Global Equity Research
08 September 2010Kian Abouhossein(44-20) email@example.comDelphine Lee(44-20) firstname.lastname@example.org
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 fixedincome revenues are likely to decline
from the peak 2009 year by -22% in2010E/09E and a further -4% CAGR in 2010-12E, accounting with 55% share for thelargest 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 todrive 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 newIB revenue wallet super-cycle.
One of the products offering potential long-termgrowth is Insurance-linked-securities. However, following the structured credit crisiswe do not see client appetite to buy illiquid structured products. For details onInsurance-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 beequities. In particular, we focus on equity derivatives
rather than highlycommoditized cash equity business as the key IB revenue driver considering itshigher long-term profitability, lower operating gearing, and more diverse businessmix.
Equity Derivatives – the key determinator for IB wallet growth.
We analyse in detail the key sub-business segments within equity derivatives andtheir potential IB revenues impact.
We conclude equity derivative business is togrow 9% CAGR 2010-2012E – the fastest growth within all IB client flowrelated businesses
assuming 5% CAGR equity market performance in 10-12E.
The historic equity derivative revenue growth rates of c.15%p.a. are unlikely tobe achievable
as clients operate with less leverage and demand relatively simplestructured products. More importantly regulation should be a trigger of structuralchange in Equity Derivatives reducing profitability, with ROEs declining from 42%to 22% in a 2011E sensitivity, mainly due to new capital rules accounting for 2/3rdof change rather than revenue loss related regulation at 1/3rd. The regulatorychanges will lead to re-assessment of the business model in our view and structuraltrend 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 requirelarge scale operations to maintain significant size index-based portfolios andcompetitive technology with the appetite and willingness to hedge at times long-dated risk. Investment costs required for algorithmic trading are relatively high, andequity finance activities are balance sheet intensive, as a result, we believe thissegment will remain dominated by the scaled players with strong balance sheets. In
Table 1: Clean IB revenue walletgoing ex-growth
Fixed Income revenue -4%Equities revenue 8%IB revenue 12%
Total revenues 3%
Source: J.P. Morgan estimates.
Table 2: IB revenue cycle