Wholesale & Investment Banking Outlook: Global Banking Fractures ...

April 11, 2013

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B L U E P A P E R

Wholesale & Investment Banking Outlook Global Banking Fractures: The Implications The bad news: The fracturing of global banking driven by Balkanisation has become one of the largest challenges for wholesale banks, taking 2-3% points off RoEs. Disjointed international policies pose the biggest threat. This presents a major challenge for non-US players who face higher costs to access the single most profitable market in the world – the US. It makes a profitable hub and spoke model in Asia and emerging markets much more challenging.

The good news: We think the market has overestimated the impact of the transformation of OTC markets on banks earnings. We estimate a 3-5% point base case fall in sales and trading revenues by 2015 vs. investors pricing in 10-20%, a thesis supported by our recent investor survey. We also see potential for collateral management earnings to offset lost revenues, though we think only a small number of firms will really benefit.

The fixed cost challenge: Much higher fixed costs against subdued revenues are proving a huge challenge. Many banks have started to embrace our “Decision Time” thesis, but the focus must shift from RWAs, capital and funding to managing the operational gearing. The quest for economies of scale/scope, and lower platform costs will lead to more tough portfolio decisions, particularly for mid-sized wholesale banks.

The bottom line: We think 12-14% returns on allocated capital are plausible in 2014-16 through restructuring and some cyclical recovery, but that the skew of winners and losers will be even greater as some firms fail to successfully clear these three key hurdles.

M O R G A N S T A N L E Y R E S E A R C H

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M O R G A N S T A N L E Y M O R G A N S T A N L E Y R E S E A R C H

April 11, 2013 Global Banking Fractures: The Implications

M O R G A N S T A N L E Y B L U E P A P E R Table of Contents

Joint Executive Summary: The Three Biggest Challenges 3

Key Findings of Our Proprietary OTC Survey 6

Morgan Stanley: Stock Implications of Our Joint Findings 7

1) Impact of Balkanisation/subsidiarisation on returns and models 10

2) Impact of the transformation of OTC markets: winners and loser 11

3) “Decision Time” – One year on: much done, much still to do. Operating gearing and scale are now the issues 14

Chapter 1: Structural Reform and De-globalisation 19

Chapter 2: Shifting Sources of Value 27

Chapter 3: Returns and Industry Structure 38

Key Stock Calls 47

Impact of OTC transformation is overestimated for leading banks 58

Balkanisation: a major headache for European firms, US firms advantaged 69

“Decision Time” – 1 year on: much done, much still to do. Addressing operating gearing and scale dominate 75

Appendix 84

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M O R G A N S T A N L E Y B L U E P A P E R Joint Executive Summary: The Three Biggest Challenges

Challenge 1: The Bad News – Balkanisation of wholesale banking markets. We think the industry and the market have yet to get to grips with the forces fracturing global wholesale banking. In particular we now anticipate a 2-3% point drag on RoE from regulatory Balkanisation. While ring-fencing is getting a lot of attention, we see national subsidiarisation gathering pace quickly. With diverging national regulatory agendas, it poses a major risk to the global banking model.

The Balkanisation of banking markets will drive starker regional distinctions and participation choices. Regulators seeking to reduce the interdependence of their banking systems with perceived higher-risk overseas lending and markets activities are introducing a large and diverse number of new proposals. We think that in isolation the proposals for ring-fencing banking activity could take ~3% points off RoEs in a realistic worst case, with significant skews across banks. However, we argue that banks can meet regulators’ objectives and see a much more limited impact on RoE (0.5% in our best case) through rethinking legal entity design, funding strategies and operating models. Much depends on the details of the final rules.

We believe the real challenge lies in the complexity and cost of dealing with multiple subsidiarisation demands across jurisdictions. The interplay of constraints imposed by host regulators in local markets, regulators in key hubs, and home market regulators creates an optimisation puzzle that is hard to solve. We estimate a total industry-wide RoE drag of 2-3% points, with limited scope for mitigation unless we start to see a more organised global policy response.

The breakdown of the hub-spoke model in Asia is accelerating. The revenue pools accessible to local business models are growing faster than the regionally accessible pools. This means the need for local funding sources is increasing. Finally, we are approaching the tipping point where the USD, the dominant regional currency, gives way to the RMB.

The US Foreign Banking Organisation (FBO) proposals are a particularly severe challenge given the importance of the US market. Funding and stressed capital are both potentially difficult to navigate and could lower returns for the Americas region by 2-4% for the most affected banks, albeit with heavy skews. And this is in a vital market that is already challenging for foreigners. We estimate the Americas delivered 55-60% of

global profit in 2012 (vs. 45-50% of global revenues), with 60% of this accruing to US banks.

Differing stances across jurisdictions of key policies including financial transaction taxes and bonus caps are likely to further fracture the global industry. While not settled yet, the more aggressive stance of Europe on these issues would in time drive a less attractive environment for transaction settlement and for talent in Europe, and of course, call an end to the relatively fluid movement of personnel between regions that exists today.

Challenge 2: The Good News – OTC reform: We anticipate a bounded 1% drag on RoE for the industry at large – which is less severe than the market expects. The restructuring of OTC markets is accelerating; while the value shifts will be dramatic, the overall effect will be bounded. However, the unintended consequence of limited inter-operability of regional clearing houses will be to fragment markets regionally, and to place even greater strain on the chronic shortage of collateral, driving new opportunities in collateral financing.

We believe the market actually over-estimates the extent of likely revenue erosion in Fixed Income. We anticipate the reforms will force $5-10bn of current revenue to migrate out of the sell-side by 2015. While this represents a 10-20% reduction in revenues in the most heavily affected areas (and still poses significant challenges for those like the IDBs with limited ability to offset), it is only 6-12% of the total OTC derivative pools of $75bn, and 3-5% of total sales & trading revenues. This compares with our proprietary investor survey which suggests investors expect 10-20% of FICC trading revenues to be affected by 2015. However, this is not to under-estimate the extent of value shift; the challenge for dealers in cleared markets is getting payback on the capital costs of providing clearing services, which is likely to underscore the importance of depth over breadth in client relationships. Much of this is still up for grabs – In our joint proprietary survey of institutional investors (see page 6) around 70% of buy-side firms had only completed on-boarding with one clearing member to date, despite around 65% indicating a plan to clear with multiple members.

The regional fragmentation of OTC markets is emerging as an unintended consequence, driving up end-user costs for collateral and funding. Participation choices have an increasingly clear regional dimension, since netting occurs at

3



M O R G A N S T A N L E Y B L U E P A P E R the regional legal entity level and since the CCP landscape is fragmenting regionally, and since margining requirements drive up the importance of funding. Inter-operability between OTC CCPs is unlikely, resulting in the trapping of collateral at the clearing entity level. While few banking providers will participate across the full set of clearing markets, these trends are actually increasing the likelihood that regional competitor segments emerge.

The chronic shortage in collateral, agitated by market fragmentation, will drive new opportunities around collateral demand and financing. We anticipate new revenue opportunities of $5-8bn, with Global Custodians and the sell-side well-positioned to take around 80% of this. The latest regulatory proposals imply a more gradual – but still massive – squeeze on collateral. We estimate +$750bn by 2015 and +$1.4trn by 2018. Access to stable sources of liquidity and the ability to integrate infrastructure solutions with risk intermediation will be vital competitive advantages. Market infrastructure providers are equipped to fulfill a central utility role; but we expect revenues to concentrate among 3-5 CCPs and 2-3 ICSDs. The overall upside for these players is likely to be lower than hoped given the incremental revenue opportunities will be divided among all participants, meaning the remaining impact will be marginal.

Challenge 3: Operational gearing – the fixed cost challenge. The industry has to find ~3% points of additional RoE through greater economies of scale and scope. With much progress on financial resources, managing operational leverage is now the driving force of portfolio rationalisation, as banks struggle to achieve economies of scale and scope in their cost structures. More innovation is needed here.

Many banks have started to embrace our “Decision Time” thesis of last year – but attention must shift from financial resources towards managing the operational gearing of the business. We've seen significant capacity reduction to help enhance returns. The greatest progress has been on RWAs, which fell ~25% as the industry worked through legacy credit books and improved velocity and RWA discipline in the core businesses. However, there has been much less progress on cost where we have only seen a 4% reduction, as increasing regulatory, restructuring and infrastructure costs have offset steep cuts in compensation.

Business line dynamics have shifted materially as a result, returning FICC to reasonable returns and pressuring IBD and equities. Persistently low client volumes, the shift to electronic trading channels and higher fixed platform costs have left many equities franchises overly operationally geared and unprofitable. In banking the issues are concentrated in Europe and Asia, where most banks are simply not generating sufficient income to cover their platform costs. By contrast, faster reaction on RWAs in Fixed Income has positioned it to deliver strong economics, although structural concerns remain. We believe investors now undervalue the quality of FICC earnings as RWA release and footprint rationalisation play out.

It is becoming increasingly challenging for any bank without scale in the US to sustain a global footprint. The US is significantly more profitable than Europe or Asia, and crucially offers scalability. This is an earnings engine that allows economies of scale to be achieved in delivering infrastructure and risk management support to a broad global business footprint.

The industry must do more on reshaping the cost structure, particularly infrastructure. However, linear bank-by-bank cost reduction efforts are unlikely to achieve the cost flexibility needed – the industry has to focus more on reducing the duplication in basic processes by finding or creating third-party providers that can deliver these services in supply chains industry-wide. We believe there will be interesting opportunities for market infrastructure players to mutualise elements of the cost base – potentially a $1.5-3bn opportunity, and an improvement on industry RoE of ~0.5%.

Exhibit 1 Evolution of industry RoE

12%

~2%

~1%

~2%

~0.5%

2-3%

~1%

8-10%

15-17%

12-14%

2015 bear

2015 bull

2015 base

Revenue growth

Structural cost work

Strategic response

Solvency and liquidity

Structural reform

OTC reform

2012

Source: Oliver Wyman analysis

4



M O R G A N S T A N L E Y B L U E P A P E R Outlook for industry returns, and winners / losers

Despite the significant challenges facing the industry, we believe that industry-wide 12-14% RoE is possible in the 2014-16 window. Returns hit 12% in 2012, lofty by recent standards. There is also significant positive news: industry restructuring is in full swing now, albeit the reaction is faster on financial resources than operational leverage; regulatory costs yet to be absorbed have fallen as parts of the solvency and liquidity program have been moderated; revenue trends are cautiously positive (though muted in 2013), with margins improving as capacity is released; as we argue above, the impact of OTC reform industry-wide will be more bounded than many believe. Offsetting these trends, de-globalisation and sticky cost structures are proving increasingly difficult challenges. Waiting in the wings, conduct risk and financial transaction taxes could yet emerge as more significant drags on returns.

Sources of value in the business are shifting, driving new paradigms around economies of scale and scope with new winning models emerging. In this industry advantages now centre on at-scale financial intermediation in flow markets, expansion into post-trade / infrastructure and transaction banking business, credit market intermediation, true corporate and FIG content / advisory capabilities as well as leveraging group linkages to wealth and commercial banking.

The squeeze is beginning to hurt in Europe. Ring-fencing, subsidiarisation, becoming a structurally less profitable region, increasing headwinds to share capture for Europeans in the US, the spectre of financial transaction taxes, and bonus caps driving up fixed costs, are all making life increasingly difficult for European wholesale banks. Many banks are managing two major European centres, both a home market and London, with the attendant costs and regulatory burdens. US banks face different challenges, in particular with faster implementation of market structure reforms in Dodd-Frank.

Among the mid-sized banks we see substantial further value to be unlocked through strategic refocusing around areas of

product excellence and / or regional depth. Capital release and cost reduction have to be delivered along lines that protect or enhance economies of scope. Strategic risks are the size and stickiness of the infrastructure cost base and the inherent volatility of a less broad product base and risk envelope.

The gains for the winners from market share consolidation are only just beginning to accrue. For those able to consolidate market share around areas of true scale, while reducing the cost and complexity of the platform, the rewards could be high. At the same time increased operational gearing, combined with multiple regulatory challenges to navigate mean the risks of failure for this approach are also high. Whether firms can compete successfully on a regional or product level for clearing business will be a key issue to watch.

Market infrastructure players are in a battle to grasp new revenue streams as the existing businesses remain under pressure. OTC reform presents new opportunities but in many cases these are smaller than hoped and will not fully recover lost execution revenues. The advantaged will be those with a first mover edge or differentiating capabilities as second movers in collateral solutions and back office outsourcing.

The spread of returns will remain wide as banks that achieve economies of scale or scope deliver improved returns. The differential impact of the three forces we centre on in this report – subsidiarisation, OTC market structure reform, and operating leverage – are all high. Some firms will feel the impact much more severely than others. Our analysis suggests that returns for the winners could be up to 3-4% points higher than the average and up to 8% points higher than the losers. Importantly, our analysis indicates that the multipliers from the wholesale banking business into the rest of a universal banking group can drive an additional 2-4% points of RoE, as measured on the wholesale banking capital base, partially explaining why many wholesale banks are willing to live with structurally lower returns.

5



M O R G A N S T A N L E Y B L U E P A P E R Key Findings of Our Proprietary OTC Survey

We conducted a survey of institutional investors in March 2013 to assess the level of readiness and expected impact on user behavior of OTC regulatory reform. Respondents included hedge funds, asset managers, insurers, pension funds and SWFs.

Key takeaways are: 1) Phasing of client clearing suggests that the major impact will

not be felt until 2015. Around 60% of respondents expect to be clearing 100% of eligible trades by 2015, but varied levels of preparedness suggest some risks to execution. Only around 40% considered themselves fully or very prepared.

2) Impact on client behavior will be profound. Critically, around 70% of institutional investors we polled said they thought the reforms would materially change their trading behavior and how they choose bank partners.

Exhibit 2

Changes to trading behavior and dealer selection % respondents

70%

30%22%

74%

Change tradingbehavior/product

use

Requiretransformation

services

Present with newopportunities

Change the way ofchoosing bank

partners

Source: Morgan Stanley Research

3) Client margining requirements will rise significantly and costs will be only partially passed on. More than 50% of respondents expect a significant increase in initial margin requirements (around 25% expect a marginal increase). Only around 40% expect to pass on the additional costs, of whom only half expect to fully pass on costs.

4) Margining costs expected to reduce OTC trading volumes materially. Around 45% of respondents expect margining costs to result in a reduced level of activity, as well as typically reducing the size of trade and frequency of trade. 8% expect volumes to decline by greater than 20%, 12% expect volumes to decline by 10-20% and 27% expect volumes to decline by 1-9%.

5) IR swaps hurt the most; government bonds, futures and swap futures benefit most. Around 60% of respondents expect a reduction in volumes of swaps, with associated increases expected in US Treasuries, US Treasury futures and swap futures.

Exhibit 3

OTC swaps hurt the most; US Treasuries, UST futures and swap futures to benefit % respondents expecting change in trading volume

12%

6%

6%

29%

5%

25%

25%

18%

33%

28%

24%

6%

59%

Corporate Bonds

CDS index options andtranches

CDS indices

CDS single name

Swaptions

Swap futures

Swaps

US Treasury Futures

US Government Bonds

Decrease Increase

Rates

Credit


6) Client clearing mandates concentrated among brokers. Around 70% of buy-side firms had only completed on-boarding with one clearing member to date. However, around 65% ultimately plan to clear with 2-4 clearing brokers.

7) Need for collateral optimisation services but only limited appetite for re-use. 40% of buy-side respondents are currently performing collateral optimisation on a piecemeal basis. Only around 10% plan to permit re-hypothecation on margin posted and around 50% are not willing to lend securities (30% undecided).

8) Interest in transforming collateral is greatest in corporate bonds and equities. Around 30% of respondents said they would require transformation services. These respondents indicated that they were most interested in transforming corporate bonds (~25%), equities (~25%) and agency MBS (~20%).

9) OTC SEF execution to be more price-driven. Around 60% of respondents expect to become more price-driven when selecting executing dealers under SEFs.

6



M O R G A N S T A N L E Y B L U E P A P E R Morgan Stanley: Stock Implications of Our Joint Findings

This valuation section solely reflects the views of Morgan Stanley Research, not Oliver Wyman.

Three things we have learned from this work

1) Balkanisation: a major headache for European firms, US firms advantaged

The Balkanization of banking markets disproportionately hurts European banks, whilst broadly benefitting US firms. A flurry of new regulations – US FBO proposals, Liikanen (German and French versions), Vickers – alongside a number of other rules has a disproportionate impact on European banks.

We believe proposed FBO (Foreign Banking Organisations) proposals in the US could place additional capital and earnings pressure on foreign banks with large US subsidiaries given the need to ring-fence capital and USD funding. This benefits US banks with large deposits bases, and home country advantage in a large, profitable market. This is a particular issue as the US has become a larger percentage of industry profit pools again, as Europe has become less profitable and EM markets have also waned. On the other hand, given the PRA already has stiff rules, we don’t see as many new rules affecting US firms.

Key stock conclusions: DBK (EW) appears the most affected given it has the largest skew of group assets and revenues from the US and largest proportion of EUR funding swapped to USD. JPM (OW) is the most advantaged.

Exhibit 4

Who is the most exposed to draft FBO rules? (% of group assets in US subsidiaries)

37%35%

23%

17%14%

10%9%

DBK CS BARC UBS HSBC BNP RBS

Note: For Barclays, US data is for 1H12. For others, end 2012 Source: Company Data, Morgan Stanley Research, SNL Financial.

2) OTC transformation: impact overestimated for leading banks

The market has overestimated the impact of OTC collateralization rules on wholesale bank earnings and RoEs for the next 3 years. Our investor poll suggests a 10-20% impact to FICC revenues is anticipated by 2015. However in view of slower phasing (e.g. of bilateral collateral rules) and a smaller percentage of affected areas (up to 40% of FICC), despite a large impact in these areas, our base case assumes a 3-5% revenue loss in FICC by 2015.

Our joint work includes a proprietary survey of institutional investors that gives us higher conviction that the impact will be phased. This is not to say there won’t be major changes: the survey undertaken jointly by MS’s Rates and Financials research teams (see page 6) also suggests a massive shift likely from OTC swaps to futures, but the banks that have an edge in futures are also the ones with large swap books. Hence, we increase our 2013-15 FICC estimates for a number of the major banks (JPM, BAC, C, GS, DBK) on the back of this note.

By contrast, we think the inter-dealer brokers (IDBs) are more heavily affected by these moves: Our estimates for the IDBs (EPS 5-6% below consensus for 2014e) suggest that the market still underestimates the impact on IDB earnings from OTC market reform.

Key stock conclusions: This supports our OW on BARC and JPM and our UW on ICAP.

Exhibit 5 We believe the net loss of revenues in FICC is only 3-5% in 2015e

40

100955

8

Baseline Revenues -FY 2015

Post ImpactRevenues - FY 2015

~40% of

FICC

Rev Loss of ~20% on impacted areas

Phase in will reduce net impact by ~60% Net revenues lost

Source: Morgan Stanley Research estimates

7



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 6 Estimated impact to group earnings from collateralisation in FICC: We expect DBK and GS to be most affected in our base case in 2015

0%0%

-1%0%

0% 0%0%

0%0%

-1%

-3%

-2%

-1%-1%

-3%

-2%

-4%

-3%

-2%

-1%

0%UBS CS DB BARC JPM BAC GS Citi

2013e 2015e Source: Morgan Stanley Research estimates

3) “Decision Time” one year on: Much done, much still to do – addressing of operating gearing and scale dominate

Banks still need to seek scale or downsize where they can’t achieve relevant scale and significantly reduce platform costs. Our work has reinforced our conviction about how much of the cost base has become semi-fixed or driven by transactional volumes, leaving less room for error. The source of competitive advantage is even more driven by relevant scale. New analysis for this note suggests scale has become even more important in driving FICC and Equities returns. Given higher fixed cost base requirements of electronic trading, firms need to have relevant scale on each platform to achieve target efficiencies, or they need to downsize or exit. Put another way, the flowmonster thesis is subtly shifting.

To achieve our aspired returns of 12-15%, European banks need to take out 10-25% of costs, and 15-20% of RWAs by 2015. For the US banks, we model group RWAs +3% to -10% by 2015. We think this is plausible, and have given some banks we cover, such as CS and Barclays, more credit than the market has for substantial cost adjustment programmes.

Key stock conclusions: CS (OW) on cost saves as has made most progress lowering its platform costs; JPM (OW) on market share gains and C (OW) on ramping expense cuts.

Exhibit 7 Scale is critical in FICC, hence the need for smaller players to focus or exit

SOGN

Nomura

UBS

BNPP

RBS

CSG

HSBC

GS

BAC

BARCDBK

Citi

JPM

0%

4%

8%

12%

16%

20%

- 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0

CIB ROE (%) - FY2012

FICC Revenues ($bn) - FY2012

FICC revenues continue to have strong correlation with CIB ROEs. Investments banks can be segregated into distinct groups based on FICC market shares

Source: Company Data, Morgan Stanley Research

Our base case: Cyclical recovery in equities and IBD

In our base case, our underlying 2013 total investment bank forecasts (FICC and Equities sales & trading plus IBD revenues) are up ~4%. We model FICC revenues up ~1% in 2013, as we expect stronger revenues against weaker comparables in Q2-Q3. This however is offset by increased regulatory challenges from mandatory clearing starting in March. In equities we expect revenues to be up ~2% from greater cyclical rebound, though this has yet to occur in Q1 as equity trading volumes in the US and Europe are down ~5% YoY. Similarly, we expect stronger YoY performance in equities in Q2-Q3. In IBD, we expect revenues to be up ~5% YoY, as ECM and M&A have a cyclical rebound while DCM issuance remains resilient, as interest rates remain low.

What’s priced in?

Our reverse sum-of-the-parts analysis suggests that most CIB divisions are valued at 0.7-1.0x book value, implying 8-11% returns on equity using ~11% CoE and minimal growth. We think 12-14% returns are plausible. Our central case for the top 13 wholesale banking divisions is 13-14% in 2013-14 (see Exhibit 8), albeit this may exclude excess capital and funding at the group level.

But every year banks will have to work harder to offset the increasing pressure from industry and regulatory change. Our base case is still slightly below the 15% return on stated equity at a group level that banks have committed to the market (typically 15-19% on tangible equity). We think, however, the range of returns will be wide.

8



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 8 The market is assuming corporate and investment banking divisions will fail to make management targets or even their cost of equity

0% 4% 8% 12% 16% 20%

Average RoE 1993-99

Average RoE 2000-06

Average RoE 2009-10

Average RoE 2011

Average RoE 2012

Management targets

MSe bottom up RoE 2013


Implied RoE from market Implied range

Source: Company Data, Morgan Stanley Research estimates (e). Average is weighted. ROE is calculated on clean underlying numbers hence excluding DVA/CVA and other one off expenses in the form of restructuring charges etc. Refers to returns of CIB divisions, excluding non-core/legacy divisions

Exhibit 9

We think banks can hit 12-14% returns in CIB as they normalize in 2013 and 2014, driving valuations potentially higher

CIB Return on Equity (%)

7.5%

9.2%

10.9%

13.5%

14.1%

14.5%

6.9%

10.0%

11.4%

11.7%

13.4%

13.5%

13.5%

13.5%

14.7%

14.8%

15.7%

16.6%

17.3%

10.8%

17.3%

14.5%

12.8%

13.6%

16.3%

18.0%

17.5%

10.1%

11.7%

10.0%

14.2%

18.2%

Nomura

GS

RBS

BNPP

Citi

CSG

BARC

Group Avg

US Avg

Europe Avg

JPM

UBS

SOGN

BAC

DBK

HSBC

2013e 2014e Source: Morgan Stanley Research estimates. Average is weighted. ROE is calculated on clean underlying numbers hence excluding DVA/CVA and other one off expenses in the form of restructuring charges etc. Refers to returns of CIB divisions, excluding non-core/legacy divisions.

Top picks

In Europe, we prefer those wholesale banks with strong restructuring and cost save potential that are also trading on undemanding valuations. Our top picks are CS, BARC, UBS, BNP. Our thesis means we are at the high end of expectations for most of the banks we cover, such as CS and BARC, where

we are 10-15% ahead of market expectations. We are below consensus on the French banks given higher provisions and slower top-line growth from weakening macro, while we think RBS has weaker earnings power due to its shrinking balance sheet.

In North America our top picks are JPM and Citi among the large cap banks. We are above consensus on JPM on expectations for share gains and above consensus on Citi on incremental cost cutting and footprint rationalization.

Exhibit 10 What’s priced in? We think a cyclical rebound and banks executing their restructuring and cost save plans could drive valuation higher

JPM

CBARC

SocGen

BAC

Underlying UBS

GS

Natixis

BNPP

HSBC

RBS

DBK

CSG

UBS

0.4 x

0.5 x

0.6 x

0.7 x

0.8 x

0.9 x

1.0 x

1.1 x

1.2 x

1.3 x

1.4 x

4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%

2014e Return on Tangible Equity

Pric

e/ 2

013e

Tan

gibl

e Eq

uity

Note: Underlying UBS refers to 2015e ROTE post-restructuring Source: Morgan Stanley Research estimates

Exhibit 11 Where we are relative to consensus on earnings

-16%

-3%

-3%

-1%

-3%

-4%

-1%

-3%

-3%

-1%

3%

-3%

6%

4%

15%

7%

-12%

-10%

-6%

-5%

-5%

-4%

-4%

-2%

-2%

2%

3%

4%

5%

8%

12%

13%

BNP

GS

TLPR

BK

SG

ICAP

RBS

STT

BAC

DB1

DBK

JPM

UBS

Citi

BARC

CSGN

2014FY2013FY

Source: Company Data, Morgan Stanley Research, Thomson One

9



M O R G A N S T A N L E Y B L U E P A P E R 1) Impact of Balkanisation/subsidiarisation on returns and models

Global banks remain under pressure from the Balkanization of banking markets. It poses a risk to cross border finance from ring-fencing as national policymakers look to reduce interdependence of their banking markets to other markets and perceived risky areas. We think domestic regulators will seek to “trap” more liquidity and capital. Some new regulations are regional (such as US FBO proposals) others are by business line (like Vickers, Liikanen, German/French rules).

European banks are most affected in the next phase given FBO proposals, Vickers reforms, Liikanen (including German and French varieties) and other responses to Eurozone stress. Therefore, we believe US banks to be advantaged as regulation for US banks within the US and outside (i.e. PRA) is more clear. For this note we have done a deep dive on the European banks most affected.

We believe proposed FBO (Foreign Banking Organisations) proposals in the US could place capital and earnings pressure on foreign banks with large US subsidiaries. For example, 37% of DBK’s balance sheet is in its US subsidiaries (and a further 20% in its branch). CS and BARC are also highly exposed.

Although we estimate a capital gap at DBK and BARC under the FBO proposals, we expect it to be addressed through substantial balance sheet shrinkage (e.g. by one-third at DBK) as well as filled by CoCo and/or hybrid issuance rather than by straight equity. We think ring-fenced funding will be a more meaningful issue for earnings.

Exhibit 12

Who is the most exposed to potential draft FBO rules? (% of group Assets in US subsidiaries)

37%35%

23%

17%14%

10%9%


Note: For Barclays, US data is for 1H12 Source: Company Data, Morgan Stanley Research, SNL Financial.

Exhibit 13

We believe DBK and BARC to be the most affected by capital rules as current capital positions in the US imply a shortfall

Capital Shortfall in US Subsidaries

20

10

0

30%

20%

0%0

5

10

15

20

25

DBK BARC CS

Cap

ital S

hortf

all (

US

$bn)

0%

5%

10%

15%

20%

25%

30%

Cap

iral S

hortf

all (

%Ti

er 1

Cap

ital)

Note: For Barclays, US data is for 1H12 Source: Company Data, Morgan Stanley Research, SNL Financial.

Exhibit 14 At DBK, US subsidiarisation still implies a capital gap of $7-9bn on our estimates post restructuring and future earnings – but also requires DBK to shrink US subsidiaries by 1/3 from $440bn to $300bn

DBK potential US Capital Gap

30.0

20.6

3.72.3

7.3

9.4

7.3

0

5

10

15

20

25

30

35

Capital gap atTaunus onlast data

Move to IHC IHC Q3 i-bankrestructuring

Earnings DTAs used Min net gap

$bn


Exhibit 15 DBK: Including lost revenues from balance sheet reduction and cost of new CoCo issuance to bridge the capital gap, we think the potential hit to 2015 underlying group PBT could be 1-12% Lost revenues/higher costs PBT €m

Shrinking US balance sheet ($100m) 80Higher US funding costs: 25-75bps higher on €90bn of intragroup funding 200-650Coco cost - $7bn @ 7.6% 0-400Total PBT lost 80-1130Source: Morgan Stanley Research

10



M O R G A N S T A N L E Y B L U E P A P E R We think funding costs could go up. Our work suggests DBK will feel the greatest impact from FBO USD proposals. For instance it could cost DBK 25-75bps more to fund the current €90bn line from parent to subsidiaries, which could add €200-650m more interest cost p.a. (or 5-15% of investment bank PBT). Including lost revenues from balance sheet shrinkage (mostly in repo) and cost of new CoCo issuance to bridge the capital gap, we think the hit to earnings could be €80-1130m or 1-12% of group PBT.

More broadly, given the focus in FBO on reducing use of local funding and swapping to USD, many European banks without a natural source of dollars will become less relevant in dollar markets as it remains the functional currency of commodity finance, trade finance, and so on. European banks have already reduced their USD portfolios materially, but we expect this will continue.

The Vickers reforms in the UK are likely to shave several percentage points off returns for UK banks. The key goal of ring-fencing retail banking operations is likely to cause funding costs to increase, as non-ring-fenced operations are explicitly not benefiting from a government guarantee. The splitting of the banks, duplication of systems and processes and monitoring of the fence is also likely to increase costs.

At this stage, we believe the potential impact from Liikanen-like proposals on French and German banks to be less adverse than implied by the report. Although we believe the potential reforms to be similar in philosophy to the US Volcker, Vickers or Liikanen proposals (i.e. aiming to remove moral hazard from the banking system while maintaining enough resources to finance the economy), we think they will be more limited in scope. We believe the outcome is closest to the US Volcker rule (i.e. ring-fencing proprietary trading activities) including other limitations (i.e. banks not allowed to own a hedge fund or provide them with unsecured funding) rather than going as far as the UK Vickers or Liikanen proposals on ring-fencing. We do not expect a drastic change to the universal banking model.

Advantaged: Major US players, such as JPM, GS, Citi, BAC, will be able to take advantage of the exit or downsizing of European players from the attractive US market as they face higher regulatory standards and funding costs than in the past. US players will also have the opportunity to acquire portfolios that European banks may be pressured to sell (i.e. recent sale of loan portfolios by RBS, BNP).

Potentially challenged: 1) Foreign banks in the US that may require greater standalone funding or capital and/or are facing risks of higher funding costs, such as DBK, and less so for BARC, CS. 2) Those that are exiting US dollar activity given funding pressures, such as French banks, as they also face greater competition from local players.

2) Impact of the transformation of OTC markets: winners and losers

We argue in the joint section of this note that the economics of facilitating OTC derivatives are about to change significantly. US regulation (Dodd-Frank Act) has seen the first phase of mandatory buy-side clearing commence (March 2013). This is driving increased initial margin collateral requirements, with transparency also set to increase under SEF requirements. We expect an impact from European mandatory clearing requirements from 2014 (post EMIR), whilst rules governing pre-trade transparency are unlikely to be implemented until 2015 (MiFID II). Margin posting for uncleared derivatives is also delayed until 2015. We explore the impact for banks, IDBs and other players.

First, Rates trading is likely to see the biggest impact. But we believe the market overestimates the impact of OTC collateralization rules on the earnings and ROEs of the investment banks. Respondents to our investor poll suggest the market anticipates a 10-20% revenue loss in FICC. However, our detailed work suggests only a 3-5% impact to FICC revenues by 2015 in our base case. This is because we believe the percentage of affected areas within FICC is likely lower than the market expects at up to 40% for the most exposed players, and the slower phasing (e.g. of bilateral collateral rules) means the full impact won’t be felt for some

Exhibit 16 We expect Rates to be the most affected by collateralization rules out of our base case of $1.4trn of new collateral needed

Rates, 65%

Credit, 2%

Equity derivatives,

21%

Commodity, 2%

FX, 10%

Note: chart shows % of net incremental collateral required. Source: Morgan Stanley Research

11



M O R G A N S T A N L E Y B L U E P A P E R years. On the back of the work in this note, we assume only 10% of the phasing is in 2013 and 60% by 2015. This equates to a 1-2% drag on FICC and equity trading revenues in 2013. We expect another 2-3% drag in 2014 and a 1% or so drag in 2015. Overall, we are looking for FICC trading revenues to grow 1% in 2013, 1% in 2014 and 3% in 2015 as OTC clearing weighs on revenue growth, partially offset by rising GDP expanding capital markets into Europe and Latin America.

We increase our FICC estimates for the US banks and DBK on the back of this note. GS and DBK prima facie look most affected by OTC transformation rules at the group level (Exhibit 19). Our base case for them assumes a ~3% hit to group earnings in 2015 using our joint assumptions about phasing.

Key assumptions in our analysis: For all the wholesale banks, our base case assumes a 20% reduction in revenues for the relevant OTC products from both lower volumes (10%) and tighter bid/ask spreads (10%). For the most exposed players, we assume 40% of FICC revenues is affected. Our bear case is 30% lower revenues implying a 30% reduction in volumes and 20% squeeze in bid/ask spreads as more clients disengage due to costs associated with clearing and margin posting as well as greater transparency reducing margins.

Our bull case assumes a 5% uplift to revenues as we assume no change to trading volumes with client activity not affected by clearing and collateral posting. But we assume bid-ask spreads widen by 5% as some clients shift to higher margin trades that are not subject to clearing requirements and are not yet required to post collateral (i.e. bilateral collateral requirements).

Relatively Advantaged: Dealers with a lower skew to FICC revenue (as a percentage of group revenues) will suffer less under the OTC derivative rules, such as JPM, BAC, and CS. UBS, with less rates business and more FX and equities, should also be less affected. BARC is also less affected than expected.

Disadvantaged: Banks with a weighted average skew towards rates and greater investment banking (FICC) earnings as a proportion of the group will feel a larger negative impact on trading volumes and spreads, such as DBK and GS. IDBs like ICAP and TLPR are also likely to see a decline in revenues.

Exhibit 17 “How much do you think overall FICC revenues could still shrink from the transformation of OTC markets by 2015?” We think markets are too fearful according to our investor poll as we think market overestimates % of affected areas and phasing

0% 5% 10% 15% 20% 25% 30%

0-5%

5-10%

10-15%

15-20%

>20%

Source: Morgan Stanley Research. Based on investor poll taken at Morgan Stanley European Financials Conference March 2013

Exhibit 18 We believe the net loss of revenues in FICC is only 3-5% in 2015e

40

100955

8



~40% of

FICC




Exhibit 19 Estimated impact on group earnings from collateralisation in FICC: We expect DBK and GS to be most affected in our base case in 2015e

0%0%

-1%0%

0% 0%0%

0%0%

-1%

-3%

-2%

-1%-1%

-3%

-2%

-4%

-3%

-2%

-1%

0%UBS CS DB BARC JPM BAC GS Citi

2013e 2015e Source: Morgan Stanley Research estimates

12



M O R G A N S T A N L E Y B L U E P A P E R Impact on OTC transformation is even bigger on IDBs We estimate that 7-10% of IDB revenues at ICAP and TLPR will be affected by the Dodd-Frank rules for US OTC derivatives. We estimate that this rises to 25-30% of group revenues as European rules are implemented.

We see risks to IDB revenues arising from a drop in overall OTC market volumes as collateral costs of doing business for the buy-side increase post Dodd-Frank. We also expect an associated shift from swaps to futures (given differentials in capital costs of clearing) could see a 10-25% reduction in swaps business. Meanwhile, increased pre-trade transparency, which drives reduced spreads for investment banks, is likely to drive pressure on IDB commission levels as banks seek to offset pressures on their own profitability.

Against this, we expect the requirement for a significant part of OTC volumes to be transacted via a swap execution facility (SEF or OTF in Europe) will increase intermediated vs. bank bilateral business, providing some potential offset for the IDBs.

Reflecting the above impact of US rules on IDBs in isolation leads to a 1-3% decline in IDB top-line revenue for ICAP and TLPR, on our estimates. Assuming lower associated broker comp offset would imply a 2-6% hit to group profits. Extending this to reflect a similar impact for Europe would increase the total impact over 3+ years to 3-10% to top line and 8-20% to profits.

Our base case estimates take into account, in addition to the above, i) the phasing of regulations; ii) some evidence of cyclical improvement in activity YTD (especially in FX and rates); and iii) the possibility of an increased share of OTC being intermediated by IDBs. We model in our base case a decrease in voice broking revenues of 0-1% pa 2012-15e.

Advantaged/disadvantaged: This is a key part of the reason why we remain cautious on the IDB sector (UW ICAP, EW TLPR). On the back of this work we have lowered our 2015 voice broking revenue assumptions by 5-10%, reflecting the ongoing drag from the above regulatory phasing and in view of expected swaps to futures migration. Despite some modest cyclical improvement noted in FX and rates, this still results in a 3-5% cut to 2014 EPS, leaving us 5-6% below consensus.

Exhibit 20 IDBs – reducing ICAP & TLPR estimates 3-5% for 2014 places us 5-6% below consensus £mn 2012 2013e % Chg 2014e % Chg 2015e % Chg

ICAP Voice revs 990 970 -7% 966 -8% 963 -10%

Other revs 476 522 4% 557 5% 596 4%Group revs 1,466 1,491 -3% 1,523 -4% 1,558 -5%EPS (p) 31.4 32.4 -4% 33.9 -5% 35.7 -8%

Cons EPS (p) 33.7 35.5 Difference to cons -4% -4%

TLPR Voice revs 805 796 0% 792 -2% 789 -4%

Other revs 53 58 0% 63 0% 69 0%Group revs 858 853 0% 855 -2% 858 -4%EPS (p) 40.4 36.3 0% 37.5 -3% 40.9 -4%

Cons EPS (p) 37.3 40.0

Difference to cons -3% -6% Note: for ICAP, 2013e = March 2014 year end; same for 2014 and 2015 Source: Morgan Stanley Research, Bloomberg

Who wins? Market infrastructure players – but we expect upside to be limited

We see opportunities for market infrastructure providers in two key areas: 1) clearing infrastructure given mandatory OTC clearing requirements (per Dodd-Frank and EMIR); and 2) collateral management and transformation services given the growing requirement for collateral (which Oliver Wyman estimates at an incremental $1.4 trillion by 2020 for cleared and non-cleared OTC trading).

Whilst we see attractive incremental revenue opportunities from OTC clearing, we expect that the need to share profits with users may limit potential – overall we expect that the global OTC clearing opportunity is no more than $1 billion revenues and could be less depending on pricing approach/economic share with users.

LCH and ICE appear well placed as the effective incumbents in interest rate (IR) and credit default swaps, respectively. LCH generated €72m of clearing fees in 2012 (up 62% on prior year) from clearing ~75% of the dealer-to-dealer market in IR swaps via OTC Swapclear, while ICE generated $66m from ICE Clear Credit and ICE Clear Europe.

The introduction of mandatory buy-side clearing in the US from March 2013 and in Europe (likely from 1H14) also presents opportunities for CME and DB1 given their credentials in IR futures clearing. DB1 hopes to provide a compelling offering via i) cross-margining offsets (futures vs. swaps) and ii) client collateral segregation. However we see competitive pressures, plus the strength of incumbent LCH (>$24 trillion of buy-side notional cleared to date) as limiting upside. Our survey on client clearing suggests LCH and CME are in a stronger position.

13



M O R G A N S T A N L E Y B L U E P A P E R Collateral management offers a potentially bigger top-line opportunity, though we suspect this is more likely to accrue to the sell-side and some of the large global custodians, rather than ICSDs (International Central Securities Depositories) given the large “collateral-acceptable” bond inventories that US money center and trust banks have and their desire to generate incremental revenues on these under-earning assets.

We see BNY Mellon, JPMorgan, Citigroup as US beneficiaries of collateral management, although the revenue opportunity is not yet meaningful. These companies carry high liquidity and high levels of acceptable collateral for futures exchanges like US government and agency bond. Collateral management should drive incremental fees as insurance companies and other investors seek to transform unacceptable collateral (like corporate debt) to acceptable collateral (US Governments). The ultimate profitability is a function of quality of collateral transformed and duration of the investment. We estimate that this service will be priced like securities lending or repo products. For now, ahead of the finalization of the rules, we assume a revenue pool of about $1-2bn which likely grows higher as short-term rates rise. We think this translates to about a $300m revenue opportunity for the largest players.

We see a more compelling opportunity for DB1 in collateral optimization services vs. OTC clearing, given capabilities in clearing allied to larger ~€11 trillion custody balances. However based on license and volume related fees and in view of competition (Euroclear is also planning to offer a “collateral super highway”); we model a ~€60 million revenue opportunity for DB1 (~2% of group) by 2015. Potential upside could come from increased custody fees to the extent that users allocate increased balances to Clearstream to benefit from the network effect. For DB1 we increase 2014 EPS estimates ~2% and 2015 ~3% given explicit forecasting of the above in our base case.

Exhibit 21 DB1: Impact on estimates from OTC clearing and collateral management – modest 2-3% increase to 2014/15e €mn 2012 2013e % chg 2014e % chg 2015e % Chg

Eurex revs 912 973 1% 1,076 2% 1,140 3%

Clearstream revs 768 779 0% 839 2% 905 5%

Group revs 2,209 2,256 0% 2,441 1% 2,594 2%

EPS (€) 3.59 3.85 1% 4.46 3% 5.09 3%

Cons EPS (€) 3.86 4.30 4.86

Difference to consensus 0% 4% 5% e = Morgan Stanley Research estimates Source: Company Data, Morgan Stanley Research, Bloomberg

Advantaged/disadvantaged: In OTC clearing we view incumbents LCH and ICE as well placed in IR swaps and CDS clearing respectively given existing success with dealers driven by a strong partnership approach. Whilst DB1’s credentials in IR futures clearing offer potential to benefit from buy-side clearing of IR swaps, we do not expect this to be meaningful to group profitability given the degree of competition for the opportunity and the head start of LCH. We model €20m revenue contribution by 2015 (<1% of group revenues).

In collateral management, we see BNY Mellon, JPMorgan, Citigroup as US beneficiaries, although the revenue opportunity is not yet meaningful. We see a more compelling opportunity for DB1 in collateral optimization services vs. OTC clearing.

3) “Decision Time” – one year on: much done, much still to do. Operating gearing and scale are now the issues

Last year in our joint report we argued: “It’s decision time for wholesale and investment banks. The market underestimates the degree to which banks will rationalize their portfolios of activities and the shifts in market shares that are likely in the next 12-24 months. Economic and regulatory uncertainty and ‘hoping for the best’ has meant players have kept many options open – but higher capital and funding costs, a raft of new regulations becoming clearer and nearer, and higher fixed costs with softer revenues will force much more change.

We believe management response to the challenges are unfinished. Given higher fixed cost bases, achieving relevant scale is more important to reach adequate returns through greater efficiency on platforms, or else players need to downsize or exit. Not only does the ‘flow monster’ thesis work in FICC but we believe this is also the case in equities. This calls for greater cost saves and further reduction in RWA.”

14



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 22 Although we are already above consensus at CS from stronger cost saves, if CS hits targets, there is potential for ~10% more upside to our estimates SFr m 2012 2013e 2014e 2015e

Base cost (flat revs) 18.5 17.3 16.7 16.1Re-investment cost 0.3 0.6 1.4VC (cash) 1.4 1.8 2.2 2.5Target excl one-offs 19.9 19.4 19.5 20.0Other non-recurring 1.4 1.7 1.0 0.7Total Implied Cost Target 21.3 21.1 20.5 20.7

% change -5.4% -0.7% -3.0% 0.9%

MSe Costs (stated) 21.3 21.8 21.5 21.8

% change 2.3% -1.7% 1.6%

MSe vs. Target % higher 0% 3% 5% 5% Underlying Revs 25.5 27.0 28.7 30.3% change 4.1% 6.0% 6.0% 5.8%

Underlying Costs 20.1 20.1 20.5 21.1MSe Underlying cost/income 78.8% 74.4% 71.4% 69.5%

Underlying profit 3.7 4.9 5.8 6.6VC/underlying profit 38% 38% 38% 38%

Current MSe EPS (SFr) 2.66 2.84 3.42 3.89EPS if hit costs (SFr) 3.15 3.85 4.38

EPS upside 11% 12% 13%

ROE (MSe) 10.7% 12.2% 12.7% 13.2%

ROTE (MSe) 14.9% 15.7% 15.6% 15.9%

ROE (Target Costs) 13.4% 14.0% 14.6%

ROTE (Target Costs) 17.1% 17.3% 17.7%e = Morgan Stanley Research estimates Source: Company Data, Morgan Stanley Research

Exhibit 23 We still expect a further 15-20% of B3 RWA reduction to come RWA reductions in Investment Banks - BASEL 3 ($bn)

179 188 187

393 386

615

710

101 120

175

306330

565

655

UBS RBS CS DBK BARC JPM GS

FY12 Target For UBS, DB includes legacy + non-core + i-bank RWA. Target dates are: UBS 2017, CS 2013, DBK 2015. For GS, the 'target' represents management's estimates for simulated passive run-off by 2015 and does not represent an actual target. For JPM, target date is 2013-14.; Source: Company Data, Morgan Stanley Research.

Since we wrote last year, we have seen massive change including UBS restructuring and reducing its target RWA by SFr80bn; RBS reduced its target by a further £40bn; CS announced a capital raising and a further SFr1.2bn of cost saves for 2013 (from SFr2bn targeted at FY11 results to SFr3.2bn today) and rising to SFr4.4bn of savings by 2015 (~20% of cost base). The ability to reduce costs will be critical in view of higher fixed costs, competition and lower volumes.

But we argue the change is far from over. We expect investment bank Basel 3 RWA to shrink a further 15-20% according to company plans as they exit legacy positions and areas where they lack competitive advantage. We think the challenge now is even more about costs and improving portfolio returns.

Scale and operating leverage have grown in importance in FICC as the top players continue to gain share at the expense of sub-scale banks. Within FICC, “flow monsters” should continue to benefit as we have seen large scale players continue to strengthen as smaller players withdraw or downsize (i.e. UBS in rates). We think sub-scale players are forced to rationalize and focus on areas where they are competitive to improve RoE.

We believe the ‘flow monster’ thesis also holds in equities. Our joint work with Oliver Wyman this year underscores the deterioration in the economics of the Equities and IBD businesses for many firms given disappointments at top line and higher fixed costs. Our analysis suggests only the top 3-4 players in equities generate return on equity above cost of equity given fixed cost base, making the business more geared. Also, given the overcapacity and the low returns for many players we expect further restructuring or downsizing to come unless equities volumes pick up substantially.

Exhibit 24 Scale is critical in FICC, hence the need for smaller players to focus or exit

SOGN

Nomura

UBS

BNPP

RBS

CSG

HSBC

GS

BAC

BARCDBK

Citi

JPM

0%

4%

8%

12%

16%

20%

- 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0





15



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 25

Gearing is also important in equities where we estimate only the top 3-4 players meet their cost of capital of 11%

JPM

CitiDBK

BARC

BAC

GS

CSG

UBS

-3%

0%

3%

6%

9%

12%

15%

18%

- 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0Equity Revenues ($bn)

Equity

Div

isio

n R

OE

(%

)

Source: Morgan Stanley Research estimates. Based on 2012 data.

We have already seen material shifts in market share as marginal players withdraw, offering an opportunity for winners to improve their profits. We see much evidence in the wholesale banks we cover of decisions to exit or downsize a large number of businesses in the last year to reduce capital drag and improve cost/income with the aim of improving ROE over time. We believe it is now more about execution of plans as banks reduce legacy exposures, implement cost saves of 10-25% over the next 2-3 years, and focus on core competencies to hit returns of 12-14%. As banks shrink books further and release capital, we see potential for greater capital return (i.e. UBS).

Relatively Advantaged: Banks that have announced material shrinkage of RWA to focus on core strengths and reduce legacy asset drag. Also, banks that have targeted significant cost savings to improve efficiencies and returns. This includes our core Overweights of CS, UBS, BARC, Citi, and JPM.

Disadvantaged: Banks that have yet to announce investment banking restructuring or cost saves to offset headwinds from regulation, competition, etc. such as SocGen.

Valuation – what’s priced in?

Base case: industry returns of 12-14% in 2013-15 Our core thesis is that corporate and investment banks will

rationalize their portfolios and headcount even further over the next 2 years. This, alongside cyclical and secular trends, will enable industry returns to improve to 12-14%, although the spread of returns will be wide. These assumptions for further rationalization are baked into our models.

Today the market is pricing that corporate and investment banking (CIB) returns will still struggle to make their cost of equity given concerns on regulation, such as the transformation of OTC markets and the Balkanisation of banking markets as well as sticky costs against a very different opportunity set. We are more optimistic as we expect managements will take action to drive higher ROEs.

Our reverse sum-of-the-parts analysis suggests that most CIB divisions are valued at 0.7-1.0x book value, implying 8-11% returns on equity. This suggests the market is questioning whether investment banks can generate acceptable returns over CoE. We think 12-14% RoE is plausible. Our central case for the top 13 wholesale banking divisions is 13-14% in 2013-14. But every year banks will have to work harder to offset the increasing pressure from industry and regulatory change. Our base case is still slightly below the 15% return on stated equity at a group level that banks have committed to the market (typically 15-19% on tangible equity). We think, however, the range of returns will be wide.

Our CIB returns on allocated capital is higher than estimates for group returns given regulator required excess capital and funding at the group level. Over time, as regulators become comfortable with bank capital levels, we expect rising buybacks to drive group returns towards CIB economic returns.

16



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 26 Investment banking industry revenue forecasts

8 12 10 13 10 9 10 14 12 13 8 8 10 9 10 12 10 11

14

2018 13 17

12 1314 18 15

11 1015

11 1215

11 13

47

4441

24

49

29 30 23

41

27

17 16

42

2629

38

2730

45

5

4

4 3 4

3

1

2

2

23 4

4

3

(2)

-$10bn

$5bn

$20bn

$35bn

$50bn

$65bn

$80bn

Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q311 Q411 Q112 Q212 Q312 Q113e AvgQ2-Q4

13e

AvgQ1-Q4

14e

IBD Equities FICC Other

e = Morgan Stanley Research estimates; Source: Company Data, Morgan Stanley Research

Exhibit 27 In a lower return world, dividend paying ability will be critical: still a minority sport, although growing potential in 2014/15 which will help the rehabilitation of banks in investors’ minds

0%

2%

4%

6%

8%

10%

12%

14%

UB

SSA

N*

ISP BP

SWED

BN

PAC

A*

BBV

A*

NA

TIX

MB

HSB

C*

BA

RC

CS

GN

CB

KG

LEE

RS

TES

EBS

HB

STA

N*

KBC IN

GN

DA

DA

NS

KJP

MS

ABU

CG

DB

KR

IBH

DN

BB

ACN

TRS

BN

YS

TTR

BS

UB

IG

SLL

OY

Citi

BMPS PM

I

Div Yield 2015e

Div Yield 2014e

Div Yield 2013e

2014 Avg. 3.0%

2015 Avg. 4.4%

14 banks paying >5% cash dividend yield in 2015

2013 Avg. 2.1%

2012 Avg. 2.0%

Source: Company Data, Morgan Stanley Research estimates (e). *Refers to banks which also pay a scrip dividend

17



M O R G A N S T A N L E Y B L U E P A P E R Changes to our forecasts

We reduce our assumptions for inter-dealer broker (IDB) voice broking revenue growth from CAGR +1% 2012-15 to -1% CAGR 2012-15. This implies a 5-10% reduction to our 2015 revenue estimate to take account of the likely impact of collateralisation rules on overall market volumes in swaps, and the likelihood of swap to futures migration, particularly in the US. For ICAP, we reduce our EPS estimates 4% for FY14 and 5% for FY15 reflecting new assumptions for voice broking revenue attrition and the recent trading statement. For Tullett Prebon we decrease our EPS estimates by 3% for 2014 and 4% for 2015.

For the European banks, we slightly tweak our investment banking estimates reflecting mark-to-market for Q1 while

adjusting for a slower impact in trading revenues in future years from swap clearing and margining rules.

For the US banks, our analysis suggests that the impact of the swap clearing and margining rules will be slightly less and felt over a longer period of time than we had been baking in our models. We had been hitting FICC revenues over a 2 year period and are now spreading out the impact over a much longer 6 year period through 2018. The phase-in is 10% in 2013, 35% in 2014, 60% in 2015, 75% in 2016, 85% in 2017 and 100% in 2018. As a result, we are raising earnings estimates for BAC, C, JPM, GS by 1-2% as we increase our FICC trading revenue forecast by 4%, 2%, 1% in 2013-15.

18



M O R G A N S T A N L E Y B L U E P A P E R Chapter 1: Structural Reform and De-globalisation

1.1 Subsidiarisation and the threats to the global model

Regulators are introducing a large number of new proposals seeking to reduce the interdependence of their banking systems, to aid recovery and resolution, and to remove moral hazard from trading businesses. The cost and complexity of complying with these requirements across jurisdictions is up to $15bn p.a. or 2-3% off RoE for the industry, with considerable skews across banks. There is limited scope to reduce this impact unless we start to see a more coordinated global policy response. This will drive starker regional participation choices, and underscore the importance of a large home market. We believe the industry has to move faster in restructuring its legal entity and funding models and proactively engage with the regulatory community around the solution.

Multiple overlapping solutions

The cost and complexity of complying with the emerging ring-fencing and resolution requirements across jurisdictions is substantial. We estimate $10-15bn p.a. of costs industry-wide, across increased capital, funding and operating costs. This could mean an industry-wide RoE drag of 2-3%, albeit with significant skews around this across banks, and much depending on the evolving regulatory landscape. The rules not only increase the cost of an in-country presence, but also make it tougher to operate cross-border businesses via hubs. The pressures stem from:

Home market regulators pressuring banks to curtail and / or ring-fence their external activities either through explicit rules (e.g. ICB in the UK) or through the lens of resolution planning (e.g. in Italy).

Home market regulators seeking to limit proprietary trading activity, or ring-fence this from retail deposit-taking activity.

Host regulators in the key hubs limiting, and seeking greater transparency and control, over risk-taking conducted overseas but booked into the hub (e.g. UK PRA).

Host regulators in the hubs and other markets pushing for increased capital and liquidity to be held locally, as well as onerous (and at times unpredictable) governance requirements (e.g. local risk appetite frameworks, local limit frameworks etc.).

Exhibit 28 Map of global structural reform proposals

Reform type US UK EU Rest of world

Split of retail vs. trading activities (moral hazard)

Limitations on foreign activities of domestic banks(localisation)

Limitations on local activities of foreign banks(localisation)

Volcker rule

Swap push‐out

ICB

FSA pressure

(individual case

basis)

FBO

Liikanen &

derivations

(Ger, Fra)

Local regulator

pressure

(Ger, Aus, CEE)

Localisation

requirements in:

Brazil

China

Russia

Korea etc.

Local regulator

pressure

(Ger)


Host regulators pushing for foreign bank branches to become subsidiaries, or treating them as if they are subsidiaries, heightening the level of scrutiny and supervision.

While each of these initiatives in isolation would have a bounded impact or could be effectively navigated, degrees of freedom are severely limited when taken in aggregation. There are levers available to reduce the impact on RoEs, but the scope and effectiveness of these will be limited unless we start to see a more coordinated global policy response. At this point, however, the direction of travel among regulators is towards lesser, not greater, harmonisation. There is increasing evidence that the period of multi-lateralism in policy response is over.

In Asia, for example, each country is now looking independently at how to best (or not) implement Basel 3. Another example is the approach to model approvals: in many countries, gaining approval for internal risk models is an increasingly slow and difficult process, even when the models have been approved by the home market regulator.

Regionalisation and starker participation choices

One consequence is a much starker focus on country and regional participation choices and investment priorities. Banks increasingly have to make decisions about whether they are in a given location with a diversified set of businesses, implying access to local funding, a more diversified earnings stream, and a broader revenue base against which to set the increased fixed costs of the onshore presence.

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M O R G A N S T A N L E Y B L U E P A P E R Exhibit 29 Impact of structural reforms

Base case

industry impact Range of impacts

across banks Regulatory uncertainty

US FBO <1% 0-3% LowMulti-jurisdictional localisation

1-3% 1-5% High

Moral hazard <1% 0-3% Medium

Total 2-3% 1-5% Source: Oliver Wyman analysis

This issue is most acute in Asia and the emerging markets due to the fragmented nature of these regions. In extremis the choice is between a retreat towards a hub-based model accepting reduced earnings power and EM growth potential, or accepting the higher costs of a multi-local model with fragmented balance sheets. Such a model might give an RoE drag of up to 5-6% (pre-mitigation). This is comparatively large versus a model that optimises capital and funding globally.

Global banks must challenge the presumption that duplicating the onshore infrastructure of the local banking system is a precondition for access to international capital and trade flows. One way is to take a more strategic approach to managing the correspondent banking network, building closer ties with selected partners whose local expertise and infrastructure can provide access to credit information and local capabilities in transaction banking, risk management and deal structuring.

The issue is not limited to the Emerging Markets of course; Balkanisation is evident even between EU states. Home market advantages will be reinforced, pushing medium- and smaller-sized banks to focus domestically, and benefiting banks with larger home markets.

The US FBO proposals present a material challenge for the US business of many foreign banks US Foreign Banking Organisation (FBO) proposals potentially impose a 2-4% ROE drag on the US businesses on average across the key affected banks, with the impact heavily skewed across banks depending on business mix and funding model. This is a material strategic concern as the US remains a key profit and growth driver and an already difficult market for foreign banks. The Americas represented not only 47% of global revenues in 2012 (up from 44% in 2011), but we also estimate that 55-60% of global profit originated there in 2012, Around 60% of this was captured by US banks (Exhibit 30 and Exhibit 57).

While the proposals are still in consultation, signs point to the core elements remaining in the final rule since they fill a major gap in the Fed’s regulatory mandate under Dodd-Frank. The rules will most strongly affect foreign banks currently operating large wholesale businesses as broker-dealers in the US.

The most immediate concerns are funding, liquidity and leverage as the US entity – the intermediate holding company (or ‘IHC’) – must now comply with local leverage rules (shifting from ~2% to ~5+%), and meet both local Fed-supervised and Basel 3 liquidity tests. This has a number of potential implications as banks seek the most cost effective response:

Shrink the US balance sheet, targeting activities with a low return on asset (e.g. repo, some corporate exposures), but accepting some associated revenue loss.

Issue additional senior unsecured funding (most likely through group level Yankee issuance to avoid dependency on cross-currency swaps), accepting some incremental funding cost increases (30-50bps).

Seek local funding sources for the US – increasing the strategic value of deposit gathering activities (wealth management, corporate transaction banking, retail banking).

These issues are being complicated as other regulators are pressing banks to repatriate trades, putting further pressure on the US balance sheet.

Exhibit 30 America is the most profitable region Share of revenue and profit by region

0%

20%

40%

60%

80%

100%

Revenue PBTAmericas EMEA Asia


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M O R G A N S T A N L E Y B L U E P A P E R In the medium term, however, we believe the changes to local risk management frameworks and particularly the adoption of the CCAR (Comprehensive Capital Analysis and Review)stress-testing programme could be even more significant.

This year's CCAR points toward how punishing it is on capital markets businesses: The Fed projects all five big US dealers to take at least $10bn (and some over $20bn) in trading and counterparty losses in the severely adverse scenario. It is tough to know whether the post-stress risk-based capital ratio or the post-stress leverage test would be the binding constraint on capital in 2016 when FBO IHCs would get their first CCAR results, but there is a strong chance it will be the risk-based capital ratio for any firm still holding mortgage assets.

There are also material new operating costs resulting from the new stress testing and risk management procedures:

substantial one-off investments (we estimate $100-150mn for the most affected banks) to cover legal entity registration and build-out of new risk infrastructure (including CCAR) and reporting structures (including US GAAP), as well as ongoing costs ($20-100mn p.a.).

The proposed rules also place restrictions on the ability of foreign banks to use USD funding raised in US wholesale markets in funding global activities. The continued importance of the US dollar as the functional global currency of trade means non-US banks without access to USD liabilities will not simply be less competitive beyond just business undertaken in the US, but also in commodity finance, trade finance, and the like. That said we anticipate acceleration in the internationalisation of the RMB, which means this will diminish as a concern in Asia at least over 2013-14 (indeed access to RMB funding will become a key differentiator in that region).

Exhibit 31 Impact of US FBO proposals

Requirements Implications Expected Cost (p.a.)

Funding and Liquidity

Basel III liquidity ratios (LCR and NSFR) IHC must hold 30-day US liquidity buffer

under stress

Increasing term $ funding, most likely through group levelYankee issuance (avoid cross-currency swaps), accepting increase in funding costs

Acquiring of a source of stable local funding – increasing strategic value of deposit gathering

$0-300mn

Leverage & Capital Adequacy

Home country stress test and capital requirements

US BHC risk-based capital (de facto >10% Core Tier 1 / RWA) and leverage (de facto 7% vs. GAAP assets) requirements

US stress test requirements (internal company run and CCAR)

Shrinking US balance sheet - Leverage constrained: Repo, corporate loans - Stressed capital constrained: mortgages

Injection of capital into the US entity

$0-150mn1

Operational Governance: new US Risk Committee and CRO function

Risk processes: Compliance with CCAR process, Fed approval for risk models

Reporting: Annual, quarterly and monthly report submissions

Ongoing systems, processes, tools and resources to manage CCAR process and other US regulatory requirements

Establishment of US risk committee and appointment of US Chief Risk Officer

$20-100mn

1. Assuming cost of capital of 12% Source: Oliver Wyman analysis.

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M O R G A N S T A N L E Y B L U E P A P E R Exhibit 32 Diverging approaches to moral hazard and risk-taking activities

UK

EU

France

Germany

US

Regulation Independent Commission on Banking (Vickers)

“Banking reform” paper

Liikanen report (EU High-Level Expert Group)

Banking Reform Bill (Dec 2012); in close cooperation with German regulation

German draft legislation; in close cooperation with the French regulation

Dodd-Frank Act (DFA) §619: The Volcker Rule

DFA §716: Swap Push-OutApplicability UK banks with >£25bn

mandated deposits Likely to affect 2-5 UK

banks

EU banks >15–25% or €100bn of HFT2 & AFS3 assets

Likely to apply to 15–20 large EU banks

French banks >20% or €100bn of HFT2 & AFS3 assets

Likely to apply to 3 French banks

German banks >20% or >€100bn of HFT2 & AFS3 assets (only for banks >€90bn total assets)

Likely to apply to 2-4 large German banks

§619: All US banks and FBOs with $1bn+ in global trading assets

§716: FDIC insured institutions

Ring-fence type Retail ring-fence Trading entity Speculative trading activities unrelated to financing economy

Speculative trading activities unrelated to financing economy

§619: Not explicit ring-fence §716: Swaps dealer

Explicitly segregated into trading entity

Most wholesale / investment banking activities including market-making and underwriting

Non-EEA activity Transactions with other FIs

except permitted activities

Prop trading Market making Alternative investment

funding (HFs, PE, SIVs)

Prop. trading (without direct client context)

(High-risk) Trading activities above threshold

Market making without direct client context

Lending & guarantee business with HF & PE

Prop. trading (without direct client context)

(High-risk) Trading activities above threshold

Market making without direct client context

Lending & guarantee business with HF & PE

§619: Ban on proprietary trading and investment activity, subject to exemptions (e.g. US government securities)

§716: Trading in derivativessubject to exemptions

Timing 2019 TBD Examined by parliament Feb 2013, enforced by July 2015

Law expected Jan 2014, enforced by July 2015

§619: July 2014, dependenton final rule

§716: July 2013 RoE impact1 0.5-3% drag

Worst case: Additional capital and funding required

Best case: Mitigated via new funding structures

0.5-3% drag

Impacts and mitigation levers similar to UK ICB

Political process less certain

0-1% drag

Impact on RoE muted by limited scale of activity in the impacted areas

0-1% drag

Impact on RoE muted by limited scale of activity in the impacted areas

0-1% drag

Significant impact already absorbed

Depending on final rules, risks remain to core market-making activities

1. Range reflects regulatory uncertainty on average industry impact; 2. Held for trading; 3. Available for sale Source: Oliver Wyman analysis

Moral hazard reforms are manageable in isolation but add complexity to the puzzle

Regulators have drafted a range of widely varying regulations aiming to insulate deposit-insured retail banking from the risks arising from trading activities, ranging from the Volcker rule in the US, to the Independent Commission on Banking (ICB) proposals in the UK. We believe that taken in isolation the regulatory goals of these ‘moral hazard’ reforms may be addressable with only limited incremental impact on wholesale banking RoEs. However much remains dependent on the final specification of the rules. Furthermore, the US, the UK and wider European rules add complexity to the design of international legal entity structures and funding models.

The UK is the most committed to ring-fencing and is pressing ahead with the ICB proposals to ring-fence the retail bank, although key details remain to be defined. In Europe, the Liikanen proposals suggested a comprehensive ring-fencing of trading activities, although national proposals (e.g. France and Germany) are somewhat more narrowly focused.

There has been much talk of trapped capital and liquidity from ICB/Liikanen-type separations – and a first pass analysis can indeed lead one to be nervous. But we think that overall effects

will be muted with a maximum average loss of 2-3% off RoE on the wholesale bank and a best case impact of near zero. Careful positioning of funding sources across entities is the key lever in managing down financial costs, with much depending on the final details of the proposals.

In a realistic worst case, loss of sovereign support and structural subordination effects would result in a 2-notch downgrade to senior ratings, with a knock-on impact on short-term ratings and the ability to issue AAA covered bonds. In such a scenario, we envisage banks raising additional capital to reduce the rating impact and suffering a funding cost hit to senior unsecured funding – translating into a 2-3% points loss of RoE on average to European trading entities, albeit with significant skews across banks.

At the other end of the spectrum, positioning of funding at a mix of holding company and operating subsidiary levels could mitigate the prima facie impact of Liikanen-type separation on earnings diversity; rating agencies may continue to view holding companies and trading entities as enjoying some degree of sovereign support and the financial impact could be near zero.

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M O R G A N S T A N L E Y B L U E P A P E R Operational separation would inevitably create some duplication, while increasing the complexity of management. However, we believe that more extreme operational impacts can be effectively mitigated through use of operating subsidiary structures separate from the financial subsidiaries as well as shared services and service level agreements consistent with a carefully considered recovery and resolution plan. If this were well managed, we would expect the operational cost impact to be <0.5% of RoE.

The US has taken a different tack through the Volcker rule, which is edging towards implementation, while swaps pushout (section 716) introduces a ring-fence of sorts by removing a large portion of swaps from legal entities holding FDIC-insured deposits and branches of foreign banks. Much has already been done to adjust to the Volcker rule, suggesting limited further RoE impact in a base case implementation. However material risks to this view remain, pending the final rule definition.

We believe the industry has to move faster in restructuring its legal entity and funding models and proactively engage with the regulatory community around the solution. While the industry has started to grapple with the regional participation choices posed, less progress has been made in reconciling legal entity and funding structures across these multiple constraints. Banks must find a way to achieve the goal of improved recovery and resolution, while minimising the costs to shareholders and debtholders. This is a complex optimisation that must also consider client booking requirements, operating costs and revenue implications, and risk management considerations.

Optimising legal entity structure raises a host of practical questions: How many legal entities do you need in each jurisdiction?

Do you operate with a branch or a subsidiary? Is an ‘international CIB unit’ a viable option in a major hub?

What is your main determinant for which assets go to which legal entity in the new world order?

- Trader / salesman has to be licensed and supervised by regulator of legal entity of destination?

- Client preference for booking locally?

- Regulator preference for booking locally?

- Consolidation of certain products in one booking location to save costs?

- Margin and netting considerations, as well as collateral availability within legal entity?

- Tax regime differentials or tax credit considerations?

Can you continue to manage “global books” in the major hubs? If not, where are the best locations to manage market and credit risk? And how should this be monitored, managed and controlled?

How costly are changes to legal structure and balance sheet usage to implement? When could second order costs like tax exceed potential benefits?

Given the uncertainty around some regulatory outcomes, and the considerable changes seen in other recent regulation, there is an understandable temptation to “wait and see” on this question. We believe a more proactive approach is warranted by banks to set out clear suggested changes to structures and to engage with regulators, rating agencies and investors to build support around a proposed way forward.

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M O R G A N S T A N L E Y B L U E P A P E R EU Financial Transaction Tax (FTT)

The FTT has considerable political momentum but debate remains around the final form. Due to be implemented by 11 EU Member States in January 2014, the FTT Directive proposes a tax on all types of financial instruments (excluding spot FX and physical commodities). However, Member States have increasingly diverging views over exactly how to administer this tax, with France (Aug 2012) and Italy (Mar 2013) already having introduced different scopes, rates and technical design features. Notable exemptions to these taxes include market making and intra-group transactions.

The current draft directive would be costly in its current form, as it is broadly defined and has very few exemptions. There are no exceptions for intra-group transactions or market making, and would be applied at a gross level for each leg of a transaction. This means a particularly high impact on high turnover products. For example, our analysis of the potential impact on the FX market suggests a direct increase in transaction cost for eligible FX product transactions of 3-7x, and an even larger cost of up to 18x for very high turnover products such as FX swaps with maturity less than 1 week. Also, financial institutions located outside the EU would be obliged to pay the FTT if they trade securities originally issued within the EU.

Transaction costs will increase the most for derivative transactions with a tight mid-to-bid, but local cash equities and listed derivatives are most susceptible to taxation. The global nature of derivatives means that where possible users will relocate these transactions to non-taxable jurisdictions executed out of non-taxable entities; the exemptions in the Netherlands and Ireland are key enablers. Purchases and sales of local cash equities and listed derivatives are most tied to local markets so cannot move outside the tax remit, and there is limited scope for mitigation. Bond activity would face a more marginal impact due to lower underlying trade velocity. Hedge funds and asset managers with flexible mandates are likely to re-balance their portfolios away from affected markets. The largest impact would likely be on end-users that are least mobile, meaning higher costs and / or less hedging in corporates, and potentially higher asset liability mismatch and basis risk in pensions and insurers.

There is considerable debate around the current Directive and we anticipate material change. Key elements that make change likely are:

Adverse impact on Member States’ real economies due to costs being passed on to end-users and “cascade” effects

Challenging collection process

Extraterritorial scope and potential for reactionary measures

Creation of an uneven playing field (between participating and non-participating EU member states) hindering enforcement

Hinders functioning of repo markets, disrupting bank funding mechanisms

That notwithstanding, we believe that this poses meaningful downside risks to banks, exchanges and end-users in affected countries, given the political momentum behind the policy.

1.2 Conduct, culture and compensation

The industry is beginning to adjust to the medium term implications of the linked challenges of conduct, culture and compensation reform. The stakes are high – we estimate the impact of a conduct-related loss on market value is 2-3x higher than the impact of an equivalent ‘on strategy’ trading loss. Different responses in different jurisdictions will further reshape the industry landscape, with the stance on bonus caps the most significant distinction to emerge to date.

Wholesale conduct risk is moving up the regulatory agenda and shifting in emphasis The recent history of the industry is blighted with conduct failures. Few global wholesale banks have failed to be impacted by one or more of the various scandals around market manipulation and mis-selling, or trading control issues. Regulators are responding with new rules and frameworks, with potentially far reaching implications. This means not just increased compliance burden as banks adopt more sophisticated approaches to ‘conduct risk management’, but also more fundamental changes to the way business is done in some areas – and potentially erosion of revenues as a result. The European and American approaches are diverging, with the Americans hardening the existing legalistic and compliance-driven approach while the Europeans pursue a more principles-based and pro-active approach. This latter approach is harder for banks to respond to, with the concept of appropriate margin particularly difficult to manage to in an industry where cross-subsidy of ‘franchise building’ loss-leaders by higher margin products is common.

The stakes are high. We estimate that over the last 5 years conduct breaches have cost the industry $30-40bn in lost revenues, reparations and fines. And these losses have a much higher ‘multiplier’ effect on bank valuations than ‘normal’ trading losses. The decrease in market capitalisation relating to a conduct loss is typically 2x to 8x greater than the size of the underlying loss event, depending on the type of event. This compares to multipliers on announced ‘normal’ trading losses that are typically in the 1-2x range.

24



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 33 Conduct risk has emerged as a very material source of value destruction

Risk Size of loss/fine

($bn) Market cap

impact* ($bn) Multiplier**

Mis-selling 0.5-1 1-8 8xTrading control issues 2-7 5-13 2xMarket manipulations 0.2-1 1-5 4xOther conduct fines 0.1-2 ~1 6x

‘Normal’ losses 0.5-6 0.5-6 1-2x

Key: “On-Strategy” Loss “Conduct Risk” events * Measures underperformance relative to a sector index at the time around the loss ** Measures the ratio of market cap impact to size of the loss/fine Source: Oliver Wyman analysis

The emerging European regulatory frameworks mark a departure from the compliance-driven approach of the past to one that will require an approach that is led from the top, embedded in the frontline and driven by judgement. Key characteristics of the new approach include:

Focus on root causes (e.g. culture, incentives, governance),

Greater scrutiny of strategy and business models,

Early identification of potential systemic issues, and

More interventionist – particularly on the business and leadership rather than risk or compliance.

While Europe has taken a more principles based approach, the US remains on the legalistic and compliance driven path in its approach to tightening conduct. This approach has been taken across various markets in the wholesale space. For example, Title 7 of the Dodd-Frank Act lays out, among other things, explicit, heightened rules that govern how swap dealers may interact with their customers and impose onerous pre-trade compliance requirements that will have an impact on the speed and effectiveness of trading. These requirements are tailored to the type of counterparty (e.g. special entity) – another example is the CFTC tightening of segregated account rules.

What should the banks be doing about it? Achieving best-in-class capabilities for managing conduct risk requires:

Adequate senior attention – the potential cost and share price implications of conduct mishaps should be a part of management performance review.

Robust governance and accountabilities that extend down into the desk / originator level, which is where these risks are taken.

Clear understanding and awareness by the business of conduct risk, its cultural implications and management’s role in the first line of defence.

A comprehensive set of tools and adequate resourcing to ensure that second and third lines of defense can provide a robust oversight.

There is a raft of alternative directives and regulations across regions. While abiding by local regulations is essential, global coordination will be necessary to avoid cross-border issues. Some banks have even decided to implement the strictest jurisdictional standards on a global scale in order to avoid this problem.

Exhibit 34 Wholesale Conduct Risk framework

Product design

Elements of the framework

Clear articulation of Conduct Risk definition and strategyStrategy

SalesPost-sales

Governance and culture

Infrastructure

Embedding Conduct Risk assessment into new product governance value chain

Conduct Risk controls in place against each step of sales process

Active monitoring and remediation post-sale where appropriate

Formal and informal processes to embed into culture

MI, metrics and Conduct Risk reporting architecture

1

3

4

5

Risk appetite2

Embedding and cascading into Risk Appetite statements

Tools and processes


25



M O R G A N S T A N L E Y B L U E P A P E R A key pillar is the linked challenges of compensation and culture reform

Increased emphasis on business conduct underscores a wider shift in the talent management model from one characterised by star producers to a more industrial approach. Individual discretion and innovation are reduced in importance while control, standardisation and franchise value is increased. This has implications for the required profiles of people to attract, retain and promote, and for compensation structures.

Diverging regulatory approaches to compensation add to the challenge. The introduction of bonus caps in the EU (in CRD4) and “say on pay” will put additional pressure on variable compensation and create further challenges for European banks globally as well as banks operating in Europe. The challenge will be to identify sustainable risk-adjusted performance at a team and individual level (alpha vs. beta performance) against the backdrop of cross-jurisdictional differences in terms of the consistency of comp approaches and competitiveness. The challenge is particularly acute for European banks operating globally who will need innovative solutions to avoid being disadvantaged in the battle for talent outside of the home market.

This is in the context of continued economic pressure on compensation levels. While 2012 saw compensation : revenue ratios fall (43% in 2012 vs. 50% in 2011), compensation as a percentage of economic profit remains stubbornly high, as do capital and infrastructure costs. In a context where the overall compensation pool will remain constrained, banks need to adapt their approaches to retain top talent (vs. advantaged peers, the shadow banking sector and boutiques) and motivate their workforce to perform. Two types of initiatives will differentiate winners in terms of Talent Management:

Effective re-assessment of the employee value proposition to steer performance in a lower bonus environment, seeking motivational levers outside of variable compensation – focus on culture, team environment, career prospects, type of work, branding and public perceptions of the company, non-traditional benefits, quasi-partnership approaches, etc.

Bringing performance management to the next level: more granular assessment of risk adjusted performance taking into account franchise value brought by the bank vs.

individual and team performance, cooperation frameworks as part of performance measurement, KPIs and objectives setting, on-going management and clarity of the link between performance and compensation and other motivation levers.

The experience in the UK mid-market derivatives business provides an interesting case study for the potential business impacts of conduct risk.

The market in derivatives and FX sales to UK mid-market corps and SMEs has been hit by severe challenges over the last 2-3 years, with considerable business erosion as a result, and a risk of continuing erosion. The challenges include:

Provisions for fines that we expect to total ~£1.5bn across the industry

New and more proactive regulatory oversight from the Financial Conduct Authority (FCA)

Customer suspicion

Nervousness about the product set among bank relationship managers

However, we still see this business as a key part of the mid-market / SME product portfolio, serving a real economic need. A derivative remains the cheapest and most effective product for managing interest rate risk in most cases, with more favorable terms and often better pricing than fixed rate loan structures.

To ensure a sustainable franchise banks are taking action to overhaul their approach to the business:

A more formulaic, controlled sales approach supported by simple menus of products

Rules over appropriate products for different target customer bases

Removal or radical overhaul of sales-based incentives for front-line sales staff

Better use of the credit process and formal reporting structures in decision-making

Taken together this implies a significant change to the culture and approach of the business. In financial terms it means a smaller, more slimly resourced, but still profitable business.

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M O R G A N S T A N L E Y B L U E P A P E R Chapter 2: Shifting Sources of Value2.1 Transformation of the OTC markets

The transformation of OTC markets is now under way and will drive profound shifts in value. The aggregate impact on revenue pools, however, now looks more clearly bounded and phased. We anticipate the reform will force $5-10bn of current revenue to migrate out of the sell-side by 2015 (off a total OTC derivative revenue base for the industry of ~$80bn) and this is likely to rise to $10-15bn in 2018 in our base case. Partially offsetting this will be new opportunities in clearing provision and new solutions to address the huge increases in collateral demand (+$1.4trn by 2018). We estimate $5-8bn offsetting revenue at stake by 2018, with the spoils to be divided between those sell-side providers, global custodians and market infrastructure players best able to adapt.

Revenue erosion over 2014-18 Our base case is a revenue decline of $5-10bn in existing execution revenue pools by 2015, primarily driven by increased capital and funding costs for both dealers and clients. While this represents a 10-20% reduction in revenues in the most heavily affected areas, it is only 6-12% of total OTC derivative pools, and 3-5% of total sales & trading revenues. The impact is heaviest in FICC, where we estimate revenue erosion represents 3-7% of total S&T revenues. We expect a "rolling thunder" as mandatory clearing in Europe is not expected until 1H 2014, while Initial Amounts (IA) margining rules for uncleared bilateral trades will only begin to be phased in during 2015 and whose impact has been mitigated by the introduction of a €50mn threshold. The impact in 2013 is likely to be minimal (<0.5% FICC revenues at risk), potentially growing to $10-15bn in 2018. We put a bull / bear range around the 2018 impact of

$5bn / $25bn, with key uncertainties around the level of volume and margin erosion.

Affected activities represent $40-75bn of 2012 revenues OTC derivatives contributed ~$80bn in revenues in 2012, representing ~45% of total sales & trading revenues across equities and fixed income. Regulation is now driving the OTC market into four broad buckets:

$20-25bn of revenue in liquid contracts likely to become classified as standardised and mandated for central clearing and SEF / OTF (electronic) execution, having already started in the US in March 2013, with Europe to follow in 2014 and Asia thereafter.

$15-25bn of uncleared institutional OTC derivative contracts that fall above the €50mn threshold that will see dealer and end client collateral requirements increase dramatically as two-way initial margin is posted for the first time.

$10-20bn of uncleared institutional OTC revenues with clients will fall under the €50mn threshold for new IA-exemption and remain broadly unaffected.

$20-25bn of end user (primarily corporate) derivatives are exempt from clearing and margining requirements, but since most are uncollateralised they would be heavily affected by CVA VaR capital charges under Basel 3. However the EU is currently proposing a further exemption for corporates from these rules – it is unclear as yet if / how this will be addressed globally.

Exhibit 35 Revenue impact of OTC transformation Decline in S&T revenue – 2015E & 2018E, $bn

0

5

10

15

20

25

Base Bear Bull Base Bear Bull

FICC Equities

5-10

~15

~3

10-15

~25

~5

2015E 2018E


Exhibit 36 Revenue pools affected by OTC reforms Product type 2012 Revenue $bn Impacts

CCP cleared OTC 20-25 Margin erosion Volume pressure

Margined (IA) OTC 15-25 Volume decline

End user OTC 20-25 Possible volume decline

Non-IA OTC 10-20 None

Listed, cash and financing 110 Volume growth

Total S&T 192 $5-10bn decline

Key: Affected by regulation Potentially affected by regulationSource: Oliver Wyman analysis

27



M O R G A N S T A N L E Y B L U E P A P E R Volume reductions more important than margin erosion The key driver of our bull / bear range is the extent of migration of client trades away from OTC derivative structures, driven by increased margin costs and limited (or even no) ability to rehypothecate. We have anchored our base case estimates in a 5-20% volume reduction across different product and client types. The impact is heaviest in uncleared margined product where the incremental funding costs for both dealers and clients are the largest. It is lowest in corporate derivatives where the proposed exemption would remove this effect from EU banks, and where the lack of viable substitute products means the scope for passing on the cost is the highest.

The impact on margins of the migration to SEF / OTF platforms is likely to be more evolutionary in our base case, and limited to the $20-25bn standardised derivatives revenue pool. We

expect incremental change to the current RFQ-based system of electronic execution rather than a more radical shift to an exchange-like execution structure. The market is anticipating adjustments to some of the key US proposals (minimum number of quotes required, block trade thresholds, post trade reporting timelines), and it looks unlikely that Europe will be more aggressive. That notwithstanding, we do anticipate continued margin pressure on standardised (cleared) swaps as they electronify and execution becomes increasingly price-driven. Trading styles will change as liquidity clusters around standardised contracts, with fewer arbitrage opportunities within the curve and more quasi-algo automated trading and monetisation of client flows. This, along with increasing value to clients in speed, reliability and breadth of access means technology becomes an important competitive differentiator.

Exhibit 37 Regulatory overview Product type Regulation Key requirements Timing Products affected Impact drivers CCP cleared OTC US: Dodd-Frank

EU: EMIR, MiFIR, MiFID II

Mandatory CCP-clearing for standardised OTC contracts

SEF / OTF execution

US: 2013 EU: 2014

Interest rate swaps CDS Equity swaps

Electronic trading Funding costs

Margined (IA) OTC BCBS / IOSCO proposals

Initial margin (IA) requirement on non-CCP cleared OTC

Phased over 2015-19

Structured OTC (credit, rates, equities)

FX options OTC commodities

Initial margin funding costs

End user exemptions: OTC

US: Dodd-Frank EU: EMIR, MiFIR,

MiFID II Basel III

End-user exemptions from clearing and margin requirement

Corporates, pension funds, public bodies

2013-15 All OTC derivatives CVA VaR RWA (if not exempted)

Non-IA OTC BCBS / IOSCO proposals

Exemptions from IA requirement - FX forwards and swaps - Net exposure and gross notional

thresholds

n/a All OTC derivatives (non-standardised)

Margin exemptions


28



M O R G A N S T A N L E Y B L U E P A P E R Capital and funding costs will drive new competitive dynamics

Current proposals imply a material increase in the combined capital and funding costs for dealers executing derivative trades. By way of illustration the capital and funding cost of an example interest rate swap contract increases by 1.5x under client clearing under current proposed rules, and by 3-5x under uncleared initial margining rules. Navigating capital and funding costs are therefore critical concerns driving the new competitive dynamics.

Clearing increases the importance of depth over breadth in client relationships. Under current proposals the clearing broker bears capital costs from its exposures to the central counterparty clearing house (CCP) and the client, while the executing broker bears the funding costs of posting margin to cover its own exposure to the CCP. The key question the industry is now grappling with is how to achieve payback on the extensive capital and operational costs of clearing. We don’t believe that a model in which clearing is given away for free or at nominal cost is viable given these costs, and have seen the industry moving away from this model over the last 12-18 months. However, it also remains unlikely that clearing will become a high RoE business on a standalone basis. Banks have two broad avenues to pursue in delivering payback on the clearing proposition:

Driving links between clearing, collateral optimisation, and collateral financing / transformation; or

Positioning clearing as a prime-like service to drive deeper relationships, targeting benefits in increased execution flow, acting as SEF-aggregators and delivering execution services to connect to SEF / OTFs on behalf of clients.

In general, this will favour global scale players able to achieve payback across a broad waterfront of products and services. However, as the leading globals lack bandwidth or appetite to clear the whole market, opportunities will remain for smaller dealers, particularly with local institutional clients seeking a clearing relationship with a local bank.

In uncleared bilateral markets the high margining and capital costs are the key concerns. Pricing idiosyncrasies will arise as margin requirements are a function of the existing netting set. There will be opportunities for banks able to devise innovative structures to deliver risk management solutions that effectively navigate these constraints, and in particular for banks able to offer solutions to optimise client margin requirements, since this is a critical concern for clients.

Exhibit 38 Institutional swaps: Increasing credit risk and funding costs Cost to dealer of providing alternative forms of IRS trade (5yr)

0 10 20 30 40 50 60 70

Non-cleared withoutIA

Non-cleared with IA

Execution-leg

Clearing-broker leg

Current OTC model

Sell-side cost p.a. ($k per $100MM notional)

Funding Capital (full EPE) Capital (short-cut method)

Standardised OTC contracts (Basel 3)

Non-standardised OTC contracts (Basel 3)

Current model(Basel 2)

Source: Oliver Wyman analysis Notes: Based on 12% cost of capital and A-rated counterparty, using internal model approach. Default fund exposure estimated using 50% CCP risk weight: RWA requirement for client-exposure in CCP-cleared trade based on 5-day MPOR. Under current B3 ‘shortcut method’, benefits of posting margin are not recognised in exposure calculation – capital and funding costs become additive. Residual exposure in full EPE re-modeling assumed to be 30% of ‘individual amount’ posted - driven by correlation between value of collateral posted and trade value (wrong-way risk). Funding cost estimated using spread of FTP rate over OIS rate.

Sharper participation choices, underscoring regionalisation More broadly, the reforms raise the bar for participation in a market as new capabilities are required, driving up infrastructure costs. For example, many banks will have to upgrade risk management engines in order to effectively capture the capital-saving benefit of posting initial margin. Failing to have this capability in place (and using the ‘short cut method’) would drive a 20-50% higher cost on uncleared margined derivatives. Similarly, many banks must invest in upgrades and improvements to their collateral management technology and operating models. And of course there are the operational and financial costs of connecting to a CCP.

These participation choices have an increasingly strong regional dimension:

The CCP landscape will differ by region, with inter-operability limited in the foreseeable future.

Netting benefits for dealers will be at the legal entity level (typically local) and focused by CCP, not at the global level.

New trade-offs among institutional clients, with some offsetting growth Investors will face a new set of trade-offs between standardised OTC, margined bilateral OTC and futures. We anticipate some pick-up in share of hedging flow as investors substitute away from OTC products, although we see some natural limits to this effect:

29



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 39 Product trade-offs: The client perspective

Margined OTC derivatives Standardised swaps Futures

1. Direct execution costs (bid/offer and commissions)

2. Indirect execution costs (slippage, information leakage)

3. End-client funding

4. Basis risk and flexibility

Key: Advantaged Neutral Disadvantaged


Current margin advantage of futures is likely to be eroded under proposed new rules that establish an equivalent margin period of risk for CCP-cleared OTC and exchange-traded contracts.

While ‘direct’ execution costs may shrink in exchange-like environments, this is offset by increased ‘indirect’ costs of execution, in particular price slippage. This is particularly important for large orders, where the bulk of the value lies.

Liquidity remains limited in futures – needs a tipping point and we don’t see the impetus for this in the near term.

OTC instruments remain more flexible, minimising basis risk for end clients.

Government bond and other cash securities are also likely to see growth as investors switch into these instruments.

$1.4trn of extra collateral needed by 2018 requiring new market solutions The proposed introduction of Initial Amounts (IA) implies an increase in collateral demand of $0.7trn by 2018, on top of the incremental $0.7trn on cleared swaps in our base case. New timelines enable a gradual implementation of IA rules starting from 2015, so a long-term collateral squeeze is now more likely than a near term de-stabilising ‘crunch’. Challenges for the industry are manifold:

Increasing the robustness of current collateral systems to handle the increased number of portfolios and industrialised third-party custodial arrangements.

Managing the data quality, both upstream from CSAs and client metadata, to downstream feeds of client-specific CSA terms into CVA desks and pricing engines.

The formation of an industry reference model (and its accompanying data standards and governance model) with the calculation of IA – without its existence, hundreds

of firm-specific VaR models could paralyze trading from unresolved disputes.

A new operational paradigm for dispute resolution, both legal and process based, given that it will move beyond valuations to a risk model basis.

This change is also driving a fundamental shift of focus onto management of liquidity risk, rather than on-balance sheet counterparty credit risk. The second order impacts of such a large increase in collateral levels on bank balance sheets is only just beginning to be understood.

We see a range of expected outcomes of $1.5-2.2trn around our 2018 estimates, with much dependent on industry-level solutions to mitigate the increases.

Market participants need to converge upon the use of regulatory approved risk models for margin calculations to avoid posting punitive levels of collateral based on the standardised schedule.

The use of exposure-based exemptions could be optimised via strategic management of individual counterparty exposures.

The level of re-hypothecation of initial margin allowed in the final rules and investor appetite will sway the impact on cost of funding.

Many of the key levers that enable the industry to control the aggregate collateral demand require a co-ordinated effort across dealers, buy-side and infrastructure providers. Delivering against these solutions will be challenging as the cost-benefit incentives are skewed across market participants:

Exhibit 40 Future collateral requirements1 for OTC derivatives Base case, $trn

0.20.4

0.8 0.9 0.90.2

0.2

0.3

0.9 1.0

0.4

0.6

1.1

1.91.8

0

1

2

3

2012 2013 2015 2018 2020

Bilateral Total Range of expected outcomes

Incremental collateral need vs 2012 ($TN)

Collateral as % of unencumbered assets (dealers only)

-

4%

+0.25 +0.75 +1.4

5% 8% 11% 12%

+1.5

1. Excludes potential collateral re-use (re-hypothecation), and excludes netting across assets classes; Source: Oliver Wyman analysis, BCBS / IOSCO QIS

30



M O R G A N S T A N L E Y B L U E P A P E R Dealers to drive for solutions that limit the impact on

existing OTC model.

‘Collateral rich’ buy-side clients likely to favour transparency and operational independence.

Competing interests among infrastructure providers as they target potential new revenue streams.

The demand for OTC post-trade services will generate a revenue opportunity of $5-8bn; global custodians and sell-side are well-positioned to take ~80% We see this as a $5-8bn opportunity in clearing and collateral services by 2018, with the spoils divided between those sell-side providers and market infrastructure players best able to adapt. Sell-side and global custodians are well positioned to capture a large share (~80%) due to balance sheet and risk taking capabilities. Market infrastructure providers are well placed to fulfill central utility roles, but we expect revenue share to concentrate among 3-5 CCPs and 2-3 international central securities depositories (ICSDs). We see five key battlegrounds:

1. CCPs / exchanges offering OTC clearing platforms: We expect the revenue opportunity to be limited by the utility approach and level of competition (~$1bn; ~5% of total post-trade revenues).

2. The collateral management opportunity, driven by a demand for additional visibility and mobility. ICSDs and custodians will seek to complement traditional businesses; dealers and prime brokers will also seek to play a role. The revenue opportunity is dependent on a final solution but we expect a gradual ramp-up over 2014-18.

3. Client clearing as an anchor product for derivatives franchises for the sell-side. Standalone revenue

opportunity likely to be relatively small compared to overall global custodian / sell-side revenue pools. Strong collateral transformation capabilities will be a key differentiator, operational excellence a requirement.

4. Collateral transformation: upgrade trades required to ‘eligibilise’ collateral for margin. Level of demand will be dependent on range of collateral accepted by CCPs and margin platforms. Likely to be an attractive add-on service to (client) clearing; the key competitive differentiator will be ability / client confidence to maintain transformation service in periods of stress.

5. Outright margin lending as a pure banking / balance sheet business. Revenue upside restricted to those able to commit balance sheet and risk capacity.

Exhibit 41 Drivers of aggregate collateral demand

I I

LeverImpact on collateral demand

(vs. 2018E base case)

1. Standardised schedule vs. internal models

2. Level of netting achieved(Cross-asset, cross-CCP)

3. Scale of collateral re-use permitted (re-hypothecation)

4. Use of exemptions (€50MM exposure floor)

Range of expected outcomes Spectrum of impactLegend:

Cross-CCP None

High Low

Full None

Internal model

Standardised schedule

I I0 + $10TN

- $0.2TN 0

0 + $0.8TN

Cross-asset

- $0.5TN 0

I I

I I

I I

I I

LeverImpact on collateral demand

(vs. 2018E base case)

1. Standardised schedule vs. internal models

2. Level of netting achieved(Cross-asset, cross-CCP)

3. Scale of collateral re-use permitted (re-hypothecation)

4. Use of exemptions (€50MM exposure floor)

Range of expected outcomes Spectrum of impactLegend:

Cross-CCP None

High Low

Full None

Internal model

Standardised schedule

I I0 + $10TN

- $0.2TN 0

0 + $0.8TN

Cross-asset

- $0.5TN 0

I I

I I

I I


Exhibit 42 OTC post trade revenue pool map (2018E, $bn)

CCPs CSDsMargin utilities

Global custodians

Sell-side/ PBs

Buy-side Total

CCP clearing ~1

Collateral mgmt. 0.2 - 0.4

Client clearing 2.5 – 5

Collateral transformation 0.8 - 1.0

Margin lending 0.5 - 0.7

Total ~1 ~0.1 ~0.1 1 - 1.5 3 - 5 ~0.1 5 - 8

Key – size of revenue opportunity: High Medium Low

1. CCPs /exchanges building OTC clearing platforms across the globe

2. Collateral mgmt. providing visibility and mobility services to enable optimisation – opportunity driven by margin requirements for non-cleared derivatives

3. Client clearing as an anchor product for derivatives franchises

4. Collateral transformation; upgrade trades required to ‘eligibilize’ collateral for margin

5. Outright margin lending as a pure banking / balance sheet business


31



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 43 Post-trade service models: old and new

CCP clearing

Collateral management

Client clearing

Collateral transformation

Margin lending

2 34

5

67

8

Existing model New model

Post-trade providers Financial intermediaries

1


We see a range of existing and new models emerging with more integrated offerings complementing specialists. More integrated models countering collateral fragmentation tend to be better positioned and likely winners. Whereas sell-side / global custodians already have moved to integrated offerings given their prime services capabilities, market infrastructure players are only starting to move. A number of specialist initiatives focusing on margining and collateral services are beginning to emerge, but most are still at a conceptual stage.

1. OTC CCPs: CCPs around the world are currently building and ramping up OTC clearing platforms – we expect only a few to dominate.

2. Tri-party ICSD offerings: Larger ICSDs have long established tri-party collateral management models, and are currently building out offerings as well as establishing alliances and bridges to other actors.

3. Margin utilities: There are various initiatives in a very early conceptual stage in the market to establish utilities for margin calculation, processing and netting for non-cleared OTC derivatives.

4. Integrated OTC infrastructure: We expect closer integration of clearing with collateral management for

non-cleared derivatives given substantial processing and margining efficiencies of combined offerings – but players only just starting to move in this direction.

5. Tri-party custodian offerings: Global custodians have been actively pushing tri-party collateral management services for a while – a natural extension to the incumbent operating model.

6. Clearing broker: Sell-side and custodians have recently added OTC clearing services and are preparing to ramp up volumes as client clearing kicks in – key test is how scalable solutions prove to be and the economic viability of a standalone clearing model.

7. Integrated OTC broker: Several players are developing integrated prime services, offering OTC clearing combined with collateral provision as a natural extension of listed and further prime brokerage activities. Operational delivery is complex and scale will be required to win the key mandate – expect a small number of winners to succeed.

8. Collateral specialist: There are early stage initiatives for banks and buy-side to build additional collateral provision services – key challenge is establishing critical mass to enable efficient functioning.

32



M O R G A N S T A N L E Y B L U E P A P E R 2.2 Structural and cyclical shifts in revenue pools

We are cautiously optimistic on the revenue outlook for the industry. We see a number of structural growth drivers linked to deleveraging and capital markets deepening. Disintermediation in Europe is a multi-year opportunity as regulators shrink Europe’s supersized banks and squeeze them out of long-dated lending, while capital market deepening continues in Asia. The function of the industry in quickly recycling illiquid risk will remain vital, though fewer firms will have the risk appetite to play this role. While we see cyclical growth for equities, we believe the business now looks less geared to the upside than in prior up-cycles.

We are cautiously optimistic on the revenue outlook for the industry

Our base case is for revenues to remain broadly flat through 2013, with a cyclical upside in equities, ECM and advisory gaining momentum through the medium term as macroeconomic threats subside.

2012 saw two key main effects driving the overall pool up by $20bn over the year:

Rebounds from 2011 losses across credit-linked products and Eurozone sovereign crisis effects, combined with tail

winds from central bank action (LTRO, Fed mortgage purchases).

Underperformance in volatility-linked businesses (swaps, FX, commodities and equities).

For 2013 we anticipate revenues to remain flat driven by three separate effects:

Normalisation of some rebound effects in credit and securitised products, and LTRO effects in rates;

Growth in FX and commodities driven by an improved macroeconomic outlook, volatility, and demand for hedging.

Stuttering growth in equities and a release of some banking revenues foregone in H2 2012.

Looking out to 2015 we assume a base case revenue CAGR of 3-4%, with cyclical and structural growth of $20-25bn weighing against regulatory headwinds from OTC reform of $5-10bn. This places industry revenues close to 2010 levels, but still $20-25bn below 2006 levels despite GDP growth of 4-5% p.a. over the period.

Exhibit 44 Historical and forecast wholesale industry revenue pools 1993-2015E, $bn

-300

-200

-100

0

100

200

300

400

'93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13E '15E

Rev

enue

s ($

BN),

GD

P (In

dex

2000

=100

)

IBD Equities Credit FX/EM/Commod Rates Writedowns/losses GDP

Total 75 70 65 80 100 110 155 140135 120 150 175 215 280 300 205 265315 260220 245

ROE (%)

240

19 8 10 15 17 14 22 1322 10 17 17 20 25 3 -25 1318 8 12

Bear

Base

Bull

BearBaseBull

Base Case


33



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 45 Revenue evolution 2011-13E, $bn

0

50

100

150

200

250

300

2011

FIC

Cre

boun

d

Vol-l

inke

dde

clin

es

2012

Nor

mal

isat

ion

of re

boun

def

fect

s

Und

erly

ing

grow

th 2013

FICC Equities IBD

Bull

Bear

Sources: Oliver Wyman analysis

Exhibit 46 Weak volumes and revenues in equities despite index recovery CAGR in recovery phase

-10%

0%

10%

20%

30%

1995-97 2003-06 2009-12

Revenue1

MSCI value2

Volumes3

1. Revenues: Total market wide equities sales and revenues in $ terms 2. MSCI value: Value of the MSCI equity index 3. Volumes: Value of shares traded across key global stock exchanges Sources: WEF, MSCI, Oliver Wyman analysis

Cyclical upside in equities, but less geared than prior cycles

A key question is the extent and timing of the revenue recovery in equities. In recent historical up-cycles equity revenues have tracked or outperformed growth in index values and traded volumes. The 1995-97 up-cycle saw revenues broadly track index growth. The 2003-06 up-cycle was boosted by the explosion in hedge fund leverage and structured products, with revenue growth outstripping index growth. 2009-12 by contrast saw valuations increase 11% but revenues fall 8% as volumes failed to recover, and volatility and capital pressures increased.

We believe in part this reflects cyclical concerns as investors have stayed on the sidelines amidst economic uncertainty. We would therefore expect this pattern to in part reverse when macroeconomic conditions genuinely improve. 2013 to date has however confirmed the enduring fragility of the recovery.

There are also structural headwinds for the industry that lead us to believe the cyclical upside may be more muted than in prior up-cycles. Pressure is most intense in the cash business where we are particularly concerned about the impact of the shift towards passive investment strategies and the impact this has on traditional brokerage income. For instance, we estimate that index mutual funds and ETFs have moved from 2% of mutual fund AUM in the US in 1995 to ~16% in 2012. The quality of revenues has also declined with institutions favouring flow products through electronic channels. Electronic execution now accounts for 40% of total cash revenues compared to 25% in 2006-07. At the same time a combination of shifting client demand and regulatory pressure is driving derivatives towards lower margin simpler structures, and lower risk capacity in trading books.

Our base case is for flat revenues in 2013 (with a bear / bull of $49bn / $53bn), meaning continued pressure on equities franchises. We expect ~8% annual growth out to 2015 to hit $65bn, although the timing and extent of the recovery remains uncertain – we put a bear / bull of $47bn / $70bn around our 2015 base case.

Secular growth from deleveraging and credit intermediation

We see a number of structural growth drivers linked to deleveraging and capital markets deepening. Disintermediation in Europe is a multi-year opportunity as regulators shrink Europe’s supersized banks and squeeze them out of long-dated lending, while capital market deepening continues in Asia. The function of the industry in quickly shifting illiquid risk is vital, though fewer firms will have the risk appetite to play this role.

A specific opportunity is the deepening of the European Debt Capital Markets (DCM). The substitution of syndicated term loans for DCM has largely played out among Northern European large corporates. The next wave of growth is achievable by attracting mid-sized corporates that were previously reliant on bilateral bank loans to the bond market, and extending this story into Southern Europe. There are twice as many ‘mid-sized’ corporates in Europe compared to the US, but the penetration of corporates active in DCM is 1.5-2.0x greater in the US and the DCM share of long-term debt is 50% greater in the US than in Europe. While some differences in corporate finance structure remain across Europe and the US, we see a structural opportunity for $100-200bn of additional DCM issuance in Europe, or a total

34



M O R G A N S T A N L E Y B L U E P A P E R revenue opportunity of $0.5-1.0bn including issuer and investor multipliers. Globals and locals will battle for the opportunity.

We also see continued structural deepening of capital markets in Asia. Asia ex Japan accounted for 17% of global DCM in 2012, compared to 5% in 2007 and 10% in 2009-10, having grown ~45% in 2012. Structural growth drivers remain: corporates are in good health, demographic changes and the development of social safety net are leading to natural demand for long-duration yielding assets to match long term pension / project liabilities, and governments keen to shift social financing away from bank lending. There are challenges, however, particularly for global banks: secondary liquidity remains limited, primary margins are tight, rating agency coverage is low and issuance is now ~75% in local currency.

The restructuring of the banking sector in Europe will continue to present opportunities for wholesale banks able to deliver innovative solutions and joined-up coverage. Client demand from tier 2-3 banks will remain strong as they continue to delever and reshape portfolios, restructure liabilities and manage to liquidity needs post LTRO. There are also early moves into direct illiquid investments by insurers, creating additional risk management needs.

Secondary market intermediation in credit products will continue to be a source of value. Capital pressure and loss experiences over recent years have forced many banks to cut inventory and some to more significantly pull back from areas of credit trading. Although new electronic and direct peer-to-peer trading approaches continue to be advanced, we see only limited scope for these to replace dealer-based execution given the structure of the markets. Conversely, pressures on market liquidity are likely to drive up the price of dealing in credit to end users, and shift competitive dynamics among sell-side providers. This will place a premium on the breadth of the distribution channel – to match supply and demand, recycle inventory rapidly and to better diversify risks; and on vertical integration across primary and secondary within sub-sections of the market (sectors, currencies, etc). Exhibit 47 Structural growth in EU mid-sized corporates DCM Profile of corporate DCM issuers, $bn

Corporate size % of corp. active in

DCM Average debt

per corp. ($bn) DCM % of corp. LT debt profile

(by revenue p.a.) EU US EU US EU US

<$0.5bn <5% 5-10% <0.05 <0.05 <30% <30%

$0.5-5bn 30-40% 50-60% ~0.4 ~0.5 40-50% ~70%

$5-20bn 70-80% 90-100% ~2.5 ~3.5 ~60% ~80%

$20bn + 100% 100% ~12 ~9 ~70% ~90%

Structural opportunity in Europe Source: Dealogic, Capital IQ, Orbis, Oliver Wyman analysis

Exhibit 48 US corporate credit: Credit spreads, inventory and revenues Index 2003 = 100

0

100

200

300

400

500

600

700

03 04 05 06 07 08 09 10 11 12Year

Revenues Inventories Credit spreads Sources: Oliver Wyman analysis

Macro risks remain key

The macro outlook remains highly uncertain and tail risk concerns from the Eurozone crisis have continued in 2013. Our base case assumes continued gradual and slow recovery, and gradual narrowing of tail risks. The bear case would see a more disorderly unwind of central bank support, with rising interest rates and negative impacts on the real economy and confidence. This scenario would be negative for equities, IBD and credit, suppressing activity and driving inventory losses, with some positives for rates and FX. Our bull case would see a more rapid economic recovery, with stronger results in ECM and advisory as pent up capacity is released after multiple years of subdued performance, and in equities trading as momentum gathers in markets.

Exhibit 49 Forecast revenue pool scenarios 2010-15E, $bn

265

220

245 240

260 260

215 205

300

0

50

100

150

200

250

300

'10 '11 '12 '13 '15 '13 '15 '13 '15

Rates FX/EM/Commod Credit Equities IBD

BearBase Bull


35



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 50 Base / bull / bear scenarios for macroeconomics factors Base case Bull case Bear case

Macro climate Improving outlook providing increasing support for equities markets and hedging products

Central banks maintaining systemic support across US and Europe

2012 growth pockets see moderation of growth without reversal of fortunes

Equities markets rebound sets in after multiple years of contraction

Gradual withdrawal of central bank support tempers inflation while not crippling the industry

Banking buoyed by release of backlog from 2011-12 and continued movement out of bank financing

Inflationary pressures force CBs to withdraw LTRO and US mortgage buying

Bond prices fall as interest rates rise and liquidity drained from the market

Medium term growth in G10 <2% and EM <5% p.a. undermining growth

Equities down as corporate profits and investment fall

Regulation Impact of regulation spread over multiple years, banks continue concerted program of mitigation

Impact of OTC reforms on volumes and margins at the lower end of the range

Banks absorb regulatory burden as top line grows and mitigation plans executed

OTC reforms have limited impact on volumes and margins

Additional B3 capital raised through retained earnings

Dislocation of the market with subsidiarisation

Sharp contraction in volumes post-OTC reforms

Downturn putting banks in the cross-hairs of regulators

Collateral requirements have significant impact on the bottom line

2013 underlying $240bn 0 to -5%

$260bn +5 to +10%

$215bn ~ -10%


Exhibit 51 FICC revenues: 2012-13 base case 2012 (vs. 2011) 2012 performance drivers 2013 (vs. 2012) 2013 performance drivers

Rates $52bn ~ +10%

Rebound in European sovereigns with ECB intervention, tightened spreads and mark-to-market uplift

LTRO providing support for swaps, increasing two way flow

$47bn ~ -10%

Stable interest environment limiting demand for hedging products

Allocation of funds out of low yielding products into credit / equities

Modest headwinds from OTC reform starting to impact revenues over the year

FX $15bn -5% to -10%

Low volatility reducing demand for hedging products

Subdued growth in global trade (+3% y-o-y)

$17bn +5% to +10%

Increase in currency volatility on the back of uncertainty over central bank mandates (BoJ, BoE)

Growth in trade (esp. in China and wider Asia) boosting corporate demand

Emerging markets $25bn ~ +10%

Rebound in CEEMEA after weak 2011, positive overflow from stabilisation of Eurozone

China underperforming with fear of heavy landing, offset by strong performance in SE Asia

$25bn 0 to +5%

Positive outlook for Russia / China GDP Debt markets continue to deepen as

investors seek yield not found in G10 Void left by some global banks to be filled by

local offerings, especially in flow

Credit and securitisation

$39bn ~ +100%

Strong rebound in m-t-m positions Agency RMBS supported by asset buying

from the Fed from Q3 Increased investor appetite for yield

prompting cash inflows and increase in issuance

$33bn ~ -15%

Downturn in securitisation reflecting normalisation after 2012 rebound

Modest adjustment of HY, with spread over IG rising to more normal levels

Increased client demand providing support as economy picks up and appetite for LBOs and associated CLOs recovers

Commodities $9bn 0 to -5%

Reduced client flows with low volatility and weak GDP outlook suppressing demand for hedging

Oil experiencing declines (very low volatility);some recovery in P&G but remains weak

Agriculture a relative bright spot

$10bn +5% to +10%

Macroeconomic recovery (notably in China and other emerging economies) to increase demand and hedging opportunities

Expected oil volatility recovery Opportunities around NA energy

investments (production, infrastructure etc) FICC $140bn $131bn Source: Oliver Wyman analysis

36



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 52 Equity revenues: 2012-13 base case

2012 (vs. 2011) 2012 performance drivers 2013 (vs. 2012) 2013 performance drivers

Cash and prop $22bn -10 to 15%

Volumes and volatility significantly down, H1 particularly bad

ECB intervention and US fed bond buying injected some life into system at the end of the year

Prop teams continue to be shuttered off as Volcker rules kick in

$22bn ~0%

Rise in global stock markets to provide increasing support over the year

Modest increase in ETF funds reflecting increasing bullishness on equity outlooks

Global stock markets (esp Europe) remaining sensitive to downside risks

Pressure on remaining prop units remains Derivatives $16bn

0 to -5% Client volumes reduced, trading

conditions remain difficult Some m-t-m losses in Q2 but overall less

impact than 2011

$16bn 0 to +5%

Reduction in m-t-m losses as indices broadlypositive for the year

Increasing volatility as markets pick up increasing demand for hedging

Continued regulatory pressure supporting ETD revenues

Prime $14bn 0 to -5%

Listed derivatives down as risk appetite remained low until Q4

Relative bright spot with strong client volumes and banks deploying liquidity to prime clients

Increase in balances and increasing AuM, leverage remains tight

Normalisation in synthetics after strong 2011

$14bn 0 to +5%

Growth in prime balances reflecting wider increases in HF AuM to $25trn

HF leverage increasing after remaining static since the crisis

Margins under pressure as supply side capacity remains high

Equities $52bn $52bn Source: Oliver Wyman analysis

Exhibit 53 IBD revenues: 2012-13 base case 2012 (vs. 2011) 2012 performance drivers 2013 (vs. 2012) 2013 performance drivers

DCM $22bn +25 to +30%

Corporate issuance up to lock in low yields and investors seeking returns

Equity buy backs also providing growth to system

Muted lending from banks pushing corporates into DCM

Asian banks capturing share as local investor pool grows

$23bn 0 to +5%

Mixed story across issuer segments and geographies

Leveraged finance boom in the US beginning to lose steam, FIG, IG and Public cannot narrow the fee pool

Longer term structural shift in Europe with corporates (esp HY) moving away from bank financing

ECM $15bn -15 to -20%

Recession in the Eurozone and stuttering growth in China / US in H1 constrained market

Weak post-IPO performance undermined market appetite for large deals

$16bn +5 to 10%

Backlog of IPOs to flow out, esp from PE firms as markets improve

Structural shifts in the market (ABOs and blocks) eroding margins

Asia normalising in wake of 2009-10 IPO boom

Europe rebounding after multiple years of contraction (2011 30% of 07 revenues)

M&A $16bn -5 to -10%

Corporates retaining cash balances economic uncertainty remains

Shareholder activism pressing corporates to increase dividends

$17bn +5 to +10%

Strong fundamentals (economic growth and cash balances) and momentum from Q4 2012 in the US

Pressure for corporates to put cash balances to use and pipeline backlog to come to market

Potential for supply side shifts in the FIG space as banks shed assets

IBD $53bn $56bn Source: Oliver Wyman analysis

37



M O R G A N S T A N L E Y B L U E P A P E R Chapter 3: Returns and Industry Structure

3.1 Operational gearing – the fixed cost structure challenge

Many banks have started to embrace our “Decision Time” thesis of last year – but attention must shift from financial resources towards managing the operational gearing of the business. We've seen significant capacity reduction to help enhance returns in 2012, but the industry must find a further ~3% points of RoE through further rationalisation to deliver greater economies of scale and scope. The greatest progress to date has been on RWAs where we have seen a ~25% decrease but there has been much less progress on cost where we have only seen a 4% reduction. Business line dynamics have shifted materially as a result, returning FICC to reasonable returns and pressuring IBD and equities.

Operational gearing is now the driving force of portfolio rationalisation. 2012 saw RoE increase to ~12%, driven by restructuring, RWA discipline and a rebound in revenues led by FICC. However, continued uncertainty over the timing and extent of the recovery, combined with the RoE drag from OTC reform and Balkanisation, means that the need for further restructuring remains intense. Strategic ‘participation’ choices on geographic and product footprint have generated savings in front office compensation costs and RWAs, but progress on pulling out the infrastructure costs has been slow, as the complexity embedded over the last decade proves extremely difficult to unwind, and new regulations and compliance costs continue to push up fixed costs. Addressing this operational gearing must now be the driving force behind the next wave of portfolio rationalisation and operating model changes that will be required to support returns in the 12-14% range.

Further rationalisation is required to support returns. Revenue growth contributed 3-4% of RoE improvement in 2012, but continued uncertainty over the timing and extent of the recovery means banks cannot rely on an improving revenue environment to drive returns. We anticipate only modest revenue growth out to 2015, contributing ~2% of RoE uplift in our base case, and continue to see a wide bull / bear. Furthermore, potential for growth in 2013 looks limited, intensifying the pressure on returns in the near term as some of the positive revenue effects embedded in 2012 returns normalise (notably rebound effects in govies / credit, impact of the Fed’s mortgage purchase programs in securitisation).

Management action delivered a 2-3% point improvement in returns in 2012, absorbing ~2% points of regulatory drag as

Exhibit 54 RoE evolution 2011-12 and 2012-15E

12%

8%

14%

17%

12-14%

~2%

~3%

~4%

3-4%

2-3%

~2%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

2015E Bull/ Bear

2015

Revenue Growth

Management Action

Regulatory Impact

2012

Revenue Growth

Management Action

Regulatory impact

2011

2009-2010

2004-2006


sharply reducing Basel 3 RWAs moved capital ratios towards target levels. But as the headwinds to RoE from Basel 3 solvency and liquidity recede, banks must now address the growing challenges of Balkanisation and the impending transformation of OTC markets. We see an aggregate further regulatory drag on RoE of ~4% points in the 2015 time horizon. Banks must deliver a further ~3% point RoE improvement from further business restructuring and tough decisions to hit the 12-14% returns window. However we estimate about half of this is already in flight from decisions made in 2012 and early 2013 that are yet to flow through to returns as cost and RWAs come out and market share redistributes.

Restructuring progress has been strongest on RWAs, weakest on infrastructure cost. Banks have met or exceeded targets for RWA reduction as they have accelerated business line exits and disposal of legacy assets. They have also driven tighter management of RWAs through the organisation by monitoring RWA limits and return metrics at a more granular business level. Industry-wide RWAs have come down ~20% on a Basel 2.5 basis and ~25% on a Basel 3 basis over 2011-12. We anticipate a further 20-30% reduction over 2013-14 as these programs continue.

By contrast, progress on costs has been more limited. Compensation was cut further at the majority of banks in 2012, in spite of the revenue recovery, driving compensation to revenue ratios down. By contrast spending on infrastructure was marginally up, albeit with significant variance across banks. Most institutions have tackled the more immediate

38



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 55 Progress on cutting RWAs but rising non-comp costs 2011-12, %

-35% -30% -25% -20% -15% -10% -5% 0% 5% 10%

Non-comp

Comp

Cost

B3 RWA

EquityMean impact on cost sub-componentMean impact on primary management action lever

Inter-quartile range


opportunities in infrastructure – what remains are harder business model changes to adapt to the new front office realities and structural work on the operating model itself.

3.2 Business line dynamics have shifted materially as a result, pressuring IBD and equities

In Equities persistently low client volumes, the shift to electronic trading channels and higher fixed platform costs have left all but the best equities franchises under water. In banking, the issues are concentrated in Europe and Asia, where most banks are simply not generating sufficient income to cover the platform costs. By contrast, faster reaction on RWAs in Fixed Income has improved its economics substantially. That said, structural concerns remain and many banks have further to go in re-shaping the FICC franchise to establish a sustainable profitable core. Regional dynamics are shifting too, favouring those with deep footprints in the US.

Equities is the area with the biggest capacity challenges now. Persistently low revenues and stubbornly high costs mean that equities is the area with the biggest capacity challenges at this point in time. Returns for the industry were sub-hurdle in 2012, with derivatives and prime no longer sufficient to offset the scale of the losses in cash equities. Strategic retrenchment to date has been at the margins or by small players, with announced exits in 2012 releasing only 2-3% of market share for consolidation. Value capture is increasingly skewed towards the largest banks who have been consolidating share. Since 2009 the top 5 banks have taken 3-4% of market share (measured in revenue terms); the next 5 have lost 2-3%, mainly in the cash and institutional businesses.

We see a need for further strategic retrenchment by marginal businesses. Banks must seize the moment to drive through

structural reforms to the operating model. Areas requiring attention are:

Simplification of the client sales channel, stripping out duplication in the cash and delta one space;

Challenging the traditional research model and innovating around charging and distribution;

Innovating around the liquidity model and associated pricing structures;

Rationalising the footprint and changing the approach to local market access; and

Eliminating redundant operational and IT infrastructure (especially in the flow institutional businesses).

By contrast hard work on Fixed Income has improved its economics, although structural concerns remain. In contrast to equities, we believe investors now undervalue the quality of FICC earnings. The core FICC franchise delivered solid returns industry-wide in 2012, supported by RWA release, cost discipline and the revenue rebound. Strategic retrenchment is only just starting to play out with 3-5% of market share to be released in 2013-14 from announced exits over 2012 and 1Q 2013. The linkage between size and profitability is also far weaker than in equities or IBD, driven by the heterogeneous nature of fixed income markets, and the importance of the corporate franchise. Advantaged players are considering selective investments to capitalise on the improving environment and shifting competitive landscape.

Exhibit 56 Derivatives and prime no longer able to subsidise cash equities Industry economic profit as % of revenue

1%-1% -2%-2%

-4%

-6%

4% 7% 7%

2010 2011 2012

PrimeCash equitiesDerivatives

Source: Oliver Wyman proprietary data and analysis

39



M O R G A N S T A N L E Y B L U E P A P E R However, FICC remains the epicentre of much of the remaining regulatory pressures and the revenue environment looks set to deteriorate in 2013. While continued RWA reduction in both the core and legacy businesses will help, further work on reshaping the business will be required to maintain returns at 2012 levels through the transition to Basel 3 RWAs. There are a number of banks for whom the path to acceptable returns in FICC remains unclear, and tough decisions will be required.

Too much optionality built up in the banking platforms. The investment banking franchise remains underwater for most banks in Europe and Asia once the full costs of coverage and lending are loaded in. While the leading corporate finance houses have sufficient scale in the US and globally to deliver attractive returns, for many banks this equation is no longer working. Furthermore, the cross-subsidy of the banking platform from FICC businesses generating outsized returns is no longer viable given how hard that business is now being squeezed to reach acceptable returns. The problem has been compounded as banks have maintained capacity in anticipation of a capital-light revenue lift that has not come.

Some banks have started to take action to cut back resources, and we see a need for significant further restructuring:

Starker participation choices between the corporate CEO-led strategic agenda, where value is driven by content excellence and capital markets distribution power, and the CFO and Treasurer-led agenda, where value is increasingly linked to the ability to link financing, hedging and transaction services capabilities.

More discipline in measuring and managing the profitability of the business – cutting through the complex web of revenue shares and double counts.

A more selective and coordinated approach to client targeting, particularly across countries.

Delayering the coverage structure – both thinning country / sector / product matrices within the investment bank, and more fundamentally integrating the corporate bank and the transaction bank where relevant.

Exhibit 57

Market share is being released Value of revenue pools sacrificed by banks through publically disclosed withdrawals in 2012, $bn

0

1

2

3

4

5

FICC Equities IBD AM EMEA APAC

Regional distributionProduct distribution

% Total revenues

3.5% 2.5% 1.0% 1.5% 4.5% 2.5%


Regional dynamics are shifting too, favouring those with a deep footprint in the US. Structural and cyclical factors continue to favour the Americas over Europe and Asia as a driver of profit. We estimate that not only did the Americas increase from 44% to 47% of global revenues over 2011-12, this revenue is also more profitable: we estimate that the Americas accounted for 55-60% of global industry profits in 2012 (Exhibit 30 and Exhibit 57).

Sticky costs and complexity are part of the problem: Europe and Asia suffer from fragmented markets that drive duplicative cost structures, particularly in the client sales and coverage functions, but also in the supporting operational stack which is often splintered across multiple hubs / markets. There are also structural factors at play, in particular ad-valorem pricing structures that make equities suffer more in the down-cycles, and lower margins in corporate finance markets. We have seen banks start to take action to withdraw capacity – narrowing the ambition outside the home market within Europe, and a more critical view of the value of the ‘growth option’ in Asia – but more is required.

40



M O R G A N S T A N L E Y B L U E P A P E R 3.3 The industry can and should do more on multi-year strategic cost reduction

Banks must now tackle long-standing challenges to move the needle on the infrastructure cost base through structural work on the operating model itself. Delivering on this will require dedicated senior attention to ensure programme delivery and to lock in gains through better governance structures and more standardised processes. We believe there will be interesting opportunities for market infrastructure players to mutualise elements of the cost base – potentially saving the industry $1.5-3bn in cost, an improvement on industry RoE of up to 0.5%.

We see significant untapped potential to pull out complexity and cost across the platform Banks must now tackle long-standing challenges to move the dial on an increasingly sticky cost base. Most banks have been through a number of rounds of cost management including actions such as expense control, organisational delayering and compensation adjustments. Some have achieved structural changes in the cost base through front-to-back steps such as consolidating and simplifying sales and trading constructs and re-calibrating the support cost base accordingly. Fewer have achieved sustainable savings in the cost base through more radical actions to optimise the operating model itself through steps such as:

Radically simplifying the operational landscape and processing environment, e.g. standardisation and consolidation processing into core hubs;

Rationalising unnecessary technology assets and simplification in IT application architecture;

Driving synergies between FICC and equities back to front, around clearing and electronic infrastructure;

Integrating securities services and markets businesses to remove duplication and deliver synergies;

Consolidating operations into centers of excellence;

Systematic role ‘purification’ across overlapping activities in Operations, Finance and Risk;

Pushing the boundaries on cross-business utilities and shared services; and / or

Greater use of third parties to generate greater cost variabilisation.

Delivering on this will require dedicated senior attention to ensure programme delivery, to embed the change required and to lock in gains through better governance structures and organisational mobilisation to address the cultural and fatigue issues that can impede the success and speed of delivery of a major change such as this.

Banks will also have to take a closer look at their spend on “reg reform”. In our estimates the majority of the increase in cost base for the last three years in risk, compliance, tech and ops has been driven primarily by regulatory programs, both in terms of local regulators raising the bar on risk management, and to satisfy new requirements stemming from programs such as DFA and EMIR / MIFID 2. However, banks will need to be mindful of how to transition these resources into Business as Usual and right-size them according to the decreased scale of recent years.

Exhibit 58 Four cost levers

Nature of levers Costs at stake1

Typical revenue

consequence

Scope of action to

date

A. Tactical efforts: targeting of discretionary spend, under-performance and re-adjustment of comp structures

3-6% <1%

B. Front office & function organisational efficiency: streamlining sales and trading constructs

5-10% Limited

C. Front to back alignment: cascading the changes in front office across the support / infrastructure models to drive efficiency

5-10%+ Limited

D. Operating model optimisation: Right-sizing to market conditions, radically simplifying operational landscape

10-15%+ Limited impact

on service quality

Key:

Good progress Limited progress

1. Range for affected banks Source: Oliver Wyman analysis

41



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 59 Sell-side mutualisation opportunity Feasibility and savings potential, $bn

Absence of competitive differentiation

Feasibility to outsource

Savings opportunity for industry ($BN) ~ 0 ~ 0.1 ~ 0.5 ~ 0.1 ~ 0.5 0.5 - 1

Life cycle

mgmt.1Collateral

mgmt.Settle-ment Custody2

Trade confirmation

Matching Clearing

Core operations e.g. Client on-boarding, trade processing, reconciliations, reporting, client service etc.

Key: High Medium Low

Total ~ $1.5 – 3 BN

Primary opportunity

1. Corporate actions, exercise and assignments, close outs, dividend processing 2. End to end custody cost base (global and sub-custodians) 3. Savings net of fees paid to utility for services Source: Oliver Wyman analysis, public financial data and proprietary data

New opportunities from cost mutualisation We believe there will be interesting opportunities for market infrastructure players to mutualise elements of the bank cost base – potentially pulling out $1.5-3bn in cost structure. The net savings from this could drive an improvement in industry RoE of ~+0.5%, driven by both headcount reduction within operations groups and reduction in capex / maintenance expenditure for supporting IT systems. The opportunity lies in those processes that both feature limited competitive differentiation for dealers and are sufficiently standardised to be delivered by an external party. Within the core operational functions we see lifecycle management, settlement and custody functions as areas with high potential for mutualisation structures.

Another area ripe for mutualisation is account on-boarding. The current process is onerous; involving large amounts of document / data collection, suitability assessments, know-your-customer / anti-money-laundering checks and annual reviews across multiple products, geographies and legal entities. Additional complexity exists due to banks often having different processes and approaches across different business lines e.g. markets, custody, payments and cash management. This complexity is set to be compounded by the effect of the incoming External Business Conduct rules for Dodd-Frank (Title 7) heightening standards of due diligence and suitability reviews. Many of these activities could be more efficiently and effectively processed by a central party, alleviating multiple reconciliations, enhancing data quality and streamlining the document collection process. Both dealers

and their clients would benefit from a smoother, more efficient process.

Successful execution will require a coordinated effort by an industry majority, galvanised by the prospect of shared benefits. The key challenges to overcome are the competing interests of potential service delivery providers, the ability to unify operating model differences and initial spend commitment required. Furthermore, dealers are struggling to assess, identify and quantify cost savings linked to the outsourcing of specific functions due to difficulties in isolating these.

Banks can draw lessons from other industries in cost management, where management are more deeply steeped in the techniques of operational – rather than financial – efficiency. In the Automotive industry, for example, we have witnessed aggressive savings in operating costs being achieved through:

Pushing standardisation of platforms across the operational process chain servicing a customer segment

Creating modules of activities that can be deployed consistently across customer segments

This means more discipline around the levels of customisation and creation of ‘cottage industries’ and is critically reliant on effective front-to-back management. The benefits realised through these types of initiatives include:

Cost reduction – sharing components to reap economies of scale in manufacturing / processing

Reduced investments – minimising development costs and the associated tooling / retooling needed

Decreased lead times – modular approach shortens development cycles and accelerates time to market for products

Improvement in quality – standardisation decreases the number of defects / fails

42



M O R G A N S T A N L E Y B L U E P A P E R 3.4 Industry structure, winners and losers

Industry restructuring is in full swing now, and the shape and structure is starting to respond to these challenges. Sources of value in the business are shifting, driving new paradigms around economies of scale and scope with new winning models emerging. Our analysis suggests that returns for the winners could be up to 3-4% points higher than the average and up to 8% points higher than the losers. Banks are pursuing increasingly divergent paths, implying different challenges and risks.

Exhibit 60 Spread of returns RoE (%)

-20%

-10%

0%

10%

20%

94-96 97-98 99-00 01-02 03-06 07-09 10-11 12

Median Inter-quartile range

Year


The spread of returns will remain wide Persistently low revenues and stubbornly high costs mean that the spread of returns will stay wide as banks pursue increasingly divergent paths, with starkly different regulatory and strategic risks. The spread of returns narrowed in 2012, but remains high relative to historical levels. The differential impact of subsidiarisation, OTC reform, and operating leverage are all high. Some firms will feel the impact much more severely than others. Our analysis suggests that returns for the winners could be 3-4% points higher than the average and up to 8% points higher than the losers.

The challenges of scale, scope and operational gearing are most acute for mid-sized players, where the retrenchment and restructuring process is still only just beginning and these platforms are not yet mature enough, particularly in scale dependent businesses (e.g. equities). Revenue concentration among the top 15 global banks is at similar levels in 2012 as it was in 2006. The distribution of profit, however, is far more sharply skewed towards the largest players. Interestingly, the smaller players within this group fare somewhat better than the

middle group, with some successfully operating regional and / or more specialist models (others remain pressured).

Winners from OTC reform will be those able to deliver operational excellence, funding and integrated solutions to defend the existing execution franchise and to capture the offsetting revenue streams in clearing and collateral optimisation / financing. These offerings must be appropriately scaled to the target franchise – we see viable roles for focused regional models as well as for global players targeting premium service offerings for the largest accounts. The losers will be those making sizeable infrastructure investments but failing to attract flows or position effectively around the new opportunities, or those simply failing to put in place adequate responses.

The impacts of subsidiarisation are uneven. European banks face the twin challenge of the US FBO proposals which are a headwind in a key market, and the need to navigate domestic efforts to ring-fence retail banking. The wider challenges of multi-jurisdictional subsidiarisation impact all banks operating a global model, and particularly those with broad but thin international footprints.

Scale, scope and shape

The process of restructuring must focus on driving economies of scale and scope around three key considerations:

Re-positioning around new sources of value

Building profitable market share in chosen areas

Managing the shape of the business portfolio

Exhibit 61 Revenue and profit distribution Based on sample of top 15 banks

53% 55% 55%63%

51%62%

33% 31% 32%31%

33%25%

14% 13% 13% 7%16% 13%

0%

20%

40%

60%

80%

100%

Revenue Profit Revenue Profit Revenue Profit

Bottom 5

Middle 5

Top 5

2006 2009 2012 Source: Oliver Wyman analysis

43



M O R G A N S T A N L E Y B L U E P A P E R Sources of value in the business are shifting with implications for winning models. Value now centres on:

At-scale financial intermediation in flow markets

Expansion in to post-trade / infrastructure and transaction banking business

Credit market intermediation

True corporate and FIG content / advisory capabilities

Leveraging group linkages to wealth and commercial banking

The right kind of market share As banks reshape their businesses they must decide what level of service is appropriate to be offered to which clients, and what products and services clients will be willing to pay for at sufficient scale to justify their cost base. Most investment banks have thousands of clients, but derive ~80% of their client revenues from just 500-800 names. We estimate that a third of industry-wide client revenues with buy-side accounts are generated by the top 50 clients. Profitability skews are even sharper, as many clients systematically squeeze their dealers for financial resources, price, quality of infrastructure delivery and premium services (e.g. research), while concentrating spend with the top 3-4 dealers. Winning the race to be one of the top dealers for the largest global clients can generate attractive economics – but losing the race is costly. Alternative strategies targeting more specialist roles with large accounts, or focused on smaller clients must be matched against an appropriate product and service platform.

Exhibit 62 We estimate a third of industry wide sales to buy-side accounts are generated by the top 50 clients

S579S1CLSS1D3SE35S4ORCLSS10

Top 50 Top 500 Rest0%

20%

40%

60%

80%

100%

20% 40% 60% 80% 100%

Largest region Rest of the worldKey:

Split of wallet by region

Client segment

S579S1CLSS1D3SE35S4ORCLSS10

Top 50 Top 500 Rest0%

20%

40%

60%

80%

100%

20% 40% 60% 80% 100%

Largest region Rest of the worldKey:

Split of wallet by region

Client segment


There is an important regional dimension to this. We estimate that 70-75% of sales to buy-side clients are concentrated in a client’s largest region. Even for the largest global clients, where non-home region sales make up 30-50% of sales, many of the larger buy-side firms are moving to a more regional trading model. For smaller clients the wallet is highly concentrated regionally, with 80-95% of sales in the home region.

Banks will also need better MIS and a client-driven management mentality to succeed. Very few dealers today, however, have infrastructure and governance in place that can provide an effective and realistic view of client profitability to support dynamic client-led strategies. Dealers will need to update their approaches to reflect the new reality of client economics, in particular with more sophistication around costs of execution, and the use of financial resources (especially funding). Dealers will also need to improve their client metadata, both because of regulatory requirements but also to understand their activity from a legal entity and client hierarchy perspective. This is the foundation on which dealers need to build a client governance model that regularly reviews and decides on resource allocation, monitors client wallet performance, collectively improves and monitors the client experience, and feeds strategic decision-making.

Shape matters in a multi-constrained world Progress on restructuring FICC means RWAs are no longer the overwhelmingly dominant constraint. Banks must manage financial resources in a multi-constrained world across leverage, liquidity and risk-based capital. This means the shape of the business portfolio is also a critical consideration as businesses rationalise. For example, there are capital benefits from combining businesses, such as credit, that are RWA-constrained with businesses, such as prime, that are leverage ratio constrained. There are also implications for earnings volatility. Many businesses naturally offset each other – for instance rates / FX revenues have historically been negatively correlated to equities revenues.

Managing across multiple external regulatory constraints – as well as internal economic and risk-based views – is increasingly a source of competitive advantage. Driving the information and incentive structures down to the level at which decisions are taken in the business requires considerable investment in management information and governance processes. This, in turn, risks adding to the infrastructure cost base unless management can at the same time re-engineer the existing functions.

44



M O R G A N S T A N L E Y B L U E P A P E R Exhibit 63 The shrinking portfolio teepee

Possible investment

banking portfolios, in absence of

corrective action

Leverage exposure

Liquidity

RW

A B3 leverage ratio

B2.5

on

mRW

A, B

3 on

cRW

A

B3 LCR, NSFR

Possible investment

banking portfolios, in absence of

corrective action

Leverage exposure

Liquidity

RW

A B3 leverage ratio

B2.5

on

mRW

A, B

3 on

cRW

A

B3 LCR, NSFR

mRWA = Market risk weighted assets cRWA = Credit risk weighted assets Source: Oliver Wyman analysis

The gains for the winners from market share consolidation are only just beginning to accrue. For those able to consolidate market share around areas of true scale while reducing the cost and complexity of the platform, the rewards could be high. At the same time, increased operational gearing, combined with multiple regulatory challenges to navigate, means the risks of failure for this approach are high.

Among the mid-sized banks we see substantial further value to be unlocked through strategic refocusing around areas of product excellence and / or regional depth. Capital release and

cost reduction have to be delivered along lines that protect or enhance economies of scope. Strategic risks are the size and stickiness of the infrastructure cost base and the inherent volatility of a less broad product base and risk envelope.

Many larger domestic and smaller regional players are at a difficult cross-roads, particularly in Europe. The proposed corporate CVA VaR exclusion is a vital lifeline, and deleverage and the deepening of debt capital markets in Europe heightens the strategic importance of institutional distribution capabilities. However, the economics remain under pressure for many banks, and more needs to be done to focus the franchise around areas of genuine advantage, particularly outside of the home market(s).

Market infrastructure players are in a battle to grasp new opportunities as the existing businesses remain under pressure. OTC reform presents new opportunities but in many cases these are smaller than hoped and will not fully recover lost execution revenues. The advantaged will be those with a first mover edge or differentiating capabilities as second movers in collateral solutions and back-office outsourcing. The former – typically the emerging large, vertically or horizontally integrated groups – will seek to integrate services, keep systems costs down for the sell-side and leverage their global scale to deliver value-added services such as cross-asset netting. The latter will seek to differentiate around local clearing and / or collateral pools, integrated OTC brokerage models, or through innovation in areas such as non-cleared derivatives or outsourcing / mutualisation.

Exhibit 64 Regulatory watch-points

Remaining RoE impact (base case)

Level of uncertainty

New developments Remaining risks and uncertainties

Solvency and Liquidity

<1% Low Progress on RWAs Moderation to liquidity and capital rules

CVA VaR

Structural reform 2-3% Medium New proposals; US FBO, Liikanen etc. Drive towards Balkanisation

Finalisation of new proposals Scope of budding subsidiarisation

reforms

OTC Reform ~1% Low New margining rule Phased implementation

Behavioural impacts in markets Perimeter of regulatory applicability

Conduct, EU FTT and other

<0.5% High Establishment of conduct bodies FTT gathering momentum / initial

implementations

Scope of conduct reforms FTT scope and implementation


45



M O R G A N S T A N L E Y B L U E P A P E R Multiple risks remain – we put a 9-16% bear / bull around our base case RoE

We see three key risks to our base case – execution, markets and regulation.

With so much to do, management execution will be key in determining winners and losers. Banks are facing an unprecedented agenda of cutting structural costs, repositioning business strategy, responding to regulatory reform and compliance, and restructuring local entities. In many cases, a rethinking of the business model and process is required, breaking ranks with conventional wisdom and making bold moves. Deeper thought on incentive structures will be needed to get costs down and address cultural change. In an industry much more focused on client service, banks will have to decide faster where they provide differentiated enough service to achieve more favourable pricing.

Regulatory tail risk is narrowing, but still some vital ‘swing factors’. We estimate that a further ~2% regulatory drag on RoE was absorbed in 2012 as the industry moved towards Basel 3 solvency targets, meaning 60% of regulatory costs have now been realised. Shifts have taken place or look likely on both funding and capital and the industry and regulators are converging around a common agenda, with the one key remaining area of uncertainty being the approach to corporate CVA VaR. OTC derivative reform will have an impact, but the boundaries are now becoming clearer. On the other hand we see increased risks from subsidiarisation and conduct risk, where the final state of regulation is less clearly defined. The banking system will seek to adjust over time as necessary, but the range of possible outcomes is still wide. The Financial Transaction Tax could potentially have a high impact on the affected banks, but there is much uncertainty about the outcome.

Exhibit 65 Future evolution of industry RoE

12%

~2%

~1%

~2%

~0.5%

2-3%

~1%

8-10%

15-17%

12-14%

2015 bear

2015 bull

2015 base

Revenue growth

Structural cost work

Strategic response

Solvency and liquidity

Structural reform

OTC reform

2012


It goes without saying that the revenue outlook will be critical. Our base case has cautious optimism and recovery although we also have broad book ends depending on investor and issuer confidence, sovereign risk scenario and wider economic recovery.

Conclusions

Industry restructuring and adaptation is in full swing as firms start to make tougher choices on where they want to compete to deliver attractive economics and serve their target client base. Despite absorbing a significant slug of regulatory change, the industry improved returns to ~12% in 2012, albeit helped by positive credit conditions.

There is much still to do. Profound structural shifts are taking hold, in particular as regulatory Balkanisation and OTC reform reshape the industry. Navigating these challenges, delivering economies of scale and scope, and positioning for growth will be the key challenges over the next three years. Those firms able to do so will offer attractive returns to shareholders, and deliver sustainable benefits to their clients and employees.

46

The Three Biggest ChallengesApril 11, 2013

CS, BARC, UBS, BNP (all Overweight) – We see strong restructuring and cost save potential alongside undemanding valuations

JPM, C (all Overweight) – JPM on expectations for share gains and above consensus on Citi on incremental cost cutting and footprint rationalization.

ICAP (UW), TLPR (EW) – We are more cautious here as we see ongoing drag to core swaps activity from OTC derivatives reform.

Key Stock Calls

47


Market assumes CIB divisions are valued at 0.7-1.0x book value, implying 8-11% returns given concerns on regulation such as transformation of OTC markets and Balkanisation of banking markets as well as sticky cost base, while we think 12-15% plausible

Source: Company Data, Morgan Stanley Research estimates (e). Average is weighted. ROE is calculated on clean underlying numbers hence excluding DVA/CVA and other one off expenses in the form of restructuring charges etc. Refers to returns of CIB divisions, excluding non-core/legacy divisions

0% 4% 8% 12% 16% 20%

Average RoE 1993-99

Average RoE 2000-06

Average RoE 2009-10

Average RoE 2011

Average RoE 2012

Management targets



Implied RoE from market Implied range

48


Source: Company Data, Morgan Stanley Research. Average is weighted. ROE is calculated on clean underlying numbers hence excluding DVA/CVA and any other one off expenses in the form of restructuring charges etc. Refers to returns of CIB divisions, excluding non-core/legacy divisions

Wide range of returns for CIB across firms. We expect more sub-scale players earning below COE in CIB to get more aggressive on RWA shrinkage or more nimble to survive in the post Dodd-Frank/MiFID world

CIB ROE (%) - 2012

2.1%

6.3%

7.8%

9.8%

10.9%

11.8%

12.5%

13.4%

13.4%

13.5%

14.5%

15.1%

15.3%

15.7%

18.2%

19.0%

Nomura

UBS

CSG

RBS

BNPP

GS

Europe Avg

Citi

Group Avg

SOGN

BARC

US Avg

DBK

BAC

HSBC

JPM

49


We forecast ROE of 12-15% in the next two years as banks continue to rationalize their portfolios alongside cyclical and secular trends, although spread of returns is wide

Source: Morgan Stanley Research estimates. Average is weighted. ROE is calculated on clean underlying numbers hence excluding DVA/CVA and other one off expenses in the form of restructuring charges etc. Refers to returns of CIB divisions, excluding non-core/legacy divisions

CIB Return on Equity (%)

7.5%

9.2%

10.9%

13.5%

14.1%

14.5%

6.9%

10.0%

11.4%

11.7%

13.4%

13.5%

13.5%

13.5%

14.7%

14.8%

15.7%

16.6%

17.3%

10.8%

17.3%

14.5%

12.8%

13.6%

16.3%

18.0%

17.5%

10.1%

11.7%

10.0%

14.2%

18.2%

Nomura

GS

RBS

BNPP

Citi

CSG

BARC

Group Avg

US Avg

Europe Avg

JPM

UBS

SOGN

BAC

DBK

HSBC

2013e 2014e

50


What’s priced in for the wholesale banks? We think a cyclical rebound and banks executing their restructuring and cost save plans could drive valuation higher

Source: Thomson One. Company Data, Morgan Stanley Research estimates (e). Underlying UBS refers to 2015e ROTE post-restructuring.

JPM

CBARC

SocGen

BAC

Underlying UBS

GS

Natixis

BNPP

HSBC

RBS

DBK

CSG

UBS

0.4 x

0.5 x

0.6 x

0.7 x

0.8 x

0.9 x

1.0 x

1.1 x

1.2 x

1.3 x

1.4 x

4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%

2014e Return on Tangible Equity

Pric

e/ 2

013e

Tan

gibl

e E

quity

51


Lackluster earnings growth for IDBs over the next few years from regulation keeps us cautious and likely caps the multiple

Source: Company Data, Morgan Stanley Research estimates (e). Note Morgan Stanley Research estimates used for BME, DB1, Moscow Exchange, ASX, BM&F, HKex, Japan Exchange Group, Multi Commodity Exchange of India, ICAP and TLPR; Thomson Reuters consensus used for others. Bubble size proportional to last reported 12m revenues. Share prices as of close 08/04/2013. Averages are market cap-weighted. Morgan Stanley holds an equity interest in NYSE Liffe US, the futures exchange of NYSE Euronext, as announced on October 30, 2009.

BGC

Tullett

ICAP

Global Avg.

Other Avg.NZX

Bursa Malaysia

JSE

Bolsa Mexicana Japan

ASX

SingEx

BM&F Bovespa

HK Exch.

NA Avg.

TMX

Nasdaq

NYSE

ICE

CME CBOE

EU Avg.

WSE

Moscow

Hellenic ExcBME

LSE

D. Börse

2x

7x

12x

17x

22x

27x

32x

-25% -15% -5% 5% 15% 25% 35%12-14e EPS CAGR

2013

e P

/E

52


Where are our EPS ahead/below consensus? We are ahead at BARC, CS, Citi from cost saves and revenue trends, while below for IDBs from new regulation

Source: Thomson One and Morgan Stanley Research Estimates. Note FY13e and FY14e for ICAP = FY14e and FY15e

-16%

-3%

-3%

-1%

-3%

-4%

-1%

-3%

-3%

-1%

3%

-3%

6%

4%

15%

7%

-12%

-10%

-6%

-5%

-5%

-4%

-4%

-2%

-2%

2%

3%

4%

5%

8%

12%

13%

BNP

GS

TLPR

BK

SG

ICAP

RBS

STT

BAC

DB1

DBK

JPM

UBS

Citi

BARC

CSGN

2014FY2013FY

53


Our focus stocks – we prefer stocks with restructuring and cost save potential

Source: Thomson One. Morgan Stanley Research

Most preferredMS

Rating

MS 13e EPS vs. Cons.

Investment thesis

Barclays O 15% Trading on a current level of 0.9x 2013e TNAV for 13.2% RoTE in 2014e, we see three key ways that the new management team can unlock value. (1) Exiting EU periphery, (2) Re-shaping the i-bank, (3) gaining share in UK retail banking.

BNP Paribas O -16% Lower tail risk reduces scope and pace of deleveraging as French banks have regained their relative funding advantage vs. Euro peers. However, cyclical / structural headwinds are here to stay and we still expect weakening earnings momentum.

Credit Suisse O 7% We believe CS has a number of levers to improve earnings momentum through investment banking and private banking franchises, supported by aggressive cost save plan. The performance of the private bank remains an important source of earnings strength. We see 10-15% additional upside to our EPS forecasts if cost saves are delivered in full.

UBS O 6% We are Overweight UBS as we believe its restructuring plan can deliver >15% ROTE over time as UBS shrinks capital-consumptive investment banking in favour of private banking which generates >30% returns. Given a potential for 50% payout, this could drive a higher multiple. Execution risks on downsizing and viability of 'new model' will be critical.

JPM O -3% We believe JPM's best-in-class franchise is well-positioned to take share and win through this environment. Share gains and improving efficiences across businesses should drive higher ROA. Rising capital return coupled with higher ROA should ultimately drive higher ROEs and upside to current valuation. Overall, we see JPM as investing to grow, which could yield even further upside to our estimates over time.

Citi O 4% We are Overweight Citi as we see a restructuring story that will unlock value and improve returns. We expect another three rounds of cost cutting and see Citi getting to 10% ROTCE in 2014. We see upside as Citi executes on its expense management program, expect further expense cuts announced in H113 and expect to see Citi demonstrate sustainable earnings which is critical for returning excess capital to shareholders.

Least preferredMS

Rating

MS 13e EPS vs. Cons.

Investment thesis

ICAP U -4% We see ongoing risks to market expectations from OTC market structure development driven by regulations (Dodd Frank, EMIR, MiFID II). Whilst cyclical headwinds have eased (e.g. YTD momentum in FX and rates business), risk of relapse on macro concerns remains. We fear that overall market liquidity in OTC derivatives is threatened by increased collateral requirements, whilst differentials in clearing collateral requirements between futures and swaps risks cannibalisation of the latter by the former. Finally the LIBOR investigation remains an unhelpful overhang.

BNY Mellon U -1% Persistently low rates are a drag on NIM, securities lending, and are costing waived management fees on money market funds. BK is fighting top line pressures through client outsourcing wins, moving up the PB foodchain with its recently announced collateral management program and efficiency focus.

54


Risk reward charts side by side for all capital market financials mentioned

Source: Thomson One. Morgan Stanley Research; For valuation methodology and risks associated with any price targets above, please email [email protected] with a request for valuation methodology and risks on a particular stock.

39%

24% 23% 22% 19%

43% 41%

30% 28%

6%3%

18%

58%

14%6%

-5% -3%-10% -10%

-16%

-100%

-50%

50%

100%

150%

Bar

clay

s

BN

P P

arib

as

JP M

orga

n C

hase

Cre

dit S

uiss

e

UB

S

Citi

Nom

ura

Cre

dit A

gric

ole

Soc

Gen

Deu

tsch

e B

ank

RB

S

HS

BC

Ban

k of

Am

eric

a

Deu

tsch

e B

oers

e

Tulle

tt

Gol

dman

Sac

hs

ICA

P

Nor

ther

n Tr

ust

Sta

te S

treet

BN

Y M

ello

n

OW EW UW

55


Wholesale banks comp sheet

Source: Company Data, Thomson Reuters, Morgan Stanley Research. e = Morgan Stanley Research estimates

Price EPS P/E (x) EPS P/E (x) EPS P/E (x) 2013e

09/04/2013 2012 2012 2013e 2013e 2014e 2014e Stated Tangible Latest 2013e Stated Tangible Stated Tangible TBVPS

UBS SFr 14.3 1.06 13.6 1.00 14.4 1.30 11.0 12.2 10.6 1.35 1.29 8% 9% 10% 11% 11.1CSG SFr 24.9 2.66 9.3 2.84 8.8 3.42 7.3 27.0 20.6 1.21 1.15 12% 16% 13% 16% 21.6DBK EUR 31.1 5.00 6.2 4.80 6.5 5.53 5.6 57.8 42.5 0.73 0.72 8% 11% 9% 12% 43.2European IB 9.7 9.9 8.0 1.10 1.05 10% 12% 11% 13%BARC p 286.0 34.6 8.3 42.4 6.7 49.2 5.8 438.0 373.0 0.77 0.77 10% 12% 12% 13% 372RBS p 273.9 15.7 17.5 26.1 10.5 32.6 8.4 608.4 475.9 0.58 0.62 5% 6% 6% 7% 445HSBC p 683.9 $0.89 11.6 $0.92 11.2 $1.09 9.5 $9.09 $7.43 1.39 1.31 10% 12% 11% 13% $7.89UK Wholesale 12.9 8.6 7.1 0.67 0.69 7% 9% 9% 10%

SocGen EUR 25.3 4.62 5.5 3.37 7.5 4.08 6.2 56.5 47.3 0.53 0.50 6% 7% 7% 8% 50.8BNPP EUR 39.4 5.11 7.7 4.45 8.9 5.26 7.5 63.5 52.8 0.75 0.72 7% 8% 8% 9% 54.8Natixis EUR 2.9 0.36 8.1 0.31 9.4 0.36 8.2 5.8 4.6 0.64 0.66 5% 7% 6% 8% 4.5French Wholesale 7.1 8.6 7.3 0.64 0.62 6% 7% 7% 8%

European Average 9.7 9.0 7.4 0.84 0.82 8% 10% 9% 11%

GS USD 146.5 14.40 10.2 13.43 10.9 13.61 10.8 144.7 134.1 1.09 1.00 10% 10% 9% 9% 146.7BAC USD 12.3 0.52 23.7 0.96 12.8 1.29 9.5 20.2 13.4 0.92 0.85 5% 8% 6% 9% 14.41C USD 43.9 3.99 11.0 4.80 9.1 5.63 7.8 61.6 51.1 0.86 0.79 8% 9% 8% 10% 55.44JPM USD 48.7 5.21 9.3 5.30 9.2 6.06 8.0 51.3 38.8 1.26 1.14 10% 14% 11% 15% 42.62US Average 13.6 10.5 9.0 1.03 0.95 8% 10% 8% 10%Total Average 11.1 9.6 8.0 0.91 0.87BNY USD 15.5 2.10 7.4 2.24 6.9 2.44 6.4 31.1 13.6 1.14 1.09 7% 18% 7% 17% 14.2STT USD 58.5 3.87 15.1 4.35 13.4 4.94 11.8 44.8 31.7 1.84 1.75 10% 14% 10% 14% 33.4NTRS USD 54.8 2.81 19.5 3.14 17.4 3.42 16.0 31.5 29.2 1.87 1.79 10% 11% 10% 11% 30.5Other US Average 14.0 12.6 11.4 1.6 1.5 9% 14% 9% 14%

2014e Core ROE (%) Ccy

2013e Core ROE (%)P/ TNAV (x)BVPS, Last Reported

56


Exchanges comp sheet

NA = Not applicable. Source: Thomson Reuters, Company Data, Morgan Stanley Research estimates (e). Morgan Stanley estimates used for BME, DB1, Moscow Exchange, ASX, BM&F, HKex, Japan Exchange Group, Multi Commodity Exchange of India, ICAP and TLPR; Thomson Reuters used for others. Share prices as of close 08/04/2013. European median, average and market cap. Weighted P/E ratios, EPS Growth, EPS CAGR and revenue statistics exclude Oslo Bors. NC – Not Covered . ++ Morgan Stanley rating/estimates for this company has been removed from consideration in this report because, under applicable law and/or Morgan Stanley policy, Morgan Stanley may be precluded from issuing such information with respect to this company at this time.

Morgan Stanley & Co. Limited ("Morgan Stanley") is acting as financial adviser to London Stock Exchange Group plc ("LSEG") in relation to its discussions with LCH.Clearnet Group Limited regarding a potential transaction, as announced on 2 September, 2011. LSEG has agreed to pay fees to Morgan Stanley for its financial services. Please refer to the notes at the end of the report.

Price Mkt. Val. Div. YieldRating 09/04/2013 (US$ bn) 2012e 2013e 2014e 2012e 2013e 2014e 1 W 1 M 3 M 12 M YTD CY13e 10-12 11-13e 12-14e (US$m) Growth y/y mkt cap/rev Buy Hold Sell

European Exchanges

BME (Spain) Underweight €18.82 2,049 1.63 1.56 1.50 11.6x 12.1x 12.5x (1.5) (2.5) (9.9) 1.8 2.0 10.8 (5%) (9%) (4%) 414 (6%) 4.95x 33% 33% 33%Deutsche Börse Equal-weight €46.74 11,789 3.59 3.85 4.45 13.0x 12.1x 10.5x (3.8) (5.9) (0.6) (6.9) 1.1 5.6 (8%) (8%) 11% 3,086 (3%) 3.82x 48% 45% 7%Hellenic Ex NC €3.88 330 0.18 0.29 0.32 21.6x 13.6x 12.1x 2.6 (20.5) (22.1) 30.5 (10.8) 5.2 (25%) (4%) 33% 41 (52%) 8.09x 40% 60% 0%LSE ++ £12.58 5,212 0.96 0.91 0.99 13.1x 13.8x 12.7x (5.3) (9.0) 10.3 18.8 15.6 2.5 17% (1%) 2% 1,245 13% 4.18x 22% 56% 22%Moscow Exchange Equal-weight RUB 4.8 3,341 4.85 4.92 4.99 9.8x 9.7x 9.5x (2.2) (12.0) 0.0 (24.7) (10.6) 3.8 0% 18% 1% 689 19% 4.85x n/a n/a n/aWarsaw SE NC PLN 38.61 512 2.52 2.75 2.99 15.3x 14.1x 12.9x (1.5) (7.6) (0.7) (2.6) (0.7) 4.2 6% (7%) 9% 83 (3%) 6.15x 30% 60% 10%European Median 4,277 13.0x 12.9x 12.1x (2.2) (9.0) (0.6) 1.8 1.1 4.2 0% (4%) 2% 689 (3%) 4.85x 32% 56% 16%European Average 4,399 13.9x 12.6x 11.7x (2.4) (9.5) (1.8) 5.1 1.8 4.9 (2%) (2%) 8% 1,068 (2%) 4.96x 33% 52% 16%Mkt Cap weighted Mean 12.7x 12.3x 11.2x (3.9) (7.7) 2.5 1.5 5.0 4.6 (1%) (2%) 5% 1,971 5% 3.98xUS/Canadian ExchangesCBOE NC $36.5 3,235 1.69 1.87 2.12 21.6x 19.5x 17.2x (0.9) 2.5 15.6 33.4 24.0 1.7 28% 8% 12% 518 (1%) 6.25x 6% 88% 6%CME Group NC $60.3 20,098 3.02 3.16 3.65 20.0x 19.0x 16.5x (0.6) (3.4) 14.0 5.8 18.9 3.4 (1%) (4%) 10% 3,224 (10%) 6.23x 43% 38% 19%ICE (ICE) NC $156.0 11,349 7.60 8.42 9.43 20.5x 18.5x 16.5x (3.4) (1.7) 22.2 14.8 26.0 0.0 16% 9% 11% 1,384 6% 8.20x 71% 24% 6%Nasdaq OMX NC $29.0 4,805 2.50 2.70 3.04 11.6x 10.7x 9.6x 3.9 (9.4) 10.0 14.4 16.0 1.8 12% 3% 10% 1,682 (1%) 2.86x 44% 56% 0%NYSE Euronext NC $37.6 9,121 1.84 2.33 2.82 20.4x 16.2x 13.3x (2.1) (1.0) 16.0 34.2 19.2 3.2 0% (3%) 24% 4,250 (14%) 2.15x 35% 53% 12%Toronto Ex NC CAD 54.8 2,900 2.95 3.66 4.36 18.6x 14.9x 12.6x (2.6) (2.3) 7.4 23.3 7.9 2.9 5% 1% 22% 647 (1%) 4.48x 11% 67% 22%N American Median 6,963 20.2x 17.3x 14.9x (1.5) (2.0) 14.8 19.1 19.0 2.4 9% 2% 12% 1,533 (1%) 5.36x 39% 55% 9%N American Average 8,584 18.8x 16.5x 14.3x (0.9) (2.6) 14.2 21.0 18.7 2.2 10% 2% 15% 1,951 (3%) 5.03x 35% 54% 11%Mkt Cap weighted Mean 19.4x 17.4x 15.1x (1.2) (2.7) 15.5 16.4 19.9 2.3 6% 1% 13% 2,541 (5%) 5.53xOther ExchangesAustralian Stock Ex (ASX) Overweight AUD 36.4 6,133 1.98 2.09 2.31 18.4x 17.4x 15.8x 0.7 1.3 12.9 13.0 16.8 5.1 (0%) 2% 8% 766 (2%) 8.0x 13% 53% 33%BM&F Bovespa Equal-weight R 13.55 13,462 0.63 0.71 1.02 21.5x 19.1x 13.2x 1.0 (3.3) (3.2) 19.0 (3.2) 4.0 5% 11% 27% 1,008 7% 13.4x 61% 33% 6%Bolsa Mexicana NC Ps. 35.50 1,730 1.15 1.34 1.59 30.9x 26.6x 22.4x (1.3) 10.5 5.8 33.0 8.9 3.2 0% 3% 17% 174 5% 10.0x 11% 56% 33%Bursa Malaysia NC MYR 7.01 1,219 0.28 0.31 0.35 24.7x 22.4x 20.0x 0.9 1.4 8.3 (0.6) 12.7 4.2 15% 7% 11% 137 (2%) 8.9x 47% 33% 20%Dubai Financial Mkt NC AED 1.13 2,461 0.00 0.02 0.03 282.5x 53.8x 33.2x 5.6 0.0 1.8 (3.4) 10.8 1.4 (37%) n/a 0% 0 16% 0% 0% 100%Hong Kong Ex Underweight HK$128.0 18,882 3.79 4.37 4.68 33.8x 29.3x 27.4x (3.1) (8.4) (12.0) (1.5) (3.0) 3.1 (10%) (4%) 11% 900 (18%) 21.0x 32% 32% 36%Japan Exchange Group Equal-weight ¥411 5,636 280.50 355.75 418.91 35.8x 28.2x 24.0x 13.8 37.7 155.8 118.3 133.5 0.8 25% 14% 22% 230 (6%) 24.5x 61% 33% 6%Jo'burg SE (JSE) NA ZAR 72.2 696 7.15 4.75 5.10 10.1x 15.2x 14.2x (1.4) (4.9) (7.4) (10.0) (7.7) 3.4 18% (12%) (16%) 152 7% 4.6x 33% 0% 67%Multi Commodity EX of India Equal-weight INR 888.9 831 58.78 61.53 69.93 15.1x 14.4x 12.7x 1.4 (8.0) (37.6) (29.6) (39.7) 1.9 28% 8% 9% 0 0% 0% 0% 0%New Zealand Ex NC NZD 1.3 287 0.04 0.06 0.07 35.9x 23.8x 19.9x (0.7) 0.8 7.3 0.5 9.9 4.0 1% 0% 35% 47 (25%) 6.1x 70% 20% 10%SingEx NC SGD 7.75 6,691 0.29 0.31 0.34 27.2x 25.3x 22.5x 1.0 0.5 9.0 16.0 10.6 3.7 (2%) 3% 10% 522 (7%) 12.8x 32% 37% 32%Other Exchange Median 2,461 27.2x 23.8x 20.0x 0.9 0.5 5.8 0.5 9.9 3.4 1% 3% 11% 174 (2%) 9.96x 32% 33% 32%Other Exchanges Average 5,275 48.7x 25.0x 20.5x 1.6 2.5 12.8 14.1 13.6 3.2 4% 3% 12% 358 (2%) 12.13x 33% 27% 31%Mkt Cap weighted Mean 38.5x 25.5x 21.5x 1.0 0.6 12.7 18.9 14.6 3.3 (1%) 3% 15% 700 (5%) 15.20xGlobal ExchangesGlobal Exchange Median 4,073 20.2x 16.8x 13.8x (1.1) (2.9) 7.3 13.7 10.2 3.3 1% 1% 11% 584 (2%) 6.19xGlobal Exchange Average 5,749 31.1x 19.3x 16.4x (0.2) (2.3) 8.9 13.2 11.4 3.4 4% 2% 12% 963 (3%) 7.91xMkt Cap weighted Mean 26.0x 19.8x 17.0x (0.8) (2.4) 11.7 14.4 14.6 3.2 2% 1% 12% 1,650 (3%) 9.28xInterdealer BrokersBGC Partners NC $5.62 922 0.58 0.56 0.66 9.7x 10.1x 8.6x (1.7) 28.9 54.0 (19.5) 62.4 5.8 (7%) (16%) 6% 1,540 8% 0.60x 33% 50% 17%GFI NC $3.34 394 0.07 0.21 0.34 47.7x 15.7x 9.7x (3.5) (2.1) (0.3) (5.4) 3.1 6.0 (49%) 1% 121% 1,014 (5%) 0.39x 67% 17% 17%ICAP Under-weight £2.93 2,890 0.33 0.32 0.34 8.9x 9.1x 8.7x (5.0) (14.6) (7.7) (22.7) (4.7) 6.8 (7%) (10%) 1% 2,569 (10%) 1.13x 23% 50% 27%Tradition NC SFr 50 331 N/A N/A N/A 0.0x 0.0x 0.0x (1.5) (7.7) (6.9) (31.5) 0.3 n/a 0% 0% 1,128 (6%) 0.29x 0% 0% 0%Tullett Equal weight £2.48 824 0.40 0.36 0.37 6.1x 6.8x 6.6x (3.6) (10.0) (7.7) (28.0) (1.6) 6.8 (6%) (11%) (4%) 1,419 0% 0.58x 50% 44% 6%Median 824 8.9x 9.1x 8.6x (3.5) (7.7) (6.9) (22.7) 0.3 6.4 (7%) (10%) 1% 1,419 (5%) 0.58x 33% 44% 17%Average 1,072 14.5x 8.4x 6.7x (3.1) (1.1) 6.3 (21.4) 11.9 6.4 (17%) (7%) 25% 1,534 (3%) 0.60x 35% 32% 13%

Mkt Cap weighted Mean 10.9x 8.9x 7.9x (3.9) (5.0) 3.5 (22.2) 8.2 6.2 (10%) (10%) 10% 2,012 (5%) 0.85x

EPS P/E Performance (%) EPS CAGR (%) Revenue (LTM) Sell Side Recs

57


• Our bottom-up analysis indicates changes in OTC derivatives markets could cost 3-5% of FICC revenues in 2015, starting from ~1% in 2013.

• Rates, followed by Equity Derivatives and FX to see the greatest impact.• GS and BARC see a ~3% hit to 2015 group earnings in our base case from a 20% revenue reduction in affected areas. This implies a 4-6% hit to investment banking profits.

• BONY, JPM and C to benefit most from the increasing opportunities in infrastructure supporting clearing, collateral management and tangential services.

Impact of OTC transformation is overestimated for leading banks

58


Which area will see greatest impact of the new collateralisation rules? We believe Rates requires the most incremental collateral out of our base case of $1.5trn of new collateral needed

Which products are most affected?

• We believe rates (interest rate swaps) to be the most impacted from upcoming collateralisation rules accounting for ~65% of the $1.5trn of net incremental collateral required. This reflects size of notional outstanding (rates accounts for ~77% at June 2012 per BIS), plusfact that rates include longer-duration swaps which carry higher capital charge.

• This is followed by equity derivatives (21%), FX (10%) and lesser impact on credit (2%) and commodities (2%)

What it means for our banks

• We believe the most impacted banks to be those with higher skew towards fixed income, particularly in rates which are within ‘macro’. Those with a greater skew toward FX and credit will be less impacted by new regulation

• Of the banks in our coverage, we think the most impacted to beDBK, GS as a % of group earnings

Source: Company Data. Morgan Stanley Research; Note: differences in disclosure between banks make an exact comparison difficult eg we note that BARC are a top 5 rates player, despite low relative skew to macro per disclosure. UBS includes non-core FICC.

Rates, 65%

Credit, 2%

Equity derivatives,

21%

Commodity, 2%

FX, 10%FICC product breakdown Macro Credit EM OtherCredit Suisse 23% 54% 19% 3%Deutsche Bank 60% 30% 5% 5%UBS AG 52% 40% 8% 0%RBS 46% 48% 0% 6%Barclays 28% 53% 13% 6%BNP Paribas 60% 30% 0% 10%Societe Generale 75% 15% 0% 10%JP Morgan 49% 33% 18%Bank of America 42% 50% 8%Citigroup 93% 7%Goldman Sachs 45% 45% 10%ICAP 61% 9% 10% 20%Tullett Prebon 48% 28% 24%

59


We believe the market overestimates the impact of OTC collateralization rules on earnings

Market view

• Our recent investor poll at the Morgan Stanley European Financials Conference on market views reveals market believes FICC revenues to be negatively impacted by 10-20% from the transformation of OTC markets

• Our detailed analysis suggests the market is too fearful as we think market overestimates % of affected areas and phasing

MS view

• In view of slower phasing (e.g. of bilateral collateral rules) and a smaller % of affected areas (up to 40% of FICC), despite hefty hit on affected areas (~20% drop in revenues in our base case), our work suggests ~3-5% impact to FICC revenues by 2015 in our base case

• We increase our US estimates (and DBK) for FICC on the back of this note

Source: Company Data. Morgan Stanley Research

0% 5% 10% 15% 20% 25% 30%

0-5%

5-10%

10-15%

15-20%

>20%

“How much do you think overall FICC revenues could still shrink from the transformation of OTC markets?”

40

100955

8



~40% of

FICC



60


Who is most affected by collateralisation in FICC? We expect DBK, GS to feel the greatest impact as a % of group earnings

• Our coverage universe assumes ~$4bn reduction from new regulation in our base case for FICC revenues vs. total projected revenue decline of $5-10bn for the industry by 2015 and $10-15bn by 2018. FICC covers ~90% of total lost industry revenues we think.

• Our base case assumes 20% reduction in FICC revenues from swap clearing driven by 10% decline in trading volumes as clients disengage as they begin posting collateral on derivative trades. We also assume a 10% decline in bid-ask spreads as greater pre/post trade transparency reduces margins

• We assume a phasing of regulation of 10% in 2013 and rising to 60% in 2015 in view of slower phasing of bilateral collateral rules• Our assumption on affected areas within FICC ranges from 20% (for UBS given low exposure to rates) and up to 40% for most exposed players• We believe DBK and GS to be the most negatively affected with new rules trimming ~3% off 2015e group earnings given exposure to affected areas

and to investment banking • Risks to the downside for our bear case include greater decline in trading volumes and tighter bid-ask spreads while upside is lower impact on trading

volumes and wider spreads as clients shift to higher margin trades that are not subject to clearing requirements


2013e 2015e 2013e 2015e 2013e 2015e 2013e 2015e 2013e 2015e 2013e 2015e 2013e 2015e 2013e 2015e 2013e 2015eFICC Revenues - Current 1,780 1,852 5,310 5,470 9,600 9,333 7,200 7,350 16,083 17,145 10,956 10,989 10,937 11,420 13,845 14,475 82,593 84,930FICC Revenues - Pre-impact 1,787 1,896 5,342 5,667 9,677 9,781 7,258 7,703 16,212 17,968 11,043 11,517 11,025 11,968 13,956 15,170 83,235 88,890 ow Impacted areas 356 370 1,593 1,641 3,840 3,733 2,880 2,940 6,433 6,858 4,382 4,396 4,375 4,568 5,538 5,790 32,097 32,999Impacted areas (% FICC) 20% 20% 30% 30% 40% 40% 40% 40% 40% 40% 40% 40% 40% 40% 40% 40% 39% 39%% Phasing 10% 60% 10% 60% 10% 60% 10% 60% 10% 60% 10% 60% 10% 60% 10% 60% 10% 60%% of Impacted lost - BULL 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5%% of Impacted lost - BASE -20% -20% -20% -20% -20% -20% -20% -20% -20% -20% -20% -20% -20% -20% -20% -20% -20% -20%% of Impacted lost - BEAR -30% -30% -30% -30% -30% -30% -30% -30% -30% -30% -30% -30% -30% -30% -30% -30% -30% -30%Revenues Impact - BULL 2 11 8 49 19 112 14 88 32 206 22 132 22 137 28 174 160 990Revenues Impact - BASE (7) (44) (32) (197) (77) (448) (58) (353) (129) (823) (88) (527) (87) (548) (111) (695) (642) (3,960)Revenue Impact - BEAR (11) (67) (48) (295) (115) (672) (86) (529) (193) (1,234) (131) (791) (131) (822) (166) (1,042) (963) (5,940)% of FICC rev lost - BASE 0% -2% -1% -3% -1% -5% -1% -5% -1% -5% -1% -5% -1% -5% -1% -5% -1% -4%Operating Magin (%) - Rates 60% 60% 60% 60% 60% 60% 60% 60% 60% 60% 60% 60% 60% 60% 60% 60% 60% 60%PBT Impact - BULL 1 7 5 30 12 67 9 53 19 123 13 79 13 82 17 104 96 594PBT Impact - BASE (4) (27) (19) (118) (46) (269) (35) (212) (77) (494) (53) (316) (52) (329) (66) (417) (385) (2,376)PBT Impact - BEAR (6) (40) (29) (177) (69) (403) (52) (318) (116) (741) (79) (475) (79) (493) (100) (625) (578) (3,564)IB PBT - Pre-impact 1,087 1,402 2,634 3,647 4,402 4,860 4,063 4,863 13,199 16,208 15,909 18,312 7,586 8,922 8,428 9,728 60,880 72,134% of IB PBT - BULL 0% 0% 0% 1% 0% 1% 0% 1% 0% 1% 0% 0% 0% 1% 0% 1% 0% 1%% of IB PBT - BASE 0% -2% -1% -3% -1% -6% -1% -4% -1% -3% 0% -2% -1% -4% -1% -4% -1% -3%% of IB PBT - BEAR -1% -3% -1% -5% -2% -8% -1% -7% -1% -5% 0% -3% -1% -6% -1% -6% -1% -5%Group PBT - Pre-impact 5,051 8,550 6,730 9,174 6,977 9,580 8,635 11,188 33,312 39,509 17,750 29,090 10,767 11,871 20,591 27,403 116,947 155,913% of Group PBT - BULL 0% 0% 0% 0% 0% 1% 0% 0% 0% 0% 0% 0% 0% 1% 0% 0% 0% 0%% of Group PBT - BASE 0% 0% 0% -1% -1% -3% 0% -2% 0% -1% 0% -1% 0% -3% 0% -2% 0% -2%% of Group PBT - BEAR 0% 0% 0% -2% -1% -4% -1% -3% 0% -2% 0% -2% -1% -4% 0% -2% 0% -2%

Total (US$)Local currency CitigroupJP Morgan Bank of America Goldman SachsUBS Credit Suisse Deutsche Bank Barclays

61


Impact of collateralisation: Deutsche Bank

Quantifying the impact: Deutsche Bank

• We believe DBK to be one of the most affected by new collateralisation rules given its greater skew to FICC (~60% of 2012 revenues) and within that ~60% to macro including rates, on our estimates.

• Given DBK is one of the top global players in US and European fixed income (top 3 in both) including interest rate derivatives, we believe the % affected in FICC is at the top end of the range at~40% exposed to affected areas (i.e. swaps and other OTC products like IRS, CDS, FX options, commodities).

What it means for our estimates

• We estimate ~5% off FICC revenues lost in our base case in 2015e assuming 20% revenue decline from a combination of volume and spread reduction in our base case.

• This implies a ~6% fall in i-bank PBT at DBK and ~3% lower group PBT when ~60% of the rules come into full effect globally and across products in 2015.

• If we look at a range of outcomes, our bear case implies a potential reduction in i-bank PBT of ~8% assuming 30% reduction in revenues and bull case accretion of ~1%.


DBK CB&S Revenues (2012)

Equity15%

IBD16%

FICC58%

Other11%

DBK FICC Revenues

Macro60%

Credit30%

EM5%

Other5%

62


Impact of collateralisation: Barclays

Quantifying the impact: Barclays

• We believe Barclays will be modestly affected by new collateralisation rules given greater skew to FICC (~63% of 2012revenues) and within that ~28% to macro including rates.

• Although Barclays’ disclosure on FICC breakdown implies its exposure to impacted areas is low, we believe in fact Barclays is a top 5 player in rates given differences in reporting. Therefore, we estimate the % of FICC in impacted areas to be at the high end of 40%


• We estimate ~5% off FICC revenues lost in our base case assuming 20% revenue decline from a combination of volume and spread reduction.

• This implies a ~4% fall in i-bank PBT at BARC and ~2% lower group PBT in 2015 in our base case. This is less than at DBK andGS.

• If we look at a range of outcomes, our bear to bull cases imply potential reduction in group PBT of ~3% and no change in the bull case


Barclays Investment Bank Revenues - 2012

Equities17%

FICC63%

IBD18%

Other2%

Barclays FICC Revenues - 2012

Macro28%

Credit53%

EM13%

Other6%

63


Impact of collateralisation: Goldman Sachs

Quantifying the impact: GS

• We believe GS to be one of the most affected by new collateralisation rules given its greater skew to FICC (~30% of 2012 revenues). FICC drives the highest proportion of group revenues


• We estimate ~5% off FICC revenues lost in our base case in 2015e assuming 20% revenue decline from combination of volume and spread reduction in impacted areas

• This implies ~4% fall in i-bank PBT at GS and ~3% lower group PBT in 2015 in our base case

• If we look at a range of outcomes, our bear to bull cases imply potential reduction in group PBT of 4% to up 1% in our bull case

GS Firm Revenues (2012)

Equity23%

IBD14%

Inv & Lending

17%

Inv Mgmt15%

FICC31%

Exposure to FICC and Impacted Revenues

32%

16%17%

12%13%

6% 7%5%

GS JPM C BACFICC Rev as % of Group Rev Impacted Rev as % of Group Rev


64


Opportunity from collateral management – BNY Mellon

Quantifying the impact: Industry-wide

• We see a wide range of possible outcomes for collateral management revenue pools. If we assume the entire $1.7 trillion is secured with corporate securities at a 20% haircut that is reinvested at 25-50bp, this yields a $1-2bn revenue opportunity from collateral transformation services (equivalent to a 6-13bp fee on collateral transformed).

• A wide range of companies are likely to seek incremental collateral management revenues, including broker/dealers, custodians, execution venues, etc.

Source: Company data 2012, Morgan Stanley Research, BIS, CME, ICE, LCH

Quantifying the impact: BNY Mellon

• Collateral transformation revenue opportunity is upside to our current earnings forecasts for BK

• We estimate the potential revenue opportunity is worth $100-200m for every 10% points of collateral transformation market share captured by BK. That’s worth about 7-13c per share or 2-5% of our 2015 earnings forecast.

Industry-wide collateral needs are expected to rise, creating opportunities in infrastructure supporting clearing, collateral management and tangential services

• We expect the impact of the flatter yield curve resulting from global monetary easing to intensify competition in collateral management. This could see custodian banks moving up into traditional prime brokerage services as they try to gain incremental business to offset pressure on margins.

Estimated Collateral Shortfall ($bn)

800

1,692

3,130

Bull

Base

Bear

Central Clearing IM

Bilateral IM

65


Impact of collateralisation on OTC: Inter Dealer Brokers (IDBs) – ICAP

Quantifying the impact: ICAP

• Voice broking represents 67% of ICAP’s revenues• Of voice revenues we estimate ~40% relates to swaps and other

OTC products (IRS, CDS, FX options, commodities, equities) impacted by Dodd Frank and associated EU regulations, with ~15% related to US business in these areas.

• Collateralisation rules and potential substitution of swaps to futures could affect 10-25% of relevant revenues near term in the US with a longer dated impact on Europe depending on timing/detail of final rules, we estimate.


• We estimate 1.5-4.0% off voice broking revenues or 1.0-2.5% off group revenues related to US business. Adjusted for broker comp costs (~60% of costs) would imply 2-5% group profit impact.

• Applying the above to capture global impact (e.g. as European regulations have an impact in 2014/15 onwards) would increase voice broking revenue loss to 4-10% and group profit impact to 5-13%.

• We forecast voice revenues down 0-1% pa in FY13-15e (March Y/E) as cyclical improvements in part offset the above drag in relevant product areas.

ICAP FY13e Revenues

FX, £97m,7%

Electronic, £270m, 18%

Post Trade & Information, £208m, 14%

Credit, £93m6%

Interest Rates,

£369m, 25%

Equities, £104m, 7% EM, £140m,

10%

Commod., £186m, 13%

Potential Voice Revenue Exposure to Regulation

US Impacted OTC, £150m,

15%

Other Voice, £573m, 58%

EU ImpactedOTC, £267m,

27%

Source: Company Data, Morgan Stanley Research Estimates

66


Impact of collateralisation on OTC: Inter Dealer Brokers (IDBs) – Tullett Prebon

Quantifying the impact: Tullett Prebon

• Voice and hybrid broking drive 94% of Tullett Prebon’s revenues. • Of this we estimate ~25% relates to swaps and other OTC products

(IRS, CDS, FX options, commodities, equities) impacted by Dodd Frank and associated European regulations and ~7% to US business in the above areas.


• We estimate 1-2% off voice broking revenues and group revenues related to US business. Assuming broker comp cost saves (~60% of total costs) would imply 2-6% hit to profits.

• Applying the above to capture global impact (e.g. as European regulations have an impact in 2014/15 onwards) would increase voice broking revenue loss to 2.5-6.0% and group profit impact to 8-20%.

• We forecast ~0-1% revenue decline per annum in 2013-15e as cyclical improvements partly offset regulatory/structural impacts.

Tullett Prebon - FY13e Revenues

Treasury Products, 229 , 27%

Interest Rate

Derivatives, 179 , 21%

Energy, 108 , 13%

Information sales, 50 ,

6%

Fixed Income

Securities, 239 , 28%

Equities, 40 , 5%

Potential Revenue Exposure from Regulation

EU Impacted OTC,

£155m, 18%

US Impacted OTC, £61m,

7%

Information, £50m, 6%

Other voice, £580m, 69%

Source: Company Data, Morgan Stanley Research Estimates

67


Opportunity from collateral management and OTC clearing – Clearstream

Quantifying the impact: Deutsche Boerse

• Clearstream accounts for ~38% of group revenues, of which Global Securities Financing (stock loan, GC pooling, triparty repo) is ~26%.

• Within GSF & Other we estimate >1/3 of revenues are from stock lending with <1/3 each from triparty repo (ensures collateral availability to support non-cleared repo) and GC pooling (centrally cleared repo/money market transactions). To date a number of CSDs have signed up to the service (CETIP, ASX, STRATE, CDS, Iberclear) plus agent banks (BNP and Citi).

• We also see potential to benefit from OTC clearing of IR swaps as buyside are mandated to clear in Europe from H114, though we expect economics to be affected by competition and the need to share benefits with users.


• We assume ~7% underlying top line growth for GSF & other and assume additional €62m recurring revenues by 2015 related to collateral management services (compares to company guidance for ~€100m over 3 years assuming 15-20 clients signed up).

• Potential upside could come from growth in custody assets if clients outside the network opt to move balances to Clearstream in order to benefit from the collateral optimisation service.

• We also assume modest benefit from OTC clearing with revenues increasing from ~€5m 2014e to €20m 2015e

NII & Other, 64 ,

3%

Settlement, 111 , 5%

GSF & Other, 219

, 10%

Xetra, 230 , 10%

Custody, 438 , 20%

Data & Analytics, 234 , 11%

Eurex, 912 , 41%

GSF & Other Revenue (€m)

219 223 239 255

4

30

62

2012 2013e 2014e 2015e

Collateral Growth Initiatives

Underlying Revenue

Source: Company data, Morgan Stanley Research Estimates

68


• Continued balkanisation of banking markets will trap even more liquidity and capital in each region, reducing the benefits of being a global bank and shifting market shares.

• FBO proposals in the US to hit DBK and BARC the hardest -- we estimate capital shortfalls of ~$20bn and ~$10bn respectively in the US subsidiaries.

• But this capital gap can be filled not by issuance of straight equity but by preference shares, hybrids, or CoCos, etc, reducing the potential for share dilution.

• The market underestimates the potentially greater cost of ring-fenced funding, which could hurt earnings and make banks less competitive in FICC markets where lower funding costs provide an advantage.

• As regulations trap capital/liquidity, footprint matters more than ever. US banks are advantaged as 50-60% of economic profit is sourced from US markets.

Balkanisation: a major headache for European firms, US firms advantaged

69


Who are the most exposed to potential draft FBO rules? We think DBK, BARC, and CS, although DBK and BARC are the most affected on capital

Who is the most exposed to potential draft FBO rules?

What does it mean for capital?

• We believe DBK and BARC to be potentially the most affected by rules for greater standalone capital as both are short of the 5.00-5.25% Tier 1 leverage ratio standard needed in the US. In contrast, CS’s US subsidiary already exceeds this requirement.

• We estimate the shortfall to be ~$20bn at DBK and ~$10bn at BARC, today representing ~30% of DBK’s Tier 1 capital and ~20% of BARC’s. Through restructuring and earnings we think DBK’sdeficit will fall closer to $7-9bn by 2015.

• We think that both banks can address the shortfall by CoCo and/or hybrid issuance rather than straight equity.

• Looking at European banks and their US subsidiary assets as a % of group funded assets indicates DBK, CS, and BARC to be the most exposed to draft FBO rules which propose holding morecapital and liquidity in the US subsidiary

• We see that 37% of DBK’s balance sheet is in the US subsidiaries (and a further 20% in the branch), followed by CS at 35% and BARC at 23%.

Capital Shortfall in US Subsidaries

20

10

0

30%

20%

0%0

5

10

15

20

25

DBK BARC CS

Cap

ital S

hortf

all (

US

$bn)

0%

5%

10%

15%

20%

25%

30%

Cap

iral S

hortf

all (

%Ti

er 1

Cap

ital)

37%35%

23%

17%14%

10%9%


% of group assets in US subsidiaries

Source: Company Data, SNL Financial, Morgan Stanley Research. Note: For Barclays US Data is for 1H12

70


Impact of Balkanisation: Deutsche Bank. We believe DBK to be the most affected by potential FBO proposals, particularly on funding rather than capital

What it means for capital

• At the end of 2011, DBK’s US holdco (‘Taunus’) had a capital shortfall of ~$30bn to reach a 5% Tier 1 leverage ratio. Pre-restructuring and mitigation, the shortfall falls to ~$20bn as it becomes an IHC. This is ~30% of DBK’s total Tier 1 capital, on our estimates.

• Earnings, deleveraging, DTA usage, and restructuring could reduce this deficit to $7-9bn by 2015e.

• In our base case, we do not think this gap triggers any common equity issuance but perhaps hybrids or CoCos from the parent to the US, which may incur a cost of up to €400m we estimate.

What it means for funding

• Fed proposals on liquidity look prima facie more challenging butthey are still in the comment period. There is a particular focus on reducing cross-currency swap usage and increasing tenor to reduce interconnectedness.

• The crux of issue is how the ‘ring-fence’ is defined given DBK uses ~€90bn of parent funding and it may have to fund more on a standalone basis, affecting EPS.

• We estimate potential lost earnings of €0.1-1.1bn or 1-12% of 2015e group PBT mainly from higher US funding costs but also from lost revenues due to smaller balance sheet and CoCo/hybrid issuance cost to reduce capital deficit.

Lost revenues/higher costs PBT €mShrinking US balance sheet ($100m) 80Higher US funding costs: 25-75bps higher on €90bn of intragroup funding 200-650Coco cost - $7bn @ 7.6% 0-400Total PBT lost 80-1130

DBK potential US Capital Gap

30.0

20.6

3.72.3

7.3

9.4

7.3

0

5

10

15

20

25

30

35

Capital gap atTaunus onlast data

Move to IHC IHC Q3 i-bankrestructuring

Earnings DTAs used Min net gap

$bn

Source: Company data, Morgan Stanley Research estimates

71


Impact of Balkanisation: Barclays. We believe Barclays could feel the impact of potential FBO proposals and, like DBK, more on funding than capital


• At 1H12, the Tier 1 Leverage Ratio for BCI (Barclays Capital Inc) was 2.16%, implying a capital shortfall of £7bn.

• We think the gap can be addressed by shrinking/re-booking repos and issuing £2.5bn of perpetual preferred stock.

• In our base case, we expect £86bn of repos reduction (£36bn re-book and reducing £49bn). Issuance of £2.5bn of Tier 1 Capital would be sufficient to achieve target Tier 1 Leverage ratio under new regime.


• Increased funding cost for BCI if it is required to raise funding at subsidiary level.

• Though incremental funding cost will be limited due to existing credit rating and smaller balance sheet.

• We estimate higher funding costs could cut group 2015e PBT by up to 7% in our Bear case.

Source: Company data, Morgan Stanley Research estimates (e)

Barclays Capital Inc. Funding£mApply change to static 1H12 Funding extra spread extra costRepo funding 150,842 0.10% (151) Other market funding 53,311 0.50% (267) Customer funding 12,033 0.10% (12) Sub debt / other 2,662 0.50% (13) 2012 total liabilities 218,849 0.20% (443) 2012 Op Profit 7,048 Impact on op profit -6.3%Apply change to 2015e Funding extra spread extra costRepo funding 70,000 0.10% (70) Other market funding 50,000 0.50% (250) Customer funding 10,000 0.10% (10) Sub debt / other 2,316 0.50% (12) 2015 total liabilities 132,316 0.26% (342) New tier 1 perpetual prefs. 2,500 5.00% (125) Total extra cost (467) 2015 Op Profit 10,729 Impact on op profit -4.3%

Barclays Capital Inc. £m 1H12 2015e % ChangeRepo assets 157,642 71,658 -55%Liquid asset buffer 15,000 23,817 59%Other 51,044 44,402 -13%Total assets 223,686 139,877 -37%

Repo funding 150,842 70,000 -54% Other market funding 53,311 50,000 -6% Customer liabilities 12,033 10,000 -17% Other 995 649 -35% Sub debt 1,667 1,667 0%Total liabilities 218,849 132,316 -40% Equity 4,837 5,061 5% Perpetual pref shares (Tier 1) - 2,500 Equity + perpetual prefs (Total Tier 1) 4,837 7,561 56%Total liabilities + equity 223,686 139,877 -37%

Key ratios:Equity/assets 2.16% 5.41% 3.2%Liquid assets/liabilities 6.9% 18.0% 11.1%

72


Impact of Balkanisation: Credit Suisse. We believe CS already has strong capitalization in US unit and funding currently looks manageable


• We believe CS’s US subsidiary (CS (USA), Inc.) already meets US requirements as it has a Tier 1 leverage ratio of 5.28% today, above the required 5.25%. Hence, we see no need for any capital issuance or transfer.

• We also estimate B3 CET1 in the US subsidiary of >10% as it holds ~40% of the group’s tier 1 capital.

• We expect the capital position to improve further even considering the impact from Basel 3 as we expect the balance sheet to reducefurther.


• Potential increase in funding costs for CS (USA), Inc. if it is required to raise funding at subsidiary level.

• Though incremental funding cost will be mitigated we think from existing credit rating (A+ by S&P), smaller balance sheet, implicit guarantee by parent (if maintained), and strong capitalization.

• We estimate higher funding costs could cut Group 2015e PBT by upto ~5% in our base case.

Source: Company data, Morgan Stanley Research estimates

CS balance sheet CS Rest of TotalSFr m (USA), Inc. CS CS2012 - current positionRepo 124,976 58,479 183,455 Other 193,897 546,835 740,732 Total assets 318,873 605,314 924,187 Goodwill + intangibles 658 7,974 8,632 Total tangible assets 318,215 597,340 915,555 Tier 1 Capital 16,794 26,887 43,681 Tier 1 Leverage Ratio 5.28% 4.50% 4.77%Surplus over 5.25% 88 2015 - projected positionRepo 90,000 50,000 140,000 Other 195,000 565,000 760,000 Total assets 285,000 615,000 900,000 Goodwill + intangibles 658 7,974 8,632 Total tangible assets 284,342 607,026 891,368 Tier 1 Capital (B3, Swiss) 16,823 26,934 43,757 Tier 1 Leverage Ratio 5.92% 4.44% 4.91%Surplus over 5.25% 1,895

CS (USA), Inc.SFr mApply change to static 2012 Funding Extra spread Extra costRepo funding 127,666 0.10% (128) Other market funding 122,979 0.20% (246) Long-term funding 35,485 0.40% (142) Other 11,781 0.00% - 2012 Total funding 297,911 0.17% (516) 2012 PBT 5,258 Impact on PBT -9.8%Apply change to 2015e Funding Extra spread Extra costRepo funding 90,000 0.10% (90) Other market funding 123,000 0.20% (246) Long-term Funding 35,000 0.40% (140) Other 12,000 0.00% - 2015e Total funding 260,000 0.18% (476) 2015e PBT 9,010 Impact on PBT -5.3%

2015 scenarios Bull Base BearFunding 260,000 260,000 260,000 Extra spread 0.05% 0.18% 0.45%Extra cost (130) (476) (1,170) 2015e PBT 9,010 9,010 9,010 Impact on PBT -1.4% -5.3% -13.0%

73


Cheaper funding costs broadly leads to higher FICC market share, which poses a risk to European banks if their US entities are forced to ring-fence and funding costs rise

Source: Company Data, Morgan Stanley Research. Excludes DVA/CVA

HSBC

SOGN

UBS

BNPPCSGRBS

GSBACBARCDBK

Citi

JPM

0%

4%

8%

12%

16%

100 130 160 190 220 250 280Senior CDS 5Y (Avg Last 12 months)

FICC Market Share (%) - FY12

Senior CDS 5Y (Avg Last 12 months) vs FICC Market Share (%) - FY12

74


• Banks still need to seek scale or downsize where they can’t achieve relevant scale and significantly reduce platform costs.

• The cost base has become semi-fixed or driven by transactional volumes, leaving less room for error.

• Given higher fixed cost base requirements of electronic trading in FICC and Equities, firms need to have relevant scale on each platform to achieve target efficiencies, or they need to downsize or exit.

• To get to 12-15% RoE, European banks need to take out 10-25% of costs, and 15-20% of RWAs by 2015. We think this is plausible.

“Decision Time” – 1 year on: much done, much still to do. Addressing operating gearing and scale dominate

75


“Decision Time” – 1 year on, much is done but we expect I-bank Basel 3 RWAs to shrink a further 15-20%

Source: Company Data, Morgan Stanley Research. For UBS, DB includes legacy + non-core + i-bank RWA. Target dates are: UBS 2017, CS 2013, DBK 2015. For GS, the 'target' represents management's estimates for simulated passive run-off and does not represent an actual target

RWA reductions in Investment Banks - BASEL 3 ($bn)

179 188 187

393 386

615

710

101 120

175

306330

565

655

UBS RBS CS DBK BARC JPM GS

FY12 Target

76


Operating leverage has grown in importance in FICC as the top players continue to gain share at the expense of sub-scale banks, forcing smaller players to exit or focus


• We think banks still need to seek scale or downsize where they can’t achieve relevant scale and dramatically reduce platform costs. This work has reinforced our conviction about how much of the cost base has become semi-fixed or driven by transactional volume, leaving less room for error. The source of competitive advantage is even more driven by relevant scale.

• We believe scale and operating leverage in FICC are key drivers of CIB ROE as FICC comprises ~55% of total investment banking revenues in 2012. We can see banks segregated into two groups based on market share as those with stronger FICC revenues (‘flow monsters’) have distinctly higher returns, such as JPM, BARC, DBK, BAC, Citi.

• On the other hand, smaller FICC players have lower returns and need to exit areas where they have low market share (i.e. UBS in rates) and/or focus in segments where they have competitive advantage (i.e. UBS in FX, CS in credit) in order to improve ROE.

• Other factors determining share include best-in-class electronic execution, strong client relationships that pull in client facilitation, capital to pull in the non-exchange traded business, funding costs, cross-sell opportunities.

SOGN

Nomura

UBS

BNPP

RBS

CSG

HSBC

GS

BAC

BARCDBK

Citi

JPM

0%

4%

8%

12%

16%

20%

- 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0




77


Source: Company Data, Morgan Stanley Research. Based on 2012 data. Assume $2bn fixed cost per player and 45% variable cost margin

• Our new analysis suggests scale is also a driving factor for Equities returns. Given higher fixed cost base requirements of electronic trading, firms need to have relevant scale on each platform to achieve target efficiencies or else need to downsize or exit.

• In Equities, we estimate only the top 3-4 players make their cost of capital given cost, competitive and volume pressure.• Competition was especially intense in 2012 as Equities revenues fell ~9% in 2012 YoY, where we saw marginal players gaining share from other players

retrenching. Keeping control of costs will be ever more important, where we think CS has started to cut 20-25% of its cost base.• We have seen smaller Equities players downsize or exit all or parts of Equities altogether such as RBS and Nomura, and we expect more restructuring

to come as we still believe there is overcapacity in the sector given low returns for many smaller players and fixed cost base, despite low capital requirements relative to FICC.

• We believe banks with smaller market shares will continue to reconsider their broader strategy (i.e. focus on specific product segments or regions) or consider further cost cuts as competition intensifies in the sector, unless equities volumes pick up dramatically.

Gearing is also important in equities where we estimate only the top 3-4 players make their cost of capital of 11%

JPM

CitiDBK

BARC

BAC

GS

CSG

UBS

-3%

0%

3%

6%

9%

12%

15%

18%

- 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0Equity Revenues ($bn)

Equ

ity D

ivis

ion

RO

E (%

)

78


We forecast Q113 revenues to be down 0-5% YoY, but full-year 2013 to be up modestly


• In our base case, our underlying 2013 total i-bank revenue forecasts are up ~4% YoY.• We model FICC revenues in 2013 up ~1% as we think stronger revenues against weaker comparables in Q2-Q3, offsetting increased regulatory challenges from mandatory clearing, which started to come into effect in the US in March.• In Equities, we expect revenues up ~2% in 2013 from greater cyclical rebound, though this has yet to occur in Q1 as equity trading volumes in the US and Europe are down ~5% YoY, though we expect YoY outperformance similarly in equities in Q2-Q3.• In IBD, we also expect revenues up ~5% YoY as ECM and M&A have a cyclical rebound while DCM issuance remains resilient as interest rates remain low

812 10 13 10 9 10 14 12 13

8 8 10 9 10 12 11 10 11

14

2018 13 17

12 1314 18 15

11 1015

11 12 10 1412 13

47

4441

24

49

2930 23

41

27

17 16

42

2629

22

39

2730

4

5

5

4

43 4

3

1

2

2

2

3

3

4

4

(2)

5

-$10bn

$0bn

$10bn

$20bn

$30bn

$40bn

$50bn

$60bn

$70bn

$80bn

Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q311 Q411 Q112 Q212 Q312 Q412 Q113e Avg Q2-Q4 13e

Avg Q1-Q4 14eIBD Equities FICC Other

79


2013e and Q113e forecasts


Local currency (ex DVA) 2012 JPM BAC Citi GS BARC RBS HSBC CSG UBS DBKEquities 4,406 3,257 2,417 8,015 1,991 1,318 2,342 4,330 2,869 2,327FICC 15,412 11,008 13,967 10,331 7,403 3,625 6,391 5,277 1,772 9,367IBD 5,769 5,309 3,641 4,926 2,123 224 NA 3,211 2,422 2,524Total IB Revenues 35,256 33,183 22,232 23,271 11,772 4,483 11,804 12,486 7,468 15,354

Local currency (ex DVA) 2013e JPM BAC Citi GS BARC RBS HSBC CSG UBS DBKEquities 4,685 3,307 2,354 7,696 2,100 1,120 2,459 4,440 2,910 2,300FICC 16,083 10,956 13,845 10,937 7,200 3,302 6,711 5,310 1,780 9,600IBD 6,118 6,034 4,217 5,659 2,200 112 NA 2,937 2,359 2,536Total IB Revenues 37,111 36,132 23,626 24,292 11,750 3,928 12,394 12,547 7,469 15,476

YoY (ex DVA) 2013e JPM BAC Citi GS BARC RBS HSBC CSG UBS DBKEquities 6% 2% -3% -4% 5% -15% 5% 3% 1% -1%FICC 4% 0% -1% 6% -3% -9% 5% 1% 0% 2%IBD 6% 14% 16% 15% 4% -50% NA -9% -3% 0%Total IB Revenues 5% 9% 6% 4% 0% -12% 5% 0% 0% 1%

Local currency (ex DVA) 1Q13e JPM BAC Citi GS BARC RBS HSBC CSG UBS DBKEquities 1,423 1,014 637 2,042 600 302 615 1,260 930 650FICC 5,020 4,087 4,065 3,405 2,300 892 1,678 1,800 580 3,000IBD 1,564 1,701 1,150 1,551 700 30 0 627 649 613Total IB Revenues 10,452 10,649 6,581 6,998 3,663 1,061 3,099 3,652 2,264 4,523

YoY (ex DVA) 1Q13e JPM BAC Citi GS BARC RBS HSBC CSG UBS DBKEquities 0% -4% -29% -14% 9% -29% 6% -7% -7% -10%FICC 0% -1% -14% -5% -4% -34% -35% -7% -6% -5%IBD 14% 40% 33% 34% 38% -75% NA -15% 2% -4%Total IB Revenues 2% 6% -1% -1% 5% -39% -20% -8% -2% -7%

80


We expect Basel 3 Core Tier 1 ratios to continue to improve as RWA in the i-bank and legacy assets reduce


BASEL 3 Core Tier 1 Ratio (%)14.1%

12.2%11.4%

10.8% 10.7% 10.7% 10.3% 10.3% 10.1% 10.0% 9.7%

11.2%

9.1%9.1%9.3%9.7%

8.9%

9.6%10.3%

9.8%10.3%

11.0%11.4%

12.4%

UBS Citi HSBC BAC CSGN BNP GS RBS JPM DBK BARC SG

2014FY 2013FY

81


On TCE/TA, we have seen a strong improvement as balance sheets shrink as banks delever and meet higher standards


TCE/TA - FY12 vs FY09

3.6%

5.8%

2.9%

3.4%

3.9%

4.4%

4.5%

4.6%

5.0%

5.8%

6.0%

6.4%

6.7%

6.9%

7.1%

8.4%

2.7%

3.0%

3.4%

4.0%

3.0%

3.3%

5.1%

4.5%

5.4%

4.7%

7.0%

6.5%

CSGN

DBK

SG

European Avg

BARC

UBS

BNP

RBS

HSBC

JPM

BAC

GS

US Avg

Citi

2009 2012

82


The difference in Tier 1 Leverage ratios has diminished between US and European banks but US is on average still c.2% higher


Tier 1 Leverage Ratio (%) - FY12 vs FY09

7.4%

4.3%

5.5%

5.7%

5.8%

6.3%

6.6%

6.7%

6.9%

7.3%

7.5%

7.7%

6.9%

7.0%

6.7%

5.8%

5.9%

3.2%

3.5%

4.3%

4.5%

3.9%

4.5%

5.1%

7.2%

7.2%

4.4%

5.3%

DBK

SG

BARC

European Avg

BNP

CSGN

UBS

HSBC

RBS

JPM

GS

US Avg

BAC

Citi

2009 2012

83


Appendix

84


Q1 constructive in issuance, rates, FX and resilient credit trading – a positive vs. market expectations

Market volumes and IBD revenues for Q1 2013 to date

FX and rates up double-digit YoY in Q1, while cash bond volumes incl. credit remain resilient YoY on a strong comp. Issuance revenues in both ECM and DCM are up year YoY. But Equities volumes are down YoY.

Our trading proxies suggest greatest strength in rates and FX asboth up double-digit YoY and QoQ. FX has benefited from stronger volatility with DB, Citi, BARC & UBS, the greatest beneficiaries we think. US cash bond volumes in Q1 are up marginally YoY on a strong comp led by credit and government bonds as DCM revenues remain resilient, up 1% YoY. On the other hand, cash equities volumes continue to be down YoY with US & Europe weaker YoY by 7% and 3% respectively. ECM revenues were strong in Q1 up 12% YoY, while M&A revenues remain lackluster down 8% YoY. Our outlook on private banking margins is mixed with greater benefit at Baer so far while rebound at UBS/CS slower due to higher UHNW skew which take longer to shift allocation.

Source: Company data, Bloomberg, Datastream, BATS Europe, Dealogic, Federal Reserve Bank of New York. Data as at Mar 29th, 2013.

Capital Market Proxies 1Q12 4Q12 2012 Avg US Equities ADV (shares bn) -7% 7% -1% US Equity Options ADV (contracts m) -4% 6% 3% European Equities ADV (€ bn) -3% 24% 8% ECM ($bn) 12% 4% 19% DCM ($m) 1% 13% 18% M&A ($m) -8% -33% -22%Total IBD Revenues ($m) 2% -5% 5% US FI Average Value Traded ($bn) 1% 7% 4% Government ($bn) 5% 12% 9% Mortgage-Backed ($bn) -5% 0% -5% Corporate ($bn) -2% 13% 7% ICAP Treasuries Value Traded ($tn) 13% 30% 22% Eurex Interest Rates ADV (€m) 24% 43% 27% CME FX ADV (contracts m) 20% 33% 21% ICAP FX Value Traded ($tn) 13% 42% 22%

1Q13 vs

85


Investment banking comparison table

Source: Dealogic, Morgan Stanley Research

All in $m. Adjusts for CVA/DVA 4Q12 vs.IBD 1Q09 2Q09 3Q09 4Q09 1Q10 2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 3Q 11 4Q 11 1Q 12 2Q 12 3Q 12 4Q 12 Q/Q Y/Y

JPM 1,380 2,239 1,658 1,892 1,446 1,405 1,502 1,833 1,779 1,922 1,039 1,119 1,375 1,245 1,429 1,720 20% 54%BAC 1,055 1,646 1,254 1,255 1,240 1,319 1,371 1,590 1,613 1,743 1,104 1,128 1,282 1,178 1,365 1,629 19% 44%GS 823 1,440 899 1,680 1,203 941 1,159 1,507 1,269 1,448 781 857 1,154 1,203 1,164 1,405 21% 64%MS 812 1,123 1,039 1,480 887 885 1,008 1,515 1,008 1,473 864 883 851 884 969 1,225 26% 39%CSG 393 634 734 1,171 823 889 869 1,253 986 1,091 728 558 801 677 898 1,055 17% 89%BARC 476 999 774 975 1,024 694 807 1,327 993 1,010 770 796 800 793 769 1,005 31% 26%C 982 1,160 1,163 1,458 1,057 674 930 1,167 851 1,085 736 638 865 854 926 996 8% 56%DBK 454 989 911 715 779 688 728 1,098 982 1,028 530 579 837 653 846 909 8% 57%UBS 601 885 821 807 575 437 418 929 725 686 570 648 692 567 610 723 18% 12%Nomura 125 305 167 489 338 224 290 412 337 168 175 223 185 128 217 282 30% 26%HSBC 195 282 244 294 210 155 217 280 237 277 193 198 307 180 260 265 2% 34%RBS 380 278 320 359 367 307 221 211 269 209 180 243 35% 15%BNP 294 365 257 246 228 160 203 203 258 178 157 142 222 127 162 142 -12% 0%Soc Gen 111 177 143 110 94 61 83 128 132 90 41 62 137 71 71 86 22% 39%CA CIB 110 201 115 148 107 93 113 128 125 108 79 61 114 59 90 94 4% 55%Natixis 34 49 28 33 42 28 33 39 52 66 20 26 59 30 36 36 -1% 40%IBD subtotal 7,846 12,494 10,207 12,752 10,435 8,929 10,050 13,767 11,714 12,680 8,008 8,127 9,949 8,858 9,993 11,815 18% 45%Equities 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q 11 2Q 11 3Q 11 4Q 11 1Q 12 2Q 12 3Q 12 4Q 12 Q/Q Y/YGS 2,504 3,793 3,302 2,173 2,470 1,534 2,012 2,033 2,322 1,876 2,189 1,669 2,364 1,695 2,105 1,851 -12% 11%MS 1,508 1,533 1,392 994 1,371 1,286 1,121 1,184 1,732 1,801 1,341 1,277 1,833 1,144 1,228 1,271 4% 0%CSG 2,012 2,041 1,756 1,104 1,548 1,368 1,254 1,382 1,712 1,341 685 807 1,479 1,161 1,022 977 -4% 21%JPM 1,557 1,034 1,284 971 1,415 847 1,231 1,090 1,478 1,145 1,047 806 1,424 1,043 1,044 895 -14% 11%BARC 772 1,160 894 545 769 840 557 987 873 918 544 480 864 670 844 777 -8% 62%BAC 1,489 1,198 1,265 949 1,530 852 974 789 1,239 1,077 754 652 1,059 780 715 713 0% 9%DBK 359 1,384 1,367 941 1,306 771 888 1,169 1,225 727 398 670 948 650 747 649 -13% -3%UBS 1,182 1,312 1,096 929 1,195 1,247 895 964 1,459 1,259 852 763 1,083 663 757 585 -23% -23%Nomura (325) 1,066 947 790 781 585 641 881 659 653 288 354 486 423 359 575 60% 62%C 1,244 1,795 1,324 732 1,218 620 1,062 808 1,103 776 289 232 902 550 510 455 -11% 96%Soc gen 844 1,408 1,512 1,023 1,088 453 826 929 1,210 886 666 550 859 603 719 501 -30% -9%HSBC 565 462 595 439 669 528 478 591 760 706 691 477 580 634 521 607 17% 27%BNP (54) 780 768 550 1,102 257 599 765 930 875 341 483 587 424 495 363 -27% -25%RBS 384 269 195 190 346 298 122 186 193 144 120 (106) -188% -157%CA CIB 361 567 510 444 496 466 407 461 456 416 366 311 342 286 273 221 -19% -29%Natixis 109 174 182 142 146 220 142 276 188 210 145 65 140 159 111 120 8% 85%Equities sub-total 14,126 19,708 18,194 12,728 17,488 12,142 13,284 14,499 17,691 14,965 10,719 9,779 15,143 11,030 11,569 10,454 -10% 7%FICC 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q 11 2Q 11 3Q 11 4Q11 1Q12 2Q12 3Q12 4Q12 Q/Q Y/YJPM 5,721 5,127 5,006 2,066 5,405 3,166 3,272 2,895 5,143 4,216 2,799 2,626 5,016 3,493 3,726 3,177 -15% 21%C 7,807 5,667 4,582 2,952 5,084 3,488 3,385 2,302 3,986 2,922 2,271 1,717 4,737 2,818 3,697 2,710 -27% 58%BARC 3,564 3,465 3,232 4,156 4,280 3,190 2,750 3,209 3,527 2,797 2,316 1,527 3,765 3,115 2,498 2,342 -6% 53%GS 6,749 7,095 6,211 3,353 5,937 3,047 2,857 1,726 4,285 1,539 1,423 1,363 3,571 2,194 2,449 2,117 -14% 55%DBK 4,897 3,503 3,147 1,926 5,259 2,710 2,890 2,130 4,934 3,120 2,152 1,697 4,150 2,734 3,086 2,081 -33% 23%BAC 4,789 5,584 4,480 2,507 5,515 2,316 3,527 1,800 4,003 2,576 314 1,303 4,131 2,555 2,534 1,788 -29% 37%Nomura 961 880 1,040 922 716 555 1,332 953 830 1,154 669 1,137 1,513 1,302 1,481 1,340 -9% 18%UBS (1,698) (53) 929 289 1,790 1,166 969 864 529 491 840 620 668 481 429 321 -25% -48%CSG 3,191 3,036 2,539 1,019 2,495 1,260 1,593 904 2,734 640 295 (311) 2,092 1,197 1,483 953 -36% -406%MS 1,472 2,354 3,279 1,463 2,715 1,730 1,311 820 1,929 1,901 1,083 1,204 2,594 770 1,458 811 -44% -33%HSBC 2,482 2,482 2,003 1,336 2,428 1,918 1,453 1,109 2,152 1,528 592 1,192 2,563 1,557 1,681 590 -65% -51%RBS 3,108 1,914 1,706 1,504 2,898 1,533 614 918 2,539 1,616 1,594 1,171 -27% 28%BNP 3,568 2,452 2,079 1,203 2432 1,521 1,435 1,321 2,047 1,519 540 387 2,140 998 1,313 1,404 7% 263%Soc gen 2,085 1,519 1,338 380 1,078 720 848 615 976 753 225 496 1,302 611 848 836 -1% 69%CA CIB 1,091 765 659 570 656 412 415 255 536 397 305 141 645 331 448 353 -21% 149%Natixis 531 579 367 219 359 206 224 185 368 279 92 229 362 288 265 212 -20% -7%FICC sub-total 47,209 44,455 40,892 24,359 49,257 29,319 29,967 22,592 40,879 27,367 16,529 16,246 41,787 26,059 28,989 22,204 -23% 37%Total revenues 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q 11 2Q 11 3Q 11 4Q11 1Q12 2Q12 3Q12 4Q 12 Q/Q Y/YGS 8,668 13,139 11,673 8,577 11,580 7,308 7,825 7,254 10,581 5,907 1,914 4,761 8,999 5,295 7,522 7,846 4% 65%JPM 8,658 8,400 7,948 4,929 8,213 5,744 5,598 6,195 8,067 6,940 4,198 4,586 8,009 5,709 6,185 5,773 -7% 26%DBK 5,552 6,505 6,505 4,268 8,293 4,614 5,438 5,003 7,601 5,175 3,595 3,229 6,362 4,364 5,003 5,190 4% 61%C 10,033 8,622 7,069 5,142 7,714 5,700 5,494 4,571 6,241 5,324 4,835 3,267 6,651 5,207 5,569 4,803 -14% 47%BAC 7,333 8,428 6,999 4,711 8,285 4,487 5,872 4,179 6,855 5,396 2,172 3,083 6,472 4,513 4,614 4,130 -10% 34%BARC 4,812 5,624 4,900 5,677 6,073 4,724 4,113 5,523 5,393 4,725 3,630 2,802 5,429 4,578 4,111 4,124 0% 47%MS 3,278 5,258 5,823 4,037 4,974 3,801 3,099 3,521 4,211 4,665 2,845 3,447 4,992 2,787 3,638 3,462 -5% 0%CSG 5,378 5,658 4,997 3,217 4,895 3,456 3,704 3,547 5,390 3,058 1,674 1,004 4,298 2,971 3,309 2,862 -14% 185%UBS (254) 1,905 2,684 2,148 3,561 2,849 2,282 2,757 2,883 2,582 2,246 2,094 2,505 1,880 1,899 1,728 -9% -17%Nomura 761 2,251 2,155 2,200 1,834 1,365 2,263 2,246 1,826 1,975 1,133 1,714 2,184 1,853 2,057 2,073 1% 21%HSBC 3,851 3,749 3,328 2,506 3890 3,073 2,645 2,847 3,149 2,511 1,476 1,867 3,450 2,371 2,462 1,462 -41% -22%BNP 3,808 3,597 3,105 1,999 3,762 1,938 2,237 2,289 3,235 2,572 1,038 1,012 2,949 1,549 1,970 1,909 -3% 89%RBS 2,278 1,851 2,438 2,660 4,199 2,954 2,750 2,267 3,611 2,138 957 1,314 3,001 1,969 1,894 1,307 -31% -1%Soc Gen (core) 3,040 3,104 2,993 1,512 2,260 1,234 1,757 1,672 2,317 1,729 932 1,107 2,298 1,285 1,638 1,423 -13% 28%CA CIB 1,562 1,534 1,284 1,162 1,259 970 935 844 1,117 922 750 513 1,101 676 811 667 -18% 30%Natixis 674 802 577 394 548 454 400 500 609 555 258 319 561 476 413 368 -11% 15%Total sub-total 69,432 80,426 74,478 55,139 81,341 54,671 56,412 55,214 73,087 56,174 33,652 36,120 69,261 47,484 53,095 49,126 -7% 36%

86


April 11, 2013 The Three Biggest Challenges

M O R G A N S T A N L E Y B L U E P A P E R Morgan Stanley Blue PapersMorgan Stanley Blue Papers address long-term, structural business changes that are reshaping the fundamentals of entire economies and industries around the globe. Analysts, economists, and strategists in our global research network collaborate in the Blue Papers to address critical themes that require a coordinated perspective across regions, sectors, or asset classes.

Recently Published Blue Papers

Releasing the Pressure from Low Yields Should Insurers Consider Re-risking Investments? March 15, 2013

Key Secular Themes in IT

Monetizing Big Data September 4, 2012

Global Autos Clash of the Titans: The Race for Global Leadership January 22, 2013

Chemicals ‘Green is Good’ – The Potential of Bioplastics August 22, 2012

Big Subsea Opportunity Deep Dive January 14, 2013

MedTech & Services Emerging Markets: Searching for Growth August 6, 2012

eCommerce Disruption: A Global Theme Transforming Traditional Retail January 6, 2013

Commercial Aviation Navigating a New Flight Path June 26, 2012

China – Robotics Automation for the People December 5, 2012

Mobile Data Wave Who Dares to Invest, Wins June 13, 2012

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Global Auto Scenarios 2022 Disruption and Opportunity Starts Now June 5, 2012

Any

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$)fJHsrlidjei34adk@y

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M O R G A N S T A N L E Y B L U E P A P E R

China High-Speed Rail On the Economic Fast Track May 15, 2011

The China Files European Corporates & China’s Megatransition

October 29, 2010

Petrochemicals Preparing for a Supercycle

October 18, 2010

The China Files US Corporates and China’s Megatransition

September 20, 2010

Solvency 2 Quantitative & Strategic Impact, The Tide is Going Out

September 22, 2010

Brazil Infrastructure Paving the Way

May 5, 2010

To find downloadable versions of these publications and information on Other Morgan Stanley reports, visit www.morganstanley.com

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M O R G A N S T A N L E Y B L U E P A P E R Morgan Stanley has agreed to sell its EMEA Private Wealth Management business in the United Kingdom, United Arab Emirates and Italy to Credit Suisse Group AG, as announced on March 27, 2013. Please refer to the notes at the end of the report.

Morgan Stanley & Co. Limited ("Morgan Stanley") is acting as financial adviser to London Stock Exchange Group plc ("LSEG") in relation to its discussions with LCH.Clearnet Group Limited regarding a potential transaction, as announced on 2 September, 2011. LSEG has agreed to pay fees to Morgan Stanley for its financial services. Please refer to the notes at the end of the report.

Morgan Stanley is acting as lead financial advisor to IntercontinentalExchange, Inc. ("ICE") with respect to its definitive agreement to acquire NYSE Euronext, as announced on December 20, 2012.

The proposed transaction is subject to approval by both companies' shareholders, US and European regulators, and other customary closing conditions. This report and the information provided herein is not intended to (i) provide voting advice, (ii) serve as an endorsement of the proposed transaction, or (iii) result in the procurement, withholding or revocation of a proxy or any other action by a security holder.

ICE has agreed to pay fees to Morgan Stanley for its financial advice, including transaction fees that are contingent upon the consummation of the proposed transaction. Please refer to the notes at the end of the report.

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M O R G A N S T A N L E Y B L U E P A P E R Disclosure

Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. As used in this disclosure section, Morgan Stanley includes RMB Morgan Stanley (Proprietary) Limited, Morgan Stanley & Co International plc and its affiliates. For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA. For valuation methodology and risks associated with any price targets referenced in this research report, please email [email protected] with a request for valuation methodology and risks on a particular stock or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY 10036 USA.

Analyst Certification

The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Huw Van Steenis. Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Global Research Conflict Management Policy

Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at http://www.morganstanley.com/institutional/research/conflictpolicies.

Important US Regulatory Disclosures on Subject Companies

The following analyst or strategist (or a household member) owns securities (or related derivatives) in a company that he or she covers or recommends in Morgan Stanley Research: Michael Cyprys - Bank of America(common or preferred stock). Morgan Stanley policy prohibits research analysts, strategists and research associates from investing in securities in their industry as defined by the Global Industry Classification Standard ("GICS," which was developed by and is the exclusive property of MSCI and S&P). Analysts may nevertheless own such securities to the extent acquired under a prior policy or in a merger, fund distribution or other involuntary acquisition. Citigroup may be deemed to control Morgan Stanley Smith Barney LLC due to ownership, board membership, or other relationships. Morgan Stanley Smith Barney LLC may participate in, or otherwise have a financial interest in, the primary or secondary distribution of securities issued by Citigroup or an affiliate of Citigroup that is controlled by or under common control with Morgan Stanley Smith Barney LLC. As of February 28, 2013, Morgan Stanley beneficially owned 1% or more of a class of common equity securities of the following companies covered in Morgan Stanley Research: BNP Paribas, Deutsche Bank, Deutsche Boerse, Nomura Holdings. Within the last 12 months, Morgan Stanley managed or co-managed a public offering (or 144A offering) of securities of Bank of America, Bank of New York Mellon Corp, Barclays Bank, Citigroup Inc., Deutsche Bank, Deutsche Boerse, HSBC, J.P.Morgan Chase & Co., Nomura Holdings, Northern Trust Corp., Royal Bank of Scotland, Societe Generale, State Street Corporation, UBS. Within the last 12 months, Morgan Stanley has received compensation for investment banking services from Bank of America, Bank of New York Mellon Corp, Barclays Bank, BNP Paribas, Citigroup Inc., Credit Suisse Group, Deutsche Bank, Deutsche Boerse, Goldman Sachs Group Inc, HSBC, J.P.Morgan Chase & Co., Nomura Holdings, Northern Trust Corp., Royal Bank of Scotland, Societe Generale, State Street Corporation, UBS. In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from Bank of America, Bank of New York Mellon Corp, Barclays Bank, BNP Paribas, Citigroup Inc., Credit Suisse Group, Deutsche Bank, Deutsche Boerse, Goldman Sachs Group Inc, HSBC, J.P.Morgan Chase & Co., Nomura Holdings, Northern Trust Corp., Royal Bank of Scotland, Societe Generale, State Street Corporation. Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services from Bank of America, Bank of New York Mellon Corp, Barclays Bank, BNP Paribas, Citigroup Inc., Credit Suisse Group, Deutsche Bank, Deutsche Boerse, Goldman Sachs Group Inc, HSBC, ICAP, J.P.Morgan Chase & Co., Nomura Holdings, Northern Trust Corp., Royal Bank of Scotland, Societe Generale, State Street Corporation, Tullett Prebon, UBS. Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client relationship with, the following company: Bank of America, Bank of New York Mellon Corp, Barclays Bank, BNP Paribas, Citigroup Inc., Credit Suisse Group, Deutsche Bank, Deutsche Boerse, Goldman Sachs Group Inc, HSBC, J.P.Morgan Chase & Co., Nomura Holdings, Northern Trust Corp., Royal Bank of Scotland, Societe Generale, State Street Corporation, UBS.

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M O R G A N S T A N L E Y B L U E P A P E R Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the past has entered into an agreement to provide services or has a client relationship with the following company: Bank of America, Bank of New York Mellon Corp, Barclays Bank, BNP Paribas, Citigroup Inc., Credit Suisse Group, Deutsche Bank, Deutsche Boerse, Goldman Sachs Group Inc, HSBC, ICAP, J.P.Morgan Chase & Co., Nomura Holdings, Northern Trust Corp., Royal Bank of Scotland, Societe Generale, State Street Corporation, Tullett Prebon, UBS. Morgan Stanley & Co. LLC makes a market in the securities of Bank of America, Bank of New York Mellon Corp, Barclays Bank, Citigroup Inc., Credit Suisse Group, Deutsche Bank, Goldman Sachs Group Inc, HSBC, J.P.Morgan Chase & Co., Nomura Holdings, Northern Trust Corp., Royal Bank of Scotland, State Street Corporation, UBS. Morgan Stanley & Co. International plc is a corporate broker to Royal Bank of Scotland. The equity research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues. Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making, providing liquidity and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in this report. Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

STOCK RATINGS

Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution

(as of March 31, 2013)

Coverage Universe Investment Banking Clients (IBC)

Stock Rating Category Count % of Total Count

% of Total IBC

% of Rating Category

Overweight/Buy 1031 36% 402 39% 39%

Equal-weight/Hold 1250 44% 480 47% 38%

Not-Rated/Hold 105 4% 27 3% 26%

Underweight/Sell 467 16% 113 11% 24%

Total 2,853 1022

For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley received investment banking compensation in the last 12 months.

Analyst Stock Ratings

Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months.

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M O R G A N S T A N L E Y B L U E P A P E R Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock's total return relative to the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views

Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below. In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below. Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below. Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.

Important Disclosures for Morgan Stanley Smith Barney LLC Customers

Citi Research publications may be available about the companies or topics that are the subject of Morgan Stanley Research. Ask your Financial Advisor or use Research Center to view any available Citi Research publications in addition to Morgan Stanley research reports. Important disclosures regarding the relationship between the companies that are the subject of Morgan Stanley Research and Morgan Stanley Smith Barney LLC, Morgan Stanley and Citigroup Global Markets Inc. or any of their affiliates, are available on the Morgan Stanley Smith Barney disclosure website at www.morganstanleysmithbarney.com/researchdisclosures. For Morgan Stanley and Citigroup Global Markets, Inc. specific disclosures, you may refer to www.morganstanley.com/researchdisclosures and https://www.citigroupgeo.com/geopublic/Disclosures/index_a.html. Each Morgan Stanley Equity Research report is reviewed and approved on behalf of Morgan Stanley Smith Barney LLC. This review and approval is conducted by the same person who reviews the Equity Research report on behalf of Morgan Stanley. This could create a conflict of interest.

Other Important Disclosures

Morgan Stanley & Co. International PLC and its affiliates have a significant financial interest in the debt securities of Bank of America, Bank of New York Mellon Corp, Barclays Bank, BNP Paribas, Citigroup Inc., Credit Suisse Group, Deutsche Bank, Deutsche Boerse, Goldman Sachs Group Inc, HSBC, J.P.Morgan Chase & Co., Nomura Holdings, Royal Bank of Scotland, Societe Generale, State Street Corporation, UBS. Morgan Stanley is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Morgan Stanley produces an equity research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com. Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the circumstances and objectives of those who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of an investment or strategy will depend on an investor's circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. Morgan Stanley Research is not an offer to buy or sell any security/instrument or to participate in any trading strategy. The value of and income from your investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in securities/instruments transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. If provided, and unless otherwise stated, the closing price on the cover page is that of the primary exchange for the subject company's securities/instruments.

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M O R G A N S T A N L E Y B L U E P A P E R The fixed income research analysts, strategists or economists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality, accuracy and value of research, firm profitability or revenues (which include fixed income trading and capital markets profitability or revenues), client feedback and competitive factors. Fixed Income Research analysts', strategists' or economists' compensation is not linked to investment banking or capital markets transactions performed by Morgan Stanley or the profitability or revenues of particular trading desks. Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common equity securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities/instruments or derivatives of securities/instruments of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities/instruments or derivatives of securities/instruments of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons. With the exception of information regarding Morgan Stanley, Morgan Stanley Research is based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue equity research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel. Morgan Stanley Research personnel may participate in company events such as site visits and are generally prohibited from accepting payment by the company of associated expenses unless pre-approved by authorized members of Research management. Morgan Stanley may make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report. To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments. Morgan Stanley is not incorporated under PRC law and the research in relation to this report is conducted outside the PRC. Morgan Stanley Research does not constitute an offer to sell or the solicitation of an offer to buy any securities in the PRC. PRC investors shall have the relevant qualifications to invest in such securities and shall be responsible for obtaining all relevant approvals, licenses, verifications and/or registrations from the relevant governmental authorities themselves. Morgan Stanley Research is disseminated in Brazil by Morgan Stanley C.T.V.M. S.A.; in Japan by Morgan Stanley MUFG Securities Co., Ltd. and, for Commodities related research reports only, Morgan Stanley Capital Group Japan Co., Ltd; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. 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LLC, which accepts

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M O R G A N S T A N L E Y B L U E P A P E R responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by the Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Morgan Stanley Private Wealth Management Limited, authorized and regulated by the Financial Services Authority, also disseminates Morgan Stanley Research in the UK. Private UK investors should obtain the advice of their Morgan Stanley & Co. International plc or Morgan Stanley Private Wealth Management representative about the investments concerned. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited. Morgan Stanley Bank AG currently acts as a designated sponsor for the following securities: Deutsche Bank. The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at Professional Clients only, as defined by the DFSA. The financial products or financial services to which this research relates will only be made available to a customer who we are satisfied meets the regulatory criteria to be a Professional Client. The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA. As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations. The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages relating to such data. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and S&P. Morgan Stanley bases projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on public information. MSCI has not reviewed, approved or endorsed these projections, opinions, forecasts and trading strategies. Morgan Stanley has no influence on or control over MSCI's index compilation decisions. Morgan Stanley Research or portions of it may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities/instruments is available on request. Morgan Stanley Research, or any portion thereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley Research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities/instruments is available on request.

Other Important Disclosures from Oliver Wyman

Copyright © 2013 Oliver Wyman. All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect. This report is not a substitute for tailored professional advice on how a specific financial institution should execute its strategy. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisers. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. This report may not be sold without the written consent of Oliver Wyman. The Oliver Wyman employees that contributed to this report are neither FSA nor FINRA registered. Oliver Wyman is not authorised nor regulated by the FSA. As a consultancy firm it may have business relationships with companies mentioned in this report and as such may receive fees for executing this business. References herein to the FSA shall be deemed to include both the FCA and PRA. Please refer to www.oliverwyman.com for further details.

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