Presentation to the Institute of International Bankers Charles Roxburgh

CONFIDENTIAL

Washington D.C., March 2008

This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

Competitive Strategies in Wholesale Financial Markets and Proposals to Restructure the U.S. Regulatory System

Presentation to the Institute of International Bankers

Charles Roxburgh

McKinsey & Company | 2

Scenarios for future of global capital markets

Competitive strategies in response

Possible directions for regulatory reform

Three topics


2007 was set to be another record year – but then it all went wrong . . .

Global capital markets revenues*

*Sales and trading, ECM, DCM, loan origination and syndication, and M&A revenues**Estimates based on results of ten Global players, which may over-state total industry growth in first half given relative out-performance by leading firms, plus third quarter actual results and mix of actual and estimated fourth quarter results for leading firms scaled up to give industry totals

315

209

2004

244

2005 2006

25**(4Q)

46**(3Q)

198**(1H)

267**

Post-write-downs – 2007

+17%

+29%-15%

$Millions

Source: McKinsey Global Capital Markets Revenue Pools; Company reports, McKinsey estimates


0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

2,600

2,800

U.S. securities industry financial results* End Q1 1980 value indexed to 100 (quarterly figures)

Before looking forward, let’s look back . . .

*Extracted from aggregated income statement, selected balance sheet, and employment data on the U.S. domestic broker-dealer operations of all NASD and NYSE member firms doing a public business derived from their Financial and Operational Combined Uniform Single (FOCUS) Report filings

Q1 1980 2000 2001 2002 2003 2004 2005 2006 20071982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 19991981

Securities firms revenue

Absolute revenues below corresponding quarter in previous year

Q1 2001 – Q2 2005“9/11 and TMT collapse”

Duration of decline – 9 quarters% max. fall – 43.0%Time to recovery – 19 quarters

Q2 1987 – Q1 1989“Black Monday”


Q1 1994 – Q4 1994“U.S. interest rate hike”


Q3 1998 – Q3 1999“Emerging markets crisis”

Duration of decline – 1 quarter% max. fall– 15.2%Time to recovery – 5 quarters

Source: SIFMA; McKinsey analysis


Last September, we defined four possible scenarios for the future . . .

Description

Bounce Back The credit and liquidity crunches turn out to be a short-term blip 2007 H2 is tough but 2007 remains a record year, revenue growth reverts to long

term trend from Q1 2008 onwards

Steady Recovery Some players keep struggling in credit in the remaining of 2007, but no major downturn in economy

After identifying all effects and losses due to the current turmoil, capital market revenues growth picks up in 2008H2

The Long Chill Weakened consumers confidence due to the US housing market downturn leads to a mild dip of economy in early 2008; slight up-tick in default rates hits credit markets

Further interest rate cut in mid-2008 rescues markets, but it takes one year for growth revival

Late Tackle Liquidity support by central banks and continued consumer confidence maintain markets’ stability and growth until around mid-2008

Inflationary pressures accelerate given loose monetary policy. Fed reverses policy and triggers 2-3 quarters of recession from mid to end 2008

Source: McKinsey


. . . which we have now narrowed down to two main scenarios

402360315267315244

2005 06 07 08 09 2010

+6%

300285256315244

2005 06

267

07 08 09 2010

-1%

Steady Recovery

Benign "soft landing" and quick economic recovery in 2008

Deal pipelines temporarily dry out creating 3-4 quarters of negative growth in credit, but recover in H2 2008

Europe and Emerging markets remain strong

The Long Chill

Early, mild recession in 2008 Structural change in credit markets Continued growth in selected asset classesStrong growth ex-US

Total & CIB revenues

Note: 2007, 2008, 2009 results include estimated write-downs & write backs

Source: McKinsey Global Capital Markets Revenue Pools; McKinsey estimate

$Millions


What will be the next shoe to drop?

Monolines?

Commercial Real Estate?

Leveraged Loans?

Sub-prime “Round 2”?

Litigation?

Regulatory over-reaction?

Source: McKinsey


There are common trends across all scenarios

Source: McKinsey

Regional balance

Product trends

Emerging markets likely to outgrow developed markets

Western Europe likely to extend lead over North America in terms to total capital markets revenues

North America lags behind

Commodities and Equity Derivatives with strong prospects under all scenarios

FX, Rates & Cash Equities as winners in "lighter crisis" scenarios and still relatively resilient in steeper crisis

Permanent loss of some revenue pools (esp. structured credit)

Continued attractiveness of annuity-like transactional products


Global revenue pools are likely to shift away from the US

Estimated revenue mix by regionPercent

40 40

4031

610

9 15

5

2005

4

2010 possible scenario

Japan

Non-Japan Asia

Other emerging markets

North America

Western Europe

100%

Source: McKinsey Corporate and Investment Banking Practice Industry Scenarios





Three topics


Three priorities for maximizing value through a potential downturn

Remain committed to clients and talentDeepen client relationships, forged through adversityRe-structure compensation to reward commitment of top talent and

strengthen link to long term value creationMaintain active recruiting strategy at all levelsReinforce meritocracy

Reconfirm & recommit to long term strategyContinue investment throughout the cycle in strategic prioritiesBuild emerging markets franchisesUndertake 'no regret' reviews of risk process, capital allocation and non-

compensation costs

Invest in the next waves of innovationDrive product innovation, e.g., insurance securitization, carbon trading, Capture convergence opportunities e.g., with asset management Improve “R&D” and streamline new product development processes Innovate business and operational models for productivity and efficiency





Three topics


In 2006 there was growing pessimism about the prospects for New York City as a financial center relative to London

Do you believe this city will become more or less attractive over the next 3 years?

More attractive

About the same

Less attractive

New York City

44

15

41

London

38

8

54

Ranking by responsePercent

Source: McKinsey Financial Services CEO Survey


Regulation was an area of particular concern

Source: McKinsey Financial Services CEO Survey

Which regulatory environment is more business-friendly?

U.S. is much better

U.S. is somewhat better

About the same

U.K. is somewhat better

U.K. is much better

Rules InspireInvestorConfidence

Clarity of Rules

Fairnessof Rules

Uniformityof RegulatoryEnforcement

Simplicity ofRegulatorySystem

Cost ofOngoingCompliance

45

23

2

26

4

31

35

19

13

2

42

32

12

131

45

32

8

13

2

43

31

7

14

5

Ranking by responsePercent

33

34

14

16

3


Several reports helped created a consensus on the diagnosis….

Source: McKinsey


. . . and a consensus is emerging on some issues . . . Supports

Drafting+

Principles-based regulations

Better regulatory coordination

Prudential supervision

Securities litigation reform

Accounting reforms/IFRS

SOX reforms

CCMRBloomberg-Schumer Chamber Roundtable Treasury

+

+

+

Source: McKinsey

???

?


. . . and a consensus is emerging on some issues . . . Supports

Drafting+

CCMRBloomberg-Schumer Chamber Roundtable Treasury

New & modernized charters

National Commission to study further

+

Regulatory structure rationalization/ consolidation

Immigration reforms for skilled talent, business travellers

Source: McKinsey

National Commission to study further

?

?

?


U.S. now faces a clear choice – bold reforms

Clarify financial market objectives

Move to principles-based and prudential regulation

Enhance regulatory coordination

Reform securities litigation

Modernize charters

Streamline and consolidate agencies

Continue accounting and auditing reforms

Improve immigration policies to ensure needed skills

Source: McKinsey


U.S. now faces a clear choice – bold reforms . . . or just muddle through

Clarify financial market objectives

Move to principles-based regulation & prudential supervision

Enhance regulatory coordination

Reform securities litigation

Modernize charters

Streamline and consolidate agencies

Continue accounting and auditing reforms

Improve immigration policies to ensure needed skills

No clear national objectives

Continue rules-based regulation with emphasis on enforcement

Rely on ad hoc, reactive coordination among agencies

Keep litigious legal environment

Leave charters unchanged

Maintain current complexity and overlap at national and state level

No further accounting or auditing reforms

Leave immigration unchanged

Source: McKinsey


Some predictions . . .

Source: McKinsey

Current market environment will dominate Congressional and regulatory debates in near term, understandably postponing needed reforms even where there may be growing consensus

More evidence of eroding US competitiveness could drive some consensus reforms this year as a “regulatory stimulus” response before the 2008 elections – e.g.▢Principles-based regulation and national standards▢Better regulatory coordination…..but need to avoid risk of regulatory over-reaction to current issues

Longer-term reforms – new charters, streamlined and consolidated agencies, securities litigation reforms, immigration reforms – will likely await new Administration and new Congress in 2009-2010 and beyond.

CONFIDENTIAL

Washington D.C., March 2008

This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

Competitive Strategies in Wholesale Financial Markets and Proposals to Restructure the U.S. Regulatory System

Presentation to the Institute of International Bankers

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Presentation to the Institute of International Bankers Charles Roxburgh