Britain's Tullett in talks to buy ICAP's global broking business

* Any deal to be structured as reverse takeover

* ICAP (LSE: IAP.L - news) would own minority stake in the enlarged Tullett Prebon

* Tullet, ICAP top two gainers on FTSE's mid-cap index (Adds detail, analyst comment, updates share prices)

By Noor Zainab Hussain and Esha Vaish

Nov 6 (Reuters) - Rival British interdealer brokers ICAP (Amsterdam: IA6.AS - news) and Tullett Prebon (LSE: TLPR.L - news) are in talks to combine their businesses, the companies said on Friday, as they seek to combat falling profits in a sector struggling with shrinking trading volumes.

The negotiations could lead to Tullett's much smaller business buying market leader ICAP's global broking business, including the latter's technology and broking platforms but not its much bigger electronic broking business.

If the deal to combine their traditional telephone broking services succeeds, it would be structured as a reverse takeover.

Tullett said it would issue more than 100 percent of its existing share capital to fund the transaction, implying a deal value of at least 800 million pounds ($1.2 billion), based on Thursday's closing prices, which gives ICAP a value of 2.9 billion pounds.

Interdealer brokers, which match buyers and sellers of currencies, bonds and other tradeable instruments, have been hit in recent years by regulations that have led their traditional investment bank clients to cut back on risky trading activities.

They have also faced sweeping reforms as regulators push more derivatives trading onto electronic platforms to make the market more transparent.

Market volatility has also been rising this year, largely led by uncertainty around the timing of an interest rate move by the U.S (Other OTC: UBGXF - news) . Federal Reserve. Concerns over slowing Chinese growth, a collapse in commodity prices and increasing geopolitical instability have injected greater uncertainty to the market and capped trading volumes.

U.S. interdealer broker BGC Partners (NYSE: BGCA - news) , with a market capitalisation of $1.9 billion, kicked off consolidation in the sector in February with its purchase of rival GFI Group (Other OTC: GFIG - news) .

Regulatory clearance given for BGC's acquisition suggests that a Tullet-ICAP deal is also likely to gain approval, analysts said.

"I'm sure there will be some scrutiny of (the deal) ... but it shouldn't be of concern to the regulators," Peel Hunt analyst Stuart Duncan said.

Tullett said it had started talks with the UK's financial regulator on capital resources requirements applicable to the enlarged group.

While a merger would consolidate Tullett and ICAP's positions as two of the world's top three interdealer players, it could further squeeze Tradition, the interdealer broking arm of Compagnie Financière Tradition.

JOB CUTS

Tullett shares suffered their biggest one-day drop since May 2010 early on Friday after it warned of falling profit margins.

The company also said that it would cut jobs and fixed costs to offset the impact of a further reduction in market volumes since the end of June, particularly in Europe.

ICAP is due to report first-half results next week.

"I thought it would have actually been ICAP buying Tullett's business rather than the other way round," Liberum analyst Justin Bates said.

"I think, strategically, (this deal) makes sense because it allows two struggling businesses to combine and cut costs aggressively."

Morgan Stanley (Xetra: 885836 - news) analysts wrote in a client note that with structural pressures across several revenue areas, consolidation made sense and typical cost benefits across the industry have been worth roughly 10 to 15 percent of the combined group.

While ICAP shareholders would hold the majority of the new Tullett shares, ICAP -- run by wealthy Conservative Party donor Michael Spencer -- would own a minority stake in the enlarged Tullett Prebon.

Global broking accounted for 62 percent of ICAP's revenue in the year to March 31, but only 25 percent of its trading operating profit.

ICAP reorganised its global broking business last year, looking to cut costs in the "extremely challenging trading environment", but there will be scope for further streamlining after the proposed merger.

"You can cut costs, but at some point there's only so much you can cut before you start damaging your business. So then the obvious solution is to stick two bigger businesses together and it gives you more opportunities to realise more synergies," Peel Hunt's Duncan said.

Tullett is being advised by independent investment bank Rothschild, while a banking source said that JP Morgan and Evercore are advising ICAP.

Tullett's shares recovered to close with a 9 percent gain at 357.7 pence, while ICAP rose almost 7 percent to 474.7 pence, making them the two biggest gainers on the FTSE-250 mid-cap index.

ICAP's foreign exchange trading platform EBS is one of the two dominant currency trading platforms and competes with Thomson Reuters (Dusseldorf: TOC.DU - news) .

Last month six former brokers from ICAP, RP Martin and Tullett Prebon were the first to be tried over the alleged rigging of the Libor benchmark used for setting interest rates on about $450 trillion of financial contracts worldwide, from complex derivatives to student loans. ($1 = 0.6613 pounds)

(Additional reporting by Pamela Barbaglia; Editing by Elaine Hardcastle and David Goodman)