Investment Banking wallet outlook - all eyes on equity derivatives

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 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.

Industry still dominated by large players SG, BNP, GS, CS and BARC: We expect Société Générale 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.

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.

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.