New rules to help create a single market for financial services across Europe could radically change the shape of the investment banking industry by putting a squeeze on smaller players.
The impact of Europe's Markets in Financial Instruments Directive (MiFID) across the financial sector is difficult to predict, experts say, but they see the banks' equities trading businesses, already facing margin pressures, bearing the brunt.
The rules aim to harmonise the way securities are traded across the European Union to create a more unified European capital market.
This involves boosting transparency so investors can see how much they are paying in commissions when buying stocks and bonds in the various markets. It also aims to do away with monopolies currently held by some local stock exchanges.
"For banks' core equities businesses it has a very significant effect in terms of requiring greater transparency," said John Tattersall, a financial services partner at accounting firm PricewaterhouseCoopers.
"It will cost the banks a fair bit to get procedures and systems up to scratch."
This is expected to benefit big banks with deep pockets for IT and potentially force some smaller players to pull out of certain businesses if they cannot easily foot the bill for new technology systems.
There could be pressure to for small banks to merge, but also more scope for outsourcing. A few banks are already big in providing outsourced services and experts predict there will be potential to increase this after MiFID.
The Financial Services Authority is set to publish proposals at the end of next month outlining how it will implement MiFID's requirements in Britain.
The FSA will publish a cost and benefit analysis of the impact of MiFID at the same tim MiFID is due to come into force in November 2007, but any changes will have to be in place by the end of January.
"MiFID is an enormously wide-ranging piece of legislation, covering many different aspects of the activities of investment banks," said Alan Yarrow, chairman of the London Investment Banking Association. "Much of the detailed national measures has yet to be finalised," he said.
A whole raft of issues need to be thrashed out between the industry and the regulator, including best execution, pre- and post-trade transparency, client classification, marketing and conflicts of interest.
JP Morgan earlier this week cut its investment banking valuation multiples by 10 per cent to reflect the regulatory risk and uncertainty posed by the new regime.
"The directive could reduce earnings per share by as much as seven per cent for European wholesale banks on our estimates, with UBS the most exposed," it said.
J.P. Morgan argued that MiFID would threaten private banking revenues for integrated banks like UBS, which have both private banking and investment banking under one roof.
"We estimate captive revenues account for 15 per cent of total investment banking revenues and that these revenues could fall by 21 per cent," JP Morgan said.
A lot of banks have enjoyed synergies from using their investment banking capabilities to service their own private banking operations.
"But MiFID will make this more expensive to do because of reporting requirements," said Tattersall from PwC.
He said it was difficult to generalise about the effects of the new rules. His firm has done MiFID impact studies, which showed dramatically different results depending on banks' business, systems and customers. "But no one escapes," he said.