Capital Hybrids - deducted Preference shares - deducted Core Tier 1 Deferred Tax Assets Minority Interests (allowing 80% in capital) Shortfall of provisions to expected losses AFS reserves - gains or losses included 100% Insurance subsidiaries Unconsolidated Investments 1st loss securitisation deductions pension fund assets Other Deductions Core Tier 1 used for capital addition limits Maximum allowed aggregate recognition DTAs at 40% cap Unconsolid. Investments & Insurance subsid.. Max Allowed Individual Inclusion DTAs at 40% cap Unconsolid. Investments & Insurance subsid. Final inclusion DTAs at 40% cap Unconsolid. Investments & Insurance subsid. Aggregate Capital addition Basel III Equity Tier 1 Risk Weighted Assets Core Tier 1 ratio Basel III Equity Tier 1 ratio Source: J.P. Morgan estimates, Company data. CS 44,796 -12,222 32,574 -3,561 -364 -751 -100 -1,000 26,798 4,729 3,561 2,978 3,373 2,978 0 2,978 29,776 296,652 11.0% 10.0% UBS 44,655 -6,964 37,691 -622 -1,465 377 -600 -2,368 -3,886 29,127 5,140 622 1,200 3,370 3,305 622 1,200 1,822 30,949 269,195 14.0% 11.5% DB 39,227 -11,564 27,663 -1,789 -207 -1,063 -2,277 -4,165 18,162 3,205 1,789 4,554 2,524 2,217 1,789 2,217 3,205 21,367 378,536 7.3% 5.6% GS 85,365 -5,000 -6,957 73,408 73,408 12,954 8,156 8,156 0 0 0 73,408 532,090 13.8% 13.8% MS 61,524 -12,916 -7,407 41,201 41,201 7,271 4,578 4,578 0 0 0 41,201 382,608 10.8% 10.8% BNP 74,352 -11,905 -1,445 61,002 -4,620 -1,721 550 -3,600 -1,146 50,466 8,906 4,620 5,892 6,262 6,121 4,620 5,892 8,906 59,371 706,532 8.6% 8.4% SG 39,435 -6,800 -1,000 31,635 -1,550 -600 -200 -2,200 -1,264 -1,000 24,821 4,380 1,550 4,728 3,283 2,930 1,550 2,930 4,380 29,201 398,549 7.9% 7.3% BARC 59,207 -10,183 -1,017 48,007 -733 -470 -25 226 -5,610 -2,799 -431 -880 37,285 6,580 733 11,220 5,389 4,224 733 4,224 4,957 42,242 508,915 9.4% 8.3% BOA-ML 177,800 139,665 -11,520 -367 127,778 22,549 11,520 14,198 15,478 11,520 0 11,520 139,298 1,508,529 9.3% 9.2% CITI 153,050 136,540 -6,080 -4,200 126,260 22,281 6,080 14,029 14,704 6,080 0 6,080 132,340 1,035,859 13.2% 12.8% 10.5% 9.8% Avg.
Based on Basel III Tier I leverage ratio, GS and MS are also the best capitalized banks, with 8.3% and 5.4% respectively end 2011E. In Table 49 below, we calculate the Basel III equity Tier 1 leverage ratios for the banks in our analysis. We have also estimated Basel III Tier I leverage ratios, assuming an allowance of 15% of hybrids in the Basel III Tier 1 capital. On average, we estimate Basel III equity Tier I leverage of 3.6% and Basel III Tier I leverage of 4.2% for Global Investment Banks, above the minimum 3% initially suggested by the Basel Committee. GS and MS again come out the strongest with 2011E Basel III Tier 1 leverage ratios of 8.3% and 5.4% respectively and thus tick the box on our preference for banks with structurally lower leverage. DB with a Basel III Tier 1 leverage ratio of 1.8% end 2011E is the worst capitalised bank within Global IBs. This would be lower than the minimum 3% initially suggested by Basel, however, the Tier I leverage requirement does not migrate to a Pillar I treatment until 1 Jan 2018. Barclays and the French banks BNP, SG have Tier I leverage ratios of 4.6%, 4.5% and 3.5% respectively.
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Table 49: Leverage ratios under US GAAP vs. JPM core tier 1 and Basel III basis, 2011E
local currency, billions, % CS US GAAP' leverage ratio Old US GAPP pro forma assets Tier 1 capital Core Tier 1 capital Tier 1 leverage ratio (%) Core Tier 1 leverage ratio (%) New leverage ratio Total reported assets 2011E Derivatives netting Exclude previous capital deductions Exclude new capital deductions Add off balance sheet items (10% CCF) Adjust up for derivative potential exposure Basel III adjusted assets Basel III Equity Tier 1 Basel III equity tier 1 leverage ratio (%) Including 15% Hybrids in Basel III equity tier 1 Basel III equity tier 1 leverage ratio with 15% hybrids (%)
UBS 1,063 45 38 4.2% 3.5% UBS 1,554 -403 -11 -14 14 96 1,236 31 2.5% 36 2.9%
DB 1,031 39 28 3.8% 2.7% DB 1,926 -642 -12 -18 18 129 1,401 21 1.5% 25 1.8%
GS 873 85 73 9.8% 8.4% GS 883 -10 -12 7 168 1,035 73 7.1% 86 8.3%
MS 798 62 41 7.7% 5.2% MS 809 -12 -20 12 103 893 41 4.6% 48 5.4%
BNP 1,315 74 61 5.7% 4.6% BNP 1,775 -291 -12 -16 38 72 1,567 59 3.8% 70 4.5%
SG 853 39 32 4.6% 3.7% SG 1,024 -142 -9 -11 21 87 970 29 3.0% 34 3.5%
BARC 937 59 48 6.3% 5.1% BARC 1,334 -309 -8 -17 26 45 1,071 42 3.9% 50 4.6%
Avg.
1,143 45 33 3.9% 2.8% CS 1,153 -10 -15 24 92 1,244 30 2.4% 35 2.8%
5.8% 4.5% Avg.
3.6%
4.2%
We would prefer banks which can potentially buyback shares, GS and MS. GS, MS and Swiss IBs UBS, CS are our preferred banks due to their strong capital position. We believe the shareholders of these banks could be rewarded through share buybacks. For Swiss banks, however, we believe a share buyback is unlikely under current scenarios as they have to reach and maintain a Core Tier 1 ratio of 16% according to FINMA guidelines in our view. On our estimates UBS can reach a 16% Core Tier I by 2012E, Credit Suisse by 2013E-014E, through retained earnings, as illustrated in Table 50 and Table 51 below. Note however that UBS gets the benefit of 0 dividend payout assumption whilst we assume dividend of SF2.00 throughout for CS.
Table 50: UBS Solid Capital Position: 16% Core Tier 1 ratio achievable by 2012E
% Basel II Stated Tier 1 ratio Basel II Core Tier 1 ratio Basel III Equity Tier 1 ratio
2009 15.4% 11.9% -
2010E 17.2% 13.9% -
2011E 16.6% 14.0% 11.5%
2012E 19.1% 16.7% 14.3%
2013E 22.5% 20.0% 17.6%
2014E 25.8% 23.4% 21.0%
2015E 29.2% 26.7% 24.3%
2016E 32.5% 30.1% 27.7%
2017E 35.9% 33.4% 31.1%
Table 51: Credit Suisse Core Tier 1 ratio of 16% achievable by 2013-2014E
% Basel II Stated Tier 1 ratio Basel II Core Tier 1 ratio Basel III Equity Tier 1 ratio
2009 16.3% 10.8% -
2010E 16.4% 11.4% -
2011E 15.1% 11.0% 10.0%
2012E 16.4% 12.5% 11.6%
2013E 18.4% 14.5% 13.6%
2014E 20.4% 16.5% 15.6%
2015E 22.4% 18.5% 17.6%
2016E 24.4% 20.5% 19.6%
2017E 26.4% 22.5% 21.6%
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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. We believe that private banking has more limited regulatory risk, and the main players would reap most of the benefits from improving equity markets. UBS and Credit Suisse have material private banking exposures accounting for c.30% of group net profits in 2012E, providing a source of more stable cash flow generation with limited credit risk and long term growth (despite currently difficult market conditions), in our view. Despite its gearing to equity markets, and regulatory risk surrounding offshore private banking, we believe private banking remains the most profitable banking business overall in the current environment. We view the offshore banking concerns as overdone and believe they are already discounted within the Swiss banks, with newsflow to slow. UBS and CS trade at 1.3x and 1.5x 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.
Table 52: Implied 2012E valuation multiples ex Wealth Management
Local currency CS SoP basis 8,612 2,729 5,884 47.1 1,231 57,977 10.0 27,286 30,692 36,920 1,558 35,362 0.9 16.6% 5.2 WM U.S. peer group basis 8,612 2,729 5,884 47.1 1,231 57,977 12.8 34,870 23,108 36,920 1,558 35,362 0.7 16.6% 3.9 UBS SoP basis 9,469 2,738 6,731 18.2 3,946 71,931 10.0 27,379 44,552 53,941 2,205 51,736 0.9 13.0% 6.6 WM U.S. peer group basis 9,469 2,738 6,731 18.2 3,946 71,931 12.8 34,989 36,942 53,941 2,205 51,736 0.7 13.0% 5.5
Group net income WM 2011E net income Ex WM net income Share price NOSH Group market cap Assumed WM PEx PE implied WM mkt value Ex WM group mkt value Group NAV o/w WM capital Ex WM group NAV Ex WM Implied P/NAV (x) Ex WM RoNAV Ex WM PE (x)
Source: J.P. Morgan estimates, Bloomberg (based on prices at COB 3 Sept 2010).
We value the Wealth Management business at 10x PE 2012E, below the average 13x for US peers or 11x for European peers.
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Table 53: Private bank peer group 2012E P/E multiples

Local currency Blackrock T-Rowe Price Janus Group US Peer Group Julius Baer Van Lanshot EFG Group Average Share price 151.6 48.1 10.1 38.3 31.0 11.3 EPS 2012E 12.4 3.1 0.9 3.3 3.6 1.9 P/E 2012E 12.2 15.3 10.9 12.8 11.6 8.5 5.9 10.7
Source: Bloomberg (based on prices at COB 3 Sept 2010).
Looking at the business mix for the Global Wholesale and Investment Banks, Swiss banks Credit Suisse and UBS have the highest gearing to asset gathering accounting for 35% and 45% of group net income in 2011E. For GS and MS, IB division contributes to 74%-91% of group net income in 2011E. Morgan Stanley has also gearing to Wealth Management with its JV, however, exposure to asset gathering/private banking is less significant than the two Swiss banks with Global WM accounting for only 12% of group earnings. Within the European IBs, DB has the highest gearing to Investment Banking activities with CB&S accounting for 65% of 2011E group net income followed by CS at 60% and UBS at 46%. French banks BNP and SG derive relatively lower share of net income at 44% and 34% from IB division in 2011E, with retail and financial services contributing 58% on average to the 2011E group net income.
Table 54: Global Investment Banks Split of group net income by divisions 2011E
% Goldman Sachs 0% 9% 91% 0% 0% 100% Morgan Stanley 0% 17% 74% 0% 10% 100% Deutsche Bank 13% 9% 65% 11% 2% 100% Credit Suisse 9% 35% 60% 0% -4% 100% UBS 19% 45% 46% 0% -10% 100% Socit Gnrale 64% 7% 34% 0% -5% 100% BNP Paribas 52% 17% 44% 0% -13% 100% Barclays 45% 5% 82% 0% -32% 100%
Retail & Financial Services Asset gathering CIB Transaction banking Other Total
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 to equities 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. GS is however even more geared to Fixed Income which accounts for 60% of IB revenues and 51% of group revenues.
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Barclays and Deutsche Bank are mainly fixed income houses with FICC accounting for 60-65% of total IB revenues and 29-34% of group revenues. These two banks are the most exposed to a decline in fixed income revenue in our view. Socit Gnrale is mainly an equity derivatives house in its CIB business, with equities accounting for 40% of total CIB revenues. However, as the business mix is more diversified with higher gearing to retail activities, equities only account for 11% of group revenues.
Table 55: Global Investment Banks - Fixed Income and Equities as % of Group 2011E revenues
Local ccy in millions, % Credit Suisse 34,661 19,508 8,160 6,844 42% 35% 24% 20% UBS 35,214 15,217 6,586 5,166 43% 34% 19% 15% Deutsche Bank 30,294 17,215 10,261 3,064 60% 18% 34% 10% Goldman Sachs 37,148 31,725 19,038 9,767 60% 31% 51% 26% Morgan Stanley 32,612 17,211 7,582 5,075 44% 29% 23% 16% BNP Paribas 43,086 11,790 4,800 2,454 41% 21% 11% 6% Socit Gnrale 26,199 7,250 2,000 2,900 28% 40% 8% 11% Barclays 32,122 14,319 9,256 2,749 65% 19% 29% 9%
Group revenues IB revenues Fixed Income clean Equities clean Fixed Income clean % clean IB revenues Equities clean % clean IB revenues Fixed Income clean % clean group revenues Equities clean % clean group revenues
The equities industry remains dominated by Goldman Sachs and Credit Suisse, which generate $9.8bn and $6.3bn of revenues respectively in 2011E, as illustrated in Table 56 below. GS has the most comprehensive equities platform with strengths in all areas of cash, derivatives to prop. As detailed in this note, Socit Gnrale is one of the largest players in equity derivatives but is a very small player in cash equities and has no prime brokerage activities. In Fixed Income, the largest players are by far Goldman Sachs, Deutsche Bank and Barclays with respectively $19bn, $13.5bn and $12bn of revenues in 2011E. We expect UBS to recover some of its market shares, generating revenues of $6.1bn in 2011E, up from $2.9bn clean in 2009, closer to industry average.
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Table 56: Global Investment & Wholesale Banks - Detailed split of Investment Banking revenues 2011E
$ million GS IB Fees Advisory Equity Underwriting Debt Underwriting Other Total Advisory & Underwriting Fixed Income SPG Credit Trading FX & Rates FX Rates GEM Commodities Prop trading Total Fixed Income revenues Equities Equity Derivatives Cash equities Prime brokerage Prop trading/other equity-related Total equities revenues Credit Portfolio Underlying CVA Other Total IB Revenues 2,176 1,355 1,093 4,624 705 4,573 6,299 1,653 4,646 803 4,320 2,337 19,038 3,604 2,935 1,728 1,500 9,767 0 0 0 34,429 MS 1,575 1,293 1,431 4,298 200 456 2,831 918 1,913 408 2,549 1,140 7,582 1,392 1,235 1,729 718 5,075 0 0 0 16,955 UBS 908 1,492 814 3,214 160 1,892 2,339 1,391 948 588 245 884 6,107 1,711 1,625 898 556 4,791 0 0 0 14,112 CS 1,604 985 1,907 4,496 681 1,242 4,192 705 3,487 651 338 464 7,567 1,913 2,556 1,322 556 6,347 0 0 0 18,410 DB 772 836 1,787 3,395 1,070 3,574 5,347 2,793 2,554 681 778 2,067 13,518 1,560 1,156 860 460 4,036 2,175 0 0 23,124 BNPP 190 90 200 480 313 395 4,422 1,197 3,225 359 216 619 6,323 2,554 82 249 629 3,513 5,517 0 0 15,834 SG 60 85 75 220 100 276 1,893 762 1,131 177 120 298 2,864 3,316 223 0 614 4,153 3,145 0 0 10,383 BARC 1,126 853 1,251 182 3,412 522 1,418 6,041 937 5,104 1,946 996 881 11,803 1,819 571 1,259 406 4,055 1,850 0 0 21,120 HSBC 1,423 569 854 2,847 382 1,082 2,125 1,095 1,030 3,004 1,163 7,756 275 393 1,521 118 2,306 135 0 0 13,044 RBS 595 476 1,310 2,382 18 3,277 1,530 806 724 740 0 1,839 7,357 762 870 218 326 2,176 0 0 11,914
Source: J.P. Morgan estimates, Company data. Notes: i) we used 1.08 for CHF/USD and 0.76 for USD/EUR rates. ii) most of the French banks commodities-related revenues are not reported in the capital markets Sales & Trading but in Financing, unlike European IBs and we have included French banks financing revenues in "Credit Portfolio", iii) Barclays Currencies includes commodities.
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Bottom-up stock selection

Goldman Sachs new top pick within Global IBs: GS trades at 1.2x tangible BV 2011E, despite higher visibility in respect to regulation and a much more manageable section 716 outcome. We expect GS to be materially impacted negatively by regulatory changes as discussed in our report Dodd/Lincoln bill analysis: implications for the future structure of the IB industry on 29 April 2010; however, with a lower compensation ratio GS in our view will be able to generate an ongoing RoNAV of 15% and should re-rate over time. We do not believe GSs franchise is impaired (except asset gathering) following recent legal issue concerns however, we would welcome a more focused GS increasing shareholder value by spinning off its asset management, private bank, and principal investment businesses to shareholders. In terms of risk management, our market RWAs analysis illustrates its best in class approach, and the group has excess capital of $29bn in our estimates, with i) Core Tier I of 15.3% end 2012E which already include the higher market risk requirements under Basel 2.5, and ii) limited impact from Basel 3. Prefer US IBs vs. European IBs OW Morgan Stanley but prefer Goldman Sachs. GS trades at 1.2x Tangible BV vs. MS at 1.0x fully diluted tangible BV 2011E, for similar returns of 14%. With MS GWM an important earnings driver going forward, no capital issues, and a cleaned up structured credit book franchise re-rating is possible over the long-term in our view and we remain OW Morgan Stanley. However, we prefer GS as i) the group has the best equity franchise with the strongest positions in most of the businesses, ii) highest restructuring potential with GS able to reallocate capital faster to adapt to the new regulatory environment - we believe that its Principal Investments business could be potentially spun-off to free up capital, although the company has made no statement on this. Eventually, GS could become smaller with few businesses but more profitable. Within European IBs, prefer UBS: We see UBS's risk-reward as highly attractive for long-term shareholders, based on our scenario analysis. UBS is currently trading at 8.3x PE 2011E, 1.6x NAV 2011E ex own debt for a RoNAV ex own debt of 21.0% in 2011E. Our OW recommendation on UBS rests on scenario analysis showing that UBS offers value in our base case and limited downside if the expected IB earnings recovery is not delivered. In addition, assuming managements medium term targets are met by 2011E, the upside in our blue sky scenario is material. We believe the IB turnaround is the key share price trigger, and net new money will come later. For further details, please refer to our report UBS: Gruebels make or break year: remain OW on risk reward analysis on 15 April 2010. Credit Suisse - OW. CS valuation appears attractive, trading at 7.9x PE 2011E, 1.8x P/NAV for a RoNAV ex own debt of 26.2% in 2011E. In our view, CS continues to tick all the right boxes: i) attractive business mix with the highly cash generative WM business accounting for 32% of group profits but only 4% capital, ii) strong capital position with a Basel 3 Equity Tier I of 10% in 2011E, iii) strong and stable management team. Stripping out WM valued at PE 11.0x 2011E would imply that the rest of the group (IB, retail, AM) is valued at 0.9x P/NAV for 16.6% RoNAV. For further details, please refer to our report Credit Suisse Group: Blue Sky analysis Sfr90: Remain OW on 15 April 2010. We however now prefer UBS over CS as market expectations remain lower for UBS, and we see higher potential for UBS to close the FICC revenue gap to industry average whilst we are disappointed with CSs ability to close its FICC gap to top 3 so far with also questionable cost management.
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Deutsche Bank - reiterate Underweight: The stock has underperformed the banking sector by -3% since our report of 6 July. Adjusting DBs valuation for its reliance on internal models for market risk reducing VAR-IRC related market RWas to 50% of total market risk, we would then estimate $43bn or 12.7% adjusted T1 2011E in IB required for DB compared to DB allocating just $22bn of capital to IB division. Clearly, our IB capital allocation analysis is based on material assumptions as there is no disclosed data. For more details, please refer to our report Global Investment Banks: Market RWA consistency questioned on 6 July 2010. On top of its capital deficit, there remains the fact that DB needs to fair value (not mark-to-market) its 34bn IAS39 reclassified assets, which would have negatively impacted shareholders equity by 3bn, had the assets not been reclassified. Hence, with our 12bn group SOP capital deficit, we believe DB needs to raise equity to rerate continuously above 1x 2011E TBV. With a SOP-based TP of 46 (Dec-11E), we see limited upside and find better value in cheaper tangible BV Banks. DB trades at 1.0x NAV ex own debt in 2011E for RoNAV of 15.4%; however, UBS and CSG would both trade at 1.0x NAV stripping out the WM business cheaper vs. DB generating 65% of profits from the IB. MS also trades at 1.0x tangible BV fully diluted in 2011E, with no capital issues and no material structured credit risk all on a mark-to-market basis, in our view. GS trades at 1.2x 2011E tangible BV. Socit Gnrale remains one of our top picks within European banks. Socit Gnrale valuation looks very attractive at 1.0x tangible BV of 44.2 ex own debt, RoNAV of 15% in 2011E, PE of 6.2x in 2012E with JPMCe 2012 EPS of 7.20 still below SG implied target of c.8.20, and strong cash generation retail and Asset Gathering account for 71% of group earnings in 2012E. In terms of strategy, SG is highly geared operationally to an improving environment both in terms of CEE as well as legacy asset exposure. In addition, we see asset disposal potential. The combination of earnings gearing as well as freeing up of capital through refocusing of businesses make SG very attractive in our view on a long-term basis. BNP Paribas remains an OW. Valuation is attractive in our view with BNPP trading at 7.7x 2011E PE and 1.2x NAV ex own debt for 16% RoNAV 2011E. In our view, BNP Paribas is well positioned for growth, remaining a counterparty of choice with strong cash flow generation and high gearing to a recovery in the credit cycle. The stock should re-rate in the long-term towards 1.5x tangible equity, however, short term upside could be capped by uncertainties in the macro environment with implied risk premium remaining high. Within the UK domestic banks, Barclays (Neutral TP 305p) is our preferred bank. With more clarity on the regulatory front and banks being given more time to comply with some of the new measures we see Barclays 2010E YE NAV at 354p per share as fairly secure. Despite the targets for Global Retail Banking announced earlier this year, especially with the appointment of Bob Diamond as Group Chief Executive we believe BarCap will remain the main earnings driver accounting for c.87% 2010E earnings. With IB earnings generally more subdued in the IB so far this year, the larger contribution from fixed income and the likelihood of a lower comp to revenue ratio should allow BarCap to produce a 2010E continuing PBT of 5.5bn. Barclays is our favourite domestic UK bank and is trading on 0.8x 2011E PNAV for a RoNAV of 11.4%. With a SoP-based Dec 2011 price target of 305p we see Barclays as range bound between 280p and 350p as the greater capital intensity of the business mix is also likely to weigh on the longer term sustainable return profile.
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Table 57: Summary wholesale and Investment Bank Valuation Table 2010E-2012E
Price TP Rec NAV 2011E NAV 2012E NAV ex own debt 2010E NAV ex own debt 2011E NAV ex own debt 2012E PE 2011E PE 2012E P/NAV 11E P/NAV 12E P/NAV ex own debt 11E P/NAV ex own debt 12E RONAV 11E RONAV 12E RONAV ex own debt gain 11E RONAV ex own debt gain 12E Core Tier 1 2011E (%)
UBS CSG DB Euro IBs SG BNPP CASA French Banks Barclays RBS HSBC UK Banks GS MS US IBs Total
18.2 47.1 50.2 44.4 53.4 10.9 3.25 0.47 6.54 147.3 26.7 -
22 59 46 58 65 15 3.05 0.42 9.00 175 33 -
OW OW UW OW OW N N UW OW OW OW -
11.6 26.2 50.5 44.4 46.7 10.8 3.89 0.51 7.26 125.5 27.4
14.0 31.1 56.4 49.8 52.0 11.9 4.26 0.55 8.25 140.6 30.8
9.1 21.0 44.9 39.9 41.6 9.77 3.51 0.51 6.35 110.1 23.6
11.3 24.9 50.4 44.2 46.4 10.64 3.76 0.51 7.13 124.7 26.8
13.7 30.0 56.3 49.6 51.7 11.70 4.17 0.55 7.84 139.9 30.2
8.3 7.9 6.8 7.8 7.1 7.7 6.6 7.3 7.8 28.9 9.4 13.0 9.3 7.7 8.8 10.0
7.6 6.7 6.5 7.0 6.2 7.1 5.4 6.5 7.5 11.0 7.6 8.3 9.0 7.5 8.5 7.7
1.6 1.8 1.0 1.5 1.0 1.1 1.0 1.1 0.8 0.9 1.4 1.2 1.2 1.0 1.1 1.2
1.3 1.5 0.9 1.3 0.9 1.0 0.9 1.0 0.8 0.9 1.2 1.1 1.0 0.9 1.0 1.1
1.6 1.9 1.0 1.6 1.0 1.2 1.0 1.1 0.9 0.9 1.4 1.2 1.2 1.0 1.1 1.2
1.3 1.6 0.9 1.3 0.9 1.0 0.9 1.0 0.8 0.9 1.3 1.1 1.1 0.9 1.0 1.1
21.0% 22.9% 14.6% 20.0% 14.9% 15.6% 15.9% 15.5% 11.4% 1.0% 16.0% 12.0% 13.5% 13.4% 13.5% 14.8%
18.8% 22.5% 13.7% 18.8% 15.3% 15.2% 17.7% 15.7% 10.9% 6.4% 17.5% 13.9% 12.4% 12.3% 12.4% 15.1%
21.6% 26.2% 15.4% 21.6% 15.0% 15.7% 16.1% 15.6% 11.4% 1.0% 16.0% 12.0% 13.5% 13.7% 13.6% 15.1%
19.2% 25.5% 14.5% 20.2% 15.3% 15.3% 17.9% 15.9% 11.0% 6.4% 17.7% 14.0% 12.4% 12.5% 12.4% 15.5%
14.0% 11.0% 7.3% 11.3% 9.1% 8.6% 9.4% 9.0% 9.4% 9.3% 11.5% 10.6% 13.9% 12.2% 13.4% 10.7%
Source: J.P. Morgan estimates, Company data. Priced from Bloomberg as of 3rd September 2010.
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60
Regulatory changes for Equity Derivatives

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Regulatory changes: impact analysis for the equities business

Proposal 1: Central clearing of OTC equity derivatives to reduce counterparty risk
Central Counterparty (CCP) clearing of OTC equity derivatives makes sense from both counterparty risk and operational risk perspectives in our view. We believe CCP clearing will reduce systemic risk and benefit both dealers and customers, provide significant netting and operational benefits, and most importantly, some regulatory capital relief from reduced counterparty risk. However, the requirement for financial end-users to centrally clear their transactions is likely to negatively impact liquidity in our view. The great majority of OTC equity derivatives to be cleared Over 55% of current equity derivatives notionals are cleared via CCPs, according to Deutsche Bank. We expect the share to further increase along with the volume growth in listed derivatives which are already standardized and transparent. Overall, OTC derivatives central clearing should be beneficial for most standardized and highly liquid derivatives. Whilst we expect the great majority of OTC equity derivatives to be cleared, a lot of the customized structured products are however unlikely to be eligible in our view. CCPs, regulators and dealers have a joint responsibility to determine what is eligible for central clearing. Exemption for commercial end-users: For corporates, mandatory central clearing and exchange trading would imply tying up liquidity, which would be damaging for the economy, however, the Dodd-Frank bill includes specific exemptions for corporate end users which are not considered major swap participants. This should be positive for the investment banks' growing corporate derivatives (or Strategic Equity Transaction) business. 16% reduction in RWAs in the equities business With OTC equity derivatives cleared through CCPs, we expect RWAs to be reduced as i) counterparty risk exposures from derivatives declines with the netting benefits and collateralization requirements and ii) the average risk weight decreases due to the lower risk-weight for CCP-cleared transactions we assumed the new risk weight would be 3%, in line with Basel Committee guidance of 1-3%, to recognize that CCP exposures are not risk free and eventually will be dependent on the robustness and risk management capabilities of CCPs. Equities RWAs for the 10 banks in our analysis are likely to decrease by estimated $48bn, equivalent to 16% of Equities RWAs on average from their preregulation levels due to the impact of CCP clearing. CCP clearing would have limited impact from a P&L perspective in our view, and we do not account for any changes in costs in our sensitivity analysis. There could be some revenue impact for the investment banks acting as clearing broker, however, we do not account for it at this point in our calculation.
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For our calculations, we assume 60% of total Counterparty Credit RWAs from derivatives would be reduced further through CCP clearing, attracting a lower risk weight of 3%. In addition, we also make assumptions about the Equity Derivatives product types which could benefit from CCP clearing in our view. For our calculations, we assume 60% of the CCP RWA reductions would benefit Flow Equity Derivatives and the remaining 40% for structured products. As a result of the RWAs reduction from CCP clearing, we expect ROE in the equities business to improve from 42% to 50% as shown in Table 58. Whilst CCP clearing is positive for risk mitigation and operational purposes, the relief from reduced counterparty credit risk RWAs would however be partially offset by increased capital requirements due to new Basel proposals on counterparty credit risk - through Credit Valuation Adjustments (CVA) for non-cleared OTC transactions, which we discuss in detail later on page 77. Note also that customised and less liquid equity derivatives products that cannot be CCP-cleared are often hedged with standardised OTC derivatives that are eligible for CCP-clearing. As a result, CCP-clearing of the hedges could already result in the loss of offsets, potentially increasing capital requirements on the customised non-CCP cleared products. In addition, the main concern for the Investment Banking industry is that clearing is the first step leading to exchange/SEF trading for OTC products.
Table 58: Global investment banks - Impact from Central clearing of OTC derivatives 2011E
$ million, %
SG Equity derivatives PRV Equity derivatives CCR RWAs ow Equity derivatives to be CCP cleared ow Equity derivatives non CCP cleared Old risk weight New risk weight Equity derivatives CCR RWAs CCP cleared Equity derivatives CCR RWAs non CCP cleared Total Equity derivatives CCR RWAs post CCP clearing RWAs reduction from CCP clearing % Equity derivatives CCR RWAs pre regulation Equities capital impact Equities RWA pre regulation RWAs reduction from CCP clearing Equities RWA post CCP clearing % decrease in Equities RWAs due to CCP clearing Impact on Equities profitability Equities ROE pre regulation Equities ROE post CCP clearing % change in Equities ROE due to CCP clearing Source: J.P. Morgan estimates, Company data. 30,544 9,163 5,498 3,665 20% 3% 825 3,665 4,490 -4,673 -51% 25,009 -4,673 20,336 -19% BNP 25,147 7,544 4,527 3,018 20% 3% 679 3,018 3,697 -3,848 -51% 23,633 -3,848 19,786 -16% DB 54,652 10,978 6,587 4,391 20% 3% 988 4,391 5,379 -5,599 -51% 27,331 -5,599 21,732 -20% UBS 24,247 7,274 4,364 2,910 20% 3% 655 2,910 3,564 -3,710 -51% 24,604 -3,710 20,895 -15% CS 23,764 7,129 4,277 2,852 20% 3% 642 2,852 3,493 -3,636 -51% 30,623 -3,636 26,987 -12% GS 67,559 20,268 12,161 8,107 20% 3% 1,824 8,107 9,931 -10,337 -51% 73,277 -10,337 62,941 -14% MS 41,366 12,410 7,446 4,964 20% 3% 1,117 4,964 6,081 -6,329 -51% 31,870 -6,329 25,541 -20% BARC 26,231 6,570 3,942 2,628 20% 3% 591 2,628 3,219 -3,351 -51% 22,099 -3,351 18,748 -15% BOAML 27,300 8,190 4,914 3,276 20% 3% 737 3,276 4,013 -4,177 -51% 27,455 -4,177 23,278 -15% CITI 18,132 5,440 3,264 2,176 20% 3% 490 2,176 2,665 -2,774 -51% 28,724 -2,774 25,949 -10% Average
-16%
58% 71% 23%
45% 54% 19%
34% 43% 26%
45% 53% 18%
46% 52% 13%
34% 39% 16%
41% 52% 25%
50% 59% 18%
35% 42% 18%
35% 39% 11%
42% 50% 19%
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Proposal 2: OTC equity derivatives trading moving onto exchanges or swap execution facilities
The Dodd-Frank Wall Street Reform and Consumer Protection Act requires that a swap which is cleared on a Designated Clearing Organization must be traded on a regulated exchange or swap execution facility1 (SEF). Due to the move from a market-making business to a SEF traded more transparent platform (i.e. more cash like), hedge funds are gaining trading flow with the ability to more aggressively compete with the banks and building algo and high frequency trading strategies around these SEF traded derivatives. ROE in the equities business declines from 42% to 40% on average in our estimates, as a result from moving derivatives to exchange/SEF trading. Both flow equity derivatives and Delta One business would be impacted in our view, with a decline in revenues of -11% and -8% respectively. The average impact on net profits is estimated to be -9% for equity derivatives and 6% for total equities including both cash and derivatives. This is based on the assumption that our estimated revenue decline is not offset by any cost reduction.
Table 59: Global Investment Banks: Impact on 2011E Earnings from moving derivatives to SEF trading
$ million, % SG Earnings impact on equities Impact on revenues ow Flow derivatives revenues ow Delta one revenues ow Structured products Impact % equity derivatives revenues Impact % total equities revenues Earnings impact (after tax) % equity derivatives net income Equities net income pre regulation Equities net income post SEF trading % total equities net income Impact on Equities profitability Equities ROE pre regulation Equities ROE post SEF trading
BNP -121 -50 -71 -4.2% -3.8% -85 -8.7% 1,059 974 -8.0% 44.8% 41.2%
DB -66 -26 -40 -3.5% -1.6% -43 -7.9% 926 883 -4.6% 33.9% 32.3%
UBS -99 -59 -40 -4.9% -2.1% -73 -12.4% 1,098 1,026 -6.6% 44.6% 41.7%
CS -86 -37 -49 -4.0% -1.4% -63 -9.7% 1,415 1,352 -4.4% 46.2% 44.2%
GS -201 -113 -88 -4.6% -2.1% -141 -10.0% 2,476 2,335 -5.7% 33.8% 31.9%
MS -82 -33 -48 -4.3% -1.6% -57 -9.6% 1,319 1,262 -4.3% 41.4% 39.6%
BARC -86 -45 -41 -4.1% -2.1% -62 -9.9% 1,111 1,049 -5.5% 50.3% 47.5%
BOAML -72 -37 -36 -4.2% -1.6% -50 -10.0% 969 919 -5.2% 35.3% 33.5%
CITI -60 -26 -33 -3.3% -1.5% -42 -7.3% 1,001 959 -4.2% 34.8% 33.4%
Avg.
-140 -60 -80 -3.6% -3.4% -101 -7.1% 1,447 1,346 -7.0% 57.9% 53.8%
-4.1% -2.1% -9.2%
-5.6% 42.3% 39.9%
Equity Derivatives CCP cleared and exchange/SEF traded - become more cash like: We estimate that bid/ask spreads for OTC equity derivatives could decline further when traded on exchange/SEF, based on the margin compression experienced in the dividend swaps market on switching to exchange trading in July 2008: When dividend swaps started trading on the EUREX exchange in July 08 (see Figure 13), bid/ask spreads declined from 4 points to only 1 point.
1 The term swap execution facility means a trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce, including any trading facility, that (A) facilitates the execution of swaps between persons; and (B) is not a designated contract market..
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The compression in margin however coincided with a notable increase in volumes. Most equity derivatives products are already listed, but we would expect the trend to accelerate with regulatory changes, with the great majority of flow and delta one products to go on exchange, with margins compression of 40% partly offset by a 25% increase in volumes. We however expect most of the structured products to be not eligible for clearing and hence exchange/SEF trading.
Figure 13: Bid/ ask spread on dividend swaps
Index points 8.0 7.0
6.0 5.0 4.0 3.0 2.0 1.0 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09
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Source: J.P. Morgan estimates. Note: dotted vertical line at start of exchange trading
Over time volumes will offset the declining revenue environment We assume an increase in overall market volumes due to increased market access and reduced transaction costs. Analysis from ICAP on transaction volume elasticity (Figure 14) would imply an increase in volumes of 250%.
Figure 14: Relationship between cost per trade and daily trading volume
$,000's of trades
Source: ICAP
Proposal 3: Post-trade transparency requirements for OTC equity derivatives

In the U.S., the Dodd-Frank Wall Street Reform and Consumer Protection Act requires real-time public reporting of all swap transactions which are subject to the mandatory clearing requirement or are cleared at a registered derivatives clearing organization or are reported to a swap data repository or the Commission. The term real-time public reporting means to report data relating to a swap transaction, including price and volume, as soon as technologically practicable after the time at which the swap transaction has been executed. The EU is following suit, with a draft law which would force traders to report the details of any OTC derivative contract they have entered into no later than the working day following the execution. The 27 member states of the EU would have to enforce penalties for those that do not comply. The experience with US corporate bonds indicated that liquidity deteriorated somewhat on implementation of post-trade transparency (TRACE) and the profitability of market-making declined. OTC equity derivatives that are already cleared would already see further margin compression due to the required move to exchange/SEF trading. However, we also expect margin compression for non-cleared OTC equity derivatives that are not CCP cleared and trading on exchange/SEF, as post trade transparency requirements would still apply for these products.
Based on the experience with TRACE, we estimate that posttrade transparency would reduce margins by c15% for impacted (low transparency) products, with no corresponding volume offset.
Based on the experience with TRACE (Figure 15), we estimate that post-trade transparency requirements could reduce margins by c15% for impacted (low transparency) OTC equity derivatives products, with no corresponding volume offset. ROE in the equities business declines from 42% to 41% on average in our estimates, as a result from moving derivatives to exchange/SEF trading. Structured products would be the main business impacted in our view, with an estimated decline in revenues of -5%. The majority of flow equity derivatives products are already listed and/or transparent, and the impact would be more limited at estimated -2%. Overall, we estimate a negative revenue impact of -1.6% for total equity derivatives. The average impact on net profits is estimated to be -4% for equity derivatives and 2% for total equities including both cash and derivatives. This is based on the assumption that our estimated revenue decline is not offset by any cost reduction. Note that our estimates are derived by first identifying the percentage of revenues in each asset class generated from low transparency products: 35% of structured products revenues and 10% of flow equity derivatives revenues.
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Table 60: Global Investment Banks: Impact on 2011E equities profitability from OTC post trade transparency
$ million, % SG Earnings impact on equities Impact on revenues ow Structured products revenues ow Flow derivatives revenues Impact % equity derivatives revenues Impact % total equities revenues Earnings impact (after tax) % equity derivatives net income Equities net income pre regulation Equities net income post OTC post trade transparency % total equities net income Impact on Equities profitability Equities ROE pre regulation Equities ROE post OTC post trade transparency % change in Equities ROE
BNP -56 -50 -7 -1.9% -1.7% -39 -4.1% 1,059 1,020 -3.7% 45% 43% -3.7%
DB -35 -32 -3 -1.9% -0.9% -23 -4.2% 926 903 -2.5% 34% 33% -2.5%
UBS -30 -22 -8 -1.5% -0.6% -22 -3.7% 1,098 1,076 -2.0% 45% 44% -2.0%
CS -41 -36 -5 -1.9% -0.7% -30 -4.7% 1,415 1,385 -2.1% 46% 45% -2.1%
GS -63 -48 -15 -1.4% -0.6% -44 -3.1% 2,476 2,432 -1.8% 34% 33% -1.8%
MS -21 -16 -4 -1.1% -0.4% -14 -2.4% 1,319 1,305 -1.1% 41% 41% -1.1%
BARC -38 -32 -6 -1.8% -0.9% -27 -4.4% 1,111 1,084 -2.5% 50% 49% -2.5%
BOAML -22 -17 -5 -1.3% -0.5% -15 -3.0% 969 954 -1.6% 35% 35% -1.6%
CITI -20 -16 -4 -1.1% -0.5% -14 -2.4% 1,001 987 -1.4% 35% 34% -1.4%
Average
-89 -81 -8 -2.3% -2.2% -64 -4.5% 1,447 1,383 -4.4% 58% 55% -4.4%
-1.6% -0.9% -3.7%
-2.3% 42.3% 41.3% -2.4%
Margins: We estimate the potential margin compression based on the experience for US corporate bonds on introduction of TRACE (Trade Reporting and Compliance Engine). TRACE was implemented in July 2002 and resulted in a bid /ask compression ranging from 8%-30% depending in transaction size, with the larger institutional trades experiencing the most pronounced compression. We believe that the experience with institutional trades provides the best reference point for potential margin compression for OTC derivatives, since derivative trades are typically institutional.
Figure 15: Estimated impact of TRACE on bid ask spreads for US Corporate bonds rated 'A and above' by transaction size ($ '000)
Basis points
100 80 60 40 20 0 5 Pre trace (bps) 10 20 Post trace (bps) 100 200 1000 Actual change (bps)
35 30 25 20 15 10 5 % decline, RHS
Note: spread shown is half of bid/ask spread for large sample of bonds pre and post TRACE Source: J.P. Morgan analysis; Data from Journal of Finance June 2007, Edwards, Harris, Piwowar,
Liquidity/volume impact: Post Trace, as Figure 16 indicates, trade sizes declined 6% (2002 to 05), with surveys reporting a moderate decline in liquidity. Overall market volumes were flat to slightly down.
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Figure 16: Post TRACE - average trade size

$ million 0.82
0.80 0.78 0.76 0.74 0.72 0.70 2002 2003 2004 Av g trade size (m)
Source: SIFMA, J.P. Morgan analysis
2005
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Proposal 4: Volcker proposed limits on prop trading

The Dodd-Frank Wall Street Reform and Consumer Protection Act prohibits a banking entity from engaging in Proprietary trading. The bill defines Proprietary Trading as, engaging as a principal for the trading account of the banking entity or nonbank financial company supervised by the Board in any transaction to purchase or sell, or otherwise acquire or dispose of, any security, any derivative, any contract of sale of a commodity for future delivery, any option on any such security, derivative, or contract, or any other security or financial instrument that the appropriate Federal banking agencies, the Securities and Exchange Commission, and the Commodity Futures Trading Commission may, by rule as provided in subsection (b)(2), determine. The Volcker rule would only apply to US subsidiaries of foreign companies that have systemically important operations in the US or that receive Bank Holding Company treatment. We have however assumed in our analysis that the rule would be applied in all jurisdictions globally. ROE in the equities business declines from 42% to 39% on average in our estimates, as a result from the Volcker rules. Our calculations are based on the assumption that only pure prop trading would be impacted by the Volcker rules proposed limit on proprietary trading, as there are exemptions for market making related activities, activities on behalf of customers and risk mitigating hedging activities. Proprietary trading is defined as engaging as a principal for the trading account of the banking entity or non-bank financial company supervised by the Board in any transaction to purchase or sell, or otherwise acquire or dispose of, any security, any derivative, any contract of sale of a commodity for future delivery, any option on any such security, derivative, or contract. We have assumed 5% of total equities revenues are pure prop trading for all the IBs, which could be i) slightly high for French banks which previously indicated that prop trading is limited, and ii) slightly low for some of the investment banks, e.g. Credit Suisse which indicated that prop accounts for less than 10% of equities revenues in 2009. Our equities and prop/flow prop trading estimates for Goldman Sachs do not include revenues from Goldman Sachs Principal Strategies (GSPS) which we have not forecasted in our total IB revenues in 2010E-012E more generally, we do not forecast revenues for Principal Investments, GSPS and SSG (Special Situations Group), although these revenues accounted for 10% or $3.5bn of total firm revenues on average over the past 5 years, according to the company. Our sensitivity analysis is on 2011E, however, the Volcker rules would only be effective from 2013 at the earliest in our view. We would expect banks to continue to generate more limited pure prop trading revenues, but to scale down the business only closer to the rule effective date. The average impact on net profits is estimated to be -8% on average for the total equities business. This is based on the assumption that our estimated revenue decline is partly offset by cost reduction assuming 40% Cost/income ratio.
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Table 61: Global Investment Banks: Impact on 2011E earnings from Volcker proposed limits on prop trading
$ million, % SG Earnings impact on equities Impact on revenues Impact % total equities revenues Equities net income pre regulation Earnings impact (after tax) Equities net income post Volcker rules % change Impact on Equities profitability Equities ROE pre regulation Equities ROE post Volcker rules % change in Equities ROE
BNP -162 -5.0% 1,059 -68 991 -6% 45% 42% -6%
DB -202 -5.0% 926 -79 848 -8% 34% 31% -8%
UBS -240 -5.0% 1,098 -105 994 -10% 45% 40% -10%
CS -317 -5.0% 1,415 -139 1,276 -10% 46% 42% -10%
GS -488 -5.0% 2,476 -205 2,271 -8% 34% 31% -8%
MS -254 -5.0% 1,319 -107 1,213 -8% 41% 38% -8%
BARC -203 -5.0% 1,111 -87 1,024 -8% 50% 46% -8%
BOAML -228 -5.0% 969 -96 874 -10% 35% 32% -10%
CITI -204 -5.0% 1,001 -86 915 -9% 35% 32% -9%
Avg.
-208 -5.0% 1,447 -90 1,357 -6% 58% 54% -6%
-5.0%
-8% 42% 39% -8%
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Proposal 5: Impact from Section 716: Prohibition against Federal Government bailouts of Swaps Entities
In our view, section 716 of the Dodd-Frank Wall Street Reform and Consumer Protection Act could have significant implications for the equities business. The proposals in the final bill are less punitive as banks would be able to retain i) trading in interest rate swaps, foreign exchange swaps, and gold and silver swaps as well as ii) all derivatives trading activities done for hedging banks' own risk, which is clearly positive. However, the provision applies to trading in agriculture, uncleared commodities, non investment grade CDS, most metals, energy swaps as well as equity derivatives. Section 716 could lead to the segregation of equity derivatives activities, in our view. The Federal Reserve and FDIC will be prohibited from providing any federal funds to bail out firms that engage in swap activities. According to this section, no Federal Assistance (which includes the Federal Reserves credit facility, discount lending window, emergency lending functions and FDICs insurance and guarantees) may be provided to any swaps entity with respect to any swap, security based swap or other activity of the swaps entity. The term swaps entity means any swap dealer, security-based swap dealer, major swap participant, major security-based swap participant, swap execution facility, designated contract market, national securities exchange, central counterparty, clearing house, clearing agency, or derivatives clearing organization that is registered under- (A) the Commodity Exchange Act; (B) the Securities Exchange Act of 1934; or (C) any other Federal or State law (including regulations). Federal Assistance cannot be used for the purpose of: (A) making any loan to, or purchasing any stock, equity interest, or debt obligation of, any swaps entity; (B) purchasing the assets of any swaps entity; (C) guaranteeing any loan or debt issuance of any swaps entity; or (D) entering into any assistance arrangement (including tax breaks), loss sharing, or profit sharing with any swaps entity. In our view, Section 716 would only be implemented for US banks and brokers, and could affect their OTC equity derivatives activities globally, whilst European IBs would not be subject to similar measures. We expect U.S. IBs to be at a disadvantage compared to the European peers due to the implementation of Section 716: Potentially higher capital requirements and funding costs: Section 716 would require US banks and brokers to hold more capital in order to retain a single A credit rating which is necessary to write long-term derivatives business in our view, and hence their financing costs would increase, with the result that more and more end-users would probably prefer to have an international bank as their
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counterparty offering cheaper derivative transactions, thus benefiting the European IBs in our view. Risk of market share loss: The US industry could become less competitive in terms of revenue and ROE generation due to counterparty risk to end-users and ability of pricing derivative contracts compared to peers. We would expect US Banks to lose some market share in derivative revenues. In our sensitivity analysis, ROE in the equities business for US banks and brokers would decline from 39% to 38% as a result of section 716, whilst returns are unchanged for European IBs. This is the result from higher capital requirements with a Tier I of 15% vs. 10% previously for US banks US structured products businesses. The scope of Section 716 still needs to be clarified but we have assumed that the equity derivatives businesses that would fall into the scope of the provision would be i) the products that are not CCP-cleared, i.e. mostly the structured products business, and ii) the US business which is based in the US and/or deals with US counterparts. As a proxy, we have estimated that the US structured products would be the main business impacted. We estimate RWAs increase by 23% on average for US banks US structured products businesses. Rather than increasing allocated equity, we have estimated an increase in RWAs equivalents. For more details on Section 716, please refer to our note, Global Investment Banks: Dodd/Lincoln Bill Analysis: implications for the future structure of the IB industry, published on 29th April, 2010.
Table 62: Global Investment Banks: Impact on 2011E Equities ROE from Section 716
$ million, % SG Equity derivatives CCR RWAs Structured products RWAs pre regulation Structured products RWAs post regulation* US structured products business Total RWAs post regulation Capital charge pre-section 716 Tier I required post section 716 Capital charge post section 716 Implied RWAs Additional RWAs from Section 716 % increase in structured products RWAs post regn. % increase in structured products RWAs pre regn. % increase in equities RWAs pre regulation Impact on Equities profitability Equities ROE pre regulation Equities ROE post Section 716 % change in Equities ROE 3,665 10,504 16,017 3,203 320 10% 320 3,203 0 0% 0% 0% 58% 58% 0% BNP 3,018 7,090 10,196 2,039 204 10% 204 2,039 0 0% 0% 0% 45% 45% 0% DB 4,391 5,576 5,591 1,118 112 10% 112 1,118 0 0% 0% 0% 34% 34% 0% UBS 2,910 3,691 3,393 679 68 10% 68 679 0 0% 0% 0% 45% 45% 0% CS 2,852 6,125 7,798 1,560 156 10% 156 1,560 0 0% 0% 0% 46% 46% 0% GS 8,107 14,655 15,808 7,114 711 15% 1,067 10,671 3,557 23% 24% 5% 34% 32% -5% MS 4,964 6,055 5,111 2,300 230 15% 345 3,450 1,150 23% 19% 4% 41% 40% -3% BARC 2,628 4,088 4,421 884 88 15% 133 1,326 442 10% 11% 2% 50% 49% -2% BOAML 3,276 5,491 6,167 2,775 277 15% 416 4,162 1,387 23% 25% 5% 35% 34% -5% CITI 2,176 5,745 9,064 4,079 408 15% 612 6,118 2,039 23% 36% 7% 35% 33% -7% 10% 11% 2% 42% 42% -2% Avg.
Source: J.P. Morgan estimates, Company data. *including the other regulatory impact but before the additional impact from Section 716.
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Proposal 6: Impact of Stressed VaR on Equities RWAs

For a more detailed discussion on Basel 2.5 changes for market risk capital, please refer to our report Global Investment Banks: Market RWA consistency questioned published on 6 July 2010 Additional capital buffer based on a stressed scenario VaR Most of the investment banks use the internal model-based approach rather than the standardized approach for calculating the market risk capital requirement in the equities business. Based on this approach, the market risk capital requirement is currently based on the average VaR over the prior 60 trading days, and therefore varies in line with changes in historical market volatility. This approach has been much criticised, especially in the wake of the Lehman bankruptcy and the subsequent 4Q08 credit market closure, for allowing banks to leverage up and not taking into account all of the potential risks in trading books whilst increasing pro-cyclicality. Under the revised proposed Basel methodology for market risk, an additional capital buffer based on a stressed-scenario VaR will be added to the current (ordinary VaR-based) capital requirement, thereby reducing leverage and procyclicality. VaR: Internal model approach was mainly based on VaR models average VaR over the prior 60 trading days which had major weaknesses as this approach i) was based on short periods of historical data which did not capture market stress periods, and ii) also enabled banks to hold significantly less capital than under the standardized approach. Basel response is to strengthen the internal model with Stress VaR. The new framework supplements the ordinary VaR calculation with an additional capital buffer based on a stressed scenario VaR. The additional capital buffer is equal to at least 3 times the 10-day 99% VaR calculated during a period of significant market stress. 38% average increase in RWAs in the equities business Based on our analysis, we estimate $120bn or an average 38% increase in total equities RWAs due to Stress VaR changes as shown in Table 63. This is the result of market RWAs more than doubling on average (1.1x increase). ROE in the equities business declines from 42% to 31% as a result of the 38% increase in RWAs. Quantifying the market Risk impact from stressed VAR Our estimated impact from new Basel rules for Stress VaR are based on the following: We start by estimating the current market RWAs based on the reported average 10-day 99% VaR in Q4 09. We have also assumed a multiplier of mc=5. Note that VaR models have shortcomings as they are not comparable, not based on the same methodologies (e.g. Monte Carlo, historical back-testing) observation periods e.g. from 0.45 years in the case of GS to 5 years for UBS. This implies that market RWAs calculations could be more conservative depending on the model. We then estimate the new market risk charge post Basel changes by taking 5 times the average 10-day 99% VaR plus 3 times (assumed multiplier ms) our estimated average 10-day Stress VaR, which we then convert into market RWAs by multiplying by 12.5.
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Table 63: Global Investment Banks: Stressed VaR impact on 2011E Equities ROE
$ million
SG Pre Basel 2.5 changes for market RWAs Equity Var 10-day 99% ($m) Multiplier Equities market RWAs Post Basel 2.5 changes for market RWAs Assumed multiplier for av VaR: mc Implied VaR used (av 10-day 99% VaR) Assumed multiplier for Stressed VaR: ms Estimated Stressed VaR Resulting VaR-based market risk capital charge Resulting VaR-based market RWAs Estimated increase in VaR-based market RWAs Increase in equities market RWAs (x) Increase in total Equities RWAs Impact on Equities profitability Equities ROE pre regulation Equities ROE post Stress VaR Impact % change in Equities ROE due to Stressed VaR capital buffer Source: J.P. Morgan estimates. 102 5 6,368 5 102 3 362 1,596 19,955 13,586 2.1 54% 58% 37% -35% BNP 159 5 9,907 5 159 3 300 1,693 21,157 11,251 1.1 48% 45% 30% -32% DB 113 5 7,076 5 113 3 214 1,209 15,109 8,033 1.1 29% 34% 26% -23% UBS 109 5 6,816 5 109 3 145 981 12,269 5,453 0.8 22% 45% 37% -18% CS 141 5 8,782 5 141 3 309 1,628 20,352 11,570 1.3 38% 46% 34% -27% GS 478 5 29,903 5 478 3 661 4,376 54,699 24,796 0.8 34% 34% 25% -25% MS 134 5 8,400 5 134 3 194 1,253 15,657 7,257 0.9 23% 41% 34% -19% BARC 103 5 6,443 5 103 3 214 1,158 14,471 8,029 1.2 36% 50% 37% -27% BOAML 141 5 8,815 5 141 3 277 1,536 19,203 10,388 1.2 38% 35% 26% -27% CITI 218 5 13,637 5 218 3 528 2,675 33,441 19,804 1.5 69% 35% 21% -41% Avg.
1.1 38% 42% 31% -28%
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Proposal 7: Impact of Incremental Risk Charge (IRC) on Equities RWAs

For a more detailed discussion on Basel 2.5 changes for market risk capital, please refer to our report Global Investment Banks: Market RWA consistency questioned published on 6 July 2010 Additional capital buffer for Incremental Risk Charge The Incremental Risk Charge (IRC) was added to the Basel II capital standards in light of the recent credit market turmoil (starting in 2007) where a number of banks have experienced large credit-trading book losses, which were not captured in the 99%/10-day VaR models, especially in 4Q08 when credit market prices were declining as investors and banks were forced to de-risk and hence unwind positions in an illiquid market. Definition: the IRC estimates the default and migration risks of unsecuritized products over a one-year capital horizon at a 99.9% confidence level. A key underlying objective of the IRC is to reflect credit default and migration risk in trading books (excluding securitizations). Whilst the great majority of the IRC will be added to market RWAs calculations in fixed income businesses, there will still be some more limited impact for the equities business in our view. 8% average increase in RWAs in the equities business Based on our analysis, we estimate $25bn or an average 8% increase in total equities RWAs due to IRC changes as shown in Table 63. This is the result of market RWAs increasing by 24% on average. ROE in the equities business declines from 42% to 39% as a result of the 8% increase in RWAs. Quantifying the impact from IRC In our base case we assume that the market RWAs for the equities business including the additional capital for Stress-VaR increase by a further 20%2 due to the IRC charge. U.S. banks: Our base case assumes a smaller 3%-7% IRC-related increase in Market RWAs for GS and other U.S. banks respectively since their market RWAs appear to already reflect some capital buffer for incremental default risk and other event risks: The following are excerpts from the GS and MS annual disclosures. Goldman Sachs: 10-K Nov 2008: Market risk RWAs are calculated consistent with the specific conditions set out in the Basel II framework (based on VaR calibrated to a 99% confidence level, over a 10-day holding period, multiplied by a factor). Additional RWAs are calculated with respect to incremental default risk and other event risks, in a manner generally consistent with our internal risk management methodologies. For positions not included in VaR because VaR is not the most appropriate measure of risk, we calculate RWAs based on alternative methodologies, including sensitivity analyses. Morgan Stanley: 10-K, Dec 2009: Market RWAs incorporate three components: systematic risk, specific risk, and incremental default risk (IDR). Systematic and specific risk charges are computed using either a Standardized Approach (applying a fixed percentage to the fair value of the assets) or the Companys VaR model. Capital charges related to IDR are calculated using an IDR model that estimates the loss due to sudden default events affecting traded financial instruments at a 99.9% confidence level. The Company received
Only 7% increase assumed for U.S. banks and 3% for GS since their starting RWAs already include significant default risk RWAs.
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2
permission from the Fed for the use of its market risk models through calendar year 2009 while undergoing the Feds review. Based on the final outcome of that review, the capital ratios may be lower or higher in 2010.
Table 64: Global Investment Banks: Incremental Risk Charge impact on 2011E Equities ROE
$ million SG Pre Basel 2.5 changes for IRC Equities Market RWAs pre IRC Post Basel 2.5 changes for IRC Assumed increase in market RWAs due to IRC Est. Increase in market RWAs due to IRC Resulting Equities Market RWAs post IRC % increase in equities market RWAs % increase in total Equities RWAs Impact on Equities profitability Equities ROE pre regulation Equities ROE post IRC Impact % change in Equities ROE due to IRC
BNP 21,157 20% 4,231 25,389 43% 18% 45% 38% -15%
DB 15,109 20% 3,022 18,131 43% 11% 34% 31% -10%
UBS 12,269 20% 2,454 14,722 36% 10% 45% 41% -9%
CS 20,352 20% 4,070 24,423 46% 13% 46% 41% -12%
GS 54,699 3% 1,641 56,340 5% 2% 34% 33% -2%
MS 15,657 7% 1,096 16,753 13% 3% 41% 40% -3%
BARC 14,471 7% 1,013 15,484 16% 5% 50% 48% -4%
BOAML 19,203 7% 1,344 20,547 15% 5% 35% 34% -5%
CITI 33,441 7% 2,341 35,782 17% 8% 35% 32% -8%
Avg. 226,314
19,955 20% 3,991 23,945 63% 16% 58% 50% -14%
25,203 251,517 24% 8% 42% 39% -9%
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Proposal 8: Impact of Credit Valuation Adjustments (CVA) on Equities RWAs

Basel Committee has proposed a capital add-on to capture mark-to-market losses due to Credit Valuation Adjustments (CVA), which would be an addition to the existing default risk treatment. The details of the proposed capital add-on are still being worked out. As per the Basel Committee consultative document, released in December 2009, In addition to the capital requirements for counterparty risk determined based on the standardised or internal ratings-based (IRB) approaches for credit risk, a bank must calculate an additional capital charge to cover mark-to-market unexpected counterparty risk losses. This additional charge must be calculated by treating counterparty exposures as bond equivalents, and is determined by applying the applicable regulatory market risk charge to such bond-equivalents, after excluding the Incremental Risk Charge (IRC). We estimate average 12% increase in Equities RWAs from CVA add-on for the 10 banks in our analysis. Equities ROEs are expected to decline 11% on average for the 10 banks in our analysis due to CVA adjustment We also show the combined impact of the CCP clearing and CVA proposals in Table 66 below. We estimate average 5% decrease in Total Equities RWAs due to the combined effect of CVA and CCP clearing. In our calculations we have used a simplistic approach, assuming a 100% CVA addon for the non-CCP cleared Equity derivatives CCR RWAs.
Table 65: Global Investment Banks: Impact on 2011E Equities ROE from Credit Valuation adjustment
$ million, % SG Total Equity derivatives CCR RWAs Equity derivatives CCR RWAs non CCP cleared Increase in Equity derivatives CCR RWAs due to CVA % increase in equity derivatives CCR RWAs pre-regulation % Total Equities RWAs pre regulation Impact on Equities profitability Equities ROE pre regulation Equities ROE post CVA Adjustment % change in Equities ROE due to CVA
BNP 7,544 3,018 3,018 40% 13% 45% 40% -11%
DB 10,97 8 4,391 4,391 40% 16% 34% 29% -14%
UBS 7,274 2,910 2,910 40% 12% 45% 40% -11%
CS 7,129 2,852 2,852 40% 9% 46% 42% -9%
GS 20,26 8 8,107 8,107 40% 11% 34% 30% -10%
MS 12,41 0 4,964 4,964 40% 16% 41% 36% -13%
9,163 3,665 3,665 40% 15% 58% 50% -13%
BAR C 6,570 2,628 2,628 40% 12% 50% 45% -11%
BOAML 8,190 3,276 3,276 40% 12% 35% 32% -11%
CITI 5,440 2,176 2,176 40% 8% 35% 32% -7%
Avg.
12% 42% 38% -11%
Table 66: Global Investment Banks: Combined Impact on 2011E Equities RWAs from CCP clearing and CVA
$ million, %
SG Pre CCP clearing and CVA Total Equity derivatives CCR RWAs Post CCP clearing and CVA CCR RWAs reduction from CCP clearing Increase in CCR RWAs due to CVA Net impact from both measures Total Equity derivatives CCR RWAs post CCP clearing & CVA % increase in equity derivatives CCR RWAs pre-regulation % Total Equities RWAs pre regulation Source: J.P. Morgan estimates, Company data. 9,163 -5,086 3,665 -1,420 7,743 -16% -6% BNP 7,544 -4,187 3,018 -1,169 6,375 -16% -5% DB 10,978 -6,093 4,391 -1,702 9,277 -16% -6% UBS 7,274 -4,037 2,910 -1,127 6,146 -16% -5% CS 7,129 -3,957 2,852 -1,105 6,024 -16% -4% GS 20,268 -11,249 8,107 -3,141 17,126 -16% -4% MS 6,222 -3,453 2,489 -964 5,258 -16% -4% BARC 6,570 -3,646 2,628 -1,018 5,551 -16% -5% BOA-ML 8,190 -4,545 3,276 -1,269 6,921 -16% -5% CITI 5,440 -3,019 2,176 -843 4,596 -16% -3% -16% -5% Avg.
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Delphine Lee (44-20) 7325-3971 delphine.x.lee@jpmorgan.com
Detailed Equity Derivatives products analysis

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Kian Abouhossein (44-20) 7325-1523 kian.abouhossein@jpmorgan.com
Structured Equity Products: towards the oligopoly

In this section, we focus on structured equity derivatives which are tailored made products to meet investors specific risk/return profiles. They are combinations of three key elements: i) underlyings (e.g. indices, equities and basket of equities, alternative investments), ii) a wrapper (notes, funds, swaps, etc), and iii) a pay off structure (income/growth, capital protection/leverage, long/short exposure, etc). The most basic structured equity derivative product is the capital protected note on a basket of FTSE 100 and Eurostoxx 50 stocks - offering investors participation in the appreciation of the FTSE 100 and Eurostoxx 50 but also protection on the downside, should the performance be negative over the investment period. Clients include both retail investors indirectly through distributors (retail banks, insurance companies, private banks, brokers, IFAs), institutional investors seeking to enhance portfolio returns or looking for financing and hedging solutions, as well as corporates looking to manage their strategic stakes, treasury shares, employees saving plans. Note that Investment banks reporting structures may differ, e.g. the corporate derivatives business could be booked in Corporate Finance or in flow equity derivatives.
Regulatory changes to reshape the competitive landscape

Regulatory changes are likely to materially impair the structured equity derivatives business in our view. In our sensitivity analysis, we estimate that ROE in the structured equity derivatives businesses will decline from estimated 27% to 14% on average in 2011E. The structured products industry is likely to become more concentrated in our view We expect the lower levels of profitability to lead to a progressive polarization amongst players, with on one end, the players in a run-off mode and on the other end the players still committed to the business and gaining market shares. Longer term, with an even more oligopolistic industry, margin compression might be slower than in flow businesses, which would help protect returns at decent levels for large players. The impact differs from bank to bank, with some investment banks clearly faring better than others. Note that our ROE estimates are based on allocated capital assumed at 10% of RWAs for the business, which would not be adjusted even post the increase in capital requirements due to regulation. On the one hand, the large structured equity derivatives houses, Socit Gnrale and BNP Paribas, remain relatively profitable. On the other hand, for smaller players like Morgan Stanley, Bank of America and Citigroup, returns decline to unattractive levels, and we believe they could consider exiting the business.
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Socit Gnrale ROE declines to 27% in 2011E from 53% pre regulatory changes, however, SG remains the most profitable structured equity derivatives house, due to: i) Lyxor Asset Managements structured fund business which accounts for 27% of structured equity derivatives revenues but requires lower capital requirements and is less impacted by new regulations, ii) lower cost/income ratio than other investment banks, despite having the largest platform with the largest cost base in absolute terms we estimate operating expenses of $0.8bn .vs. less than $0.4bn on average for peers. We estimate SG cost/income ratio at 50%, lower than industry average of 64%. BNP Paribas structured equity derivatives business is significantly impacted by proposed regulations with ROE declining from 42% to 21%. The group remains however more profitable than the majority of players. Similarly to SG, BNPP benefits from a strong franchise with a lower cost base we estimate cost/income ratio of 55%. Deutsche Bank ROE would decrease to 16% from c.28% pre regulatory changes. Deutsche Bank adjusted its structuring capabilities early 2009, but remains committed to the business. The group notably sees strategic transactions as one of three key areas of growth - their 2010 target included expansion in emerging markets. Returns are lower, however, DB remains a relatively large player, and could benefit longer term of its larger distribution platform through Deutsche Postbank in Germany, which also happens to the largest market for 1retail structured products. Credit Suisse, UBS and Barclays ROE drop to an estimated 14% on average from 27% pre regulatory changes. Both Credit Suisse and UBS have exited the highly structured equity derivatives business but remain large players. ROE for the three banks are c.15% that shareholders should require, and small cost adjustments could be required to improve returns. We estimate Goldman Sachs ROE drops from 20% to 11% post regulation. In our view, Goldman Sachs could consider allocating capital to other businesses instead, given that structured products become less attractive vs. European peers due to the impact of Section 716 and the higher market and counterparty risk requirements. Note however that GS allocates more capital in most IB businesses vs. continental European IBs as the group mostly uses the standardized approach for calculating risk; as a result, profitability of the businesses could be distorted. In our view, GS would more likely adapt its geographic mix to adapt the business to the new environment. The other investment banks would see their ROE decline well below 10% post regulatory changes, on our estimates. This would be likely to trigger strategic changes, as returns in the business would be materially impaired. In our view, if this scenario materializes, smaller players in structured equity derivatives such as MS, BoA, and Citi with c.$0.3bn of revenues could consider exiting the business to refocus on other equities businesses with higher ROE. Regulatory changes would have significant changes for the overall industry, and in our view, in the long-term structured products could be created by non-bank entities as intellectual human capital moves from the banking industry, especially investment banking, into less regulatorily constrained entities offering risk-taking and hence above IB profit and payout opportunities.
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Table 67: Global Investment Banks structured equity derivatives summary P&L 2011E
$ million, % 2011 Structured products Costs Pre-provision profits Loan losses and other Pretax Net profits Cost/income Tax rate Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE SG 1,550 -775 775 0 775 558 50% 28% 558 1,050 53% 500 1,858 27% BNP 945 -520 425 0 425 298 55% 30% 298 709 42% 263 1,231 21% DB 604 -363 242 0 242 157 60% 35% 157 558 28% 136 867 16% UBS 424 -305 119 0 119 87 72% 27% 87 369 23% 70 543 13% CS 691 -449 242 0 242 177 65% 27% 177 612 29% 150 979 15% GS 910 -482 428 0 428 300 53% 30% 300 1,466 20% 266 2,504 11% MS 306 -221 86 0 86 60 72% 30% 60 606 10% 49 974 5% BARC 616 -443 172 0 172 123 72% 29% 123 409 30% 100 670 15% BOAML 324 -234 91 0 91 64 72% 30% 64 549 12% 52 985 5% CITI 311 -224 87 0 87 61 72% 30% 61 574 11% 49 1,263 4% Total 6,683 -4,016 2,667 0 2,667 1,884 64% 30% 1,884 6,902 27% 1,636 11,873 14%
ROE in structured equity derivatives declines from 27% to 14% in 2011E, mainly as a result of higher capital requirements under new Basel rules for market risk (Basel 2.5) and counterparty risk for OTC derivatives (Basel 3 on Credit Valuation Adjustment). 72% increase in RWAs: We expect RWAs to increase 72% on average, mainly due to Basel 2.5 Stress VaR related changes for market risk (40% increase in RWAs), and Basel 3 proposals for CVA (39% increase in RWAs). Basel 2.5 new market risk requirement for Incremental Risk Charge has a more limited impact, increasing RWAs by only 9% as most of the additional IRC requirements will mostly impact Fixed Income businesses rather than equities. The great majority of structured products cannot be centrally cleared, however, we have assumed that the most simple short dated products could be CCP cleared, reducing partly the negative impact from CVA. However, the overall structured products business will require more counterparty risk capital. US banks would also require additional capital for their US structured products business which we assumed would be pushed out under Section 716. -13% decline in profits: The main impact from regulation on net profits comes from the OTC derivatives post trade transparency requirements. We have assumed that 35% of revenues in the business come from products with low transparency and could be at risk due to margin compression from increased transparency. We estimate -15% revenue impact for these products with no cost offset. Overall, we see a -5% decline in total structured products revenues. Investment banks most impacted in their structured products business would be Bank of America, Citigroup and Morgan Stanley with ROE declining by an estimated -56% on average to well below 10% ROE, as i) the impact on earnings is higher as a result of their higher cost/income ratio (72% on average), and ii) higher capital requirements with Section 716 penalizing US banks compared to European peers.
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French banks would also experience significant decline in ROE with -49% on average due to relatively high regulatory impact on RWAs, mainly Basel 2.5 related. However, with ROE of 27% for SG and 21% for BNP, returns remain well above industry average, as the French banks benefit from lower cost/income (50%-55%).
Table 68: Global Investment Banks Impact from regulatory changes on the structured equity derivatives business 2011E
$ million SG Net income pre regulation Impact from moving to SEF trading Impact OTC derivatives transparency requirements Total impact on profits Net income post regulation RWAs pre regulation RWAs reduction from CCP clearing Additional RWAs from Basel 2.5 Stress VaR changes Additional RWAs from Basel 2.5 IRC changes Additional RWAs from CVA Additional RWAs from Section 716 Total impact from regulation RWAs post regulation ROE pre regulation ROE post regulation Decline in ROE
BNP 298 0% -12% -12% 263 7,090 -22% 48% 18% 30% 0% 74% 12,308 42% 21% -49%
DB 157 0% -13% -13% 136 5,576 -40% 29% 11% 55% 0% 55% 8,665 28% 16% -44%
UBS 87 0% -19% -19% 70 3,691 -40% 22% 10% 55% 0% 47% 5,429 23% 13% -45%
CS 177 0% -15% -15% 150 6,125 -24% 38% 13% 33% 0% 60% 9,794 29% 15% -47%
GS 300 0% -11% -11% 266 14,655 -28% 34% 2% 39% 24% 71% 25,040 20% 11% -48%
MS 60 0% -19% -19% 49 6,055 -42% 23% 3% 57% 19% 61% 9,736 10% 5% -49%
BARC 123 0% -19% -19% 100 4,088 -33% 36% 5% 45% 11% 64% 6,702 30% 15% -50%
558 0% -11% -11% 500 10,504 -18% 54% 16% 24% 0% 77% 18,582 53% 27% -49%
BOAML 64 0% -19% -19% 52 5,491 -30% 38% 5% 42% 25% 79% 9,847 12% 5% -55%
CITI 61 0% -19% -19% 49 5,745 -19% 69% 8% 27% 36% 120% 12,626 11% 4% -63%
Total 1,884 0% -13% -13% 1,636 69,019 -28% 40% 9% 39% 12% 72% 118,731 27% 14% -50%
Figure 17: Structured equity derivatives products revenue wallet $bn

12.5 10.5 8.4 13.2
Structured products more concentrated than pre-crisis We expect the global revenue pool in structured equity derivatives of $7.7bn in 2011E, back to 2009E levels. Since the crisis, the industry has been more concentrated with 15-20 players competing for a smaller revenue pool which we estimate is 39% below 2007 peak levels. The top five players account for 61% of the total wallet in our estimates. European institutional clients and hedge funds have also reconsidered their trading relationships in structured products, with the number of brokers used on average declining from 6.5 pre-crisis to 4.0 in 2009, compared to over 15 in European cash equity. The decline is even larger for hedge funds, with the number of brokers down to 3.0 in 2009 from 6.0 previously. This is in sharp contrast to flow derivatives where the number of brokers used increased slightly from 6.0 on average pre-crisis to 6.5 in 2009. In our view, the structured products industry could become even more concentrated due to i) the higher regulatory capital requirements and lower returns, and ii) the relatively high barriers of entry both in terms of risk management and investment costs. Part of the return erosion could be mitigated by margin repricing, however, this could prove to be more challenging in the new regulatory environment with increased post trade transparency requirements. In addition, structured equity derivatives could become an even more European business as a result of Section 716 in our view. We expect EMEA to account for
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7.7
7.1
7.7
2006
2007
2008
2009
2010E 2011E 2012E
Source: J.P. Morgan estimates. Note: client-driven revenues excluding gains/losses from hedging/risk management.
72% of our estimated $7.7bn global revenue pool, with Americas only accounting for 11%; however, the share of Americas could decline further as US business US based revenues or revenues with US based counterparts would require more capital and hence be less attractive from a profitability standpoint.
Figure 18: Structured products revenues 2011E Figure 19: Structured equity derivatives products regional split of the estimated $7.7bn global revenue pool in 2011E
Asia, 1.3, 17%
Figure 20: Structured products average number of brokers used

Pre-crisis 6.5 2009 6.0
Others, 3.0, 39%

Americas,
4.0
Top fiv e play ers, 4.7, 61%
0.8, 11%
3.0
EMEA, 5.5, 72%
Total institutions
Hedge Funds
Industry still dominated by large players SG, BNP, GS, CS and BARC: We expect Socit Gnrale and BNP Paribas to remain the largest structured equity derivatives houses, with revenues of $1.5bn to $0.9bn respectively and ROE above 20% even after regulatory changes, as they both benefit from scaled platforms, higher efficiency levels and large distribution networks. Deutsche Bank, CS and BARC also have strong positions with revenues of $0.6-0.7bn and ROE of about 15%, we estimate. Tier 2 players Morgan Stanley, Bank of America and Citi with revenues of $0.3bn and returns below 10% could potentially consider exiting a business which will require i) more RWAs (both market risk and counterparty risk) and ii) more capital against the RWAs as a significant part of their business will fall within the scope of Section 716.
Table 69: Structured equity derivatives industry industry revenues and market share 2009-2011
$ million Socit Gnrale BNP Paribas Goldman Sachs Credit Suisse Barclays Deutsche Bank UBS Bank of America Citigroup Morgan Stanley Industry wallet 2009 1,563 859 928 700 600 609 350 350 300 300 7,684 % 20% 11% 12% 9% 8% 8% 5% 5% 4% 4% 100% 2010E 1,428 859 835 630 570 548 385 315 270 285 7,122 % 20% 12% 12% 9% 8% 8% 5% 4% 4% 4% 100% 2011E 1,550 945 910 691 616 604 424 324 311 306 7,681 % 20% 12% 12% 9% 8% 8% 6% 4% 4% 4% 100%
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Revenue outlook: still a growth business

10% revenue growth 2011E-012E following 2-3 difficult years: Revenues in structured product are expected to reach a low in 2010E, following a -39% decline in 2009 and -7% in 2010E, but should recover in 2011E-012E with a 10% CAGR growth. Overall, with the weak 2010, this would imply 4% CAGR growth 2009-2012 for the industry, broadly in line with SG expectation of a moderate growth between 3% and 6%. We expect a slightly more moderate revenue growth going forward compared to the past and estimate 10% growth p.a. in the next few years, compared to 15% pre-crisis, as demand for complex and riskier products is likely to remain weaker in the medium term. The retail business is however slowly recovering with improved volumes and still relatively resilient margins, but most importantly, we see more growth potential in the Corporate business (Strategic Transactions) and the Institutional business, with solid demand from pension funds, insurance companies and banks. Interest rates environment less favourable for margins In addition to equity market conditions and volatility levels, one of the key drivers for the business is the interest rate environment. Due to the low interest rates, economics of the structured retail products have been less attractive, and participation rates for investors are lower at 30% compared to 60-70% previously. That said, in a low interest rate environment, retail client demand for equity products with guaranteed capital features remains solid. Most structured products have a principal guarantee feature, and can be split into two components: a zero coupon bond and an OTC option. With the low interest rates, there is no longer a large discount to par for zero coupon bonds, which implies that the premium available for acquiring upside is more limited. For example, we assume the retail investor buys a 5 year bond and OTC call option on the FTSE100 and the Eurostoxx50 from a retail bank, which in turn has bought the product from a separate investment bank. The retail investor will pay the face value for the note, i.e. 100% (Table 70). The distributor has made a margin of 2% from the outset on selling the note as the value and the cost for the distributor of the note is less than the 100% that the investor paid. We can split the cost of the note into two parts: o A zero coupon bond - Cost 88%: Assuming 2.5% interest rates (5 year Euro zero curve), a zero coupon bond with a 100% face value and five year maturity priced at a discount to yield is worth 88%. An OTC option Cost 10%: We assume the distributor pays another 10% to the investment bank for the option. Hence the total cost of the note for the retailer is 98% and the spread for the retailer is 2% (200bp). Margins are lower than in 2006 mainly due to the lower interest rates, and the investor participation rate is also lower: because interest rates are lower, the value of the zero coupon bond has increased, leaving a more limited premium available for the option.
o o
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Investment bank estimated 40bp spread: Zero coupon bond prices are highly transparent, so we assume that the bank can not make any margin on selling the bond to the distributor. Instead the margin is dependent on how cheaply the bank can create and hedge out the option. In this simple product we believe the spread for the investment bank will be below 40bp, down from 100bp previously, due to increased competition for a smaller business. With volatility also higher than previously, we believe the cost of hedging has increased. For more complex products the spreads will be higher, and in general we estimate the cost of creating the option will result in approximately a 100bp spread for the investment bank originating the note, but clearly this will be dependent on the complexity of the product, the capabilities of the bank and the level of competition for a given issue.
Table 70: Profitability of the structured retail derivatives business
% Retail investor price paid Value of zero coupon bond Cost of European call option Distributor price paid to IB Distributor margin IB cost of zero coupon bond at 100% face value IB cost of creating European call option IB margin Total margin on product
2006 100.0% 84.0% 13.0% 97.0% 3.0% 84.0% 12.0% 1.0% 4.0%
2009 100.0% 88.0% 10.0% 98.0% 2.0% 88.0% 9.6% 0.4% 3.4%
Funding, another key consideration for margin and pricing Investors in structured notes would have credit risk to investment banks issuing the products. However, counterparty risk concerns have decreased compared to 2008, especially with the banks with a strong signature, and client demand has improved. With the institutional bond issuance market still volatile, structured issues have provided IB players with an important source of funding in times when refinancing needs are particularly high. Structured equity derivatives players which are viewed as counterparty of choices have been able to protect margins in our view.
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Figure 21: Bank funding 3M spot FRA/OIS basis

bp
200 180 160 140 120 100 80 60 40 20 0 Dec-08 Dec-09 Mar-09 Mar-10 Jun-08 Jun-09 Sep-08 Sep-09 Jun-10
Figure 22: Financials CDS 5yr senior spreads

bp
300 250 200 150 100 50 0 Mar-07 Mar-08 Mar-09 Nov-07 Nov-08 Nov-09 Mar-10 Jul-07 Jul-08 Jul-09 Itrax x DB CSG BNP SG
Source: J.P. Morgan.
Bank liquidity has not yet returned to more normal levels. 3-month FRA/OIS spread declined to below 40bp, from peak 200bp in Q4 08, but still above pre-crisis levels, as illustrated in Figure 21 above. Funding remains a key issue for banks, and CDS senior spreads are still trading at wider levels of 100-135bp vs. 10-20bp pre-crisis. As a result, we believe that smaller banks with lower ratings could have been tempted to compete on margins for funding purposes, but with counterparty risk concerns for lower quality names, client business would still tend to go to counterparty of choices. Margins lower than pre-crisis but holding up well Margins have declined compared to historical levels as client demand has shifted to shorter tenors, less complex payoffs and more liquid underlyings. The market for long dated highly complex structures with illiquid underlyings is closed, however, complex exotics with liquid underlyings are still traded. That said, margins are more sensitive to competition levels in our view. A few players have exited the market or scaled down their ambitions post crisis, e.g. Credit Agricole, Natixis, Commerzbank, and although the number of players is still relatively high, competition on margins is not as fierce as in the past. Tight margins in the institutional business: Margins are generally relatively low for institutional products which tend to be simple ones, and we estimate 10bp for instance for a 1 year put options on 3 indices. Low but resilient margin in the retail business: Margins are higher for retail products due to the higher risk embedded in the products. Margins on pay-offs products like worse-offs have been declining to 40bp due to increasing competition for a smaller business, compared to 75-80bp previously. Margins are however better on algo products and hedge fund derivatives. Structured retail products: moderate revenue growth We expect moderate revenue growth in the retail structured business for the next few years, with improved volume growth of 5%-10% p.a. and resilient margins.
Figure 23: Structured products margin

Pre-crisis 2009 75
40
15
10
Institutionals
Retail
Source: J.P. Morgan estimates. Note: margins for simple exotic products, e.g. 1 year put options on 3 indices for institutionals.
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Structured retail products issuances have dropped sharply since Q3 08, with volumes declining by -37% in Q4 08, as illustrated in Figure 25 below. Overall, issuance volumes declined by -12% in 2009, following the -9% decrease in 2008, and stood 20% below 2007 peak levels. Recent trends have however been encouraging with issuance volumes starting to stabilize since Sept: after the significant declines in the first 9 months of 2009, volumes increased +39% YoY in Q4 09 and 40% in Q1 10. Whilst volumes are below historical levels, they have been picking up from the weak 2009 levels. Socit Gnrale expects revenues in structured retail products to be broadly flat in 2010 vs. 2009, and still c.40% down vs. 2007; SG sees retail volumes recovering 30% YoY to c.190bn in 2010 and margins potentially declining but remaining resilient in a more concentrated market. We note however that structured retail volumes are more dependent on market conditions than in the institutional and corporate market. The recent market downturn has led to a significant reduction of retail clients appetite for equity linked investment products, and in our view, structured retail volume growth is unlikely to reach the 10-20% level achieved pre-crisis. Steady growth in equity markets without sharp drops or corrections is indeed supportive, but overall, we would expect less than 5%-10% growth p.a. in the next few years.
Figure 24: Structured retail products - monthly issuance volumes since 2000
25,000 North America Europe Asia ex Japan
Figure 25: Structured retail products YoY growth in issuance volumes Q1 04 Q2 10

80% 60%
20,000
40%
15,000
20% 0% -20%
10,000
5,000
-40%
0 Dec-02 Dec-07 Oct-03 Sep-01 Aug-04 Sep-06 Oct-08 Apr-01 Apr-06 Aug-09 Feb-02 Mar-04 Feb-07 Mar-09 Jan-00 Jun-00 Jan-05 Jun-05 Jan-10 Nov-00 May-03 Nov-05 May-08 Jun-10 Jul-02 Jul-07
-60% Q1 04 Q2 04 Q3 04 Q4 04 Q1 05 Q2 05 Q3 05 Q4 05 Q1 06 Q2 06 Q3 06 Q4 06 Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10
Source: StructuredRetailProducts.com
Asian market still relatively small but promising: Asia retail investors have proved to have a strong appetite for products that assume equity risk. Although demand was challenged with the collapse of Lehman and more recent market volatility, we continue to see Asia and Emerging Markets as potential growth drivers in the medium/long term. Structured retail products remain for now a European business with 78% of the global issuance volumes from Europe in 2009, up from 73% in 2007. Within Europe, France, Switzerland and Germany in particular continue to be the main markets, although the UK retail structured products market has seen significant growth in 2009. Asian structured retail products suffered the most from the crisis, with volumes down -68% in 2009, but should recover from the lows in our view. In addition, whilst most players have long been focusing on the retail business, there is growth potential on the institutional client business.
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Innovation less relevant? In terms of products, there has been a clear shift to simpler payoff profiles, and shorter maturities, and products are much closer to the traditional flow derivatives products. For retail clients, the focus has been on underlyings rather than pay offs. Whilst 2009 has seen the decline in the share of products linked to equities vs. other asset classes, we would expect the share of equities to return progressively to historical levels as risk appetite for riskier asset class increases. As illustrated in Figure 26 below, fixed income products have been favored over equity in 2009, with the share of equity declining to 61% in 2009, from 80-82% in 2006-07. In terms of distribution, the crisis has led to a sharp drop in structured products provided by investment banks, universal banks, asset managers and insurance companies which all distributed in 2009 less than half of the volumes issued in 2007. On the other hand, retail banks and other savings institutions remain the dominant providers with 58% of volumes. In our view, distribution remains a key asset in the structured products business, especially from a margin perspective, and large players with distribution networks, e.g. SG and BNP, should continue to benefit from this.
Figure 26: Structured retail products - issuance volumes by asset class
250,000 225,000 200,000 175,000 150,000 125,000 100,000 75,000 50,000 25,000 0 2005 2006 2007 2008 2009 2010YTD Equities Rates FX/Commodities HF/Alternativ es
Figure 27: Structured retail products issuance volumes by product provider

250,000 225,000 200,000 175,000 150,000 125,000 100,000 75,000 50,000 25,000 0 2005 2006 2007 2008 2009 2010YTD
other Private Bank Asset Manager Commercial Bank Insurance Company Investment Bank Universal Bank Retail Bank
Institutional market: reduced demand due to less liquidity Structured products have gained credibility and turned into a real asset class for institutional investors. Institutional clients have been increasingly using these products for ALM purposes, to enhance bond yields (which are not attractive in the current low interest rate environment) and/or get exposure to different asset classes and alternative investments. Structured products are significantly different from an equity + bond allocation and can improve the risk/return on a diversified portfolio. In the institutional space, demand has been impacted by lower levels of liquidity resulting in lower leverage and asset inflows, however, demand is less dependent on market performance than in the retail market, and there is still appetite for efficient wrapping and hedging products. 53% of European institutions expect to increase
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their use of structured products in 2010, according to Greenwich Associates 2009 survey. We continue to see institutional and corporate demand for ad-hoc solutions: 1) On the Asset side, there is demand for absolute return and managed products: Simple hedging products for institutionals with i) relatively large size tickets, ii) exposures to indices rather than single stocks, iii) short maturity (less than 1218 months), and iv) risks (volatility/correlation) that are easy to hedge. Search for upside on the equity asset through absolute return and managed products Focus on underlying, themes (e.g. green energy), research-driven products, rather than complex pay-offs. Algorithmic indices are an alternative to hedge funds for alpha generation 2) On the liability side, there is demand for derivatives solutions to regulation and changing environment, e.g. demographics: Structured products with long maturities for insurance companies, wrappers for pension funds. Insurance companies use structured products for portfolio management purposes. Pension funds have been increasingly using hedging structured products for the Variable Annuity business, mainly in the US, but also in Japan which is a large market for VA. There is also demand for retirement product from insurance and pension fund companies. Future demand from banks as a result of the higher capital requirements: the new regulatory environment could create demand from banks to optimize funding and asset/liability management. The Institutional business is also to a large extent dependent on the investment banks corporate relationships, e.g. in advisory and primary business. Some of the large investment banks have been able to capitalize on their institutional client relationships in cash equities and other areas to cross sell relatively simple but large size structured products. Strategic equity transactions is a key area of growth in our view with estimated 10%-15% p.a. Corporate clients have much strengthened balance sheets and are cash rich, which provides opportunities for strategic transactions. Products include management of strategic stakes or treasury shares, M&A related transactions and special situations, employees savings plans. SG had the best year ever in 2009 (revenue growth of 95% YoY), and for DB, this activity is one of the 3 key areas of expansion the group expects exotic and corporate to account for 25% and 16% respectively of equity derivatives revenues in 2010. Whilst French banks corporate relationships is more limited on a global basis (e.g. outside top 10 players in M&A - Figure 28 below), their presence and client franchise in Europe is more significant, which has supported both their institutional and corporate derivatives activities in our view. Socit Gnrales equity derivatives
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business had over 75 active institutional clients and over 50 active corporate clients in 2005, numbers which are now significantly higher.
Figure 28: Global M&A revenue league table 2009
$ million
Figure 29: Global syndicated loan revenue league table 2009

$ million
1,500
400 350
1,200
300 250 200
900
600
150 100
300
50
0 UBS MS GS CSG Lazard DB BARC BAC JPM C
0 Citi WFC DB BNPP CASA SBI BoA ML BARC RBS

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Source: Dealogic.
Source: Dealogic.
We estimate the share of client-driven revenues from institutional clients stood at 60%-70% for Credit Suisse, UBS and US brokers which benefit from strong client relationships in their cash franchises. For French banks and Deutsche Bank, the split between institutional and retail would be more balanced, close to 50:50 in our view, as the banks still rely to a larger extent on their retail networks.
Top players to benefit from high barriers of entry

With returns set to be less attractive due to regulatory changes, we believe that some of the structured equity derivatives players could exit the business, and the industry is likely to become more oligopolistic than in the past. In addition to regulatory hurdles, the structured equity derivatives industry is also characterized by high barriers of entry, and in our view, the players with strong competitive advantages could have the potential to increase margins, partly offsetting the negative impact from regulatory changes. In our view, the main barriers of entry in structured equity derivatives are: 1. Risk management systems: the business generates complex risks which are difficult to hedge such as correlation, and the need for strong risk management systems are required to generate sustainable returns. Investment cost of a scaled platform and the need for cost efficiency: running structured equity derivatives activities requires an industrial set up with relatively high investment costs, and cost efficiency is also key to improve profitability, especially in a rigorous regulatory environment.
2.
JPM
3.
Distribution networks: retail structured products still accounts for a large part of the business, and access to large distribution networks is a strong competitive advantage with positive implications in terms of margins.
I) Risk management remains key for structured products With exotic options, investment banks are exposed to complex risks which are difficult to hedge, such as correlation. Whilst market risks such as price risk (delta), volatility, interest rate and FX risks can be hedged relatively easily with liquid futures, options and interest rates and FX derivatives, more complex risk such as correlation are more difficult to hedge. In addition, banks are also left with residual/second order risk which is also difficult to hedge. Whilst residual risk is limited at the inception of the product, it becomes quite significant when markets are very volatile.
Figure 30: Equity derivatives risk management
Capital protected note: Zero Coupon Bond + OTC option Risk exposure Price Int. rates FX Volatility Dividends Correlation Risk kept on books Flow desk Exotics trading desk Market hedge Interdealer mkt Offsetting structured trade
Prop. Desk an 'internal custo mer'
Delta hedge price risk through listed futures Hedge interest rate risk with interest rate swaps
Correlation swap to hedge funds via hedge fund desk Variance swaps, dispersion instruments and gap-risk sold to hedge funds, institutions and HNWIs
Recycle risk
Hedge volatility via options
Exposure sold/offset with other position better price
Complex risks
Source: J.P. Morgan
How banks dealt with correlation risk: The main exotic risk, correlation, can be recycled, meaning repackaged and sold as a separate product to hedge funds and prop desks. Structured products desks which tend to run structural short correlation positions could recycle their correlation risk to hedge funds through correlation swaps, variance swaps and dispersion trades where the bank is long correlation. One popular trade for investors had been to sell correlation by taking a short position on index variance and a long position on the variance of the components.
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Limitations to risk recycling: Due to i) limited demand for these products even precrisis, and ii) significantly reduced hedge fund risk appetite since Q1 08, most of the correlation risk has remained on the Investment Banks books. Because structured products desks tend to be short correlation and short volatility, and most of them had cumulated large positions over the past 5 years going into 2008, revenue risk increased with higher levels of correlation which materialized in Q4 08 (see Figure 31 and Figure 32). As markets deteriorated post Lehman, volatility and correlation levels shot up, leading to record losses in the management of the books, more than offsetting the record client revenues in 2008. One other mitigating item could be using potential reserves. Banks were not permitted to recognize "day-one" profits on derivatives that cannot be priced with observable market data. This changed with the introduction with SFAS 157, however, part of the cumulated reserves could have been used to offset potential losses.
Figure 31: Realised correlation Euro Stoxx 50 banks
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 Dec-06 Dec-09 Oct-07 Sep-06 Apr-08 Aug-08 Sep-09 Feb-09 Mar-06 Mar-07 Mar-10 Jun-06 Jul-07 Jan-08 Jun-09 Nov-08 Jun-10 1M 3M 6M
Figure 32: Realised correlation Euro Stoxx 50

0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 Dec-07 Sep-07 Aug-08 Aug-09 Oct-09 Feb-09 Mar-07 Mar-08 Jan-07 Jun-07 Jun-08 Jan-10 Apr-10 Nov-08 May-09 Jul-10 E-STOXX-50 AVGCORR 1M E-STOXX-50 AVGCORR 3M E-STOXX-50 AVGCORR 6M
Model risk: One risk that can not be hedged out is model risk. Model risk is the risk that the derivative is mispriced or mishedged as a result of inadequate modeling of the derivative. This can relate to both faulty modeling, but also arises as some risks are very difficult to model and the bank will have to settle for models that will only be an approximation of the contracts risks. In our view, particularly smaller firms may lack the scale and resources to invest heavily in risk management systems and will therefore be more likely to take losses related to modeling risk. In the long run, risk management of the books is even more important as clientdriven revenue growth is likely to be lower than before the crisis. We see management of complex risks such as correlation as a significant barrier to entry as investment banks require: Intellectual capital and state-of-the-art IT operation; learning-curve of managing risk, based on similar products produced in the past;
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Not just structuring ability, but also a strong flow desk and risk management capability; Comprehensive client coverage: Recycling risk has become more challenging with the number of hedge funds active in correlation trading limited to about 20, as a result, client coverage is key to better manage the risks. Management understanding of the risks involved in structured equity derivatives and long-term business commitment even once mark-to-market losses occur. In our view, one of Socit Gnrales key competitive advantages has been its hedge funds coverage, and more generally its clients coverage globally, enabling the group to recycle part of the risk. Given the large size of its structured products business, we believe that the group's correlation positions must have been relatively large, however, SG managed to book limited losses in Q4 08 relative to peers. Selfimposed risk limits post the trading fraud could have possibly helped them, however, the group still had to manage large risks inherited from previous years. In our view, SG benefited from its large client base in France and Emerging Markets. II) Scale of the platform, cost advantage Fixed costs are very high in the structured products activities, requiring heavy investments in IT and infrastructures, and hence, strong management commitment with a solid understanding of the risk/return profile of the business. Running structured products activities requires an industrial set-up with structurers, sales, traders, together with sizeable back office functions requiring high infrastructure investments. Socit Gnrale for example has a sales team in Structured Products of over 150 people, 100 financial engineers and 200 FTEs at Lyxor, in our estimates. Support functions, IT, legal & compliance are key to speed up time-to-market for new products, whilst minimizing operational and reputational risk. In our view, one key strength of the French banks, Socit Gnrale in particular, is that management has a strong understanding of the business with the head of Global Markets, Christophe Miann, being one of the founders of the equity derivatives platform and the group is committed to its CIB businesses, and to equity derivatives in particular where i) SG enjoys leadership positions and ii) profits account for 24% of group in 2011E. SG makes significant investments in IT & infrastructure about 100m per year on IT expenses, of which 30m in new IT systems in our view a significant barrier top entry for smaller scale operations. The dependence on a well functioning back office is also illustrated by Socit Gnrale which has 1,600 back office employees compared to 950 front office staff in the equity derivatives business equivalent to 1.7 back offices per front office staff, compared to 1:1 on average for the investment banking industry on our estimates. Scale also comes with high costs, however, French banks benefit from location in Paris. We estimate total cost/employee of 1m in equity derivatives, compared to closer to c.$2m for US and European IB peers.
Table 71: Socit Gnrale Structured Products business 2009E

Staff numbers Sales Financial engineers Lyxor Total Number of teams Europe Americas Asia Total 150 100 200 450 14 5 4 23
Source: J.P. Morgan estimates, Company reports.
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Table 72: Equity derivatives revenue and costs per staff 2009E
Socit Gnrale 950 1,600 1.7 300 100 400 300 200 50 950 4,637 4.9 BNP Paribas 600 1,000 1.7 275 75 350 250 600 2,036 3.4 Deutsche Bank 450 450 1.0 450 2,083 4.6 Credit Suisse 400 400 1.0 400 1,778 4.4 UBS 500 500 1.0 500 2,465 4.9
Front office (including Lyxor) Back office Back office: Front office Trading Structuring Trading & structuring Sales Structured Asset Management (Lyxor) Other Total Front office Revenues ($m) Revenues/Front office staff ($m / FO staff)
III) Distribution networks Investment banks sell the retail structured products to individual investors through a large scope of distributors: banking networks, insurance companies, brokers, IFAs, private banks and family offices. We estimate 85% of structured products are capital guaranteed products - 95% in some countries (Italy, Spain, Portugal, Denmark, Poland), as i) risk aversion remains relatively high amongst retail investors especially post the financial crisis, and ii) these products are favored by client relationship managers who are wary of losing client confidence. Distribution capabilities are key, and in our view, this has been one of the key strengths for French structured derivatives houses which benefited from large retail networks in France and abroad, as well as strong relationships with the groups wealth and asset management subsidiaries. The European retail business is to a large extent captive, unlike in the US. With the acquisition of Fortis banking businesses, BNP Paribas is well positioned to develop its structured products business further, with cross-selling through its 3 domestic networks in France, Italy and Belgium.
Table 73: Snapshot of the groups' retail networks
Socit Gnrale Retail networks Domestic CEE/EM Italy Belgium/Luxembourg Number of individual customers (m) Domestic CEE/EM Italy Belgium/Luxembourg 3,000 3,700 9.6 12.1 BNP Paribas 2,200 1,948 750 1,458 7.1 4.7 2.6 3.9 Deutsche Bank 1,831* 739 261 n.a. 10.0m for DB and 13.9m for Postbank n.a. n.a. n.a. Credit Suisse 220 1.7 UBS 303 2.5 -
Source: Company reports. * including Deutsche Postbanks 850 retail branches
Private banking have also provided another distribution channel. Although they have been moving towards open platform, relationships between the private banks and the investment banking arms remain strong. In our view, one third of BNP Paribas' business for instance is captive.
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SGs competitive advantage: Lyxor One key competitive advantage for Socit Gnrale is the Lyxor franchise which distributes structured products and alternative investments to Socit Gnrales retail, private banking and institutional clients. Lyxor merged with SGAM Alternative Investments in Sept 09, but is part of Socit Gnrales CIB division. Socit Gnrale made the strategic decision to keep the asset manager in the investment bank, to benefit from the CIB division's IT and infrastructure, and expertise in structured products. In total, Lyxor has assets under management of 82bn, but this also includes 38bn of AuM in ETFs. Only the Lyxor Structured funds and Lyxor Structured Alternative Investments are part of the Structured Products business: Lyxor Structured funds (23.7bn of AuM end 2009): The products are similar to capital guaranteed products, either sold to Socit Gnrale customers, or 'white labeled' to retail networks and private banks globally. The structured funds guarantee a return, e.g. Initial NAV x 100% + 60% of the increase in the CAC40, and Lyxor would usually counter guarantee this with SG CIB. Lyxor will only receive an upfront fee for distributing these products and no subsequent management fee. We estimate Lyxor generated $265m of revenues from these products in 2009. Lyxor Structured alternative investment (20.1bn of AuM) this is Lyxors alternative asset management arm. Lyxor offers a broad range of hedge funds, funds of hedge funds and absolute return funds. The flagship funds come from the hedge fund managed account platform (c.$20bn of AuM) which includes more than 100 hedge funds covering all principal strategies: long/short equities, event driven allocations, CTAs, global macro, etc (see split of funds on the Lyxor platform in Figure 35 below). Lyxor regularly adds new hedge fund managers according to a strict risk control process and give managers mandates to replicate their benchmark fund on the platform according to specific investment guidelines and risk limits. The key advantages of investing in managed accounts over traditional hedge fund structures are i) transparency and ii) better liquidity with positions that are redeemable once a week. Lyxor investors pay a standard hedge fund fee, e.g. 2% of invested capital plus 20% on performance, as well as Lyxor's fee of 85bp p.a. (excluding administration costs). We estimate spread on managed accounts and other alternative investments of 90bp which would equal ca $220m of revenues from this business. We see further growth in this business as Lyxor adds more managed accounts in Asia and Europe. Out of the 170 managed accounts, 90% are US hedge funds, but Lyxor intends to increase the number of managed accounts in Europe and Asia closer to that of the US. The firm notably targets Asian funds to account for 20% of all managed accounts in the medium term, up from less than 10% currently.
Figure 33: Lyxor Structured funds

bn
30.0 25.0 20.0 15.0 10.0 9.7 5.0 0.0 2001 2003 2005 2007 2009 2011e 5.6 13.2 17.2 19.7 19.0 23.7 21.5 19.4 24.9 26.1
Source: Company reports.
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Figure 34: Lyxor Structured Alternative Investments

bn
40.0
Figure 35: Lyxor managed account platform split of the funds by strategies
CB & Equity
35.0 33.4 30.0 27.6 25.8 23.3 20.0 19.5 15.0 14.2 10.0 10.6 6.3 3.5 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e 2011e 21.0 20.1
v olatility arbitrage 11% CTA L/S equity 37% 12% Currency Trading 0%
25.0
L/S credit arbitrage 3% Global macro 7%
Ev ent driv en & risk arbitrage Fix ed Income arbitrage 3% 27%
5.0
Source: Company reports. End Nov 2009. Note: including SGAM Alternative Investments since Sept 09.
Source: Company data.
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Flow equity derivatives

In this section, we focus on flow equity derivatives excluding delta one products, i.e. options (listed and OTC), both plain vanilla and exotic flow option products - more complex exotic options are part of structured products as well as warrants, and volatility products (variance swaps, correlation swaps, dispersion trades). Investment banks reporting structures may differ, e.g. UBS exchange-traded options activities seem to be part of the prime brokerage business. However, given the significant differences in market trends and growth prospects, we will look at delta one products in a separate section.
The new reign of cash equity-like liquidity providers?

Figure 36: Flow equity derivatives* Global revenue pool 2006-2012E ($bn)
8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2006 2007 2008 2009 2010 2011 2012 3.3 5.5 6.6 7.5 6.3 6.7 7.0
I Industry Wallet of $6.7bn in 2011E, growing at 5% CAGR We estimate 2011E Flow Equity Derivatives revenue wallet to be 11% below the record revenue levels of 2009, with margin compression on increased competition leading to lower revenues. The global revenue pool in option and volatility trading amounted to $7.5bn in 2009, recovering from $3.3bn in 2008, but we estimate the wallet to decline to more normalized levels of $6.7bn in 2011E. In 2012E, we estimate the revenue wallet to increase at a modest rate of 5% to $7bn. In our view, the option and volatility trading industry could become even more competitive than it is already with i) more players competing for a revenue wallet that is not growing much, and ii) increased margin pressure and operating leverage with the overcapacity building up. With the significant correlation losses in structured products in 2008, most players have been refocusing on flow businesses, leading to increased competition in 2011E for a smaller wallet. II Flow equity derivatives industry returns not as attractive post regulatory changes. Returns erosion due to margin compression: Post the financial crisis which led to significant losses in structured products, most equity derivatives players refocused in 2009 on Flow businesses as i) returns were higher than in structured products estimated 38% vs. 25% in structured products, and ii) client volumes had been shifting towards more transparent, liquid on exchange products with lower counterparty risk. Margins and returns have however been declining faster as a result of the increased competition and overcapacity building up. We estimate flow equity derivatives ROE to decline from average 38% in 2009 to 29% in 2011E even before accounting for the impact of any regulatory changes, as the business is becoming more commoditized and more cash-like in our view. Returns are however less attractive than in cash equities as the capital requirement is much higher than cash equities. At 29% on average pre regulatory changes, ROEs are closer to returns in structured products which on the other hand benefits from more resilient margins. Regulatory changes to reduce returns further: The flow equity derivatives business is less impacted by regulatory changes than structured products as the increase in capital requirements is less significant. However, returns in Flow equity derivatives still decline by a significant -37% from 29% to 18% post regulatory
Source: J.P. Morgan estimates * excluding delta one and convertibles.
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changes, mainly as a result of additional margin compression from moving OTC derivatives to exchange/SEF trading. 39% decline in net profits: The main impact from regulation on net profits comes from moving OTC derivatives to exchange/SEF trading. Our revenue growth assumption of 5% CAGR 2010E-12E already account for margin compression, however, we see additional margin pressure from shifting trading from OTC to exchange with revenue impact of -11% and no assumed cost offset. The majority of flow equity derivatives products are already trading on exchange, however, we estimate 45% of the transactions are still agreed on an OTC basis, and revenues on these products could decline -25% with margin compression of 45% more than offsets the potential increase in volumes (assumed 25% increase). We also estimate a limited -2% revenue impact from OTC post trade transparency requirements, as the majority of flow products are expected to be traded on exchange over time. Overall, we expect revenues to decline -13% due to regulatory changes with no cost offset, leading to an average 39% erosion in net profits in flow equity derivatives. 4% average decline in RWAs: We expect RWAs in flow equity derivatives to decline by -4% on average post regulation, mainly due to the RWA reduction from introduction of CCP clearing, which more than offsets the increase in RWAs due to CVA and the Basel proposed changes on Stress VaR.
Table 74: Global Investment Banks Impact from regulatory changes on the flow equity derivatives business 2011E
$ million SG Net income pre regulation Impact from moving to SEF trading Impact OTC derivatives transparency requirements Total impact on profits Net income post regulation RWAs pre regulation RWAs reduction from CCP clearing Additional RWAs from Basel 2.5 Stress VaR changes Additional RWAs from Basel 2.5 IRC changes Additional RWAs from CVA Total impact from regulation RWAs post regulation ROE pre regulation ROE post regulation Decline in ROE 135 -32% -4% -36% 86 4,251 -66% 54% 16% 26% 30% 5,535 32% 15% -51% BNP 110 -32% -4% -36% 70 3,072 -75% 48% 18% 29% 20% 3,682 36% 19% -47% DB 45 -38% -5% -43% 26 2,733 -123% 29% 11% 48% -34% 1,797 17% 15% -13% UBS 96 -45% -6% -51% 47 3,445 -65% 22% 10% 25% -7% 3,199 28% 15% -47% CS 73 -38% -5% -43% 42 2,756 -79% 38% 13% 31% 3% 2,838 26% 15% -44% GS 246 -32% -4% -36% 157 6,595 -94% 34% 2% 37% -21% 5,205 37% 30% -19% MS 72 -32% -4% -36% 46 3,824 -99% 23% 3% 39% -34% 2,519 19% 18% -3% BARC 101 -32% -4% -36% 64 2,983 -67% 36% 5% 26% 0% 2,982 34% 21% -36% BOAML 68 -38% -5% -43% 39 2,471 -101% 38% 5% 40% -19% 2,003 28% 20% -29% CITI 49 -38% -5% -43% 28 2,585 -64% 69% 8% 25% 38% 3,566 19% 8% -58% Total 995 -35% -5% -39% 604 34,716 -84% 38% 9% 33% -4% 33,325 29% 18% -37%
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Figure 37: Flow equity derivatives* Split of the $6.7bn global revenue pool by region 2011E
Asia, 0.9, 13% EMEA, 2.5, 37%
III Trends are however different in Europe vs. the US We see differences between i) European players with limited presence in the US, more focused on the slightly higher margin OTC business where margin compression is due to increase with electronic trading and movement of businesses to exchanges, and ii) large players in the US providing liquidity in a similar fashion as in cash equities, but also affected by margin compression as all flow equity derivatives players globally invest in the US business, e.g. Deutsche Bank which is targeting to be top 3 by volume by end 2011. The US flow equity derivatives business is however likely to show more resilience in volumes as most of it is already listed compared to Europe where the business is more OTC and we estimate higher margin compression both due to the movement to electronic platforms as well as increased regulation. We estimate that the US will account for 49% of the global $6.7bn flow equity derivatives revenue pool in 2011E, up from 45% in 2006. French banks lack presence in the US: French banks like Socit Gnrale with a smaller presence and client franchise in the US might have to make strategic decisions to gain market shares. BNP Paribas could partly benefit from its acquisition of Bank of America prime brokerage activities. Looking more like cash equities: The US option market is progressively moving from a quote driven market where liquidity is provided by market makers to an order-driven market, similar to cash equities, with liquidity provided by natural market participants. The other markets are also evolving in that same direction in our view, although at a slower pace due to differences in market infrastructures. Electronic and technological capabilities as barriers of entry: As algorithms and electronic trading grow in importance, only the players with the technological capabilities and large electronic platform could remain competitive in a fastgrowing segment. As investments and infrastructures costs are relatively high and need constant upgrades, we view technology as one of the main barriers of entry. Diversified platform and risk management are also key: With margin compression and increased competition, differentiating factors will become more important, such as a scaled platform with a comprehensive presence in diverse geographies and asset classes, synergy witch cash, and large infrastructure and post trade services.
Americas, 3.3, 49%
Source: J.P. Morgan estimates. * excluding delta one and convertibles.
Figure 38: Flow equity derivatives revenues 2011E
IV Winners will be players with the scale to provide liquidity We expect the industry to remain relatively concentrated with the top five players accounting for 44% or $2.9bn of the total $6.7bn wallet in 2011E. In our view, the winners in flow equity derivatives would be players with the scale to provide liquidity in a similar fashion as cash equities. The flow equity derivatives business is becoming more commoditized with increased price/choice transparency for clients, pure prop will be limited and the winners would be players who are in the centre of the flow and have the scale to provide liquidity. Goldman Sachs remains the leader in the flow equity derivatives segment, generating $1bn of revenues in 2011E and the highest ROE with 30% post regulatory changes. In our view, GS benefits from its strong cash equities business and institutional/corporate client franchise with it provides more flows and better prices as market maker, as well as expertise in electronic trading -
Top fiv e play ers 44% Others 56%
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SIGMA X is the largest broker dealer ATS (Alternative Trading System, also referred as dark pools) in the US. Socit Gnrale is the second largest player globally with estimated $535m of revenues in flow equity derivatives. SG initially developed its flow franchise as an extension of its structured equity derivatives activities, but the flow business has grown significantly and now benefits from strong market shares in Europe, with leading rank in warrants where we estimate SG generates $0.2bn of revenues. Note that SG flow equity derivatives revenues are also likely to include a higher proportion of exotic flow products than peers given its expertise in structured products. Returns are significantly affected by regulatory changes, declining from 32% to 15% in our estimates. SG remains a large player however, the key issue is growth in the US. In Europe, the group has been able to leverage its corporate relationships and now intends to expand in the US flow business, however, in the US, SG lacks presence and does not have the institutional relationships from the US brokers' cash equities businesses. BNP Paribas, UBS and Barclays are also significant players with about $0.40.5bn of revenues. BNP Paribas has strong positions in Europe; however like Socit Gnrale it lacks presence in the US, while UBS and Barclays benefits from presence in the US. Barclays has notably been leveraging Lehmans platform in the US.
Table 75: Global Investment Banks flow equity derivatives ROE decline post regulatory changes 2011E
$ million, % SG Flow equity derivatives revenues Costs Pre-provision profits Loan losses and other Pretax Net profits Cost/income Tax rate Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE 535 -348 187 0 187 135 65% 28% 135 425 32% 86 554 15% BNP 448 -291 157 0 157 110 65% 30% 110 307 36% 70 368 19% DB 233 -163 70 0 70 45 70% 35% 45 273 17% 26 180 15% UBS 525 -393 131 0 131 96 75% 27% 96 344 28% 47 320 15% CS 333 -233 100 0 100 73 70% 27% 73 276 26% 42 284 15% GS 1,006 -654 352 0 352 246 65% 30% 246 659 37% 157 520 30% MS 294 -191 103 0 103 72 65% 30% 72 382 19% 46 252 18% BARC 402 -261 141 0 141 101 65% 29% 101 298 34% 64 298 21% BOAML 324 -227 97 0 97 68 70% 30% 68 247 28% 39 200 20% CITI 234 -164 70 0 70 49 70% 30% 49 259 19% 28 357 8% Total 4,334 -2,274 1,100 0 1,100 777 68%
995 3,472 29% 604 3,332 18%
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More challenging revenue environment going forward: 5% CAGR 2010E-2012E

5% revenue growth vs. 15%-20% pre-crisis: Revenue growth is likely to become more challenging going forward, and we estimate revenue growth of 5% p.a. vs. 15%-20% previously, mainly as a result of the margin compression on increased competition and expansion of electronic trading. In our view, the flow equity derivatives business is likely to evolve towards a "cash" model with high and low touch segments. The issue is that overcapacity is building up in flow equity derivatives, with all players aiming to take market share in a business which is becoming commoditized. Client demand still weak vs. pre-crisis The main users of options and volatility products remain asset managers, institutionals and hedge funds. The client mix was estimated 80% asset managers and institutionals 5 years ago, but decreased with the expansion of hedges funds. The crisis did not fundamentally change the mix, as both institutionals and hedge funds suffered from the market collapse, and we still estimate the majority of the activities is related to asset managers and institutionals (70%) with hedge funds accounting for 25% of the total client base for plain vanilla options, as illustrated in Figure 39. We estimate that the $7.5bn revenue pool in 2009 was split: 40% or $3.0bn from asset managers and 30% or $2.3bn from institutional clients which invest mostly in plain vanilla options for yield enhancement or hedging purposes, generally short dated options (less than one year maturity). 25% or $1.9bn from hedge funds which take leverage directional views (10-20x leverage), with option premiums much lower than cash prices. When markets recover, hedge funds may buy more stock options to gain leverage and express views in event-driven situations. They are generally looking for catalysts-based strategies. Hedge funds also buy options to release cash balance - when already long the stock, they could sell equity to buy in-the-money calls, to extract cash from their positions. Overall, client demand remains relatively weaker than in the past, with both asset managers and hedge funds still recovering from the poor performances of the past few years and asset outflows stabilizing. We would however expect hedge funds client business to increase faster than asset managers and institutionals in the next few years, as i) hedge funds take more risk than in 2009 where their activity was limited to some return enhancing strategies involving buying short dated options with very low premiums, rather than taking riskier leveraged directional bets, and ii) valuations improve on their positions in dividend swaps and convertibles. Ongoing margin compression is the key issue A favorable market environment with rising equity markets, medium volatility, low or medium correlation, is generally supportive for options trading. Given the potential macro risks still present in the market, we would expect equity implied volatility levels to stay in the 18-25% range, above 2004-06 levels, which should be relatively favorable for options trading.
Figure 39: Flow equity derivatives* Split of the $7.5bn revenue pool in 2009 by clients
Corporates 5% Institutional s 30% Hedge funds 25%
Asset Managers 40%
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Figure 40: S&P 500, Russell 2000, Nasdaq 100 and S&P Latam 40 Index 6M implied volatilities
70 65 60 55 50 45 40 35 30 25 20 15 10 5 0 Feb-08 May-08 SPX Index - 6M NDX Index - 6M RTY Index - 6M
Figure 41: S&P 500 and Euro Stoxx 50 index 3M implied and realized volatility
70 60 50 40 30 20 10 SPX 3M realised SX5E 3M realised SPX 3M implied SX5E 3M implied
Aug-08
Aug-09
Nov-08
May-09
Nov-09
May-10
Aug-10
Feb-09
Feb-10
Feb-08 May -08
Aug-08
Nov -08
Feb-09 May -09
Aug-09
Nov -09
Feb-10 May -10
Aug-10
Source: J.P. Morgan Global Equity Derivatives & Delta One Strategy.
However, the main issue remains margin compression, as listed options trading gains market share vs. the OTC business, margins decreased further with i) the mix shift in favour of index and listed products with higher liquidity but lower margin, ii) increased competition from players which are coming back more aggressively to the market, and iii) the growth in electronic trading and direct market access, in the US in particular.
Figure 42: Split of commissions spend on options in Europe by trade Figure 43: Split of commissions spend on options in North America size by trade size
$ thousands
$7,501 - $20,000 21%
$ thousands
$7,501 - $20,000
17%
$5,001 - $7,500
5%
$5,001 - $7,500
13%
$2,501 - $5,000
8%
$2,501 - $5,000
11%
$1,000 - $2,500
15%
$1,000 - $2,500
23%
$501 - $999
16%
$501 - $999
14%
$1 - $500
35%
$1 - $500
23%
0%
5%
10%
15%
20%
25%
30%
35%
40%
0%
5%
10%
15%
20%
25%
Source: Greenwich Associates 2009 European Equity Derivatives study.
Source: Greenwich Associates 2009 North American Equity Derivatives study.
US flow equity derivatives: looking more like cash?

There are key regional differences between the US and the European and Asian option markets. Whilst the US options market is mainly listed, price driven, transparent, the European and Asia businesses are more OTC based. US equity derivatives market has historically mainly been driven by flow and equity finance, and differs from European markets which have been dominated by
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structured products. In our estimates, flow equity derivatives (excluding delta one and prime brokerage) accounted for about 40% of the US equity derivatives revenue wallet, with structured products accounted for only 15%. More resilient volumes: The US market has always been dominated by listed options, with transparent prices. Trends are similar to cash equities, with investment banks providing liquidity and running options as an agency business. Liquidity is not only high on index options such as the S&P 500 index options which have been the most actively employed tools to hedge portfolios against market downturn, but liquidity is also higher on single stock options - trading is available for over 600 names in the US compared to the 170 names in Europe, and average daily turnover on single stocks in the US amounts to about $30bn vs. less than $6bn in Europe. Overall, volumes in single stock and index options have been more resilient in the US, with US index options turnover at around $111bn in YTD 2010 vs. c.$115bn in 2007, and US single stock options turnover at around $34bn in YTD 2010, close to 2007 levels.
Figure 44: Split of the US equity derivatives revenue wallet 2009E
Convertibles Structured 5% products 15% Flow 40%
Figure 45: US listed options Turnover (daily average, $bn)

$200 $180 $160 $140 $120 $100 $80 $60 $40 Index Options Single Stock Options
Delta one 40%
$20 $0 Sep-09 Mar-09 Mar-10 Jan-09 Jan-10 Jul-09 May-09 Nov-09 May-10 Jul-10
Figure 46: US single stock options estimated margins*

35 30 25 20 15 10 5 0 Less than 3 months Less than 6 months 1 y ear ex piry 2 y ear ex piry 3 y ear ex piry
More margin compression: Margins have continued to decline in the US, with the decline in volatility, investor risk appetite still weak and increased competition. Margins are particularly low on short dated options where most of the activity is 5 to 10bp on listed products in our estimates, but improve on 2 year or 3 year expiry contracts. The average amount spend by US institutions on option commissions was $4.5m, however, over 60% paid less than $2.5m (source: Greenwich Associates). From quote-driven to order-driven market: The market depth in the US has favored higher levels of automation, and trades can be processed electronically. Real money investors increasingly use electronic transactions for options, with their share of electronic trading increasing from 5% in 2004 to estimated 15-20% in 2009. Overall, we estimate electronic trading in the US options market to account for about 18% of total order flow in 2009, still below the estimated 30% in futures market or 60% in cash equities, as illustrated in Figure 47 below. Electronic trading is likely to
Source: J.P. Morgan estimates. * Full service
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further grow in our view, with options following a similar trend to futures, and we expect electronic trading to grow to 30% of total order flow for options in 2011E. Electronic trading will compress margins further, and in our view, margins on listed options is likely to decline progressively to the levels seen in the cash markets - we estimate options commission rates of 8bp for full service and 2bp for electronic/program, compared to 4bp and 0.5bp respectively for cash equities (Figure 48). The SEC introduced in Jan 2007 the penny pilot program which was an initiative to quote a number of options classes in pennies, to help tighten price spreads. The program was extended in Sept 09, and more than 300 options accounting for over 85% of volumes will be traded in pennies, up from 63 options or 50% of volume currently. Similarly to what happened to cash equity markets when they started trading in decimals, this will reduced spreads further whilst encouraging algorithmic trading. With margin compression, competition is focused on the differentiating factors: pricing and execution, but also electronic services and post trade services. In our view, competition is likely to increase further with more algorithmic trading offered by i) the large electronic trading brokers, Goldman Sachs, Morgan Stanley and Credit Suisse which are extending their automated electronic systems in cash equities and futures to the options market, but also from ii) the new entrants such as Citi and Barclays which just launched their new electronic trading systems for options.
Figure 47: US equities market electronic trading as % order flow
Cash equities Futures Options 80%
Figure 48: US listed options Turnover (daily average, $bn)

Cash equities 8.0 Futures Options
60% 50%
5.0 4.0
30% 23% 18% 10% 5%
30%
2.0 0.5 1.0
2004
2009
2011
Full serv ice

Electronic/program
In our view, the US option market is progressively moving from a quote driven market where liquidity is provided by market makers to an order-driven market, similar to cash equities, with liquidity provided by natural market participants. This trend would imply even lower margins, partly offset by higher volumes, and overall, only the investment banks with the technological capabilities can remain competitive and attract flows in the market.
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Europe: OTC still the king?

Europe remains a margin business, with transactions still agreed OTC, although they could be crossed on exchange. The market structure with several national exchanges with different trading protocols and requirements, as well as the lack of a simpler, single post trade clearing and settlement infrastructure has been a challenge to electronic trading. Some of the clients also do not have the capacity to trade on exchange. The Euro Stoxx 50 remains the most liquid index option by a significant margin c.30bn of average daily turnover vs. c.10-15bn for the second most liquid index, the DAX. In single stock options, daily turnover remains lower than in the US market and, volumes are concentrated in a few names with financials and German underlyings still dominating the single stock flow. In Europe, OTC volumes dropped significantly, with OTC options accounting for estimated 30% of total volumes, compared to over 60% pre-crisis. Whilst contract volumes for listed options remained relatively robust (equivalent to end 2007 levels), OTC volumes declined by c.70% in our estimates. Overall, we believe that total option volumes dropped by some -40% in 2009. Turnover for European listed options has dropped to below pre-crisis level on both single stock (4.0bn), down about -46% compared to average 2007 levels and index options (50bn), down -26%.
Figure 50: European listed options Daily option notional volume (3 mth average, bn)
100 80 60 40 20 0 Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09 Jul-10
Total index Total Single Stock (RHS)
Figure 49: European option market volumes OTC vs. listed

100 80 60 40 60% 20 30% 0 Pre-crisis 2009E 70% 40% Listed OTC
Figure 51: Options notional amounts OTC vs. listed

8000 7000 6000 5000
OTC Options
Listed Options
10 8 6 4 2 0
4000 3000 2000 1000 0
H1 1998
H1 1999
H1 2000
H1 2001
H1 2002
H1 2003
H1 2004
H1 2005
H1 2006
H1 2007
H1 2008
Source: BIS.
Ongoing margin compression: Margins on OTC options increased sharply during the crisis as a result of the reduced liquidity, reduced risk appetite and concerns on counterparty risk, however, margins have dropped since then, and now stand below crisis levels. In Europe, margins declined to below 5bp on the liquid index options, whilst margins for single stock halved to 25bp for 1-year expiry. However, margins are higher on longer expiry contracts, with additional 15bp per year. Lower levels of activity with a reduced client base, with increased competition from new entrants such as Barclays and Nomura has contributed to the margin compression.
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H1 2009
Figure 52: Bid/Offer spread on the Eurostoxx 50 index Dec-010 2900 strike call
30 25 20 1M Average
Figure 53: Bid/Offer spread on the Deutsche Bank Dec-010 52 strike call
25 1M Average
20
15
15
10
10 5 0 Apr-09 Oct-09 Dec-08 Dec-09 Aug-09 Sep-09 Apr-10 May-09 Nov-09 May-10 Aug-10 Feb-09 Feb-10 Mar-10 Jan-09 Jun-09 Jan-10 Jun-10 Jul-09 Mar-09 Jul-10
5
0 Oct-09 Jul-09 Aug-09 Sep-09 Dec-09 Jul-10 May-09 Nov-09 May-10 Aug-10 Apr-09 Feb-10 Mar-10 Apr-10 Jun-09 Jan-10 Jun-10
Source: Bloomberg.
Source: Bloomberg.
Figure 54: European single stock options estimated margins*

bp
50 45 40 35 30 25 20 15 10 5 0 Less than 3 Less than 6 months months 1 y ear ex piry 2 y ear ex piry 3 y ear ex piry
European option markets suffered from the decline in the OTC market, and similar to the US, listed options and electronic trading are gaining market share, however, the European market is likely to evolve more slowly due to lower levels of liquidity, client demand and a more complex market structure. The mix between OTC and exchange-traded could also depend on the type of counterparty, however, clients now generally prefer exchange-traded transactions rather than pure OTC. Note however that even if the transaction is exchange traded, it is still agreed on an OTC basis. The great majority of the order flow is still voice broking, i.e. the client calling the broker and then the transaction is crossed on exchange. Most trading in the inter-dealer broker market is however generally done through the exchange, as i) exchange-traded transactions are more economic than in the past due to the decrease in exchange fees, ii) counterparty risk has become a key concern, and iii) regulatory changes strongly favors on-exchange trading.
Source: J.P. Morgan estimates. * Full service
Risk management: entry barrier

Risk management of options is more complex due to the non-linear pay-out profile. Prices of options are sensitive to changes in the underlying price (delta risk), the volatility (vega risk), the interest rate (Rho), the time to maturity (theta risk or time decay) and the strike price. Vega more difficult to hedge: Whilst delta can be hedged with stocks which have high levels of liquidity, vega is more difficult to hedge as it is mostly hedged with other options. Whilst option traders could easily hedge vega risk of $500,000 in the past, due to the reduced risk appetite, they find it more difficult to hedge vega of $50,000 already. Gamma (leverage) is the second derivative to changes in the share price, and is important because it corrects for the convexity of value. When a trader deltahedge a portfolio, he may also seek to neutralize the portfolio's gamma to ensure the hedge will be effective over a wider range of underlying price movements
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Stocks and futures have a gamma of zero, and cannot be used to hedge gamma risk, as a result, gamma hedging mostly involves options. Other second order derivatives: An option portfolio can also be very sensitive to second order derivatives, e.g. vega convexity or second order sensitivity to volatility, which are difficult to hedge in volatile markets with low levels of liquidity. Unlike cash equities, liquidity in option markets is much lower and can dry up very quickly in deteriorating market conditions. How option desks manage the greeks: Limits are defined for each greek letter and permission is required to exceed a limit at the end of the trading day. We understand options traders tend to be delta neutral at the end of each day - for example, if a trader sells 10 calls with a 0.5 delta, he has to buy 5 shares to hedge delta. Market makers do not however necessarily manage gamma and vega risks on a daily basis. In our view, most banks would use the large volumes, to offset some of the risks, using flows as "natural hedges", and only actively hedge the risks of the entire portfolio by buying options at competitive prices, which reduces the cost of insurance. Losses from short gamma positions: Trading desks client business mostly involves writing options, and as sellers of options, they tend to generate short gamma and vega positions. The position deltas move in the opposite direction to the stock movements. If the trader is short a call and the stock drops, the delta becomes positive, and the trader has to sell calls or stocks to remain delta neutral. Similarly, the position vegas move in the opposite direction to the changes in volatility. As volatility increases, the vega becomes positive, and the trader has to buy more options. As experienced in Q4 08, option and volatility trading desks made significant losses due to their short convexity positions. As market deteriorated, volatility increased and trading desks had to re-delta hedge, buying volatility at wider levels and realizing the losses of the short gamma positions.
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Figure 55: CBOE S&P 500 volatility index

90 80 70 60 50 40 30 20 10 0 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Figure 56: S&P 500 1 year convexity over the past 14 years
Source: J.P. Morgan Equity Derivatives Research.
Source: Bloomberg.
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Delta One products

In this section below, we focus on delta one products, i.e. flow equity derivatives with a linear, symmetric payoff profile which closely track their underlying asset and risk free rate, have a delta close to 1. These businesses would include futures execution, equity swaps, dividend swaps, ETF, program trading, index arbitrage and Stat arbitrage. Note however that investment banks' reporting structures may differ, with equity swaps often part of prime brokerage within cash equities, and program trading often part of cash equities.
Competing on technology and balance sheet

Delta one products are the area of growth in our view, with strong growth in client volumes, resilient margins and untapped potential in emerging markets. Most players have high ambitions in delta one products, ETF in particular where volumes expected to grow further by 20% p.a. Industry wallet of $10.8bn in 2011E, back to 2009 peak We estimate the total delta one revenue wallet to amount to $11bn in 2011E, back to 2009 levels after a challenging 2010 (-8% YoY). The industry is relatively concentrated with the top 5 players accounting for 41% or $4.5bn of revenues in 2011E. 9% CAGR revenue growth in 2010E-2012E Delta one is one of the fastest growing businesses within equity derivatives, and we estimate revenues to grow 9% CAGR 2010E-12E, driven by volume growth in ETF and equity swaps, with limited margin compression. Delta one desks benefited from very favorable conditions in 2009, with i) a flight to highly liquid and transparent delta one products, ii) high frequency trading thriving on the relatively high levels of volatility, iii) equity finance activities supported by wide margins, and iv) gains on dividend positions with dividend swap pricing improving 40%. 2010E has been a more challenging year, with revenues declining -8% from their 2009 levels, on challenging market conditions and reversal of some of the prop/hedge gains, with dividend pricing declining -15% to -30% in Q2 10, and lower volumes compared to the high 2009 base. Solid revenue growth in 2011E-12E: following a difficult 2010 year, we expect revenues to be supported by further growth in ETF, algorithmic trading and high frequency strategies, as well as resilient margins. Most profitable business with 40% ROE in 2011E post regulatory changes ROE in the delta one derivatives businesses declines by -43% from 71% pre regulatory changes to 40% post regulation in 2011E, primarily as a result of the increase in Market risk RWAs from Basel changes related to Stress VaR and IRC. However, at 40%, it remains the most profitable business within equity derivatives.
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48% increase in RWAs: We expect 2011E RWAs to increase 48% on average, mainly due to Basel Stress VaR related changes (39%) and to some extent from market risk requirements from Incremental risk charge (9%). -16% decline in profits: We estimate the regulation relating to moving derivatives to SEF trading to have average -16% impact on 2011E Net Income. We have assumed an average -8% impact on 2011E revenues from moving delta one derivatives to SEF trading and no cost offset.
Table 76: Global Investment Banks - Impact from regulatory changes on the delta one derivatives business 2011E
$ million SG Net income pre regulation Impact from moving to SEF trading Net income post regulation % impact on profits RWAs pre regulation RWAs reduction from CCP clearing Additional RWAs from Basel 2.5 Stress VaR changes Additional RWAs from Basel 2.5 IRC changes Additional RWAs from CVA Total impact from regulation RWAs post regulation ROE pre regulation ROE post regulation Decline in ROE 383 -57 325 -15% 3,501 0% 54% 16% 0% 70% 5,962 109% 55% -50% BNP 331 -50 281 -15% 3,309 0% 48% 18% 0% 66% 5,476 100% 51% -49% DB 156 -26 130 -17% 2,733 0% 29% 11% 0% 40% 3,839 57% 34% -41% UBS 177 -30 148 -17% 2,460 0% 22% 10% 0% 32% 3,251 72% 45% -37% CS 213 -36 178 -17% 3,062 0% 38% 13% 0% 51% 4,626 70% 38% -45% GS 368 -61 307 -17% 7,035 0% 34% 2% 0% 36% 9,573 52% 32% -39% MS 204 -34 170 -17% 2,550 0% 23% 3% 0% 26% 3,218 80% 53% -34% BARC 175 -29 146 -17% 2,099 0% 36% 5% 0% 41% 2,958 83% 49% -41% BOAML 150 -25 125 -17% 2,745 0% 38% 5% 0% 43% 3,919 54% 32% -42% CITI 139 -23 116 -17% 2,872 0% 69% 8% 0% 77% 5,087 49% 23% -53% Total 2,295 -371 1,925 -16% 32,367 0% 39% 9% 0% 48% 47,908 71% 40% -43%
Large players to remain large In our view, the delta one products segment could remain relatively concentrated. Delta one trading desks generate most revenue through a variety of high frequency trading strategies related to relative value trading, index arbitrage, and equity finance operations. These activities require large scale operations to maintain significant size index-based portfolios and competitive technology. 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 Europe, the largest players in delta one products include Socit Gnrale, BNP Paribas, and Goldman Sachs. In the US, the large cash equities players, Goldman Sachs and Morgan Stanley lead the industry. Key for US players is the client relationship with institutionals, hedge funds and corporates, as well as the leverage with cash equities and prime brokerage. All large players still generate very attractive returns of over 50%, despite the -43% negative impact from regulatory changes. Compared to flow equity derivatives, the delta one products unit benefits from i) lower cost/income ratios at 54% on average in 2011E vs. 68% in flow equity derivatives as there are more technology costs involved but the business is less human capital intensive, ii) higher volumes with increasing demand for more liquid and transparent products, and iii) more resilient margins.
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Goldman Sachs and Socit Gnrale are the largest players globally in the delta one derivatives segment with estimated revenues of $1.2bn and $1.1bn respectively in 2011E. In our view, GS benefits from its strong high frequency trading capabilities and client franchise in both cash equities and prime brokerage. SG however lacks presence in the US, and does not have the client relationships from the US brokers' cash equities businesses. However, the group benefits from strong positions in algorithmic trading (index arbitrage and stat arbitrage notably), equity swaps, and dividend swaps and is the second largest player in ETF in Europe with Lyxor. SG also aims to double its ETF business from current levels (32bn of AuM end 2009, 21% market share). BNP Paribas with $0.9bn of 2011E revenues is also one of the large players in the delta one derivatives business. BNP Paribas is one of the largest players in Europe, with strong positions in index arbitrage, equity swaps and dividend swaps, and could benefit from the growth in its prime brokerage activities acquired from Bank of America. Credit Suisse and Morgan Stanley generate about $0.6bn of 2011E revenues from delta one derivative products. Morgan Stanley is one of the largest players in the US with strengths in high frequency trading and equity finance activities. Barclays, Deutsche Bank and UBS generate about $0.5bn of revenues from delta one derivative products.
Table 77: Global Investment Banks delta one derivatives summary P&L 2011E
$ million SG Delta One products revenues Costs Pre-provision profits Loan losses and other Pretax Net profits Cost/income Tax rate Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE 1,063 -532 532 0 532 383 50% 28% 383 350 109% 325 596 55% BNP 945 -473 473 0 473 331 50% 30% 331 331 100% 281 548 51% DB 532 -292 239 0 239 156 55% 35% 156 273 57% 130 384 34% UBS 540 -297 243 0 243 177 55% 27% 177 246 72% 148 325 45% CS 648 -357 292 0 292 213 55% 27% 213 306 70% 178 463 38% GS 1,169 -643 526 0 526 368 55% 30% 368 703 52% 307 957 32% MS 646 -356 291 0 291 204 55% 30% 204 255 80% 170 322 53% BARC 545 -299 245 0 245 175 55% 29% 175 210 83% 146 296 49% BOAML 475 -261 214 0 214 150 55% 30% 150 275 54% 125 392 32% CITI 443 -244 199 0 199 139 55% 30% 139 287 49% 116 509 23% Total 7,006 -3,753 3,253 0 3,253 2,295 54%
71%
40%
Growth potential in algorithmic trading

Algorithmic trading has been one of the key revenue drivers in the past few years in delta one, and we see further growth in both cash equities and futures. Whilst algo trading adds margin pressure to the overall equities business with potential risk of cannibalization of revenues, volumes and high velocity of the trades have partly offset the negative impact. Competition has long been intense to lower execution costs, and the opportunity costs of not providing algorithmic trading could
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be high in our view. As algorithms become more complex and customized, trading desks increasingly provide advisory services, on top of the traditional execution services. Algorithms for futures still in the early stages: In the US, we estimate that algorithmic trading accounts for about 25% of order flows in cash equities, but only 8% in futures in the US in 2009E. In our view, this could increase further by 2011E to 35% in cash equities where electronic trading is already well established, but there is more potential growth in futures, closer to 20%, as the investment banks expand their offerings to asset managers.
Table 78: US equities and futures Estimated breakdown of the order flow
Futures 2009 60% 32% 8% 100% 2011 40% 40% 20% 100% Cash equities 2009 40% 35% 25% 100% 2011 25% 40% 35% 100%
Broker via phone/fax ECN/DMA/Crossing Networks Algorithmic Total order flow

The US futures market has strong similarities with the cash market in terms of liquidity, margins and volumes: margins are closer to cash equities than other equity derivatives, and volumes have been higher than in cash equities over the past 3 years (Figure 58) average daily turnover in Aug 2010 amounted to $131bn in futures vs. $130bn in cash equities (Figure 57). Unsurprisingly, algorithmic trading started in cash equities which high levels of transparency and price discovery facilitated electronic trading from an early stage, but has now moved to futures where liquidity is also very high.
Figure 57: US turnover by instruments ($bn)
Index Options, $81 Futures, $131
Figure 58: US average daily turnover of equity instruments ($bn)
ETF Options, $25
SS Options, $30
ETFs, $55
Source: J.P. Morgan Equity Derivatives research.

Cash, $130
Source: J.P. Morgan Equity Derivatives research. Past week average. Cash volumes including shares traded on electronic markets.
In Europe, the growth potential could be even higher in our view although most of European buy side companies use algorithmic trading alongside with brokers, or direct market access, algorithmic trading accounts for less than 5% of cash equities and futures flows. In our view, this should increase progressively towards 20% as i)
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investors get more comfortable with the service and use algorithms for both execution and investment purposes e.g. market making, arbitrage, or pure speculation (including trend following) and ii) investment banks adapt the offering both in cash and futures. Where technological innovation drives market shares: Investment banks all offer the basic algorithms for executing trades: volume weighted average price (VWAP), time weighted average price (TWAP), implementation shortfall, volume participation and smart routing methods. However, competition has increased amongst investment banks and agency brokers, and the introduction of broker-neutral/multi-broker trading systems for buy side firms five years ago made it significantly easier for them to use algorithms from a very large range of brokers. As a result, there is a constant need to upgrade technology to make the algorithms smarter, more sophisticated, but more importantly, more adapted to client needs. In our view, further growth in algorithmic trading could come from: More customized algorithms: investors have been increasingly using algorithms for investment strategies, and the focus is more on flexibility and customization. As a result, the investment banks have been competing on technology to bring more customized algorithms. Portfolio trading: algorithms have long involved single-stock orders only, but growth has been strong in portfolio algorithms which allow to trade portfolios of stocks, a stock within a basket in relation to the other stocks in the same basket. The next step is then algorithmic trading across asset classes, e.g. involving both stocks and futures. Technological investments, a barrier of entry: Algorithmic trading is a high cost business with heavy investments in infrastructure and IT required - for hardware, market and client connectivity, data center build-outs and trade cost analysis, in addition to distribution, sales and quantitative traders to monitor and adapt the algorithms. Whilst costs of offering the basic algorithms are decreasing, providing more advanced and customized services is more expensive and challenging in terms of IT/infrastructure. Full-service brokers still have a competitive advantage, as they benefit from the scale to absorb the costs, and we estimate full service brokers account for 55% of total market share in algorithmic trading. Algorithmic trading industry remains concentrated, with the biggest market shares split between less than 10 full service brokers. In our view, the largest cash equity houses with already comprehensive algorithmic trading services and access to multiple execution venues (exchanges, ECNs, ATS, dark pools) are the best placed to benefit from the growth into futures and cross-asset products. Credit Suisse which was the first broker to introduce algorithmic trading remains one of the top leaders, followed by Bank of America, Morgan Stanley, Goldman Sachs and UBS.
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Figure 59: Algorithmic trading providers estimated split of market share 2009
Other 10%
Table 79: Top 10 algorithmic trading firms 2008

Rank 1 2 3 4 5 6 7 8 9 10
Source: Institutional Investor.
Agency brokers 35%
Full serv ice brokers 55%
Firm Bank of America Credit Suisse Lehman Brothers Morgan Stanley UBS Goldman Sachs JPMorgan Merill Lynch Citi Deutsche Bank
High frequency trading strategies as main liquidity providers In US equities, High Frequency Trading (HFT) has replaced traditional market makers and agency brokers as liquidity providers, providing a large percentage of the displayed liquidity available on exchanges and other public markets. High Frequency Trading is used by prop shops, some sophisticated hedge funds and investment banks, both in their market making activities and in their prop trading businesses. Within IBs, the largest players are Goldman Sachs and Morgan Stanley. HFT generally refers to fully automated trading strategies in equities, derivatives or currencies with a holding period ranging from a couple of minutes to milliseconds. HFT include arbitrage strategies to benefit from short term pricing inefficiencies, but the main HFT strategy remains market making where traders aim to generate revenues from imbalances in market liquidity. Key is the speed of the technology and the complex algorithms as well as the ability to adapt the strategies to market changes or reverse engineering by competitors.
Table 80: High frequency profile & Strategies
Holding Period Strategies Ultra high freq Less than 2 minutes Index Arb Rebate capture Order flow trading High Freq Less than 2 hours Mean revision Momentum Pattern recognition Med Freq Less than 2 days Info trading Factor models Stat Arb Low Freq Less than 2 weeks Stat Arb
Source: Tradeworx.
HFT thrives in market conditions with high levels of volatility, and growth has been tremendous in the past few years, partly fuelled by volatility and high demand for liquidity. Since then, volatility has declined leading to fewer windfall profits, however, we see further growth in this area, both in equities and futures, with technological advances and ongoing investments by all players including exchanges to chase liquidity.
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Equity swaps dominated by banks with prime broker access and balance sheet flexibility
The swaps activities are balance sheet intensive with relatively low margins, and as a result, investment banks with strong capital and liquidity positions would have a competitive advantage. Investors on both sides of the swaps have counterparty risks to the swap dealer, and the margin spread charged, and the lending/borrowing activities related to equity swaps are directly linked to the banks credit quality. Hedge funds are one of the main users of equity swaps products, and prime broker access is also key in our view.
Figure 60: Financials CDS 5yr senior spreads
300 250 200 150 100 50 0 Mar-07 Mar-08 Mar-09 Mar-10 Jul-07 Jul-08 Jul-09 Nov-07 Nov-08 Nov-09 Jul-10 Itrax x DB CSG BNP SG
Table 81: Top 10 global prime brokers

Rank 1 1 3 4 5 6 7 8 9 9 Prime Broker Credit Suisse Deutsche Bank Morgan Stanley Goldman Sachs J.P. Morgan BofA Merrill Lynch Newedge UBS Citi Barclays Capital Weighted score 6.06 6.06 6.02 6.01 5.86 5.85 5.74 5.72 5.71 5.71
Source: Global custodian 2010 prime brokerage survey. Note: with outliers.
Making money in equity swaps Equity swaps sector swaps, index swaps, customized swaps are equity finance products to mainly asset managers and hedge funds which would pay an interest rate (generally floating) to receive the equity underlying assets' returns, or vice versa. Investment banks generally hedge out the risks and lock in a small margin: hedge the equity risk by buying/selling the underlying, and the interest rate risk with instruments like a zero coupon bonds. For example, we assume an asset manager enters an index swap with an investment bank, where he pays Libor + fixed margin of 30bp (swap coupon) on a quarterly basis for the return on the S&P 500 for a year. To hedge its position, the Investment Bank could buy the S&P 500 futures and sell a zero coupon bond. Assuming the performance of the portfolio is higher than the swap coupon of 30bp (with LIBOR at 30bp), the investment bank would pay the asset manager the difference, and lock in the margin between the swap coupon and the risk free rate of 30bp. Assuming the performance is lower, the investment bank would then receive the difference from the asset manager, and still earn the interest spread between the swap coupon and the risk free rate. Swaps remain on the banks book, and similarly to other equity finance activities like stock lending and borrowing, swaps are balance sheet intensive, and the bank's
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liquidity would be key. The treasury department charges the swap desk the cost of funding, and net of the funding cost, the swap desk generate a margin of 5bp to 15bp.
Table 82: Profitability of the swap business
% Swap coupon: Libor + 30bp Deduct cost of hedging interest rate risk Margin Deduct cost of funding Margin net of funding cost
0.60% -0.30% 0.30% -0.15% 0.15%
In addition, the bank may also use the hedge position stock as part of a funding transaction such as stock lending, repo or as collateral for a loan. Overall, equity finance activities levels of profitability would have similar drivers to fixed income businesses. The swap coupon paid/received by the customer would depend on: Market interest rates and yield curve: Steep yield curves are supportive for swap trading desks which are naturally long duration as they tend to hedge their rates exposures with shorter duration products. The cost of funding charged by the treasury department to the swap desk, and more generally the group's cost of funding - which can be measured by the CDS spread. Equity swaps and more generally equity finance are OTC activities with counterparty risks involved on both side of the transactions.
Figure 61: US yield curve 2 Yr 3 mth
bp
250 200 150 100 50 0 -50 -100 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Figure 62: Equity swaps margins dependent on bank funding 3M spot FRA/OIS basis
bp
200 180 160 140 120 100 80 60 40 20 0 Dec-08 Dec-09 Sep-08 Mar-09 Sep-09 Mar-10 Jun-08 Jun-09 Jun-10
Source: Bloomberg. In bp.
Source: J.P. Morgan estimates. In bp.
Where the equity swaps business differs is on the P&L from dividends: In addition to interest spreads, the equity swap desk generates revenues from dividends. Most equity swaps do not pay dividends, except for total return swaps, but the pricing of the swaps would account for dividends in both cases.
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Dividend swaps and futures can be used to hedge dividend risk, however, these instruments are less liquid, and as result, risk management is more difficult. Equity swaps activities portfolio management revenues are quite sensitive to large movements in dividend swaps pricing. Moderate growth outlook in the medium term 2010E has been a challenging year, however revenue growth will be moderate in the medium term in our view, as we expect growth from Emerging Market and increased risk appetite from hedge fund to partly offset the decline in hedging/prop revenues. Portfolio management revenues to improve 5% in 2011E-2012E: 2009 was a very strong year for swaps, with equity swap trading desks benefiting from a favourable environment: i) low interest rates, relatively steep yield curve, and wide margins in the fixed income markets, and ii) dividend swaps pricing increasing by over 40% on average. In our view, the "easy" prop/hedge gains are unlikely to be repeated in the coming years, with more normal market conditions, and portfolio management revenues are likely to grow by a moderate 5% in 2011E-2012E following the correction in 2010E. Client-driven revenues to improve 10%-15% in 2011E-2012E: Asset Managers, and Hedge Funds remain the main users of equity swaps, with estimated 45% and 40% of client counterparts. With the recovery in inflows and AuM, asset managers appetite for access products to emerging markets for diversification or yield enhancement purposes could increase in our view. We also expect hedge funds risk appetite to improve from the low levels of 2009 equity swaps are unfunded instruments that trade on margins, and they can provide leverage of up to 20:1, compared to a maximum of 2:1 under US regulation for cash equities.
Figure 63: Breakdown of Equity swaps users

Retail Corporates 10% Asset Managers 45% 5%
Hedge Funds 40%
Dividend swaps
A business dominated by the large structured product houses Dividend swaps providers tend to be the main structured equity derivatives houses. Dividend swaps were first traded in the late 1990's/early 2000's as a way of reducing dividend exposure that had accumulated on structured equity derivatives providers books. As a result, the main players are Socit Gnrale, BNP Paribas, Deutsche Bank and UBS in our view. Structured equity derivatives houses structurally long dividends: The large majority of equity structured products are capital protected notes where the investor often gets exposure to the basket of stocks less dividends. The investor demand is equivalent to a long equity forward exposure, which consequently leaves investment banks with short equity forward (and therefore long dividend) exposure. Dividend swaps initially created to hedge long dividend exposures: The simplest way to hedge long dividend exposures would be for investment banks to buy equity forwards, but equity forwards contain exposure to both interest rates and can obscure the sensitivity to dividends. This is the reason why dividend swaps were initially created, to allow investment banks to sell on their dividend exposure in a clear and transparent format.
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2010 disappointing so far, however volumes to improve with the return of the main buyers - hedge funds. Volumes in dividend swaps futures which were introduced on the EUREX exchange in July 2008 have been progressing from 9.1 million contracts in Jan 09 to 75.9 million in Oct 09. However, 2010 has been a difficult year for dividend swaps, with volumes declining to 7.7 million contracts in July 2010. While total OTC volume is difficult to determine, we estimate that c 50% of all dividend swap trading is now done via exchanges. Overall, OTC and listed have improved from the unusually low levels of 2008, in 2009 before the decline post Q1 2010. We expect OTC and listed volumes to improve in 2011E2012E with the increase in hedge risk appetite.
Figure 64: Open interest and volume for Euro Stoxx 50 dividend futures
Open interest / Volume (000)
25 20 15 10 5 0 Sep-08 Sep-09 Jan-09 Mar-09 Jan-10 Mar-10 Jul-08 Jul-09 Nov-08 May-09 Nov-09 May-10 Jul-10 Open Interest (RHS) Volume (LHS) 140 120 100 80 60
40 100 80 60
Figure 65: DJ Euro Stoxx50 dividend swap futures volumes

Number of contracts traded, 000s
120
40 20 0
20 0 Sep-08 Sep-09 Mar-09 Mar-10 Jul-08 Jul-09 Jan-09 Nov-08 May-09 Nov-09 Jan-10 May-10 Jul-10
Source: Bloomberg.
Source: Bloomberg.
Margins resilient, recovery post the decline in 2009: With the improved price discovery from on-exchange trading, volumes and the number of market participants increased, but bid/offer spreads declined significantly in 2009 as illustrated in Figure 66 below, pricing OTC and on exchange had been very close. However, since the launch of dividend swaps futures, the bid/offer spread declined from 4 dividend points to only 1 point. We expect margins to remain at these low levels in 2011E-2012E.
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Figure 66: Dividend swap futures pricing

Index points
210 200 190 180 170 160 150 140 130 120 110 100 90 80 70 60 50 Dec-07 Oct-07 Oct-08 Aug-07 Aug-08 Apr-07 Apr-08 Feb-07 Feb-08 Jun-07 Jun-08
Figure 67: Bid/ask spreads on dividend swaps

Index points
8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08
E-STOXX-50 DIVSWAP ASK 2012
Dec-08
Dec-09
Aug-09
Oct-09
Aug-10
Apr-09
Feb-09
Feb-10
Jun-09
Apr-10
Jun-10
Source: J.P. Morgan, Bloomberg. DEDZ2 Index
Source: J.P. Morgan. Note: Bloomberg codes are DEDZ0 Index and UKDZ9 Index. Dotted vertical line marks start of exchange trading.
ETF dominated by a few providers

A very concentrated market The ETF market is relatively concentrated, with a few players enjoying the lions share. Whilst the number of ETF providers exceeded 100, the top 7 ETF providers accounted for 83% of the market in terms of AuM, with iShares (now owned by Blackrock) dominating the pack with a market share of 46% globally, followed by State Street (14%), Vanguard (10%) and Lyxor (4%). In our view, the ETF market will continue to be dominated by current main participants. Given the size of the US ETF market, European or Asian players are unlikely to increase their global market shares without any presence in the US where the barriers of entry are high for both retail and institutional markets. European players such as Lyxor and DBx-Trackers are however relatively successful in Europe. The European market is dominated by 3 players: iShares with a 36% market share, followed by Lyxor ETFs (19%), and DB x-Trackers (16%).
Table 83: Top ETF providers ranked by Assets under Management (end Q2 10)
$ billion 1 2 3 4 5 6 7 8 9 10 11 12 iShares State Street Global Advisors Vanguard Lyxor AM DB x-trackers PowerShares ProShares Van Eck Nomura AM Credit Suisse AM Zurich Cantonal Bank Bank of New York Total US 352.1 133.5 103.3 32.4 23.6 14.6 8.7 693.2 Europe 77.9 1.0 41.6 35.9 1.0 10.8 8.9 218.0 Total 469.5 144.3 103.4 42.5 36.6 33.4 23.6 14.6 13.2 10.8 8.9 8.7 1025.9 Market share 45.8% 14.1% 10.1% 4.1% 3.6% 3.3% 2.3% 1.4% 1.3% 1.1% 0.9% 0.8% 100%
Source: BlackRock, Bloomberg.
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Jul-09
Revenues mostly coming from management fees The great majority of revenues generated in ETFs is from the management fees, whilst commissions in secondary trading are lower. $2.6bn of global revenues from management fees: ETF funds providers charge investors relatively low costs vs. traditional mutual funds, with commissions limited to management fees which are also lower at 5bp to 65bp. Assuming an average management fee of 25bp, the $1,026bn of AuM would generate over $2.6bn of management fees for ETF providers. However, these revenues are management fees that would not be booked in the investment bank, except for Socit Gnrale Lyxor ETF which is part of the CIB division. As a result, SG revenues in ETFs would be higher than peers - we estimate Lyxor ETFs generate about $130m of management commissions. $0.6bn revenues in secondary trading: In the secondary market, ETFs are bought on a commission basis, just like shares. They can generally be purchased on margin and are lendable, and can be bought and sold at market, limit or as stop orders. Only so-called authorized participants (broker-dealers) actually buy or sell shares of an ETF directly from/to the fund manager, and then only in creation units, large blocks of ETF shares (usually 50,000), which are usually exchanged in-kind with baskets of the underlying securities. Volumes are relatively low compared to cash equities, especially in Europe where trading is mostly OTC and the market is very fragmented with different listings and reporting requirements, smaller AuM sizes - e.g. the daily average number of shares traded on a liquid Eurostoxx ETF is about 5,000-10,000. Market makers also make money from arbitrage. ETFs tend to trade, or close to their underlying NAVs. Authorized participants can use their ability to exchange creation units with their underlying securities to provide liquidity of the ETF shares and help ensure that their intraday market price approximates the net asset value of the underlying assets. Other sources of revenues include arbitraging the other tracking errors (differences in ETF funds performance relative to the index it tracks), coming from rebalancing due to corporate actions and index changes, or the dividend reinvestment policy of the fund. Some ETFs hold dividends in cash and only pay them out to investors on a periodic basis, and a lag in dividend reinvestment can cause small underperformance in rising markets. Growth outlook We see ongoing growth in ETFs funds, with AuM increasing at over 15%-20% CAGR, vs. 32% CAGR 2000-09 from $74bn in 2000 to $797bn in 2007. ETFs funds have continued to grow throughout the crisis, with the number of funds increasing further by 66% to 1,947 at YE 2009 and AuM increasing by 30% to $1,036bn globally. YTD 2010, the number of funds has gone up further by 16% to 2,252, while the AuM has been relatively stable at $1,026bn. We continue to see solid growth in AuM driven by new issuance volumes: Asia: although ETFs remains dominated by the US in terms of geographies, there has been a rapid development in Asia which only accounted for $59bn or 6% of
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total AuM globally. Whilst the US will remain the main market for ETFs due to the size of its institutional as well as retail markets, we would expect Asia to grow from the current low penetration levels. More generally, demand has increased for emerging markets underlying. Strong demand for transparent and liquid products: ETFs have continued to grow throughout the crisis as demand remains strong for transparent and liquid products. With concerns on counterparty risks receding, ETFs could lose some market shares to swaps, however, ETF products are likely to remain attractive both in terms of providing access exposures to several asset classes including commodities and rates, but also in terms of funding compared to swaps as ETFs allow cross-margining. In the secondary market, trading has been closely correlated to the level of market volatility. The share of ETF turnover increases with volatility levels at the peak of the crisis, ETFs accounted for almost 50% of US equity volumes, however, as volatility declined in 2009, index trading through ETFs declined in favor of risktaking activities through single stocks. In a lower volatility environment, we would expect ETF daily turnover to be lower than the $100-150bn experienced in Q4 08-Q1 09.
Figure 68: Global ETF Assets Under Management by region ($bn)
1100 1000 900 800 700 600 500 400 300 200 100 0 2000
Source: BGI
US
Europe
Other
2001
2002
2003
2004
2005
2006
2007
2008
2009
Q1-10
Q2-10
Stable demand from the retail investor base in the US: ETFs are primarily used by institutional investors, market intermediaries and hedge funds for a variety of purposes, which include asset allocation, index tracking, diversification and hedging strategies. However, in the US, there is also a relatively large retail market with individuals buying ETFs through retail brokerage. We estimate that retail clients could account for about a third of investors in ETFs.
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Table 84: ETFs - Global institutions reported assets by firm type, as of end Dec 08
$ million Type of Firm Investment Managers Bank And Trust Endowment Fund Finance Company Foundation Hedge Fund Insurance Company Investment Advisor Pension Fund Private Equity Sovereign Wealth Fund Venture Capital Brokerage Firms Strategic Entities Holding Company Government Agency Corporation Total
Source: Blackrock, Thomson Reuters.
All Reporting Firms Number of Reported Assets Institutions (US$ mn) 7,061 11,817,584 493 419,345 17 11,477 2 6 44 11,043 1,030 349,620 136 160,902 4,462 10,209,252 226 553,665 331 41,858 15 45,210 305 15,206 143 338,226 30,237 4,318,779 501 254,762 97 640,813 29,639 3,423,204 37,441 16,474,589
Reported ETF users Number of Reported Assets Institutions (US$ mn) 2,443 176,880 158 15,959 8 1,811 2 4 356 14,194 16 1,670 1,857 134,501 38 8,692 7 21 1 28 45 86,869 11 10,418 5 3,210 6 7,207 2,499 274,167
% of ETF users Number of Reported Assets Institutions (US$ mn) 34.6% 1.5% 32.0% 3.8% 47.1% 15.8% 0.0% 0.0% 4.5% 0.0% 34.6% 4.1% 11.8% 1.0% 41.6% 1.3% 16.8% 1.6% 2.1% 0.0% 6.7% 0.1% 0.0% 0.0% 31.5% 25.7% 0.0% 0.2% 1.0% 1.3% 0.0% 0.0% 0.0% 0.2% 6.7% 1.7%
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Convertibles
In this section, we focus on the convertible bonds business, including market making, convertible arbitrage but our revenue estimates also account for half of the underwriting revenues. Note however that some of the Investment banks have different reporting structures, with convertibles not part of the equity derivatives activities. Industry wallet of $4.1bn in 2011E, 6% below 2009: We estimate the convertibles revenue wallet to amount to $4.1bn in 2011E, improving towards 2009 levels following a more challenging 2010, driven by increased refinancing needs in the next few years. 2009 was a very good year for convertibles, with revenues mainly driven by the sharp recovery in the asset class pricing leading to mark-to-market gains on the portfolio management book. Going forward, we expect revenue generation to be driven by underwriting, with prop revenues expected to decline -58% in 2011E from 2009 levels. Overall, we would expect revenue wallet in 2011E to be 6% below 2009 level, as illustrated in Figure 69 below.
Figure 69: Global convertibles revenue wallet 2009-2012E
$bn
Primary 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2009 2010E 2011E 2012E
130 120 110 100 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 170 160 150 140
Figure 70: Convertibles JACI Global Currency Neutral Index

Index point
Market making
180
Source: J.P. Morgan estimates. Note: including only 50% of underwriting revenues (the other 50% is booked in the Investment Banking business (Advisory & underwriting).
Source: Bloomberg.
Revenue Outlook: 6% growth CAGR 2010E-12E Convertibles valuations have recovered from the end 2008 lows and are now back to pre-crisis peak levels. In our view, revenues from market making will be more challenging from these levels, however, refinancing needs are expected to increase, and the revenue outlook should improve - we estimate a relatively conservative 6% CAGR growth in 2010E-12E. Prop revenues down -58% 2011E/09: Convertible bond prices have recovered sharply from the November 2008 lows, with the JACI Index increasing by about 40% in 2009, close to 2007 peak levels and has held up well YTD 2010. The government and central bank actions helped in stabilizing the financial markets, with volatility declining rapidly from the extreme levels, credit spreads tightening, basis risks/hedging and liquidity returning to more normal levels.
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Figure 71: Credit Suisse Equity convertibles market value (indexed)

Q4 07 = 100
120 100 100 80 60 40 20 0 Q4 07 Q2 08 Q3 08 Q4 08 98 81
Some of the investment banks like Credit Suisse have reduced most of their convertibles exposures end 2008 76% in the case of CS - to i) limit exposure to basis risk and changes in hedging relationships, and ii) refocus on client flow with limited facilitation. However, we believe that most players in the industry benefited from the sharp rebound in 2009, and the mark-to-market and prop gains are unlikely to be repeated going forward. Underwriting revenues to increase c.15% p.a.: With over $4 trillion of corporate and financial institutions debt maturing in 2011-2012, we expect c.15% growth for convertible bond issuance p.a. Issuance volumes in 2009 amounted to $99bn, still 49% below peak levels in 2007 and YTD 2010 issuance volumes are $54bn as illustrated in Figure 73 below. Secondary trading revenues are very limited with small volumes and margins of 0.25bp to 2bp. Convertibles industry relatively concentrated The industry is however still relatively concentrated with the top five players accounting for 42% or $1.8bn of the total $4.1bn wallet in 2011E. Industry dominated by GS, Citi and BoA: The convertibles market is much larger in the US compared to Europe or Asia, and unsurprisingly, US players GS, Citi and BoA dominate the market with estimated revenues of $0.3-0.5bn in 2011E, as they leverage their corporate relationships, sizeable fixed income platform and solid positions in listed options.
24
Figure 72: Global convertible issuance volumes by region: YTD 2010

Other 8% EMEA 20% U.S. 43%
Market shares have not significantly changed, as in our view; there are barriers to entry in the convertibles business: Strong corporate relationships: Convertibles activities are mostly driven by primary business, with the underwriting fee of 50-100bp split 50% in ECM and 50% in Equities. Competition is increasing in secondary trading with the emergence of new agency-based market makers operating on an eat what you kill" basis (sales and trading revenues directly linked to the spreads of bonds crossed), however, pure market making revenues remain limited as a percentage of total and ECM's client franchise is key in our view. Global presence: Geographical diversification is a competitive advantage in our view, however, presence in the US is required to get scale in convertibles as the US accounts for 43% of YTD 2010 convertible issuances (Figure 72), and is the largest region in terms of market capitalisation and the most liquid one for convertibles. Synergies with flow equities and credit: Convertibles are hybrid securities with debt- and equity-like features, and essentially consist of a corporate bond and a warrant. Pricing convertibles requires assumptions on i) the volatility of the underlying stock to value the option, and ii) the credit spread for the fixed income portion. As a result, convertibles activities would benefit from strong flow fixed income and equities desks. Risk management: as convertibles are particularly illiquid vs. equities and bonds, risk management of the positions is key to avoid mark-to-market losses, as experienced in 2008.
AsiaPacific 29%
Source: Dealogic
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Figure 73: Global convertibles issuance total volumes

$ billion
250 195
Table 85: Global convertible bond issuance 2009

$ million Bookrunner JPMorgan Goldman Sachs Citi Morgan Stanley Credit Suisse Deutsche Bank Bank of America Merrill Lynch BNP Paribas Nomura Barclays Capital Subtotal Total
Source: Dealogic
Value 11,076.37 9,707.75 9,503.92 9,144.76 6,977.99 5,852.88 5,233.39 4,079.63 3,985.16 3,421.53 68,983.39 96,385.53
200
150
131 105 99
100 54 50
Number of Deals 63 48 44 49 40 38 45 19 12 23 206 409
% Vol. Sh 11.49 10.07 9.86 9.49 7.24 6.07 5.43 4.23 4.13 3.55 71.57 100
0 2006 2007 2008 2009 2010 YTD
Source: Dealogic.
30% ROE business despite increased regulatory capital requirements Convertibles is also a reasonably profitable business with ROE of 30% in 2011E in our estimates post regulation, despite the -32% decline in returns from 45% due to the 48% increased in capital requirements (Stress VaR and IRC related).
Table 86: Global Investment Banks Convertibles bonds summary P&L 2011E
$ million, % SG Convertibles Revenues Costs Pre-provision profits Loan losses and other Pretax Net profits Cost/income Tax rate Pre-regulatory changes Net income Allocated equity ROE Post-regulatory changes Net income Allocated equity ROE 166 -83 83 0 83 60 50% 28% 0 60 200 30% 0 60 341 18% BNP 215 -107 107 0 107 75 50% 30% 75 189 40% 75 313 24% DB 192 -96 96 0 96 62 50% 35% 62 191 33% 62 269 23% UBS 223 -112 112 0 112 82 50% 27% 82 172 47% 82 228 36% CS 240 -120 120 0 120 88 50% 27% 88 214 41% 88 324 27% GS 520 -260 260 0 260 182 50% 30% 182 513 35% 182 698 26% MS 146 -73 73 0 73 51 50% 30% 51 96 53% 51 121 42% BARC 257 -129 129 0 129 92 50% 29% 92 155 59% 92 218 42% BOAML 285 -142 142 0 142 100 50% 30% 100 192 52% 100 274 36% CITI 449 -224 224 0 224 157 50% 30% 157 201 78% 157 356 44% Total 2,692 -1,346 1,346 0 1,346 948 50%
948 2,124 45% 948 3,141 30%
Source: J.P. Morgan estimates. Notes: i) disclosures or reporting structures from the companies may differ; ii) convertibles revenues estimates assuming half of the underwriting fees, with some banks having JVs with Corporate Finance, others with Fixed income (credit trading).
Risk management is key given the relatively high liquidity risk Liquidity is the key risk in convertibles in our view. The convertibles market lost almost half of its value in Q4 08, triggered by i) the Lehman collapse along with concerns on counterparty risks, ii) the SEC short selling ban on financial stocks preventing convertibles managers from delta hedging their position, and iii) deleveraging by hedge fund managers as a result of prime brokers calling margins and refusing to refinance. Some of the investor funds were running with leverage of between 3x and 4x, which amplified the losses.
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Figure 74: Global convertible issuance volumes
Liquidity conditions have improved, with markets recovering, prime brokers easing financial conditions and hedge funds and other investors coming back to the market. However, convertibles remain structurally an asset class with high sensitivity to liquidity issues. The two main reasons in our view are: The relatively limited size of the market: the convertibles market is constrained by the size of the issued bonds. Total number of convertible bonds amounted to 1,400 and the global market capitalization of c.$400bn. 70% of issuance volumes come from small and mid-cap companies (Figure 74), and the size of the bonds is relatively small on average with 60% of the issuance volumes are under $250m. Very limited trading volumes: The European market is significantly less liquid than the US with often less than $250m average daily traded volume per desk or $1bn-$2bn in total, and the main investors in Europe are asset managers which have a "buy and hold" strategy. The US is a relatively more liquid market, with a higher proportion of hedge funds investors although the share of hedge funds has declined to less than 50% of investors (down from 80% in June 2008), with leverage of 1.5x (down from 3x-4x pre crisis). Gamma and Vega difficult to hedge: Convertibles desks have long positions due to their inventory/warehouse used to facilitate client trades. Similarly to convertible arbitrageurs, hedge funds and prop desks with long convertible exposures, the delta would be hedged by shorting the stocks. Similarly to options, these positions would be long gamma and vega, and these risks are more difficult to hedge. The issue when market volatility is extremely high, the asset class reacts negatively due to illiquidity and the implied volatility of convertibles tends to decrease along with the increase in realized volatility, i.e. convertibles have a short gamma profile on the tails, quite the opposite to expectations.
Large cap, 30%
Small cap, 52%
Mid cap, 18%
Source: Dealogic. Large cap: above $5bn, small cap: less than $1bn.
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Lyxor, an asset manager within the IB

Lyxor, a unique model
Lyxor is a key differentiating factor for Socit Gnrale which is the only investment bank which owns a specialized asset manager. Socit Gnrale made the strategic decision to create Lyxor within CIB in 1998, and has kept it in the investment bank, even after the merger of Lyxor with SGAM Alternative Investments in Sept 2009. Lyxor is headed by Laurent Seyer, and is one of the 6 business lines within the Global Markets division led by Christophe Miann. In total, Lyxor had assets under management of 82bn end 2009. The key advantages for the group structure in equity derivatives are: The economies of scale with the sharing of infrastructure/IT and support functions as well as risk management with 20 FTEs in the risk department, and over 1,600 support staff in total in equity derivatives. The sharing of expertise driving financial innovation - Lyxor can benefit from the structuring capabilities of the financial engineers in structured equity derivatives. Captive distribution network: The Investment Bank effectively owns a strong asset management franchise which distributes structured products and alternative investments to Socit Gnrales retail, private banking and institutional clients.
Lyxor Alternative Investments

With 20bn of AuM in alternative investments, Lyxor is one of the top 10 players globally. Lyxor offers access to a broad range of hedge funds, funds of hedge funds and absolute return funds to a diversified client base investment advisors, retail networks, private banks and institutional clients. The flagship funds come from the hedge fund managed account platform (c.$12bn of AuM) which includes more than 100 hedge funds covering all principal strategies: long/short equities, event driven allocations, CTAs, global macro, etc (see split of funds on the Lyxor platform in Figure 35 below). Lyxor regularly adds new hedge fund managers according to a strict risk control process and give managers mandates to replicate their benchmark fund on the platform according to specific investment guidelines and risk limits.
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Figure 75: Lyxor Structured Alternative Investments

bn
30
Figure 76: Lyxor managed account platform split of the c.$12bn funds by strategies
CB & Equity v olatility arbitrage
25 23.3 20 19.5 15 21
25.8
11% CTA L/S equity

19.7
12% Currency Trading 0%
37%
14.2 10
10.6
L/S credit
5 3.5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 6.3
Ev ent driv en & risk arbitrage Fix ed Income arbitrage 3% 27%
arbitrage 3% Global macro 7%
Source: Company reports. End Nov 2009. Note: including SGAM Alternative Investments since Sept 09.
Business proposition: For each selected hedge fund, a segregated, autonomous fund is set up, controlled by Lyxor (assets at Lyxor), and a management mandate is granted to the manager of the hedge fund, with Lyxor having full knowledge of the positions taken. The key advantages of investing in managed accounts over traditional hedge fund structures are i) transparency of positions with valuation independent from the investment manager, and ii) better liquidity with positions that are redeemable once a week. Lyxor investors pay a standard hedge fund fee, e.g. 2% of invested capital plus 20% on performance, as well as Lyxor's fee of 85bp p.a. (excluding administration costs). 20% revenue growth We estimate Lyxor AI revenue growth of c.20% CAGR 2009-011E to $330m in 2011E, driven by AuM growth more than offsetting the slight decrease in margins. We see further growth in this business as Lyxor adds more managed accounts in Asia and Europe. Out of the 170 managed accounts, 90% are US hedge funds, but Lyxor intends to increase the number of managed accounts in Europe and Asia closer to that of the US. The firm notably targets Asian funds to account for 20% of all managed accounts in the medium term, up from less than 10% currently.
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Table 87: Socit Gnrale Lyxor Alternative Investments

$ million Managed account platform revenues Other funds revenues Total Alternative Investments revenues Managed account platform AuM Other funds AuM Total Alternative Investments AuM Managed account platform margins Other funds margins Total Alternative Investments margins
2008 60 129 188 7,000 12,880 19,880 0.85% 1.00% 0.95%
2009 81 144 225 12,000 16,000 28,000 0.85% 1.00% 0.94%
2010E 130 168 298 20,400 17,600 38,000 0.80% 1.00% 0.90%
2011E 220 185 405 34,680 19,360 54,040 0.80% 1.00% 0.88%
2010E/09 60% 16% 32% 70% 10% 36% -
2011E/010E 70% 10% 36% 70% 10% 42% -
Lyxor ETFs and Index funds

Lyxor ETFs and index funds had assets under management of 42.5bn end 2009, split 30bn of ETF and 12.5bn of index funds. Lyxor ETF is the second largest ETF provider in Europe with over 200 ETFs listed on nine stock exchanges worldwide. AuM amount to $42bn or 19% share in a European market dominated by 3 players mainly (see Figure 78 below). About $60m of revenues The majority of revenues generated in Lyxor ETFs is derived from the management fees, whilst commissions in secondary trading are significantly lower. Management fees range from 15bp to 85bp for the most difficult access markets (e.g. emerging countries). Unlike traditional mutual funds, there are no entry or exit fees. Assuming an average management fee of 30bp, we estimate Lyxor ETFs generates about $130m of management commissions. ETFs are not actively managed, and hence, management fees are lower compared to traditional mutual funds. To generate accurate benchmark tracking, ETFs providers use two main methodologies: physical replication, and synthetic replication which has become the most popular technique in Europe. Physical replication: the fund invests in all the securities constituting the index tracked. Key issues with this methodology are: i) higher risk of tracking error and ii) higher transactions costs as portfolio balancing must take place if index constituents are added or removed. Liquidity of the underlying securities is also another key consideration. The ETF fund manager generally lend out portfolio holdings to improve performance and reduce tracking error, however, this introduces counterparty risk. Synthetic replication: the fund invests in a universe of stocks that may be different from the universe constituting the index tracked, and then enters into a swap agreement. Under UCITS, the value of a swap provided by a single counterparty must be less than 10% of a fund's asset. This limits counterparty risk and also reduces cost of replication. Overall, we estimate the cost of replication to about 15-20bp, and revenue margin for Lyxor net of the cost of replication amounts to c.15bp per annum or $60m of revenues in 2009.
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Figure 79: Lyxor Structured funds

bn
30
10%-15% revenue growth We see ongoing growth in ETFs funds, with industry AuM increasing at over 15%20% CAGR, vs. 32% CAGR 2000-09 from $74bn in 2000 to $797bn in 2007. We continue to see growth in AuM driven by i) new issuance volumes in Asia where the current penetration levels are currently low, ii) ongoing strong demand for transparent and liquid products, with lower counterparty risk, that also allow crossmargining. Margins could be under pressure due to increased competition from new entrants, not only large asset managers (Goldman Sachs Asset Management, Pimco, Charles Swab, T Rowe Price), hedge funds (Marshall Wace), but also other platforms such as ETFX, a platform set up between Merrill Lynch, Citi, Rabobank and ETF Securities, which is looking to develop white-label products. We however expect growth in AuM to more than offset the potential negative impact from margin compression. Whilst the number of players is increasing, we see the industry further consolidating at a later stage as scale of the platform, breadth of the product offering and liquidity of the products are all necessary to remain competitive. Overall, Lyxor ETF should continue to benefit from its dominant market shares in Europe, and we estimate 10%-15% revenue growth in 2009-2011E.
Figure 78: European ETF market split of AuM (end Q2 10)
Others
42.5
25 24.7 20 19.7 15 13.2 10 9.7 5 5.6 17.2 19 21.5 19.4
0 2001 2002 2003 2004 2005 2006 2007 2008 2009
Figure 77: Lyxor ETFs and Index Funds

bn
45 40 35 30 25 20
18.7 27 25.6
24% iShares 36%
Credit Suisse AM 5%
15 10 5
3.5 6.6 1.2 2.1 11
DB x -trackers 16% Ly x or AM 19%
2001
2002
2003
2004
2005
2006
2007
2008
2009
Source: Blackrock.
Source: Company reports. Note: including SGAM Alternative Investments since Sept 09.
Lyxor Structured funds

Lyxor Structured funds amounted to 24.7bn or 30% of total Lyxor AuM. The main products are formula-based funds which are similar to capital guaranteed products: Lyxor provides the fund wrapper for the structured product which is either sold to Socit Gnrale customers, or 'white labeled' to retail networks, insurance brokers and private banks globally. The structured funds guarantee a return, e.g. Initial NAV x 100% + 60% of the increase in the CAC40. Lyxor would usually counter guarantee
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this with SG CIB; the product is structured when it is issued, and there is no subsequent active management. Lyxor will only receive an upfront fee of estimated 90bp for distributing these products and no subsequent management fee. Inflows were limited in over the past two years, with the growth in structured funds AuM coming from the consolidation of SGAM AI. Hence, we estimate that Lyxor Structured Funds generated less than $10m of revenues in 2008-09. As detailed in our section entitled "Structured products", we see more limited growth going forward and estimate 5% growth p.a., driven by i) weaker demand from retail investors, only partially offset by more resilient institutional demand, and ii) a less favorable interest rate environment. That said, we see Lyxor Structured Funds as well positioned to capture market share gains, as the crisis has led to some alternative investment companies exiting the industry or further consolidation.
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Appendices
133
Appendix I: How we estimate capital allocated to the equities business

We estimate the capital requirements for the Equities business using the sum of Market Risk, Counterparty credit risk and Operational Risk requirements for the individual IBs.
Market Risk based Capital

We start by estimating the current market RWAs based on the reported average 10-day 99% VaR in Q4 09. We have used a multiplier of mc=5, and we are assuming that all the banks are using the internal model-based approach for calculating market risk for their equities business, rather than the standardized approach. We then estimate the new market risk charge post Basel changes by taking 5 times the average 10-day 99% VaR plus 3 times (assumed multiplier ms) our estimated average 10-day Stress VaR, which we then convert into market RWAs by multiplying by 12.5. Health warnings: Note that VaR models have shortcomings as they are not comparable, not based on the same methodologies (e.g. Monte Carlo, historical back-testing) observation periods e.g. from 0.45 years in the case of GS to 5 years for UBS. This implies that market RWAs calculations could be more conservative depending on the model. Goldman Sachs RWAs in its equities business amount to $29.9bn, well above the $6.3bn to $13.6bn for peers in our estimates. This is due to their VaR model an exponentially weighted VaR approach, with a decay rate of 20% per month which heavily weights volatility in the most recent months but also assigns lower weights to earlier periods. The shorter observation period does imply a higher sensitivity to the most recent market behavior. The higher VaR and hence higher market RWAs implies lower ROE on a relative basis for GS, which does not perfectly reflect the level of profitability of GS vs. peers.
Counterparty Credit Risk based Capital

We estimate the capital requirements for Equities business arising from Counterparty credit risk by using the positive replacement values for Equity derivatives post netting and collateral as a proxy. For banks which do not disclose their post netting and collateral positive replacement value, we have assumed 70% reduction from netting and collateral.
Operational Risk based Capital

We estimate the operational risk based capital requirements by using the standardised approach as defined by the Basel Committee. For the regulatory capital charge per year, we use the Equity Sales and trading revenues and then use a 2 multiplier of 18% as specified by the Basel Committee for the Trading and sales business lines. The total capital charge is calculated as the 3-year average of the summation of regulatory capital charge for the Equities business.
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The total Risk Weighted Assets for the the equities business is (Market RWAs, CCR based RWAs and Operational Risk RWAs) We then allocate capital to the equities business using 10% of the total Equities RWAs.
Table 88: Capital allocation to the Equities business: pre-regulatory changes 2009E
$ million SG Equity Var 10-day 99% ($m) (1) Multiplier (2) Equities market RWAs = (1) x (2) x 12.5 Equity derivatives PRV (loc. Curr.) Equity derivatives PRV post netting and collateral (loc. Curr.) Equities CCR RWAs ($m) Equities revenues average 09-11 (3) Beta (4) Equities operational RWAs = (3) x (4) x 12.5 Equities total RWAs Allocated capital % total RWAs Equities allocated capital
BNP 159 5 9,907 17,560 5,268 7,544 2,748 18% 6,182 23,633 10% 2,363
DB 113 5 7,076 38,162 7,666 10,978 4,123 18% 9,276 27,331 10% 2,733
UBS 109 5 6,816 25,100 7,530 7,274 4,673 18% 10,514 24,604 10% 2,460
CS 141 5 8,782 24,600 7,380 7,129 6,538 18% 14,711 30,623 10% 3,062
GS 478 5 29,903 67,559 20,268 20,268 10,279 18% 23,127 73,298 10% 7,330
MS 134 5 8,400 41,366 12,410 12,410 4,916 18% 11,061 31,870 10% 3,187
BARC 103 5 6,443 17,784 4,454 6,570 4,038 18% 9,086 22,099 10% 2,210
102 5 6,368 21,328 6,398 9,163 4,212 18% 9,477 25,009 10% 2,501
BOAML 141 5 8,815 27,300 8,190 8,190 4,644 18% 10,450 27,455 10% 2,745
CITI 218 5 13,637 18,132 5,440 5,440 4,287 18% 9,647 28,724 10% 2,872
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Appendix II: Structured products

Introduction to structured equity derivatives product
The basic underlying building blocks of a structured derivatives product are more intuitive. By definition an exotic derivative is either: a plain vanilla underlying (such as a single stock) with an exotic structure (for example the payoff not including the best and worst performing month in a year); or a plain vanilla structure (for example a call option), on an exotic underlying (i.e. a basket of 20 stocks); or an exotic underlying with an exotic structure. We outline some of the choices that investors and structured product developers will make in creating a structured retail product in below: 1. Underlying assets: Many structured products use a liquid index, such as the DJ Eurostoxx50 or FTSE 100, as the underlying for determining the performance of the structured note. More complex solutions may involve a basket of stocks, a basket of hedge funds or alternative assets such as commodities. In some cases, the main purpose of the derivative is to facilitate investors access to underlying securities such as a basket of hedge funds or other asset classes, or certain commodities in which the investor may not be able to easily invest. Capital protection: A very common feature of retail structured products is that they offer some sort of capital protection, i.e. the investor will have his initial investment guaranteed, similar to a bond that is held to maturity. Gearing: As derivatives can easily be used to increase leverage to certain market movements, the exposure to the underlying asset is often leveraged, capped or limited, depending on the investors needs and risk appetite. In a more complex solution, the gearing to markets may for example increase as the note appreciates and decrease as the note loses value. Life of product: The last choice in our simplistic structure regards the life of the product (tenor or maturity). This can also include notes where the payoff varies over time, for example, a note where the underlying is the Eurostoxx50 excluding the performance in August and September which have historically been weaker months.
2.
3.
4.
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Figure 80: Structured equity derivatives products basic building blocks

bn
Underlying asset: Stock market index Single stock Basket of stocks Alternative investments Funds/Hedge funds
Capital protection: Full Partial None
Structured Product
Maturity: Long 5y + Medium ter m 1-5y Short ter m 1y
Market view/gearing: Increase leverage to underlying asset. De-leverage underlying asset Leverage to volatility
Example: the basic 5-year capital protected note

Using this methodology, we can describe one relatively basic product, a 5-year Capital Protected Note on a basket of the FTSE 100 and the DJ Eurostoxx50: The underlying asset will be the basket of the FTSE 100 and the DJ Eurostoxx50. The maturity is 5 years. The investment has limited gearing to the underlying, investors get 60% of the average appreciation of the FTSE 100 and DJ Eurostoxx50. This feature is commonly described as the participation being 60%. In the current low volatility environment we believe the participation on this type of note could be significantly higher. The note is fully capital protected, if the basket of the Eurostoxx50 and the FTSE were to decline over the 5-year period, the investor would receive his initial investment back. Hence mathematically the payoff can be described as:
Underlying Final P = 100% + 60% * MAX 100%;0 Underlying Initial
Product example: Best of/ Worst of structures

In the best of/worst of structures, returns depend on relative returns within a basket of assets, such as a number of individual stocks or different equity indices.
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In a typical best of structure, the total return over the life of the note is the average of the returns on the best performing constituent stock or index during each of a series of pre-defined periods throughout the life of the note. This means that, as far as each period is concerned, the investor benefits most when the stocks are negatively correlated, as this increases the probability of each period having at least one stock performing well. In worst of structures, by contrast, returns are linked to the changes in prices of those constituent stocks or indices that have risen the least other things being equal, investors benefit from positive correlation, obtaining the highest returns when the prices of all stocks rise together.
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Appendix III: Flow equity derivatives

Options
An option is a contract between two parties concerning the buying or selling of an asset at a reference price during a specified time frame. During this time frame, the buyer of the option gains the right, but not the obligation, to engage in some specific transaction on the asset, while the seller incurs the obligation to fulfill the transaction if so requested by the buyer. The price of an option derives from the value of an underlying asset (single stocks, indices) plus a premium based on the time remaining until the expiration of the option. An option which conveys the right to buy something is called a call; an option which conveys the right to sell is called a put. The price specified at which the underlying may be traded is called the strike price or exercise price. In return for granting the option, called writing the option, the originator of the option collects a payment, the premium, from the buyer. The writer of an option must make good on delivering (or receiving) the underlying asset or its cash equivalent, if the option is exercised.
Variance swaps
What is a variance swap? A variance swap is an OTC derivative that allows investors to trade future realized (or historical) volatility against current implied volatility. In a variance swap, two parties agree to exchange cash flows based on the measured variance of a specified underlying asset during a certain time period. The two parties agree on the strike price of the contract (the reference level of variance against which cash flows are exchanged), as well as the number of units in the transaction. The payoff of the variance is determined by: i) a variance notional that is never exchanged and is expressed in volatility terms, and ii) the difference between the realized variance (final realized volatility square), paid by one leg of the swap, and the variance strike, fixed amount paid by the other leg of the swap. Final payoff = Variance amount x (Final Realized Volatility - Strike price) For example, suppose two parties agreed to trade a six-month variance swap on the Standard & Poors 500 index with a strike price of 25 percent and a unit amount of 50,000. Suppose realized standard deviation of the S&P 500 during this time period turns out to be 30 percent. The payoff to the party that receives volatility is 50,000 x (0.302 0.252) x 100, or 137,500. If realized standard deviation were 20 percent instead, the payoff to the party that pays volatility would be 50,000 x (0.252 0.202) x 100, or 112,500. Uses and applications Most obvious application is volatility trading, with variance swaps being the natural instruments for investors taking directional bets on volatility. However, variance swaps are also used for trading spreads on indices, as well as correlation.
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Volatility trading: The advantage of variance swaps is that they provide pure exposure to the volatility of the underlying price, as opposed to call and put options which may carry directional risk (delta). The profit and loss from a variance swap depends directly on the difference between realized and implied volatility. Variance swaps are especially attractive to volatility sellers, as implied volatility tends to be higher than final realized volatility, a phenomenon known as the variance risk premium, creating an opportunity for volatility arbitrage. Spread on indices: Variance swaps are also used to capture the volatility spread between two correlated indices, for instance by being long 3-month DAX Variance and short 3-month EuroStoxx 50 variance. Correlation trading and dispersion trades: a popular trade had been to sell correlation by taking a short position on index variance and a long position on the variance of the components. However, this trade proved to be difficult to hedge in Q4 08, and with reduced risk appetite from investors as well as investment banks, this trade is no longer popular.
Volatility swap
A volatility swap is a forward contract on the future realised volatility of a given underlying asset. Volatility swaps allow investors to trade the volatility of an asset directly, much as they would trade a price index. The underlying is usually a foreign exchange (FX) rate (very liquid market) but could be as well a single name equity or index. However, the variance swap is preferred in the equity market due to the fact it can be replicated with a linear combination of options and a dynamic position in futures. Unlike a stock option, whose volatility exposure is contaminated by its stock price dependence, these swaps provide pure exposure to volatility alone. You can use these instruments to speculate on future volatility levels, to trade the spread between realized and implied volatility, or to hedge the volatility exposure of other positions or businesses.
Dispersion and correlation trading

Correlation trading Correlation trading is a strategy in which the investor gets exposure to the average correlation of an index. The key to correlation trading is understanding the principle of diversification - that the volatility of a portfolio of securities is less than (or equal to) the volatility of a single security in that portfolio. The lower the correlation among the individual securities, the lower the overall volatility of the entire portfolio. To buy correlation, investors can: i) buy a portfolio of options on the index and sell a portfolio of options on the individual constituents of the index, or ii) buy a variance swap on the index and sell the variance swaps on the individual constituents. Popular trade was to sell correlation (sell index variance swaps, buying single stock variance swaps) but is difficult to hedge. Correlation swaps: A correlation swap is an OTC derivative that allows one to speculate on or hedge risks associated with the observed average correlation, of a
140
collection of underlying products, where each product has periodically observable prices, as with a commodity, exchange rate, interest rate, or stock index. Correlation risk refers to the underlying assets in a structured note becoming more or less correlated. In a bespoke option on a basket of individual names a dealer may have a significant correlation risk. Correlation swap allows the dealer to structure this basket and sell this risk (realised correlation of portfolio) in return of a fixed strike. For example, a one-year correlation swap on the Eurostoxx 50 index might have an implied correlation of 0.47. If the trade is agreed at E1 million, should the realised correlation fall during that year to 0.43, the trade would settle with on party paying the other E4 million. Dispersion This strategy typically involves short option positions on an index, against which long option positions are taken on a set of components of the index. If maximum volatility is realized, the strategy will make money on the long options on the individual stocks and will lose very little on the short option position on the index, since the latter would have moved very little. Volatility dispersion trading is a popular hedged strategy designed to take advantage of relative value differences in implied volatilities between an index and a basket of component stocks, looking for a high degree of dispersion.
Warrants
Warrant is a security that entitles the holder to buy stock of the company that issued it at a specified price, which is usually higher than the stock price at time of issue. Warrants have similar characteristics to that of other equity derivatives, such as options, for instance exercising: A warrant is exercised when the holder informs the issuer their intention to purchase the shares underlying the warrant. The warrant parameters, such as exercise price, are fixed shortly after the issue of the bond. With warrants, it is important to consider the following main characteristics: Premium: A warrant's "premium" represents how much extra you have to pay for your shares when buying them through the warrant as compared to buying them in the regular way. Gearing (leverage): A warrant's "gearing" is the way to ascertain how much more exposure you have to the underlying shares using the warrant as compared to the exposure you would have if you buy shares through the market. Expiration Date: This is the date the warrant expires. If you plan on exercising the warrant you must do so before the expiration date. The more time remaining until expiry, the more time for the underlying security to appreciate, which, in turn, will increase the price of the warrant (unless it depreciates). Therefore, the expiry date is the date on which the right to exercise no longer exists. Restrictions on exercise: Like options, there are different exercise types associated with warrants such as American style (holder can exercise anytime before expiration) or European style (holder can only exercise on expiration date).
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Appendix IV: Delta one products

Futures and forwards
A futures contract is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality at a specified future date at a price agreed today (the futures price). The price is determined by supply and demand competing buy and sell orders on the exchange at the time of the purchase or sale of the contract. The future date is called the delivery date or final settlement date. A futures contract gives the holder the obligation to make or take delivery under the terms of the contract. A forward contract is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a forward contract. The price agreed upon is called the delivery price, which is equal to the forward price at the time the contract is entered into. The price of the underlying instrument, in whatever form, is paid before control of the instrument changes. This is one of the many forms of buy/sell orders where the time of trade is not the time where the securities themselves are exchanged. The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands on the spot date. The difference between the spot and the forward price is the forward premium or forward discount, generally considered in the form of a profit, or loss, by the purchasing party. Being traded OTC, forward contracts specification can be customized and may include mark-to-market and daily margining. Hence, a forward contract arrangement might call for the loss party to pledge collateral or additional collateral to better secure the party at gain.
ETFs
What are ETFs? An exchange-traded fund (or ETF) are open-end index funds that are listed and traded on exchanges like stocks. Each shares of an ETF represents a fractional ownership in a portfolio of assets and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. ETFs can track any securities or commodities underlying. Why so popular? The main advantages of using ETFs are the easy diversification at lower costs, the transparency and flexibility, and the tax efficiency. Broad market access: Easy and quick way to obtain exposure to a desired market or benchmark, by trading just a single security. Transparency and intraday liquidity with real time trading and pricing. Unlike mutual funds, ETFs can be traded during the day, and like stocks, ETFs shares can be sold short, even on downticks, or be purchased on margin. Prices are transparent and as exchange traded securities, counterparty risk is limited.
142
Lower costs: ETFs generally have lower costs because i) they are passively managed, and ii) they do not have to buy and sell securities to accommodate shareholder purchases or redemptions. Tax efficiency: because ETFs are created and redeemed "in-kind", capital gains distributions are minimized.
Equity swaps
Introduction: Equity swaps are contractual agreements between two parties that provide for the periodic exchange of cash flows over a specified period, where at least one of the two payments is linked to the performance of an equity index, a basket of stocks or a single stock. All payments are based on a fixed notional amount and are made over a fixed period. As a result the returns of any asset could be swapped for another without incurring the transaction costs in the cash market. Equity swaps could be tailored to meet an individual investors requirements. The agreement is flexible in respect of the timing of the periodic exchanges of cash flows, specified period and potential for future modifications to the terms of the contract. Leverage: Equity swaps serve as a financing tool as they are unfunded instruments which trade on margin. The embedded leverage could allow investors to achieve cash extraction by commiting less capital to obtain equivalent exposure. Mechanics: The product issuer would enter into an equity swap with an investor to exchange a Liborbased return for the return of an equity index, a basket of stocks or single stock. Hence, the cash flows swapped under the agreement are: Underlying Returns The underlying return is the percentage change in the underlying equity applied to an agreed notional amount over a specified time period. If the return is positive, a payment equal to the equity appreciation is made by the seller. If the return is negative, the buyer will make a payment of an amount equal to the equity depreciation. Libor Payments The investor will pay an amount based on an agreed Libor rate plus or minus a spread applied to the notional amount of the swap. Usually, the spread would be a factor of market supply and demand for swaps (especially relevant for index swaps), sentiment towards the underlying, and the counterparty credit rating. The Libor payment is usually made by the buying party to compensate the selling party for the funding costs of the notional amount. In some instances, the Libor amount could be negative if the discount provided by the guaranteed outperformance is larger than the funding cost itself. In such cases, the Libor payment will be made by the selling party.
Dividend swaps
A dividend swap offers straightforward and direct exposure to the dividends paid by an underlying stock or index. It is a swap contract where the parties agree to exchange a pre-agreed dividend level (the implied dividend, or strike) for the actual amount of dividends paid by the stock or index (the realised dividend) between two specified dates. The realized dividend is the total amount of all qualifying dividends going ex by the underlying equity or index, between the start date (exclusive) and end date (inclusive).
143
The buyer of a dividend swap is long dividends at the pre-agreed level. If the stock or index delivers a higher dividend amount than the fixed leg of the swap, the long dividend position will profit. Conversely, if the stock or index delivers a lower dividend amount, then the long dividend swap position will suffer a corresponding loss. Similarly, the seller of a dividend swap is short dividends.
144
Appendix V: Detailed breakdown estimates

Equity derivatives revenue wallet 2009-2012E
Table 89: Global Investment Banks Equity derivatives revenue wallet 2009
$ million SG Structured products Flow and listed derivatives ow Delta One ow flow equity derivatives Convertible bonds Equity derivatives ex prop. Prop trading/flow prop Total equity derivatives revenues
BNP 859 1,360 859 501 215 2,435 -398 2,036
DB 609 905 564 341 215 1,729 355 2,084
UBS 350 975 475 500 203 1,528 250 1,778
CS 700 1,072 661 411 266 2,038 428 2,466
GS 928 2,350 1,200 1,150 550 3,828 1,448 5,276
MS 300 930 630 300 150 1,380 257 1,637
BARC 600 1,000 550 450 289 1,889 294 2,183
1,563 1,759 1,074 685 186 3,508 1,129 4,638
BOAML 350 800 500 300 300 1,450 420 1,870
CITI 300 700 450 250 500 1,500 840 2,340
Total 6,559 11,851 6,964 4,888 2,873 21,284 5,023 26,308
Wallet 7,717 18,233 10,713 7,520 4,421 30,370 7,175 37,546
Table 90: Global Investment Banks Equity derivatives revenue wallet 2010E
BNP 859 1,290 859 431 215 2,364 -38 2,326
DB 548 701 479 222 183 1,431 287 1,718
UBS 385 991 491 500 223 1,599 266 1,865
CS 630 913 595 319 240 1,784 236 2,021
GS 835 2,038 1,080 958 495 3,368 729 4,098
MS 285 881 599 282 146 1,311 430 1,741
BARC 570 878 495 383 253 1,700 309 2,009
1,428 1,484 967 517 158 3,070 287 3,357
BOAML 315 784 475 309 279 1,378 315 1,693
CITI 270 564 369 195 390 1,224 280 1,504
Total 6,125 10,523 6,408 4,115 2,581 19,230 3,102 22,333
Wallet 7,176 16,173 9,856 6,317 3,979 27,328 4,431 31,759
BNP 945 1,393 945 448 215 2,553 348 2,902
DB 604 764 532 233 192 1,560 322 1,882
UBS 424 1,064 540 525 223 1,712 334 2,045
CS 691 981 648 333 240 1,913 223 2,135
GS 910 2,174 1,169 1,006 520 3,605 750 4,354
MS 306 941 646 294 146 1,393 503 1,895
BARC 616 946 545 402 257 1,819 304 2,123
1,550 1,599 1,063 535 166 3,315 604 3,920
BOAML 324 799 475 324 285 1,408 295 1,704
CITI 311 677 443 234 449 1,436 394 1,830
Total 6,683 11,340 7,006 4,334 2,692 20,715 4,076 24,790
Wallet 7,681 17,446 10,778 6,668 4,142 29,269 5,824 35,093
145
BNP 1,054 1,519 1,040 480 236 2,810 202 3,011
DB 665 831 585 247 204 1,700 333 2,033
UBS 472 1,165 594 572 246 1,883 334 2,216
CS 751 1,050 700 350 253 2,054 325 2,379
GS 1,001 2,342 1,285 1,056 550 3,893 850 4,743
MS 343 1,026 711 315 163 1,532 485 2,017
BARC 665 973 572 402 308 1,946 316 2,263
1,697 1,735 1,170 565 183 3,614 438 4,052
BOAML 357 863 523 341 299 1,519 337 1,856
CITI 342 733 487 246 471 1,545 447 1,992
Total 7,346 12,238 7,666 4,572 2,913 22,497 4,066 26,562
Wallet 8,444 18,827 11,794 7,033 4,482 31,753 5,809 37,561
Total equities revenue wallet 2009-2012E

$ million SG Total equities revenues ow cash equities ow cash equities ow electronic ow prime brokerage ow equity derivatives ow Structured products ow Flow equity derivatives ow Delta One products ow Convertibles ow prop trading
BNP 2,367 331 71 25 235 2,435 859 501 859 215 -398
DB 4,563 2,379 1,120 250 1,009 1,729 609 341 564 215 455
UBS 4,769 2,895 1,271 600 1,023 1,528 350 500 475 203 346
CS 7,339 4,446 1,617 1,200 1,629 2,038 700 411 661 266 856
GS 12,030 5,246 1,813 1,400 2,033 3,828 928 1,150 1,200 550 2,956
MS 4,908 3,015 765 500 1,750 1,380 300 300 630 150 513
BARC 4,198 1,889 507 60 1,322 1,889 600 450 550 289 420
4,913 266 211 55 0 3,508 1,563 685 1,074 186 1,139
BOAML 4,901 2,851 1,400 451 1,000 1,450 350 300 500 300 600
CITI 5,372 2,672 1,212 260 1,200 1,500 300 250 450 500 1,200
Total 55,360 25,989 9,986 4,801 11,202 21,284 6,559 4,888 6,964 2,873 8,087
Wallet 84,682 43,529 22,192 6,401 14,936 30,370 7,717 7,520 10,713 4,421 10,782
BNP 2,643 317 55 25 237 2,364 859 431 859 215 -38
DB 3,769 1,860 858 213 789 1,431 548 222 479 183 479
UBS 4,459 2,418 1,023 540 855 1,599 385 500 491 223 443
CS 5,928 3,671 1,354 1,080 1,237 1,784 630 319 595 240 473
GS 9,039 4,345 1,535 1,260 1,549 3,368 835 958 1,080 495 1,326
MS 4,765 2,839 696 480 1,663 1,311 285 282 599 146 615
BARC 3,862 1,776 441 69 1,266 1,700 570 383 495 253 386
3,570 213 166 47 0 3,070 1,428 517 967 158 287
BOAML 4,482 2,654 1,288 460 906 1,378 315 309 475 279 450
CITI 3,413 1,839 873 196 770 1,224 270 195 369 390 350
Total 45,931 21,931 8,289 4,370 9,272 19,230 6,125 4,115 6,408 2,581 4,770
Wallet 70,297 36,609 18,420 5,826 12,363 27,328 7,176 6,317 9,856 3,979 6,360
146
BNP 3,233 331 57 25 249 2,553 945 448 945 215 348
DB 4,037 2,017 923 234 860 1,560 604 233 532 192 460
UBS 4,791 2,523 1,053 572 898 1,712 424 525 540 223 556
CS 6,348 3,878 1,389 1,166 1,322 1,913 691 333 648 240 556
GS 9,767 4,663 1,599 1,336 1,728 3,605 910 1,006 1,169 520 1,500
MS 5,075 2,964 720 516 1,729 1,393 306 294 646 146 718
BARC 4,055 1,830 488 83 1,259 1,819 616 402 545 257 406
4,153 223 172 51 0 3,315 1,550 535 1,063 166 614
BOAML 4,550 2,720 1,314 506 900 1,408 324 324 475 285 422
CITI 4,077 2,116 960 237 920 1,436 311 234 443 449 525
Total 50,086 23,266 8,675 4,725 9,865 20,715 6,683 4,334 7,006 2,692 6,105
Wallet 76,142 38,732 19,278 6,301 13,153 29,269 7,681 6,668 10,778 4,142 8,141
BNP 3,367 355 60 29 266 2,810 1,054 480 1,040 236 202
DB 4,288 2,117 962 252 903 1,700 665 247 585 204 471
UBS 5,187 2,747 1,131 641 976 1,883 472 572 594 246 556
CS 6,879 4,166 1,451 1,283 1,432 2,054 751 350 700 253 658
GS 10,510 5,017 1,666 1,416 1,935 3,893 1,001 1,056 1,285 550 1,600
MS 5,493 3,261 766 593 1,902 1,532 343 315 711 163 700
BARC 4,177 1,813 516 95 1,201 1,946 665 402 572 308 418
4,296 235 180 55 0 3,614 1,697 565 1,170 183 448
BOAML 4,953 2,836 1,379 557 900 1,519 357 341 523 299 598
CITI 4,492 2,297 1,093 284 920 1,545 342 246 487 471 650
Total 53,642 24,844 9,204 5,205 10,435 22,497 7,346 4,572 7,666 2,913 6,301
Wallet 81,460 41,307 20,453 6,940 13,914 31,753 8,444 7,033 11,794 4,482 8,401
147
Equities business cost/income ratios

% Structured products Flow and listed derivatives ow Delta One ow flow equity derivatives Convertible bonds Prop trading Total equity derivatives cost/income Cash equities Electronic Prime brokerage Cash prop trading Total equities cost/income
SG 50% 54% 50% 60% 45% 30% 46% 85% 85% 50% 30% 48%
BNP 55% 54% 50% 60% 45% 30% 58% 85% 85% 50% 30% 58%
DB 60% 57% 55% 60% 45% 40% 54% 90% 90% 50% 40% 63%
UBS 72% 60% 55% 65% 45% 40% 58% 90% 90% 50% 40% 68%
CS 65% 57% 55% 60% 45% 40% 55% 90% 90% 50% 40% 66%
GS 53% 57% 55% 60% 45% 40% 51% 90% 90% 50% 40% 60%
MS 72% 57% 55% 60% 45% 40% 56% 90% 90% 50% 40% 62%
BARC 72% 57% 55% 60% 45% 40% 57% 90% 90% 50% 40% 59%
BOA-ML 72% 57% 55% 60% 45% 40% 54% 90% 90% 50% 40% 66%
CITI 72% 57% 55% 60% 45% 40% 50% 90% 90% 50% 40% 60%
Average 64% 57% 54% 61% 45% 38% 54% 89% 89% 50% 38% 61%
% Structured products Flow and listed derivatives ow Delta One ow flow equity derivatives Convertible bonds Prop trading Total equity derivatives cost/income Cash equities Electronic Prime brokerage Cash prop trading Total equities cost/income
SG 50% 55% 50% 65% 50% 35% 50% 85% 85% 55% 35% 52%
BNP 55% 55% 50% 65% 50% 35% 52% 85% 85% 55% 35% 53%
DB 60% 60% 55% 70% 50% 40% 55% 90% 90% 55% 40% 65%
UBS 72% 65% 55% 75% 50% 40% 61% 90% 90% 55% 40% 69%
CS 65% 60% 55% 70% 50% 40% 58% 90% 90% 55% 40% 69%
GS 53% 60% 55% 65% 50% 40% 54% 90% 90% 55% 40% 64%
MS 72% 58% 55% 65% 50% 40% 55% 90% 90% 55% 40% 63%
BARC 72% 59% 55% 65% 50% 40% 59% 90% 90% 55% 40% 62%
BOA-ML 72% 61% 55% 70% 50% 40% 58% 90% 90% 55% 40% 70%
CITI 72% 60% 55% 70% 50% 40% 55% 90% 90% 55% 40% 65%
Average 64% 59% 54% 68% 50% 39% 56% 89% 89% 55% 39% 63%
148
Equities businesses summary P&L

Table 99: Goldman Sachs Equities businesses summary P&L 2009
$ million
Cash equities Revenues Costs Pre-provision profits Provisions Pretax Net profits Allocated equity Cost/income Tax rate ROE
Electronic
Prime Services 2,033 -1,017 1,017 0 1,017 712 2,052 50% 30% 35%
Total cash equities 5,246 -3,908 1,338 0 1,338 936 2,521 74% 30% 37%
Structured products 928 -492 436 0 436 305 1,466 53% 30% 21%
Flow Equity Derivat. 1,150 -690 460 0 460 322 660 60% 30% 49%
Delta One
Convert.
1,813 -1,632 181 0 181 127 293 90% 30% 43%
1,400 -1,260 140 0 140 98 176 90% 30% 56%
1,200 -660 540 0 540 378 704 55% 30% 54%
550 -248 303 0 303 212 513 45% 30% 41%
Total Equity Deriv. ex prop 3,828 -2,089 1,739 0 1,739 1,217 3,342 55% 30% 36%
Prop trading 2,956 -1,182 1,774 0 1,774 1,242 1,466 40% 30% 85%
Total equities 12,030 -7,180 4,850 0 4,850 3,395 7,330 60% 30% 46%
Table 100: Credit Suisse Equities businesses summary P&L 2009

$ million
Electronic
Prime Services 1,629 -815 815 0 815 595 1,072 50% 27% 55%
Structured products 700 -455 245 0 245 179 612 65% 27% 29%
Flow Equity Derivat. 411 -246 164 0 164 120 276 60% 27% 43%
Delta One
Convert.
1,617 -1,455 162 0 162 118 153 90% 27% 77%
1,200 -1,080 120 0 120 88 122 90% 27% 72%
661 -364 297 0 297 217 306 55% 27% 71%
266 -120 146 0 146 107 214 45% 27% 50%
Total Equity Deriv. ex prop 2,038 -1,185 853 0 853 623 1,409 58% 27% 44%
Prop trading 856 -342 514 0 514 375 306 40% 27% 122%
Total equities 7,339 -4,877 2,463 0 2,463 1,798 3,062 66% 27% 59%
Table 101: Socit Gnrale Equities businesses summary P&L 2009

$ million
Electronic
Prime Services -
Total cash equities 266 -226 40 0 40 29 100 85% 28% 29%
Structured products 1,563 -781 781 0 781 563 1,050 50% 28% 54%
Delta One
Convert.
211 -179 32 0 32 23 75 85% 28% 30%
55 -47 8 0 8 6 25 85% 28% 24%
1,074 -537 537 0 537 387 350 50% 28% 110%
186 -84 102 0 102 74 200 45% 28% 37%
Total Equity Deriv. ex prop 3,508 -1,813 1,695 0 1,695 1,220 2,026 52% 28% 60%
Prop trading 1,139 -342 797 0 797 574 375 30% 28% 153%
Total equities 4,913 -2,381 2,532 0 2,532 1,823 2,501 48% 28% 73%
149
Table 102: BNP Paribas Equities businesses summary P&L 2009

$ million
Electronic
Prime Services 235 -117 117 0 117 82 331 50% 30% 25%
Total cash equities 331 -199 132 0 132 92 366 60% 30% 25%
Delta One
Convert.
71 -61 11 0 11 7 24 85% 30% 32%
25 -21 4 0 4 3 12 85% 30% 22%
859 -430 430 0 430 301 331 50% 30% 91%
215 -97 118 0 118 83 189 45% 30% 44%
Total Equity Deriv. ex prop 2,435 -1,300 1,135 0 1,135 794 1,536 53% 35% 52%
Prop trading -398 119 -279 0 -279 -195 461 30% 30% -42%
Total equities 2,367 -1,379 988 0 988 692 2,363 58% 35% 29%
Table 103: Deutsche Bank Equities businesses summary P&L 2009

$ million
Electronic
Prime Services 1,009 -505 505 0 505 328 864 50% 35% 38%
Total cash equities 2,379 -1,737 642 0 642 417 1,137 73% 35% 37%
Delta One
Convert.
1,120 -1,008 112 0 112 73 219 90% 35% 33%
250 -225 25 0 25 16 55 90% 35% 30%
564 -310 254 0 254 165 273 55% 35% 60%
215 -97 118 0 118 77 191 45% 35% 40%
Total Equity Deriv. ex prop 1,729 -977 752 0 752 489 1,295 57% 35% 38%
Prop trading 455 -182 273 0 273 178 301 40% 35% 59%
Total equities 4,563 -2,896 1,667 0 1,667 1,083 2,733 63% 35% 40%
Table 104: UBS Equities businesses summary P&L 2009

$ million
Electronic
Prime Services 1,023 -512 512 0 512 374 861 50% 27% 43%
Delta One
Convert.
1,271 -1,144 127 0 127 93 123 90% 27% 75%
600 -540 60 0 60 44 49 90% 27% 89%
475 -261 214 0 214 156 246 55% 27% 63%
203 -91 112 0 112 82 172 45% 27% 47%
Prop trading 346 -138 208 0 208 152 295 40% 27% 51%
Total equities 4,769 -3,264 1,505 0 1,505 1,099 2,460 68% 27% 45%
150
Table 105: Morgan Stanley Equities businesses summary P&L 2009

$ million
Electronic
Prime Services 1,750 -875 875 0 875 613 1,211 50% 30% 51%
Delta One
Convert.
765 -689 77 0 77 54 159 90% 30% 34%
500 -450 50 0 50 35 64 90% 30% 55%
630 -347 284 0 284 198 255 55% 30% 78%
150 -68 83 0 83 58 96 45% 30% 60%
Prop trading 513 -205 308 0 308 215 414 40% 30% 52%
Total equities 4,908 -3,029 1,879 0 1,879 1,316 3,187 62% 30% 41%
Table 106: Barclays Equities businesses summary P&L 2009

$ million
Electronic
Prime Services 1,322 -661 661 0 661 473 796 50% 29% 59%
Total cash equities 1,889 -1,171 718 0 718 513 928 62% 29% 55%
Delta One
Convert.
507 -456 51 0 51 36 122 90% 29% 30%
60 -54 6 0 6 4 11 90% 29% 39%
550 -303 248 0 248 177 210 55% 29% 84%
289 -130 159 0 159 114 155 45% 29% 73%
Total Equity Deriv. ex prop 1,889 -1,135 754 0 754 539 1,072 60% 29% 50%
Prop trading 420 -168 252 0 252 180 210 40% 29% 86%
Total equities 4,198 -2,474 1,724 0 1,724 1,233 2,210 59% 29% 56%
Table 107: Bank of America Merrill Lynch Equities businesses summary P&L 2009
$ million
Electronic
Prime Services 1,000 -500 500 0 500 350 961 50% 30% 36%
Delta One
Convert.
1,400 -1,260 140 0 140 98 137 90% 30% 71%
451 -406 45 0 45 32 55 90% 30% 57%
500 -275 225 0 225 158 275 55% 30% 57%
300 -135 165 0 165 116 192 45% 30% 60%
Prop trading 600 -240 360 0 360 252 329 40% 30% 76%
Total equities 4,901 -3,248 1,653 0 1,653 1,157 2,745 66% 30% 42%
151
Table 108: Citigroup Equities businesses summary P&L 2009

$ million
Electronic
Prime Services 1,200 -600 600 0 600 420 1,005 50% 30% 42%
Delta One
Convert.
1,212 -1,091 121 0 121 85 144 90% 30% 59%
260 -234 26 0 26 18 57 90% 30% 32%
450 -248 203 0 203 142 287 55% 30% 49%
500 -225 275 0 275 193 201 45% 30% 96%
Prop trading 1,200 -480 720 0 720 504 345 40% 30% 146%
Total equities 5,372 -3,243 2,129 0 2,129 1,490 2,872 60% 30% 52%
Regulatory impact on the equity derivatives business

Table 109: Global Investment Banks Equity derivatives businesses net income and allocated capital pre and post regulatory changes 2011E
$ million 2011E Impact from regulation on net income Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives Impact from regulation on capital Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives Net income post regulation Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives Allocated capital post regulation Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives
SG 0 -11% -36% -15% 0% -31% -18% 77% 30% 70% 70% 70% 66% 500 86 325 60 194 1,165 1,858 554 596 341 628 3,977
BNP
DB
UBS
CS
GS
MS
BARC
BOAML -19% -43% -17% 0% -54% -26% 79% -19% 43% 43% 43% 46% 52 39 125 100 57 372 985 200 392 274 329 2,180
CITI
Average
-12% -36% -15% 0% -43% -20% 74% 20% 66% 66% 66% 61% 263 70 281 75 91 780 1,231 368 548 313 763 3,222
-13% -43% -17% 0% -44% -22% 55% -34% 40% 40% 40% 32% 136 26 130 62 70 425 867 180 384 269 296 1,994
-19% -51% -17% 0% -43% -27% 47% -7% 32% 32% 32% 26% 70 47 148 82 83 430 543 320 325 228 234 1,650
-15% -43% -17% 0% -57% -23% 60% 3% 51% 51% 51% 46% 150 42 178 88 42 499 979 284 463 324 185 2,235
-11% -36% -17% 0% -33% -20% 71% -21% 36% 36% 36% 39% 266 157 307 182 212 1,124 2,504 520 957 698 997 5,677
-19% -36% -17% 0% -35% -24% 61% -34% 26% 26% 26% 25% 49 46 170 51 136 452 974 252 322 121 366 2,034
-19% -36% -17% 0% -50% -25% 64% 0% 41% 41% 41% 39% 100 64 146 92 65 467 670 298 296 218 222 1,704
-19% -43% -17% 0% -39% -21% 120% 38% 77% 77% 77% 86% 49 28 116 157 101 452 1,263 357 509 356 458 2,942
-13% -39% -16% 0% -40% -22% 72% -4% 48% 48% 49% 47% 1,636 604 1,925 948 1,053 6,166 11,873 3,332 4,791 3,141 4,478 27,615
152
Company Financials
153
Credit Suisse Group

Overweight
Company Data Price (SF) Date Of Price Price Target (SF) Price Target End Date 52-week Range (SwF) Mkt Cap (SF bn) Shares O/S (mn) 47.14 03 Sep 10 59.00 31 Dec 11 60.90 39.80 55.8 1,184 Credit Suisse Group (CSGN.VX;CSGN VX) FYE Dec 2008A Adj. EPS FY (SF) (4.68) Adj P/E FY NM Headline EPS FY (SF) (7.28) NAV/Sh FY (SF) 19.8 Dividend (Net) FY (SF) 0.10 P/NAV FY 2.4 Tier One Ratio FY 13.3% RoNAV FY -23.2% 2009A 5.91 8.0 5.62 23.9 2.00 2.0 16.3% 26.1% 2010E 5.30 8.9 5.46 23.1 2.00 2.0 16.4% 23.7% 2011E 6.00 7.9 6.10 27.2 2.00 1.7 15.1% 22.9% 2012E 7.00 6.7 7.13 32.3 2.00 1.5 16.4% 22.5%
Source: Company data, Bloomberg, J.P. Morgan estimates.
Our Dec 2011 sum-of-the-parts-based price target for Credit Suisse is SF59. Note that we are rolling our SOP-based target price to Dec-11E, with this note. Our SOP multiples are differentiated by business and for franchise quality.
Table 110: Credit Suisse: SOP Valuation 2012E
Sfr millions 2012 Earnings Wealth Management Clients Corporate and Institutional Clients Private Banking Investment Banking Asset Management Divisional Total Corporate centre of which excess capital TOTAL - CASH / Core Tier I Target price Dec 2011
P/E 10.0 8.0 9.5 6.5 9.0 7.8 9.0 8.4 8.4
Capital (mn) 1,558 2,731 4,288 27,293 1,350 32,931 5,883 38,814
P/BV 17.5 2.4 7.9 1.2 2.8
AuM (bn) 956 151 1,107
% of AuM 2.9% 4.3%
Value/ share 22 5 27 26
% of total 38% 9% 46% 45% 5% 96% -4% 8% 100%
Valuation (mn) 27,286 6,471 33,756 32,434 3,777 69,967 (3,253) 5,883 72,596 72,596
ROE 175% 30% 18% 31% 27%
2,729 809 3,537 4,990 420 8,947 (361) 27 8,612 8,612
466
0.8%
3 57
1.0
-3 5 59 59
22%
154
UBS
Overweight
Company Data Price (SF) Date Of Price Price Target (SF) Price Target End Date 52-week Range (SwF) Mkt Cap (SF bn) Shares O/S (mn) 18.24 03 Sep 10 22.00 31 Dec 11 19.60 13.31 64.9 3,558 UBS (UBSN.VX;UBSN VX) FYE Dec Adj. EPS FY (SF) Adj P/E FY Headline EPS FY (SF) NAV/Sh FY (SF) P/NAV FY Tier One Ratio FY Dividend (Net) FY (SF) RoNAV FY 2008A (7.83) NM (7.28) 7.4 2.4 11.0% 0.00 -103.5% 2009A 0.07 258.2 (0.74) 7.7 2.4 15.4% 0.00 -10.1% 2010E 1.52 12.0 1.66 9.4 1.9 17.2% 0.00 19.2% 2011E 2.20 8.3 2.23 11.6 1.6 16.6% 0.00 21.0% 2012E 2.40 7.6 2.43 14.0 1.3 19.1% 0.00 18.8%
Our Dec 2011 sum-of-the-parts-based price target for UBS is SF22. Note that we are rolling our SOP-based target price to Dec-11E, with this note. Our SoP multiples are differentiated by business and franchise quality, and IB multiple is adjusted for regulatory uncertainty.
Table 111: UBS: SOP Valuation 2012E
Sfr milions 2012 earnings P/E Capital P/BV AuM (bn) % of AuM 3.2% 4.8% 1.0% Value per share 7 3 10 2 6 733 1.0% 2 -0.3 19 -1 4 22 As % of total 30% 16% 46% 7% 26% 8% -1% 86% -5% 19% 100% Valuation ROE
Wealth Management Retail & Corporate Wealth Management and Swiss Bank Global Asset Management Investment Bank Wealth Management Americas PW Acquitistion expense Divisional Total Corporate Functions/other adj./tax Of which excess capital Total Banking
2,653 1,706 4,359 721 4,225 821 (151) 9,976 (588) 81 9,469
10.0 8.0 9.2 9.0 5.5 8.5 8.5 7.6 9.0 9.3
2,205 2,457 4,662 462 22,083 2,410 29,617 874 16,670 47,160
12.0 5.6 8.6 14.0 1.1 2.9 2.6 1.0 1.0 1.9
842 842 641
26,534 13,646 40,180 6,485 23,238 6,982 -1,281 75,605 -4,414 16,670 87,861
120% 69% 94% 156% 19% 34% 34%
20%
155
Deutsche Bank
Underweight
Company Data Price () Date Of Price Price Target () Price Target End Date 52-week Range () Mkt Cap ( bn) Shares O/S (mn) 50.22 03 Sep 10 46.00 31 Dec 11 60.55 40.13 31.2 621 Deutsche Bank (DBKGn.DE;DBK GR) FYE Dec 2008A Adj. EPS FY () (7.28) Headline EPS FY () (7.20) Adj P/E FY NM P/NAV FY 1.4 Dividend (Net) FY () 0.50 NAV/Sh FY () 35.7 Tier One Ratio FY 10.1% RoNAV FY -20.4% 2009A 4.36 8.12 11.5 1.3 0.75 39.4 12.6% 11.1% 2010E 6.60 7.14 7.6 1.1 1.00 45.0 11.6% 14.6% 2011E 7.35 7.88 6.8 1.0 2.00 50.5 10.4% 14.6% 2012E 7.75 8.30 6.5 0.9 2.00 56.4 11.0% 13.7%
Our Dec-2011 Sum-of-part based price target for Deutsche Bank is 46. Note that we are rolling our SOP-based target price to Dec-11E, with this note. Our SOP multiples are differentiated by business and franchise quality.
Table 112: Deutsche Bank: SOP Valuation 2012E
million Adj. Earnings (mn) 1,285 823 462 3,755 3,209 546 115 175 -175 5,155 Multiple X 8.4 8.0 9.0 7.9 7.5 10.3 7.5 7.0 8.3 Capital (mn) 4,227 2,487 1,741 37,431 34,466 2,965 1,050 -12,455 30,253 Multiple 2.6 2.5 2.4 0.8 0.7 1.9 0.8 1.0 1.4 AuM (bn) 1,147 208 940 AuM X Value bn 10.8 6.6 4.2 29.8 24.2 5.6 0.9 1.2 -12.5 30.3 per share 16 10 6 45 36 8 1 2 -19 46 46 % 36% 22% 14% 99% 80% 19% 3% 4% -41% 100% RoE 30% 33% 27% 10% 9% 18% 11% 17%
PCAM Private and Business Clients Asset and Wealth Management CIB Corporate Banking & Securities Transaction Banking Corporate Investment Adjustments/Centre Excess capital Deutsche Group Operational Value Total 2011 YE Price Target
0%
156
Goldman Sachs
Overweight
Company Data Price ($) Date Of Price Price Target ($) Price Target End Date 52-week Range ($) Mkt Cap ($ bn) Shares O/S (mn) 147.29 03 Sep 10 175.00 31 Dec 11 193.60 129.50 79.8 542 Goldman Sachs Group (GS;GS US) FYE Dec 2008A Adj. EPS FY ($) 4.44 Headline EPS FY ($) 4.67 BV/Sh FY ($) 104 P/NAV FY 1.6 Dividend (Net) FY ($) 1.40 NAV/Sh FY ($) 92.9 Tier One Ratio FY 15.6% RoNAV FY 5.6% 2009A 19.43 23.74 102 1.6 1.40 93.8 15.0% 21.1% 2010E 13.53 15.59 120 1.3 1.40 110.8 17.2% 13.3% 2011E 15.84 18.25 135 1.2 1.40 125.5 16.1% 13.5% 2012E 16.40 18.90 150 1.0 1.40 140.6 17.6% 12.4%
Source: Company data, Bloomberg, J.P. Morgan estimates. 'Bloomberg' above denotes Bloomberg consensus estimates.
Our Dec 2011 sum-of-the-parts based price target for Goldman Sachs is $175. Note that we are rolling our SOP-based target price to Dec-11E, with this note. Our SoP multiples are differentiated by business and franchise quality.
Table 113: Goldman Sachs: SOP Valuation 2012E
$ million 2012 Earnings 9,520 9,520 0 886 544 343 271 -443 10,235 P/E 8.3 7.5 8.6 9.0 8.0 9.0 11.0 Core Tier I capital 50,931 40,331 10,599 2,898 1,777 1,122 29,476 83,305 AuM P/core Tier I 1.6 1.8 0.8 2.6 2.8 2.4 1.0 1.4 Value/ Share 122 114 8 12 8 4 47 -6 175 % of Total 70% 65% 5% 7% 4% 3% 27% -4% 100% Valuation (mn) 79,402 70,923 8,480 7,634 4,892 2,742 29,476 (3,983) 112,529 RoE 18.7% 23.6% 30.6% 30.6% 30.6% 12.3%
Global capital Markets and PI Global Capital Markets Principal investments Asset Management & Securities Services Asset Management Securities Services Excess capital over core Tier I Cost of pref/other Divisional Total core capital
15.1
157
Morgan Stanley
Overweight
Company Data Price ($) Date Of Price Price Target ($) Price Target End Date 52-week Range ($) Mkt Cap ($ bn) Shares O/S (mn) 26.66 03 Sep 10 33.00 31 Dec 11 35.78 22.40 37.2 1,397 Morgan Stanley & Co. Inc. (MS;MS US) FYE Dec 2008A Adj. EPS FY ($) 1.55 Adj P/E FY 17.2 Headline EPS FY ($) 1.55 BV/Sh FY ($) 30 NAV/Sh FY ($) 27.2 Dividend (Net) FY ($) 1.08 P/NAV FY 1.0 Tier One Ratio FY 17.9% 2009A (0.78) NM (0.76) 27 18.3 0.17 1.5 15.3% 2010E 2.74 9.7 3.77 30 24.2 0.20 1.1 16.9% 2011E 3.46 7.7 4.63 34 27.4 0.30 1.0 16.1% 2012E 3.58 7.5 4.78 37 30.8 0.30 0.9 17.5%
Our new Dec 2011 sum-of-the-parts-based price target for Morgan Stanley is $33. Note that we are rolling our SOP-based target price to Dec-11E, with this note. Our SoP multiples are differentiated by business and franchise quality.
Table 114: Morgan Stanley: SOP Valuation 2012E
$ million 2012 Earnings Institutional Securities Asset Management Global Wealth Management including SSSB Eliminations Excess capital Divisional Total Target Price Dec 2011
P/E
Average Tier I Equity 36,847 2,500 2,775 500 10,490 53,112
P/BV
AuM (bn)
% of AuM
4,888 396 771 528 99 6,682
7.5 8.5 9.0 8.0 9.2
1.0 1.3 2.5 1.0 1.2
301 1,573
1.1% 0.4%
Val ue/ Sha re 20 2 4 2 6 33 33
% of Total 59% 5% 11% 7% 17% 100%
Valuation (mn) 36,659 3,368 6,937 4,222 10,490 61,677
RoE
13% 16% 28% 106% 13%
158
BNP Paribas
Overweight
Company Data Price () Date Of Price 52-week Range () Mkt Cap ( bn) Shares O/S (mn) Price Target () Price Target End Date 53.47 03 Sep 10 60.38 40.81 63.3 1,185 65.00 31 Dec 11 BNP Paribas (BNPP.PA;BNP FP) FYE Dec 2008A Adj. EPS FY () 4.19 Adj P/E FY 12.8 Headline EPS FY () 3.34 BV/Sh FY () 46 NAV/Sh FY () 32.1 P/NAV FY 1.7 Tier One Ratio FY 7.8% P/BV FY 1.2 2009A 5.07 10.5 5.65 57 43.8 1.2 10.1% 0.9 2010E 5.90 9.1 6.02 54 42.0 1.3 10.8% 1.0 2011E 6.90 7.7 6.78 59 46.7 1.1 10.5% 0.9 2012E 7.50 7.1 7.55 64 52.0 1.0 11.1% 0.8
Our SOP-based Dec-2011E price target for BNP Paribas is 65. Note that we are rolling our SOP-based target price to Dec-11E, with this note. Our SOP multiples are differentiated by business and franchise quality. We have also accounted for additional 50bn market risk requirements in CIB resulting from Basel 2.5 rules.
Table 115: BNP Paribas: SOP Valuation 2012E
million 2012 Earnings (mn) 1,422 2,422 1,126 519 295 481 1,553 667 655 232 3,537 693 475 -1,234 76 8,944 P/E 8.5 7.9 8.0 8.0 8.5 7.0 8.3 9.0 7.5 8.5 8.0 7.5 8.0 8.5 8.7 Capital (mn) 6,274 12,688 3,954 3,497 2,920 2,317 6,600 1,700 4,500 400 30,969 5,204 2,943 7,213 67,391 P/BV 1.9 1.5 2.3 1.2 0.9 1.5 2.0 3.5 1.1 4.9 0.9 1.0 1.3 1.0 1.2 AuM (bn) % of AuM Value/ share 10.1 16.0 7.6 3.5 2.1 2.8 10.8 5.0 4.1 1.7 23.7 4.4 3.2 -8.8 6.0 65 65 % of total 15% 24% 12% 5% 3% 4% 17% 8% 6% 3% 36% 7% 5% -13% 9% 100% Valuation (mn) 12,086 19,044 9,009 4,156 2,512 3,368 12,882 6,000 4,912 1,971 28,295 5,200 3,797 -10,492 7,213 78,025 1,193 ROE 23% 19% 28% 15% 10% 21% nm 39% 15% 58% 11% 13% 16% 13%
Retail banking in France SFS + Intl retail Personal Finance BancWest Europe Mediterranean Equipment solutions Investment Solutions Wealth & Asset Management Insurance Securities Services Corporate and investment banking BNL BeLux retail banking Other central revenues/costs Other capital Group Nb shares (m) Target price ()
940.0 793.0 147.0
1.4% 0.8% 3.3%
159
Socit Gnrale
Overweight
Company Data Price () Date Of Price Price Target () Price Target End Date 52-week Range () Mkt Cap ( bn) Shares O/S (mn) 44.52 03 Sep 10 58.00 31 Dec 11 54.24 29.70 33.0 742 Socit Gnrale (SOGN.PA;GLE FP) FYE Dec 2008A Adj. EPS FY () 4.19 Adj P/E FY 10.6 Headline EPS FY () 3.67 BV/Sh FY () 65 NAV/Sh FY () 40.1 P/NAV FY 1.1 ROE FY 7.1% Tier One Ratio FY 8.8% 2009A (0.49) NM 1.12 57 35.1 1.3 2.3% 10.7% 2010E 4.50 9.9 4.58 62 40.1 1.1 9.3% 10.9% 2011E 6.30 7.1 6.30 67 44.4 1.0 11.6% 11.4% 2012E 7.20 6.2 7.20 72 49.8 0.9 12.2% 10.5%
Source: Company data, Reuters, J.P. Morgan estimates.
Our sum-of-the-parts-based Dec-2011 price target for Socit Gnrale is 58. Note that we are rolling our SOP-based target price to Dec-11E, with this note. Our SOP multiples are differentiated by businesses and for franchise quality. We have also accounted for additional 50bn market risk requirements in CIB resulting from Basel 2.5 rules.
Table 116: Societe Generale : SOP Valuation 2012E
million 2012 Earnings (mn) 1,563 789 1,016 407 88 231 129 1,770 -215 -52 5,277 P/E 8.5 9.0 10.0 10.7 9.5 10.0 9.5 8.0 7.0 8.1 Capital (mn) 5,128 4,249 8,363 1,273 460 537 276 21,371 -4,791 35,592 P/B 2.6 1.7 1.2 3.4 1.8 4.3 4.5 0.7 1.0 1.2 AuM (bn) % of AuM Value/ share 18 10 14 6 1 3 2 19 -2 -7 58 % of total 31% 17% 24% 10% 2% 5% 3% 33% -4% -11% 100% Valuation (mn) 13,286 7,097 10,162 4,370 832 2,308 1,230 14,157 -1,508 -4,791 42,773 733 58 ROE 30% 19% 12% 32% 19% 43% 47% 8% 15%
Retail banking in France Specialised financial services (SFS) Retail international Global Investment & Management Services Asset management Private Banking Securities Services & Online services Total Corporate & Investment Banking Central revenues/costs Unallocated capital Group Nb shares 2012e Target price
190.0 93.7 96.3
2.3% 0.9% 2.4%
160
Valuation Methodology and Risks

BNP Paribas (Overweight; Price Target 65.00)
Valuation Methodology Our SOP-based Dec-2011E price target for BNP Paribas is 65.. Our SOP multiples are differentiated by business and franchise quality. Note that we have also accounted for an additional 50bn in market risk requirements in Corporate & Investment Banking resulting from new Basel II rules, as well as for additional adjustments for market RWAs consistency across banks. Risks to Our View Key investment risks on the downside and upside include: - The performance of the capital markets, in particular with respect to demand for equity derivatives, and derivatives trading profits in the environment of increasing correlation and falling dividend expectations impacting the CIB division, as well as structured credit pricing leading to potential asset writedowns both at BNP Paribas and Fortis Bank. - Asset quality, and the performance of the US operations in BancWest as well as its US commercial real estate book, which in our view requires potentially further writedowns. - The French retail banking environment, and the net interest margin trends in this market, equity markets performances, macro-economic conditions as well as the impact of the interest rate environment and changes to the shape of the yield curve. - In terms of M&A, we see some potential Fortis execution risk due to the size of the balance sheet.
Credit Suisse Group (Overweight; Price Target SF 59.00)

Valuation Methodology Our Dec 2011E sum-of-the-parts-based price target for Credit Suisse is SF59. Note that our SOP multiples are differentiated by business and for franchise quality. Risks to Our View We believe the key risks that could keep our rating and target price from being achieved include the following: The performance of the capital markets , impacting both the investment banking capital markets business as well as the performance of Credit Suisses assets under management. Historically CS franchise has had boom-bust characteristics due to poor cost management during market declines. M&A- CS may acquire some small private banking operations- raising potential risk of overpaying. Growth in new private banking money and the development of private banking transaction margins. Impact of legislation and regulatory issues surrounding Swiss banking secrecy and customer confidentiality. The US, as well as global, economies could experience a 'double dip with a corresponding deterioration in credit quality and weaker revenues. In addition, widening credit spreads, could affect funding costs. Legal risk in part from the structured credit and financial market crisis could become an issue in particular for banks with material capital markets activities as well as within asset and wealth management.
161
Deutsche Bank (Underweight; Price Target 46.00)

Valuation Methodology Our Dec-2011E Sum-of-part based price target for Deutsche Bank is 46. Note that our SOP multiples are differentiated by business and franchise quality. Risks to Our View We believe the key risks (both upside and downside) that could keep our rating and target price from being achieved include the following: 1. The performance of the capital markets, impacting both the investment banking capital markets business (particularly Fixed Income) as well as the performance of Deutsche Banks assets under management. 2. Potential acquisitions risk both within the domestic German market, uncertainties regarding strategy for Deutsche Postbank (with potential capital raising risk if they should decide to acquire the free float minority interest). 3. Provision and mark-to-market risk in Deutsche Banks riskier assets such as monoline exposures, leverage finance, sub prime, alt A, HELOC and prime RMBS (US as well as European), CMBS, CDOs and other structured credit assets. In addition, other assets such as credit card loans, consumer finance and other ABS could potentially become an issue. 4. The US, as well as global, economies could experience a 'double dip with a corresponding deterioration in credit quality and weaker revenues. In addition, widening credit spreads, could affect DBs profitability. 5. Legal risk in part from the structured credit and financial market crisis could become an issue in particular for banks with material capital markets activities as well as within asset and wealth management.
Goldman Sachs (Overweight; Price Target $175.00)

Valuation Methodology Our Dec 2011E sum-of-the-parts based price target for Goldman Sachs is $175. Note that our SoP multiples are differentiated by business and franchise quality, and the IB multiple is adjusted for regulatory uncertainty. Risks to Our View We believe the key risks (both on the upside and downside) that could keep our rating and target price from being achieved include the following: The performance of the capital markets , impacting both the investment banking capital markets business (especially fixed income) as well as the performance of Goldman Sachs assets under management. Despite decent risk reductions, liquidity and mark-to-market risk remains in Goldman Sachs legacy assets such as leverage finance, residential and commercial real estate and other structured credit assets. In addition, other assets such as credit card loans, consumer finance and other ABS could potentially become an issue. Funding risk with Goldman Sachs being predominantly wholesale funded could become a material issue should credit markets freeze up. The US, as well as global economies could experience a 'double dip with a corresponding deterioration in credit quality and weaker revenues, impacting Goldman Sachs profitability. Legal risk coming out from the structured credit and financial market crisis could become a material issue both from a financial and reputational perspective. Regulatory risk with the proposed changes in Basel rules and financial reform in OTC derivatives could significantly reduce profitability of the group.
162
Morgan Stanley (Overweight; Price Target $33.00)

Valuation Methodology Our Dec 2011E sum-of-the-parts-based price target for Morgan Stanley is $33. Note that our SoP multiples are differentiated by business and franchise quality, and the IB multiple accounts for regulatory uncertainty. Risks to Our View Risks that could prevent the stock from achieving our target price and rating include: The performance of the capital markets, impacting both the investment banking capital markets business as well as the performance of Morgan Stanleys assets under management. Execution risk in Morgan Stanleys Wealth management joint venture with Citigroups SSB division. Mark-to-market risk in Morgan Stanleys riskier assets such as leverage finance, residential and commercial real estate and other structured credit assets. In addition, other assets such as credit card loans, consumer finance and other ABS could see mark-to-market gains and losses. Funding risk with Morgan Stanley being predominantly wholesale funded could become a material issue should credit markets freeze up. The US, as well as global, economies could experience a 'double dip with a corresponding deterioration in credit quality and weaker revenues. Legal risk in part from the structured credit and financial market crisis could become an issue, in particular for banks with material capital markets activities as well as within asset and wealth management.
Socit Gnrale (Overweight; Price Target 58.00)

Valuation Methodology Our sum-of-the-parts-based Dec-2011E price target for Socit Gnrale is 58. Note that we have also accounted for additional 50bn in market risk requirements in Corporate & Investment Banking resulting from new Basel II rules, as well as our additional adjustments for market RWAs to harmonize calculations between banks using internal models vs. standardized approach. Our SOP multiples are differentiated by businesses and for franchise quality. Risks to Our View We believe the key risks that could keep our rating and price target from being achieved include the following: - Asset quality, and the performance of the emerging markets businesses as well as emerging market macro risks related to FX as well as the political environment - Performance of the capital markets, in particular with respect to demand for equity derivatives, and derivatives trading profits in the environment of increasing correlation and falling dividend expectations impacting the CIB division as well as structured credit pricing leading to potential asset writedowns. - The French retail banking environment, and the net interest margin trends in this market, as well as the impact of the interest rate environment and changes to the shape of the yield curve.
163
UBS (Overweight; Price Target SF 22.00)

Valuation Methodology Our Dec 2011E sum-of-the-parts-based price target for UBS is SF22. Note that our SoP multiples are differentiated by business and franchise quality, and IB multiple is adjusted for regulatory uncertainty. Risks to Our View Risks that could prevent the stock from achieving our target price and rating include: The performance of the capital markets, impacting both the investment banking capital markets business as well as the performance of UBS assets under management. Potential risk of further markdowns in remaining legacy credit assets, and potential risk of further balance sheet assets becoming impaired, although greatly reduced post transaction with SNB. The US, as well as global, economies could experience a 'double dip with a corresponding deterioration in credit quality and weaker revenues. Growth in new private banking money and the development of private banking transaction margins in particular UBS's ability to stem recent outflows, and rebuild its franchise. Legal risk in part from the structured credit and financial market crisis, could become an issue in particular for banks with material capital markets activities as well as within asset and wealth management
Barclays (Neutral; Price Target 305p)

Valuation Methodology Our Dec-11 target price of 305p is based on our sum of the parts analysis. Risks to Our View We believe the key risks that could prevent our price target and rating from being achieved are regulatory risks. Barclays has lower exposure to UK mortgages than UK peers and potentially better customer asset quality. Nevertheless, through Barclays Capital, it is significantly exposed to the fixed income cycle and the corporate credit cycle while Barclaycard gives high exposure to consumer credit. Given the high dependence on investment banking activities Barclays is vulnerable to a slowdown in volumes and/or further deterioration in the economic environment which could result in higher writedowns. Barclays is also exposed to the economic cycle through its lending exposure in particular to the UK credit cycle, South Africa and Spain. Being a retail bank it is also exposed to the interest rate environment.
164
Credit Suisse Group: Summary of Financials

Profit and Loss Statement SwF in millions, year end Dec Net interest income % Change Y/Y Non-interest income Fees & commissions % change Y/Y Trading revenues % change Y/Y Other Income Total operating revenues % change Y/Y Admin expenses % change Y/Y Other expenses Pre-provision operating profit % change Y/Y Loan loss provisions Other provisions Earnings before tax % change Y/Y Tax (charge) % Tax rate Minorities Net Income (Reported) FY08A FY09A FY10E 4,849 (29.6%) 27,590 15,085 9.7% 13,233 8.9% -729 32,438 (3.5%) -9,050 (5.7%) (14,178) 9,210 1.3% -185 9,025 5.2% (2,226) 24.7% (152) 6,628 FY11E 4,849 0.0% 29,812 15,085 0.0% 13,233 0.0% 1,494 34,661 6.9% -9,326 3.1% (14,868) 10,466 13.6% -190 10,276 13.9% (2,673) 26.0% (220) 7,384 8,553 6,891 1.2% (19.4%) 3,575 26,726 15,059 13,750 (22.1%) (8.7%) -9,880 12,151 (260.7%) (223.0%) -1,604 825 12,128 33,617 (66.2%) 177.2% -10,197 -9,601 7.7% (5.8%) (13,272) (14,927) -11,341 9,089 (210.2%) (180.1%) -814 -506 -12,155 8,583 (221.0%) (170.6%) 4,594 (1,835) 37.8% 21.4% (120) (193) (8,219) 6,724 Ratio Analysis FY12E SwF in millions, year end Dec Per Share Data 4,849 EPS Reported 0.0% EPSAdjusted 32,439 % Change Y/Y 15,085 DPS 0.0% % Change Y/Y 13,233 Dividend yield 0.0% Payout ratio 4,121 BV per share 37,288 NAV per share 7.6% Shares outstanding -9,599 2.9% Return ratios (15,560) RoRWA 12,130 Pre-tax ROE 15.9% ROE -140 RoNAV 11,990 Revenues 16.7% NIM (NII / RWA) (3,118) Non-IR / average assets 26.0% Total rev / average assets (260) NII / Total revenues 8,612 Fees / Total revenues Trading / Total revenues FY08A FY09A FY10E FY11E FY12E -7.28 5.62 5.46 6.10 7.13 (4.68) 5.91 5.30 6.00 7.00 (166.0%) (226.1%) (10.3%) 13.2% 16.6% 0.10 2.00 2.00 2.00 2.00 (96.0%) 1900.0% 0.0% 0.0% 0.0% 0.2% 4.4% 4.4% 4.4% 4.4% -1.4% 35.6% 36.6% 32.8% 28.0% 28.35 32.09 31.49 35.56 40.68 19.79 23.88 23.09 27.17 32.28 1,139.4 1,169.2 1,186.1 1,186.1 1,186.1
(1.8%) (32.2%) (21.8%) (23.2%)
3.0% 24.6% 19.3% 26.1%
2.8% 24.1% 17.7% 23.7%
2.7% 25.8% 18.6% 22.9%
2.8% 26.5% 19.0% 22.5%
3.3% 0.3% 1.0% 70.5% 124.2% (81.5%)
3.1% 2.4% 3.1% 20.5% 40.9% 36.1%
2.0% 2.6% 3.0% 14.9% 46.5% 40.8%
1.6% 2.6% 3.1% 14.0% 43.5% 38.2%
1.6% 2.8% 3.2% 13.0% 40.5% 35.5%
Balance sheet SwF in millions, year end Dec ASSETS Net customer loans % change Y/Y Loan loss reserves Investments Other interest earning assets % change Y/Y Average interest earnings assets Goodwill Other assets Total assets LIABILITIES Customer deposits % change Y/Y Long term funding Interbank funding Average interest bearing liabs Other liabilities Retirement benefit liabilities Shareholders' equity Minorities Total liabilities & Shareholders Equity
FY08A
FY09A
FY10E
FY11E
FY12E SwF in millions, year end Dec Cost ratios Cost / income Cost / assets Staff numbers Balance Sheet Gearing Loan / deposit Investments / assets Loan / assets Customer deposits / liabilities LT Debt / liabilities Asset Quality / Capital Loan loss reserves / loans NPLs / loans LLP / RWA Loan loss reserves / NPLs Growth in NPLs RWAs % YoY change Core Tier 1 Total Tier 1
FY08A
FY09A FY10E FY11E FY12E
235,797 237,180 227,205 234,021 241,042 (2.0%) 0.6% (4.2%) 3.0% 3.0% 1,639 1,395 1,253 1,253 1,253 40,825 35,225 29,033 29,904 30,801 613,818 542,914 590,064 607,766 625,999 (26.3%) (11.6%) 8.7% 3.0% 3.0% 1,003,688 852,880 830,810 858,996 884,766 9,330 9,267 9,582 9,582 9,582 143,295 110,704 138,605 142,764 147,046 1,170,350 1,031,427 1,119,229 1,152,806 1,187,390
193.5% 2.0% -
73.0% 2.4% -
71.6% 2.1% -
69.8% 2.1% -
67.5% 2.1% -
66.4% 3.5% 20.1% 31.6% 13.4%
73.5% 3.4% 23.0% 32.8% 16.2%
69.9% 2.6% 20.3% 30.1% 16.9%
69.9% 2.6% 20.3% 30.5% 16.6%
69.9% 2.6% 20.3% 30.6% 16.2%
355,169 322,908 325,222 334,979 345,028 (16.7%) (9.1%) 0.7% 3.0% 3.0% 150,714 159,365 182,710 182,710 182,710 243,370 191,687 198,763 204,726 210,868 1,011,394 864,884 852,256 900,026 921,546 178,121 130,497 147,941 152,379 156,950 32,302 37,517 37,349 42,183 48,246 14,919 10,811 10,726 11,048 11,379 1,170,350 1,031,427 1,119,229 1,152,806 1,187,390
0.7% 0.6% 0.6% 0.5% 0.5% 1.2% 1.0% 0.9% 1.1% 1.0% 0.32% 0.23% 0.08% 0.06% 0.04% 60.1% 60.7% 63.3% 51.0% 51.0% 40.0% (15.7%) (13.8%) 24.2% 0.0% 257,467 221,609 242,526 296,652 311,485 (17.5%) (13.9%) 9.4% 22.3% 5.0% 8.6% 10.8% 11.4% 11.0% 12.5% 13.3% 16.3% 16.4% 15.1% 16.4%
Source: Company reports and J.P. Morgan estimates.
165
UBS: Summary of Financials

Profit and Loss Statement SwF in millions, year end Dec Net interest income % Change Y/Y Non-interest income Fees & commissions % change Y/Y Trading revenues % change Y/Y Other Income Total operating revenues % change Y/Y Admin expenses % change Y/Y Other expenses Pre-provision operating profit % change Y/Y Loan loss provisions Other provisions Earnings before tax % change Y/Y Tax (charge) % Tax rate Minorities Net Income (Reported) FY08A FY09A FY10E FY11E 5,220 0.0% 29,994 17,887 0.0% 11,145 32.5% 962 35,214 7.8% -5,810 0.2% (17,670) 11,734 34.1% -55 11,679 35.6% (2,511) 21.5% (500) 8,668 6,203 6,445 5,220 16.2% 3.9% (19.0%) -1,663 17,987 27,437 26,824 17,712 17,887 (25.3%) (34.0%) 1.0% -29,369 -325 8,413 115.5% (98.9%) (2,689.4%) 882 600 1,137 4,540 24,432 32,657 (85.9%) 438.2% 33.7% -9,580 -6,251 -5,797 12.9% (34.7%) (7.3%) (18,059) (17,788) (18,108) -23,099 393 8,753 707.7% (101.7%) 2,126.6% -2,995 -1,833 -138 -26,094 -2,562 8,615 829.6% (90.2%) (436.2%) 6,766 443 (1,601) 25.9% 17.3% 18.6% (569) (600) (603) (19,897) (2,719) 6,411 Ratio Analysis FY12E SwF in millions, year end Dec Per Share Data 5,220 EPS Reported 0.0% EPSAdjusted 32,104 % Change Y/Y 17,887 DPS 0.0% % Change Y/Y 13,255 Dividend yield 18.9% Payout ratio 962 BV per share 37,324 NAV per share 6.0% Shares outstanding -6,124 5.4% Return ratios (18,387) RoRWA 12,813 Pre-tax ROE 9.2% ROE -50 RoNAV 12,763 Revenues 9.3% NIM (NII / RWA) (2,744) Non-IR / average assets 21.5% Total rev / average assets (550) NII / Total revenues 9,469 Fees / Total revenues Trading / Total revenues FY08A FY09A FY10E FY11E FY12E -7.28 -0.74 1.66 2.23 2.43 (7.83) 0.07 1.52 2.20 2.40 128.3% (100.9%) 2,048.4% 44.7% 9.2% 0.00 0.00 0.00 0.00 0.00 0.0% 0.0% 0.0% 0.0% 0.0% -0.0% -0.0% 0.0% 0.0% 0.0% 11.17 10.46 12.22 14.42 16.82 7.45 7.65 9.38 11.58 13.98 3,473.5 3,921.2 3,945.8 3,945.8 3,945.8
(5.9%) (1.1%) (70.2%) (6.4%) (52.7%) 0.7% (103.5%) (10.1%)
3.1% 19.3% 13.4% 19.2%
3.6% 22.2% 16.5% 21.0%
3.4% 20.7% 15.4% 18.8%
2.1% (0.1%) 0.2% 136.6% 590.8% (646.9%)
3.1% 1.1% 1.5% 26.4% 72.5% (1.3%)
2.5% 1.9% 2.3% 16.0% 54.8% 25.8%
1.9% 2.0% 2.3% 14.8% 50.8% 31.6%
1.8% 2.0% 2.4% 14.0% 47.9% 35.5%
Balance sheet SwF in millions, year end Dec ASSETS Net customer loans % change Y/Y Loan loss reserves Investments Other interest earning assets % change Y/Y Average interest earnings assets Goodwill Other assets Total assets LIABILITIES Customer deposits % change Y/Y Long term funding Interbank funding Average interest bearing liabs Other liabilities Retirement benefit liabilities Shareholders' equity Minorities Total liabilities & Shareholders Equity
FY08A
FY09A
FY10E
FY11E
FY12E SwF in millions, year end Dec Cost ratios Cost / income Cost / assets Staff numbers Balance Sheet Gearing Loan / deposit Investments / assets Loan / assets Customer deposits / liabilities LT Debt / liabilities Asset Quality / Capital Loan loss reserves / loans NPLs / loans LLP / RWA Loan loss reserves / NPLs Growth in NPLs RWAs % YoY change Core Tier 1 Total Tier 1
FY08A
FY09A
FY10E FY11E FY12E
340,308 306,828 265,678 265,678 265,678 1.3% (9.8%) (13.4%) 0.0% 0.0% 2,927 2,680 1,832 1,832 1,832 6,140 82,627 72,616 64,403 57,119 1,428,294 783,217 842,456 781,147 725,969 (4.0%) (45.2%) 7.6% (7.3%) (7.1%) 1,785,985 1,479,328 1,330,039 1,220,634 1,134,700 12,935 11,008 11,202 11,202 11,202 59,386 60,425 179,899 287,193 388,148 2,015,551 1,340,539 1,517,744 1,554,170 1,591,470
608.8% 1.4% 51,371
98.4% 1.8% 63,610
73.2% 66.7% 65.7% 1.6% 1.5% 1.5% 64,070 64,552 65,042
71.7% 0.3% 16.9% 23.6% 9.8%
74.7% 6.2% 22.9% 30.6% 9.8%
65.9% 4.8% 17.5% 26.6% 8.5%
65.9% 4.1% 17.1% 25.9% 7.4%
65.9% 3.6% 16.7% 25.3% 6.3%
474,774 410,475 403,182 403,182 403,182 1.1% (13.5%) (1.8%) 0.0% 0.0% 197,254 131,352 129,521 114,345 100,947 125,628 65,166 78,337 69,158 61,055 1,282,168 947,742 829,095 802,076 755,338 33,146 33,988 145,051 279,898 402,269 340,308 306,828 265,678 265,678 265,678 8,002 7,620 7,327 7,327 7,327 2,015,551 1,340,539 1,517,744 1,554,170 1,591,470
0.9% 0.9% 1.2% 1.5% 0.99% 0.89% 69.8% 57.4% 183.0% 11.3% 302,273 206,525 (18.8%) (31.7%) 8.0% 11.9% 11.0% 15.4%
0.7% 0.7% 0.7% 1.2% 1.2% 1.2% 0.07% 0.02% 0.02% 57.0% 57.0% 57.0% (31.1%) 0.0% 0.0% 209,195 269,195 282,655 1.3% 28.7% 5.0% 13.9% 14.0% 16.7% 17.2% 16.6% 19.1%
166
Deutsche Bank: Summary of Financials

Profit and Loss Statement in millions, year end Dec Net interest income % Change Y/Y Non-interest income Fees & commissions % change Y/Y Trading revenues % change Y/Y Other Income Total operating revenues % change Y/Y Admin expenses % change Y/Y Other expenses Pre-provision operating profit % change Y/Y Loan loss provisions Other provisions Earnings before tax % change Y/Y Tax (charge) % Tax rate Minorities Net Income (Reported) FY08A FY09A FY10E 15,252 22.4% 14,523 10,376 16.4% 2,908 (59.1%) 29,775 6.6% -12,202 12.3% (9,233) 8,236 5.4% -1,486 6,751 30.2% (2,258) 33.5% (21) 4,492 FY11E 14,708 (3.6%) 15,586 10,895 5.0% 2,908 0.0% 30,294 1.7% -12,117 (0.7%) (9,130) 9,047 9.8% -1,405 7,642 13.2% (2,751) 36.0% 0 4,891 12,453 12,460 40.7% 0.1% 1,039 15,462 9,748 8,911 (19.2%) (8.6%) -9,992 7,109 (240.9%) (171.1%) 13,492 27,922 (56.1%) 107.0% -9,159 -10,870 (29.3%) 18.7% (7,964) (8,916) -4,594 7,816 (149.3%) (270.1%) -1,074 -2,631 -5,668 5,185 (165.1%) (191.5%) 1,845 (243) 29.1% 4.3% 69 (14) (3,823) 4,942 Ratio Analysis FY12E in millions, year end Dec Per Share Data 14,536 EPS Reported (1.2%) EPSAdjusted 16,152 % Change Y/Y 11,370 DPS 4.4% % Change Y/Y 2,908 Dividend yield 0.0% Payout ratio - BV per share 30,688 NAV per share 1.3% Shares outstanding -12,028 (0.7%) Return ratios (9,601) RoRWA 9,060 Pre-tax ROE 0.1% ROE -1,005 RoNAV 8,055 Revenues 5.4% NIM (NII / RWA) (2,900) Non-IR / average assets 36.0% Total rev / average assets - NII / Total revenues 5,155 Fees / Total revenues Trading / Total revenues FY08A FY09A FY10E FY11E FY12E 7.14 7.88 6.60 7.35 51.3% 11.5% 1.00 2.00 33.3% 100.0% 2.0% 4.0% 14.0% 25.4% 63.89 69.38 45.05 50.54 665.0 665.0 8.30 7.75 5.4% 2.00 0.0% 4.0% 24.1% 75.27 56.42 665.0 -7.20 8.12 (7.28) 4.36 (184.3%) (159.9%) 0.50 0.75 (88.9%) 50.0% 1.0% 1.5% -6.9% 9.2% 52.61 54.82 35.68 39.39 583.7 659.0
(1.3%) (18.0%) (12.0%) (20.4%)
1.0% 16.3% 14.8% 11.1%
1.4% 17.1% 11.4% 14.6%
1.3% 17.2% 11.0% 14.6%
1.3% 16.7% 10.7% 13.7%
4.0% 0.1% 0.7% 92.3% 72.3% (74.1%)
4.6% 0.8% 1.5% 44.6% 31.9% 25.5%
5.0% 0.8% 1.7% 51.2% 34.8% 9.8%
3.9% 0.8% 1.6% 48.6% 36.0% 9.6%
3.7% 0.8% 1.6% 47.4% 37.0% 9.5%
Balance sheet in millions, year end Dec ASSETS Net customer loans % change Y/Y Loan loss reserves Investments Other interest earning assets % change Y/Y Average interest earnings assets Goodwill Other assets Total assets LIABILITIES Customer deposits % change Y/Y Long term funding Interbank funding Average interest bearing liabs Other liabilities Retirement benefit liabilities Shareholders' equity Minorities Total liabilities & Shareholders Equity
FY08A
FY09A
FY10E
FY11E
FY12E in millions, year end Dec Cost ratios Cost / income Cost / assets Staff numbers Balance Sheet Gearing Loan / deposit Investments / assets Loan / assets Customer deposits / liabilities LT Debt / liabilities Asset Quality / Capital Loan loss reserves / loans NPLs / loans LLP / RWA Loan loss reserves / NPLs Growth in NPLs RWAs % YoY change Core Tier 1 Total Tier 1
FY08A
FY09A FY10E FY11E FY12E
269,281 258,105 299,368 356,400 367,196 33.9% (4.2%) 16.0% 19.1% 3.0% 1,938 3,343 4,276 5,681 6,686 987,268 672,845 863,203 871,835 (6.5%) (31.8%) 28.3% 1.0% 1,021,846 933,157 929,871 1,097,557 1,234,874 9,877 10,169 12,531 12,531 12,531 935,997 559,881 750,554 704,146 2,202,423 1,501,000 1,925,655 1,944,912 1,983,810
126.9% 0.8% 79,374
70.9% 72.0% 70.1% 70.5% 1.3% 1.1% 1.1% 1.1% 78,754 76,048 74,038 72,028
68.9% 12.4% -
76.3% 17.5% -
87.3% 103.1% 105.4% 15.8% 18.6% 18.8% -
395,553 344,220 347,662 351,139 354,650 (13.8%) (13.0%) 1.0% 1.0% 1.0% 251,857 171,646 220,207 222,409 318,329 216,948 278,326 281,109 961,462 888,787 881,619 969,745 180,490 123,008 157,809 159,387 30,708 36,125 42,489 46,138 50,052 772 772 772 772 772 2,202,423 1,501,000 1,925,655 1,944,912 1,983,810
0.7% 1.3% 1.4% 1.6% 1.8% 1.7% 3.4% 3.3% 3.1% 3.3% 0.34% 0.91% 0.51% 0.41% 0.26% 42.5% 37.5% 42.9% 50.0% 54.1% 14.6% 95.7% 11.7% 14.1% 8.8% 307,732 273,000 305,685 378,536 391,289 (6.2%) (11.3%) 12.0% 23.8% 3.4% 7.0% 8.7% 7.9% 7.3% 8.1% 10.1% 12.6% 11.6% 10.4% 11.0%
167
Goldman Sachs: Summary of Financials

Profit and Loss Statement $ in millions, year end Dec Net interest income % Change Y/Y Non-interest income Fees & commissions % change Y/Y Trading revenues % change Y/Y Other Income Total operating revenues % change Y/Y Admin expenses % change Y/Y Other expenses Pre-provision operating profit % change Y/Y Loan loss provisions Other provisions Earnings before tax % change Y/Y Tax (charge) % Tax rate Minorities Net Income (Reported) FY08A FY09A FY10E FY11E 4,276 7.2% 17,946 9,851 (19.8%) 8,095 (72.8%) 22,222 45,173 38,719 37,148 (51.7%) 103.3% (14.3%) (4.1%) 8,952 9,151 9,744 7,223 9.3% 2.2% 6.5% (25.9%) 10,934 16,193 15,389 14,859 2,336 19,829 13,585 15,065 (86.7%) 748.8% (31.5%) 10.9% 2,336 19,829 13,585 15,065 (86.7%) 748.8% (31.5%) 10.9% 14 6,444 4,701 4,881 0.6% 32.5% 34.6% 32.4% 281 1,193 440 300 2,041 12,192 8,444 9,884 Ratio Analysis FY12E $ in millions, year end Dec Per Share Data - EPS Reported - EPSAdjusted % Change Y/Y - DPS % Change Y/Y - Dividend yield - Payout ratio - BV per share 37,153 NAV per share 0.0% Shares outstanding 6,708 (7.1%) Return ratios 14,861 RoRWA 15,584 Pre-tax ROE 3.4% ROE - RoNAV 15,584 Revenues 3.4% NIM (NII / RWA) 5,049 Non-IR / average assets 32.4% Total rev / average assets 300 NII / Total revenues 10,235 Fees / Total revenues Trading / Total revenues FY08A FY09A FY10E FY11E 18.25 15.84 17.1% 1.40 0.0% 1.0% 7.7% 134.90 125.46 623.9 FY12E 18.90 16.40 3.5% 1.40 0.0% 1.0% 7.4% 150.09 140.65 623.9 4.67 23.74 15.59 4.44 19.43 13.53 (82.1%) 337.8% (30.3%) 1.40 1.40 1.40 0.0% 0.0% 0.0% 1.0% 1.0% 1.0% 30.0% 5.9% 9.0% 104.15 101.61 120.28 92.88 93.77 110.83 459.9 627.5 623.9
0.5% 3.6% 3.2% 5.6%
2.8% 28.0% 17.2% 21.1%
1.9% 16.6% 10.3% 13.3%
1.9% 16.5% 10.8% 13.5%
1.9% 15.5% 10.2% 12.4%
1.1% 2.2% 19.2% 44.3% 36.4%
5.2% -
4.5% -
4.2% -
4.2% -
Balance sheet $ in millions, year end Dec ASSETS Net customer loans % change Y/Y Loan loss reserves Investments Other interest earning assets % change Y/Y Average interest earnings assets Goodwill Other assets Total assets LIABILITIES Customer deposits % change Y/Y Long term funding Interbank funding Average interest bearing liabs Other liabilities Retirement benefit liabilities Shareholders' equity Minorities Total liabilities & Shareholders Equity
FY08A
FY09A
FY10E
FY11E
FY12E $ in millions, year end Dec Cost ratios Cost / income Cost / assets Staff numbers Balance Sheet Gearing Loan / deposit Investments / assets Loan / assets Customer deposits / liabilities LT Debt / liabilities
FY08A
FY09A
FY10E
FY11E
FY12E
64,665 55,303 57,261 57,261 57,261 (49.9%) (14.5%) 3.5% 0.0% 0.0% 884,547 848,942 883,188 883,188 883,188
89.5% 2.2% 30,067
56.1% 3.0% 32,500
64.9% 2.8% 32,500
59.4% 2.5% 32,500
58.1% 2.4% 32,500
26.4% 7.3% 29.9% 2.1%
30.7% 6.5% 23.2% 2.0%
30.9% 6.5% 23.2% 1.4%
30.9% 6.5% 23.4% 1.4%
30.9% 6.5% 23.7% 1.4%
Asset Quality / Capital 27,643 39,418 37,024 37,024 37,024 Loan loss reserves / loans 79.9% 42.6% (6.1%) 0.0% 0.0% NPLs / loans - LLP / RWA 27,643 39,418 37,024 37,024 37,024 Loan loss reserves / NPLs - Growth in NPLs - RWAs % YoY change 64,369 70,714 81,995 91,121 100,597 Core Tier 1 16,471 6,957 6,957 6,957 6,957 Total Tier 1 884,547 848,942 883,188 883,188 883,188
400,376 431,890 445,037 532,090 542,732 7.9% 3.0% 19.6% 2.0% 10.3% 12.2% 14.5% 13.9% 15.3% 15.6% 15.0% 17.2% 16.1% 17.6%
168
Morgan Stanley: Summary of Financials

Profit and Loss Statement $ in millions, year end Dec Net interest income % Change Y/Y Non-interest income Fees & commissions % change Y/Y Trading revenues % change Y/Y Other Income Total operating revenues % change Y/Y Admin expenses % change Y/Y Other expenses Pre-provision operating profit % change Y/Y Loan loss provisions Other provisions Earnings before tax % change Y/Y Tax (charge) % Tax rate Minorities Net Income (Reported) FY08A 3,581 28.8% 11,004 10,123 (9.6%) 5,073 58.2% 6,033 24,710 (11.8%) 10,146 26.3% 12,306 2,258 (34.4%) 2,287 (32.6%) 480 21.0% 112 1,595 FY09A FY10E FY11E 23,970 31,181 32,612 (3.0%) 30.1% 4.6% 8,063 8,448 6,836 (20.5%) 4.8% (19.1%) 14,438 15,426 15,198 1,469 7,307 10,579 (34.9%) 397.4% 44.8% 857 7,307 10,579 (62.5%) 752.6% 44.8% (336) 1,511 3,235 (39.2%) 20.7% 30.6% 2,253 417 872 (907) 5,120 6,472 Ratio Analysis FY12E $ in millions, year end Dec Per Share Data - EPS Reported - EPSAdjusted % Change Y/Y - DPS % Change Y/Y - Dividend yield - Payout ratio - BV per share 34,163 NAV per share 4.8% Shares outstanding 7,181 5.1% Return ratios 15,995 RoRWA 10,986 Pre-tax ROE 3.9% ROE - RoNAV 10,986 Revenues 3.9% NIM (NII / RWA) 3,376 Non-IR / average assets 30.7% Total rev / average assets 929 NII / Total revenues 6,682 Fees / Total revenues Trading / Total revenues FY08A FY09A FY10E FY11E FY12E 1.55 -0.76 3.77 4.63 4.78 1.55 (0.78) 2.74 3.46 3.58 (34.6%) (150.4%) (451.7%) 26.4% 3.2% 1.08 0.17 0.20 0.30 0.30 0.0% (84.3%) 17.6% 50.0% 0.0% 4.3% 0.7% 0.8% 1.2% 1.2% 69.6% -22.2% 5.3% 6.5% 6.3% 30.24 27.26 30.42 33.65 37.01 27.24 18.28 24.17 27.41 30.76 1,047.6 1,360.6 1,868.5 1,868.5 1,868.5
0.6% 4.5% 3.1% 5.8%
(0.3%) 1.8% (1.9%) (3.4%)
1.6% 12.5% 8.7% 14.6%
1.7% 16.4% 10.0% 13.4%
1.7% 15.5% 9.4% 12.3%
1.3% 2.9% 14.5% 41.0% 20.5%
3.3% -
3.9% -
4.0% -
4.2% -
Balance sheet $ in millions, year end Dec ASSETS Net customer loans % change Y/Y Loan loss reserves Investments Other interest earning assets % change Y/Y Average interest earnings assets Goodwill Other assets Total assets LIABILITIES Customer deposits % change Y/Y Long term funding Interbank funding Average interest bearing liabs Other liabilities Retirement benefit liabilities Shareholders' equity Minorities Total liabilities & Shareholders Equity
FY08A
FY09A
FY10E
FY11E
FY12E $ in millions, year end Dec Cost ratios Cost / income Cost / assets Staff numbers Balance Sheet Gearing Loan / deposit Investments / assets Loan / assets Customer deposits / liabilities LT Debt / liabilities Asset Quality / Capital Loan loss reserves / loans NPLs / loans LLP / RWA Loan loss reserves / NPLs Growth in NPLs RWAs % YoY change Core Tier 1 Total Tier 1
FY08A
FY09A
FY10E
FY11E
FY12E
31,294 27,594 27,738 27,738 27,738 (59.0%) (11.8%) 0.5% 0.0% 0.0% 3,138 12,216 11,673 11,673 11,673 658,812 771,462 809,456 809,456 809,456
90.9% 3.4% 46,964
96.3% 2.9% 61,388
76.6% 2.9% 61,388
67.6% 2.7% 61,388
67.8% 2.9% 61,388
19.8% 4.8% 26.0% -
15.4% 3.6% 24.9% -
15.5% 3.4% 23.7% -
15.5% 3.4% 23.9% -
15.5% 3.4% 24.1% -
157,980 179,273 179,251 179,251 179,251 (32.7%) 13.5% (0.0%) 0.0% 0.0% 14,821 26,246 26,524 26,524 26,524 50,831 46,688 52,942 58,995 65,257 19,155 9,597 9,597 9,597 9,597 658,812 771,462 809,456 809,456 809,456
278,780 9.3% 17.9%
305,000 9.4% 8.6% 15.3%
328,426 382,608 386,434 7.7% 16.5% 1.0% 12.4% 12.2% 13.7% 16.9% 16.1% 17.5%
169
BNP Paribas: Summary of Financials

Profit and Loss Statement in millions, year end Dec Net interest income % Change Y/Y Non-interest income Fees & commissions % change Y/Y Trading revenues % change Y/Y Other Income Total operating revenues % change Y/Y Admin expenses % change Y/Y Other expenses Pre-provision operating profit % change Y/Y Loan loss provisions Other provisions Earnings before tax % change Y/Y Tax (charge) % Tax rate Minorities Net Income (Reported) FY08A 8,829 (3.9%) 19,209 7,252 8.0% 11,957 7.0% -662 27,376 (11.8%) -17,427 5.0% (973) 8,976 (26.9%) -5,752 3,926 (64.5%) (472) 12.0% (431) 3,023 FY09A 9,931 12.5% 20,626 7,832 8.0% 12,794 7.0% 9,634 40,191 46.8% -18,298 5.0% (5,042) 16,851 87.7% -8,369 9,000 129.3% (2,526) 28.1% (642) 5,832 FY10E 10,192 2.6% 22,148 8,458 8.0% 13,690 7.0% 10,628 42,968 6.9% -19,213 5.0% (6,510) 17,245 2.3% -5,524 12,108 34.5% (3,814) 31.5% (1,137) 7,157 FY11E 11,305 10.9% 23,783 9,135 8.0% 14,648 7.0% 7,999 43,086 0.3% -20,174 5.0% (5,401) 17,512 1.5% -4,500 13,346 10.2% (4,004) 30.0% (1,250) 8,092 Ratio Analysis FY12E in millions, year end Dec Per Share Data 11,670 EPS Reported 3.2% EPSAdjusted 0 % Change Y/Y - DPS % Change Y/Y - Dividend yield - Payout ratio 32,835 BV per share 44,505 NAV per share 3.3% Shares outstanding - Return ratios (25,887) RoRWA 18,618 Pre-tax ROE 6.3% ROE -4,156 RoNAV 14,841 Revenues 11.2% NIM (NII / RWA) (4,452) Non-IR / average assets 30.0% Total rev / average assets (1,375) NII / Total revenues 9,014 Fees / Total revenues Trading / Total revenues FY08A FY09A FY10E FY11E FY12E 3.34 5.65 6.02 6.78 7.55 4.19 5.07 5.90 6.90 7.50 (45.1%) 21.1% 16.3% 17.0% 8.6% 1.01 1.50 1.55 2.00 2.20 (69.9%) 48.8% 3.3% 29.0% 10.0% 2.0% 3.1% 3.2% 4.1% 4.5% 30.2% 26.6% 25.8% 29.5% 29.1% 46.18 56.67 53.89 58.52 63.87 32.12 43.77 42.00 46.66 52.02 905.1 1,032.5 1,189.7 1,193.1 1,193.1
0.7% 9.4% 7.3% 13.1%
0.8% 15.4% 11.0% 14.4%
1.1% 18.9% 10.9% 14.7%
1.2% 19.1% 12.1% 15.6%
1.2% 19.5% 12.3% 15.2%
1.7% 1.0% 1.5% 32.3% 26.5% 43.7%
1.6% 1.0% 1.9% 24.7% 19.5% 31.8%
1.6% 1.1% 2.2% 23.7% 19.7% 31.9%
1.6% 1.3% 2.4% 26.2% 21.2% 34.0%
1.6% 1.3% 2.6% 26.2% 21.2% 34.0%
FY08A
FY09A
FY10E
FY11E
FY12E in millions, year end Dec Cost ratios Cost / income Cost / assets Staff numbers Balance Sheet Gearing Loan / deposit Investments / assets Loan / assets Customer deposits / liabilities LT Debt / liabilities
FY08A
FY09A
FY10E
FY11E
FY12E
494,401 678,766 712,704 748,340 785,756 11.1% 37.3% 5.0% 5.0% 5.0% 14,298 25,369 30,893 35,394 39,549 1,344,168 1,071,591 1,125,171 1,181,429 1,240,501 108,372 144,996 152,246 159,858 167,851 20.9% 33.8% 5.0% 5.0% 5.0% 1,771,350 1,921,147 1,942,737 2,039,874 2,141,867 10,918 10,979 10,979 10,979 10,979 117,692 151,366 (122,613) (325,436) (527,552) 2,075,551 2,057,698 1,878,486 1,775,170 1,677,535
60.8% 0.9% -
58.1% 1.1% -
59.2% 1.4% -
58.7% 1.4% -
58.2% 1.5% -
119.4% 112.2% 112.2% 112.2% 112.2% 64.8% 52.1% 59.9% 66.6% 73.9% 29.0% 40.0% 46.0% 51.2% 56.8% 20.5% 30.6% 33.8% 37.6% 41.7% 7.8% 10.7% 11.8% 13.1% 14.6%
Asset Quality / Capital 413,955 604,903 635,148 666,906 700,251 Loan loss reserves / loans 19.4% 46.1% 5.0% 5.0% 5.0% NPLs / loans 157,508 211,029 221,580 232,659 244,292 LLP / RWA 187,234 226,206 237,516 249,392 261,862 Loan loss reserves / NPLs 709,182 900,418 1,068,191 1,121,601 1,177,681 Growth in NPLs 1,180,595 826,663 669,255 504,414 342,107 RWAs % YoY change 47,488 58,658 64,007 69,681 75,710 Core Tier 1 5,740 10,843 11,385 11,954 12,552 Total Tier 1 2,016,583 1,977,354 1,878,486 1,775,170 1,677,535
2.8% 3.6% 4.2% 4.5% 4.8% 3.7% 5.3% 5.6% 5.3% 5.1% 1.07% 1.35% 0.87% 0.64% 0.57% 70.0% 66.6% 70.0% 70.0% 70.0% 37.7% 96.4% 12.5% 0.0% (0.0%) 535,100 620,700 636,986 706,532 729,388 (1.0%) 16.0% 2.6% 10.9% 3.2% 5.4% 8.0% 8.7% 8.6% 9.2% 7.8% 10.1% 10.8% 10.5% 11.1%
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Socit Gnrale: Summary of Financials

Profit and Loss Statement in millions, year end Dec Net interest income % Change Y/Y Non-interest income Fees & commissions % change Y/Y Trading revenues % change Y/Y Other Income Total operating revenues % change Y/Y Admin expenses % change Y/Y Other expenses Pre-provision operating profit % change Y/Y Loan loss provisions Other provisions Earnings before tax % change Y/Y Tax (charge) % Tax rate Minorities Net Income (Reported) FY08A 7,948 217.7% 13,918 7,415 (1.5%) 4,470 (56.4%) 2,033 21,866 28.5% -6,912 12.7% (8,616) 6,338 134.1% -2,655 3,675 99.1% (1,235) 28.7% 763 2,010 FY09A FY10E FY11E 11,148 (2.5%) 15,051 9,195 10.0% 4,901 15.0% 955 26,199 2.4% -5,534 (10.5%) (10,484) 10,181 6.0% -3,382 7,004 39.1% (1,904) 28.0% 483 4,617 11,635 11,429 46.4% (1.8%) 10,095 14,154 7,812 8,359 5.4% 7.0% 947 4,262 (78.8%) 350.0% 1,336 1,534 21,730 25,583 (0.6%) 17.7% -6,609 -6,184 (4.4%) (6.4%) (9,157) (9,798) 5,964 9,601 (5.9%) 61.0% -5,848 -4,694 131 5,034 (96.4%) 3,742.7% 308 (1,326) (38.5%) 27.0% 430 353 678 3,355 Ratio Analysis FY12E in millions, year end Dec Per Share Data 12,545 EPS Reported 12.5% EPSAdjusted 14,808 % Change Y/Y 9,195 DPS 0.0% % Change Y/Y 4,901 Dividend yield 0.0% Payout ratio 712 BV per share 27,353 NAV per share 4.4% Shares outstanding -6,106 10.3% Return ratios (10,484) RoRWA 10,763 Pre-tax ROE 5.7% ROE -2,922 RoNAV 8,066 Revenues 15.2% NIM (NII / RWA) (2,195) Non-IR / average assets 28.0% Total rev / average assets 593 NII / Total revenues 5,277 Fees / Total revenues Trading / Total revenues FY08A FY09A FY10E FY11E 6.30 6.30 40.0% 1.50 50.0% 3.8% 23.8% 66.54 44.45 733.1 FY12E 7.20 7.20 14.3% 1.80 20.0% 4.5% 25.0% 71.94 49.84 733.1 3.67 1.12 4.58 4.19 (0.49) 4.50 (48.0%) (111.7%) (1,013.9%) 1.20 0.25 1.00 33.3% (79.2%) 300.0% 3.0% 0.6% 2.5% 32.7% 22.3% 21.8% 64.57 57.21 62.23 40.08 35.10 40.14 548.4 730.8 733.1
1.3% 20.4% 7.1% 10.7%
0.2% 3.7% 2.3% (1.3%)
1.5% 18.4% 9.3% 12.0%
2.0% 24.7% 11.6% 14.9%
1.9% 23.2% 12.2% 15.3%
2.3% 1.3% 2.0% 36.3% 33.9% 20.4%
3.6% 0.9% 2.0% 53.5% 36.0% 4.4%
3.4% 1.4% 2.5% 44.7% 32.7% 16.7%
3.2% 1.5% 2.6% 42.6% 35.1% 18.7%
3.0% 1.4% 2.7% 45.9% 33.6% 17.9%
FY08A
FY09A
FY10E
FY11E
FY12E in millions, year end Dec Cost ratios Cost / income Cost / assets Staff numbers Balance Sheet Gearing Loan / deposit Investments / assets Loan / assets Customer deposits / liabilities LT Debt / liabilities Asset Quality / Capital Loan loss reserves / loans NPLs / loans LLP / RWA Loan loss reserves / NPLs Growth in NPLs RWAs % YoY change Core Tier 1 Total Tier 1
FY08A
FY09A
FY10E FY11E
FY12E
354,613 373,399 380,867 392,293 404,062 16.2% 5.3% 2.0% 3.0% 3.0% 8,880 12,122 16,816 20,198 84,937 82,049 82,049 82,049 82,049 0.7% (3.4%) 0.0% 0.0% 0.0% 946,312 960,538 982,726 950,559 950,289 6,530 6,620 7,160 7,160 7,160 92,199 48,310 48,310 48,310 48,310 1,130,003 1,023,701 1,023,701 1,023,701 1,023,701
67.9% 1.4% -
74.7% 1.5% -
62.7% 1.6% -
61.1% 1.6% -
60.7% 1.6% -
122.3% 51.0% 38.9% 25.0% 10.7%
108.0% 48.3% 44.5% 29.3% 13.0%
107.7% 108.9% 47.5% 46.6% 45.2% 46.3% 30.2% 31.1% 13.0% 13.0%
126.2% 45.4% 47.5% 32.0% 13.0%
282,514 300,054 309,056 318,327 327,877 4.4% 6.2% 3.0% 3.0% 3.0% 120,374 133,246 133,246 133,246 133,246 121,773 93,186 80,028 67,232 53,505 513,224 535,049 523,495 522,646 518,479 483,389 363,670 363,670 363,670 363,670 354,613 373,399 380,867 392,293 404,062 4,802 4,634 4,634 4,634 4,634 1,130,003 1,023,701 1,023,701 1,023,701 1,023,701
1.9% 2.7% 3.5% 5.2% 0.79% 1.75% 55.6% 50.7% 30.8% 38.8% 345,518 324,100 5.8% (6.2%) 6.6% 8.3% 8.8% 10.7%
3.5% 3.6% 6.2% 6.0% 1.43% 1.00% 0.77% 56.0% 60.0% 20.8% 0.0% (100.0%) 332,729 346,549 413,718 2.7% 4.2% 19.4% 8.6% 9.1% 8.6% 10.9% 11.4% 10.5%
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Other Companies Recommended in This Report (all prices in this report as of market close on 03 September 2010, unless otherwise indicated) Bank of America (BAC/$13.50/Overweight), Barclays (BARC.L/325p/Neutral), Citigroup Inc. (C/$3.91/Overweight), Credit Agricole (CAGR.PA/10.94 [06-September-2010]/Neutral), HSBC Holdings plc (HSBA.L/663p [06-September2010]/Overweight), Royal Bank of Scotland (RBS.L/47p [06-September-2010]/Underweight)
Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analysts compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.
Important Disclosures
Market Maker: JPMS makes a market in the stock of BNP Paribas, Socit Gnrale. Market Maker/ Liquidity Provider: J.P. Morgan Securities Ltd. is a market maker and/or liquidity provider in Barclays, BNP Paribas, Credit Agricole, Credit Suisse Group, Deutsche Bank, Goldman Sachs, HSBC Holdings plc, Morgan Stanley, Royal Bank of Scotland, Socit Gnrale, UBS. Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for Bank of America, Barclays, BNP Paribas, Citigroup Inc., Credit Agricole, Deutsche Bank, Goldman Sachs, HSBC Holdings plc, Morgan Stanley, Royal Bank of Scotland, Socit Gnrale within the past 12 months. Analyst Position: The following analysts (and/or their associates or household members) own a long position in the shares of Bank of America: Eric Beinstein. The following analysts (and/or their associates or household members) own a long position in the shares of Citigroup Inc.: Arun Kumar. The following analysts (and/or their associates or household members) own a long position in the shares of Morgan Stanley: Amit Goel. The following analysts (and/or their associates or household members) own a long position in the shares of UBS: Kian Abouhossein. Beneficial Ownership (1% or more): J.P. Morgan beneficially owns 1% or more of a class of common equity securities of Bank of America, Barclays, Citigroup Inc., Goldman Sachs, HSBC Holdings plc, Morgan Stanley. Client of the Firm: Bank of America is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. Barclays is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. 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Royal Bank of Scotland is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. Socit Gnrale is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. UBS is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, noninvestment banking securities-related service and non-securities-related services. Investment Banking (past 12 months): J.P. Morgan received, in the past 12 months, compensation for investment banking services from Bank of America, Barclays, BNP Paribas, Citigroup Inc., Credit Agricole, Deutsche Bank, Goldman Sachs, HSBC Holdings plc, Morgan Stanley, Royal Bank of Scotland, Socit Gnrale, UBS. Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking services in the next three months from Bank of America, Barclays, BNP Paribas, Citigroup Inc., Credit Agricole, Credit Suisse Group, Deutsche Bank, Goldman Sachs, HSBC Holdings plc, Morgan Stanley, Royal Bank of Scotland, Socit Gnrale, UBS.
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Non-Investment Banking Compensation: JPMS has received compensation in the past 12 months for products or services other than investment banking from Bank of America, Barclays, BNP Paribas, Citigroup Inc., Credit Agricole, Credit Suisse Group, Deutsche Bank, Goldman Sachs, HSBC Holdings plc, Morgan Stanley, Royal Bank of Scotland, Socit Gnrale, UBS. An affiliate of JPMS has received compensation in the past 12 months for products or services other than investment banking from Bank of America, Barclays, BNP Paribas, Citigroup Inc., Credit Agricole, Credit Suisse Group, Deutsche Bank, Goldman Sachs, HSBC Holdings plc, Morgan Stanley, Royal Bank of Scotland, Socit Gnrale, UBS. Broker: J.P. Morgan Securities Ltd. acts as Corporate Broker to Barclays. J.P. Morgan and/or its affiliates is acting as financial advisor to Ameriprise Financial Inc (NYSE: AMP) in connection with its definitive agreement to acquire the long-term asset management business of Columbia Management from Bank of America Corp (NYSE: BAC) as announced on September 30, 2009. The transaction is subject to customary regulatory reviews and approvals. It is expected to close in the spring of 2010.
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Coverage Universe: Kian Abouhossein: BNP Paribas (BNPP.PA), Commerzbank (CBKG.DE), Credit Agricole (CAGR.PA), Credit Suisse Group (CSGN.VX), Deutsche Bank (DBKGn.DE), Deutsche Postbank (DPBGn.DE), Goldman Sachs (GS), Morgan Stanley (MS), Natixis (CNAT.PA), Socit Gnrale (SOGN.PA), UBS (UBSN.VX)
J.P. Morgan Equity Research Ratings Distribution, as of June 30, 2010 Overweight (buy) 46% 49% 44% 68% Neutral (hold) 42% 46% 48% 61% Underweight (sell) 12% 31% 9% 53%
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Table 117: Global Investment Banks split of total equities revenues 2009E
$ million SG Total equities revenues ow cash equities ow cash equities ow electronic ow prime brokerage ow equity derivatives ow Structured products ow Flow equity derivatives ow Delta One products ow Convertibles ow prop trading 4,913 266 211 55 0 3,508 1,563 685 1,074 186 1,139 BNP 2,367 331 71 25 235 2,435 859 501 859 215 -398 DB 4,563 2,379 1,120 250 1,009 1,729 609 341 564 215 455 UBS 4,769 2,895 1,271 600 1,023 1,528 350 500 475 203 346 CS 7,339 4,446 1,617 1,200 1,629 2,038 700 411 661 266 856 GS 12,030 5,246 1,813 1,400 2,033 3,828 928 1,150 1,200 550 2,956 MS 4,908 3,015 765 500 1,750 1,380 300 300 630 150 513 BARC 4,198 1,889 507 60 1,322 1,889 600 450 550 289 420 BOAML 4,901 2,851 1,400 451 1,000 1,450 350 300 500 300 600 CITI 5,372 2,672 1,212 260 1,200 1,500 300 250 450 500 1,200 Total wallet 84,682 43,529 22,192 6,401 14,936 30,370 7,717 7,520 10,713 4,421 10,782
Source: J.P. Morgan estimates. Note: clean revenues adjusted for exceptional items and DVA.
Table 118: Global Investment Banks weighted average revenue progression by business 2008 2012E
% 09/08 Equity derivatives Cash equities incl electronic trading Prime Services Sub total flow Prop trading/hedge gain/loss/other Total Equities Clean Revenue Structured Credit Trading Credit trading (incl. loans, bonds, CDS) Total Credit Rates Currencies Commodities Emerging Markets Fixed Income Sub total flow Prop trading/hedge Gains/other Total Fixed Income clean revenues Financing & Advisory clean revenues Total IB clean revenues 8% -16% -20% -8% -151% 53% 66% 94% 87% 70% 24% 8% 49% 51% -167% 165% 13% 83% 10E/09 -11% -15% -16% -13% -39% -17% -20% -16% -17% -25% -22% -12% -18% -20% -33% -22% -2% -17% 11E/10E 8% 5% 7% 7% 28% 9% 0% 5% 4% -9% -7% 4% 4% -2% 7% -1% 12% 4% 12E/11E 9% 7% 9% 9% -2% 7% -2% -3% -3% -9% -8% 1% 7% -4% -16% -6% 9% -13% 09-012E CAGR 2% -1% -1% 0% -9% -1% -8% -5% -6% -15% -12% -2% -3% -9% -15% -10% 7% -4% 010E012E CAGR 8% 6% 8% 8% 12% 8% -1% 1% 1% -9% -7% 3% 6% -3% -5% -4% 12% 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.
Table 119: Global Investment Banks Equity derivatives businesses ROE

% 2009 Structured products Flow equity derivatives Delta one products Convertibles Prop/flow prop Total equity derivatives
25% 38% 72% 55% 71% 46%
2011E pre regulation 27% 29% 71% 45% 58% 42%
2011E post regulation 14% 18% 40% 30% 24% 22%
Decline in ROE 2011E -50% -37% -43% -32% -60% -47%
176

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Global Equity Research

Global Investment Banks

(44-20) 7325-1523 kian.abouhossein@jpmorgan.com

Global Equity Research 08 September 2010

Covering analysts for Barclays: Carla Antunes da Silva

Amit Goel, CFA

Covering analyst for Bank of America, Citigroup: Vivek Juneja

Global Equity Research 08 September 2010

Table 2: IB revenue cycle

Table 3: Global equity derivatives revenues growth expectations

Global Equity Research 08 September 2010

Source: J.P. Morgan estimates.

Figure 1: Averaged weighted spread on 28 significant series on ISE

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

Valuation ex revenue growth Why Buy IBs?

Source: J.P. Morgan estimates.

Global Equity Research 08 September 2010

20.3% 12.1% 34% -32%

Global Equity Research 08 September 2010

GS CITI UBS MS CS BOA BNP BARC SG DB Avg.

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

Global Equity Research 08 September 2010

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

TP 22 59 46 58 65 15 3.05 0.42 9.00 175 33 -

Global Equity Research 08 September 2010

Global Equity Research 08 September 2010

Global Equity Research 08 September 2010

Equities business outlook matters

FICC Equities 27% 55%

IB revenue wallet trend - Equity Derivatives key driver

Global Equity Research 08 September 2010

Figure 3: Global Investment Banks Clean Investment Bank revenues 1999-2012E

Fixed Income only one direction: down

Global Equity Research 08 September 2010

Rates Emerging Markets

Currencies Prop/flow prop

17.2 8.1 18.9 20.7 14.5 8.7 19.2 19.2

40 20 0 2009E 2010E 2011E 2012E 39.9

Global Equity Research 08 September 2010

Table 9: Global fixed income: revenue growth 2009-2012E

Equities needs to drive IB wallet upwards

Cash equities Equity derivatives

Electronic Prop trading/flow prop

8.4 8.1 6.4

30.3 29.3 27.3

14.9 12.4 5.8 13.2

Global Equity Research 08 September 2010

Table 6: Global equities: revenue growth 2009-2012E

Source: J.P. Morgan estimates.

Global Equity Research 08 September 2010

Flow equity derivatives Prop trading/flow prop

Delta One products

7.2 4.4 10.7 4.4 4.0 9.9 6.3 7.1

5.8 4.1 10.8 6.7 7.7

5.8 4.5 11.8

7.5 12.0 12.5 7.7

2011E 9% 8% 9% 5% 4% 8% 31% 11%

-7% -11% -8% -16% -10% -10% -38% -15%

CAGR 09E012E 4% 1% 3% -2% 0% 2% -7% 0%

CAGR 010E012E 10% 8% 9% 5% 6% 8% 14% 9%

012E/09E 12% 3% 10% -6% 1% 6% -19% 1%

Global Equity Research 08 September 2010

Detailed growth rate discussion