A passerby is seen outside the Toronto Stock Exchange at the Exchange Tower in Toronto, Ont. Feb. 7/2011.Kevin Van Paassen
Xavier Rolet wasted little time after his plane touched down in Toronto Sunday night.
After months of talks, the head of London Stock Exchange Group PLC was set to unveil a merger with TMX Group Inc., owner of the Toronto Stock Exchange. It would be Canada's most politically sensitive business deal since Ottawa blocked BHP Billiton Ltd.'s bid for Potash Corp. of Saskatchewan Inc. - and Mr. Rolet wanted to personally sell it to Canadian policy makers.
On Monday, the French-born executive and TMX chief executive officer Tom Kloet briefed Ontario Finance Minister Dwight Duncan on the coming deal. Then they hopped on a plane to Quebec City to see Quebec Finance Minister Raymond Bachand. Finally, they hit Ottawa, where they met with Finance Minister Jim Flaherty and officials from Industry Canada. Meantime, TMX officials in Western Canada met with British Columbia and Alberta policy makers. Each got the same pitch: The London and Toronto exchanges were poised to announce a "terrific merger agreement" that would keep regulatory authority in Canada, while handing the TMX a major role in a company that would be a more powerful contender in international markets.
What the emissaries didn't say about the deal was that the proposal is one of the few global opportunities left for two relatively small stock market players. Competitors have been bulking up with mergers for years, leaving historic financial temples such as the LSE and TSX looking increasingly regional. Indeed, the race to consolidate has become so intense that hours after the Toronto and London deal was unveiled Wednesday, the Deutsche Boerse and NYSE Euronext revealed they were in advanced merger talks to create by far the world's largest exchange company.
It will be weeks before Mr. Rolet and Mr. Kloet learn whether their diplomacy worked. During that time, provincial and federal regulators and politicians will have to take a hard look at the TMX's role in Canada's capital markets. It's the same dilemma soon to face regulators in the U.S. if the New York Stock Exchange is sold to the German exchange, and Australia is also grappling with the debate as the ASX looks to merge with the Singapore exchange.
Stock exchanges with such storied histories - NYSE was founded in 1817, TSX and ASX both date back to 1861- are deeply tied to their nation's identities, as well as their economies.
Already, Ontario's Finance Minister, whose government must approve the deal, has expressed concern that the deal is a de facto takeover by London and Canada could lose a "strategic asset." That echoes the argument Saskatchewan Premier Brad Wall used against the Potash deal in a campaign that won him huge popularity, which must be an alluring prospect to an Ontario government facing an election in October.
Quebec, which also must approve the deal, plans public hearings. And finally, the federal government of Prime Minister Stephen Harper, a minority that also faces the constant threat of an election, must sign off.
"The common reaction would be we don't want to give up one of our national treasures, and politicians are going to be sensitive to that," said Mike Pagano, a finance professor at Villanova School of Business and an expert in stock exchanges.
"You can argue the securities exchanges are national assets, just as you have electric utilities or other infrastructure."
But the relevance of the one main stock exchange in a country is in doubt. Upstart markets are popping up around the globe, including in Canada, offering competition and creating pressure on the incumbents like TMX. Profits from stock trading are falling for companies such as TMX, and that's a driving force behind of wave of consolidation that has sparked $100-billion of exchange deals in the past decade - one that long ago swallowed up the national exchanges of two other G7 countries, Italy and France.
From the business leaders who need the TSX to get capital, the reaction has been mostly positive, so long as regulators ensure Canada's interests are protected. Even passionate boosters of the exchange who were deeply involved in it when it was still owned by the Bay Street establishment believe that a new era has dawned.
"In our day the whole point of running the Toronto Stock Exchange was to make sure that Toronto continued to be in a dominant position," said Pearce Bunting, president of the exchange from 1977 to 1995. But the world has changed. "You don't need to have a huge exchange any more. Today, traders can place an order from anywhere and it flies around the world in seconds."
National importance
The big question that must be answered by regulators looking at approving the TMX-LSE deal is this: How crucial is a stock exchange these days to a country's financial heart?
Beyond that, they must determine the best way to keep that heart beating vigorously - through a TMX that is a smaller part of a bigger international enterprise, or one that is purely Canadian, but risks being alone in a world in which other players are rapidly coming together to offer new products and cheaper trading.
Those questions are hard to answer because there are still few concrete details on how exactly the merger would shape the markets in Canada.
One argument for this week's deal is that it allows Canada's stock exchange to do both - to be a part of something greater while it still preserves at least some Canadian control of the business, something that is possible only because the LSE and TMX Group are similar in size. Indeed, while much has been made of the fact that Toronto is the slightly junior partner in the marriage, with LSE getting the CEO role, the reality is that few other Canadian companies have ever negotiated so many control protections in a foreign merger. The president and chief financial officer will be Toronto based, for example, and the TMX will have only one fewer board seat than the LSE.
People involved in the negotiations say the unique governance rights handed to the TMX were shaped after Ottawa rejected BHP's $39.6-billion (U.S.) bid for Saskatchewan's potash giant in early November. The exchanges' talks had been under way for months when the federal government killed the Potash bid.
That sent a strong message that the LSE had to offer more attractive terms to secure political support.
"The Potash failure spooked everyone. If this deal was going to happen, London realized it was going to have to make some meaningful concessions to Toronto," said one person involved in the discussions.
Negotiating those concessions nearly scuttled the merger talks in December. Both sides had planned to complete a merger agreement before Christmas. But weeks of what one person described as "very tough" disagreements over how much executive power would be shared with Canadian officials led to a stalemate in December.
Both sides agreed to take a time out over the Christmas holidays. In January, LSE officials returned in a more giving mood. "London really wanted to do the deal and they understood that they were going to have to share the levers with Toronto," this person said.
There are, of course, many real-world examples of international stock exchange mergers to learn from. The Paris Bourse, the Brussels exchange and the Amsterdam exchange combined in 2000 to create the Euronext. Italy's main exchange is owned by LSE.
Trading volumes soared in the following years. For example, Paris booked $1.1-trillion (U.S.) of stocks traded in 2000, and by 2008 the number stood at $3.3-trillion, according a recent article in the International Journal of Financial Research. And the city remains a hive of financial activity, home to global players in the financial markets such as BNP Paribas.
"We've seen a bunch of these and nobody is walking away from Paris or Amsterdam because of the Euronext," said Doug Clark, head of research at ITG Canada, one of the country's busiest brokerages serving big money managers.
The international consolidation wave has been inexorable. After Euronext created a pan-European exchange, it merged with the NYSE to create a transatlantic company in 2007. Now, NYSE Euronext and Deutsche Boerse are upping the ante again.
Pressure on TMX
Against that backdrop, the TMX is tiny, with $575-million (Canadian) of revenue last year. NYSE Euronext alone had $4.4-billion (U.S.).
Growth options in Canada are limited. TMX already owns the biggest stock markets, the main derivatives market and some of the key energy markets. There are not many other things to buy or build. Revenue growth has averaged 4 per cent over the past two years.
Competition from alternative trading systems is intense. TMX's market share in equity trading in Canada, once nearly 100 per cent, has fallen to about 70, with the new bank-backed Alpha Trading System taking the biggest chunk.
The result is falling prices. Even with record volumes last year as trading activity on all markets exploded, TMX's direct earnings from trading fees are declining.
So it probably was inevitable that a for-profit company, out of major options for domestic growth and challenged by growing competition, would seek to find an international merger partner.
The pitch with the TMX-LSE is that it will create a resource-focused market that, though smaller than behemoths like NYSE Euronext-Deutsche Boerse, will dominate in the areas of oil and gas and mining in a world of soaring commodity prices.
One plan is to create a "passport system" that would enable companies listed in Toronto to easily list in London to get access to investors there, and vice versa. The hope is that Toronto could draw companies attracted by the city's deep talent pool of mining bankers, analysts and lawyers.
"As a resource CEO I would be hopeful that the traditional resource-oriented strength of the TSE and the increasing strength of resources on the London exchange actually can create some synergies, and that could provide opportunities for a company like Rio Tinto," Tom Albanese, chief executive officer of British-Australian miner Rio Tinto, said in an interview on Thursday. Rio Tinto, the world's third-largest miner, is listed on the LSE but not in Toronto.
Paul Blythe, CEO of Vancouver-based Quadra FNX Mining Ltd., said the deal would "almost certainly be good for our business in terms of access to capital and liquidity." But he fears the federal government will stand in the way for political reasons. "At face value, Canada would lose some control of its capital markets plus regulatory control. I can't see this flying in the present minority environment."
But the business forces that make it necessary for TMX to do something to grow - namely, more competition - might also make such a deal easier to digest.
When the exchange was the only place to trade stocks, giving up Canadian control would have been unthinkable. But the monopoly no longer exists, and the actual trading system itself is not irreplaceable. It is just a lot of very fast computers, wires and software. In fact, building a new stock market can be done for relatively little money with off-the-shelf technology. The proof is in the fact that six alternatives to the TSX have sprung up in the past few years as regulators have encouraged new competitors. But the TSX has something those markets don't, something that is harder to replicate. They are markets; it is an exchange. The distinction is subtle, but important.
An exchange has been granted dispensation by regulators to be a gatekeeper to public markets. Exchanges vet companies before agreeing to list their shares, ensuring that minimum standards are kept to protect investors. That confers upon the stock a legitimacy that attracts big institutional investors, enabling companies to raise large amounts of money. Without a marquee exchange listing, companies are forced to exist in a grey market with little investor interest.
Raising that capital and gaining those listings creates an ecosystem of lawyers and bankers in cities like Toronto and Calgary.
The concern is that if TMX's influence wanes once it is merged with the LSE, that ecosystem might start to die off. There's concern among a few Toronto securities lawyers, for example, that there could be less business helping companies to list.
The exchanges have tried to address that by making Toronto the global hub for the listings business of the merged companies.
"The global listings business for the global exchange with the largest number of listings in the world will be run out of Toronto - that's a pretty powerful statement," Mr. Kloet said in an interview.
Also, in listings there is the potential for new entrants. The small Canadian National Stock Exchange offers listings, and Alpha is applying to regulators to become an exchange so it can too.
"People are now recognizing that this is a business where you have a choice, so people know that if the incumbent isn't doing a good job delivering good service and product at a competitive price, they have options," said Ian Bandeen, chief executive of TMX competitor CNSX Markets Inc., which owns Canadian National Stock Exchange and the Pure Trading alternative market. "They don't have to have quite the same fears about losing the incumbent."
Difficult choices
In many ways, it's now or never for the TMX if it hopes to be a player with any say in its future. If regulators turn the deal down, London is likely to look elsewhere for a partner.
"You would hate to see London get together with [Brazil's]Bovespa or South Africa and create this global listing powerhouse and we're not a part of it," said Mr. Clark of ITG.
Staying alone could also leave TMX vulnerable to a bid from a bigger exchange operator like NYSE Euronext or Nasdaq OMX, analysts said. Then, the terms would not be as generous as with London, because those exchanges are much larger. And a deal with an American exchange could bring massive job cuts; many of Toronto's services could be done from New York.
Many analysts, and many of those close to the TMX-LSE deal, say this transaction is likely a stepping stone to more. An exchange in Asia would be a logical target for a future deal, or perhaps another resource-heavy market in South America or South Africa.
That would mean that the Canadian influence would likely be watered down further in a larger company. Again, it all comes down to the question of is Canada better off having a smaller stake in something big, or a big stake in something small.
If the right answer is going big, there's little time to lose. Each transaction like NYSE Euronext-Deutsche Boerse threatens to push TMX Group further behind, said Villanova's Prof. Pagano.
"If you dig in your heels, you become isolationist, London will go look at someone else, and ultimately Toronto could become isolated in this global push to create economies of scale and economies of scope."
With files from reporters Tara Perkins in Toronto and Brenda Bouw in Vancouver.
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THE COMPETITION
TMX Group is selling its deal as a merger of equals. But it is also a reaction to the change that alternative trading systems have stirred up since they crept north of the border in 2007. These alternative places to swap stocks now have about 35 per cent of equity trading volume in Canada. A look at the key rivals to the TMX's Toronto Stock Exchange:
Alpha Trading System
Historically, the TSX's trading flow was dominated by the biggest Canadian banks and independent brokerages. Then nine of these organizations got together and decided that instead of paying someone else for each trade executed, they would create their own trading platform. Today, Alpha boasts the largest trading market share outside of the TSX and it poses the biggest threat to the exchange.
Omega ATS/Pure Trading/Chi-X
These upstart platforms don't have as much clout, but still cause grief for the TSX. Unlike the TSX, which has spent vast sums of money upgrading its servers, these systems started fresh with the best and fastest technology. That matters because about 20 per cent of all Canadian trading is conducted by high-frequency traders, which crave speed.
Tim Kiladze
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THE ASIAN BATTLEGROUND
Anyone who wonders just how long the regulators could drag out this merger may look to Australia for guidance. Singapore Exchange Ltd. launched an $8.3-billion (U.S.) takeover bid for Australia Stock Exchange Ltd. in October and the bid's future is still up in the air.
If passed, the takeover would create the world's fifth-largest exchange. The TMX-LSE merger and the talks of a NYSE Euronext-Deutsche Boerse combination have actually helped the deal's proponents: It's suddenly much more believable that ASX could fall far behind its rivals if the Singapore transaction falls through. Still, there are some tough hurdles to clear.
Regulator
The proposed takeover must get the blessing of Australia's Treasurer, Wayne Swan, who is advised by the country's Foreign Investment Review Board, as well as approval from the Australian Securities & Investment Commission and both houses of Australian parliament. That makes it a federal political battle. Singapore's regulators, including the Monetary Authority of Singapore, must also weigh in.
The outcome is still too hard to predict. Some political parties, such as the Australian Greens, are opposed, but the Australian Consumer and Competition Commission has already ruled that it has no objections.
Takeover v. Merger
The Asian deal is universally regarded as a takeover bid, rather than a merger of equals, because Singapore's exchange is much larger then Australia's. That terminology has some Australians upset, so it isn't a surprise that the LSE and TMX are using "merger of equals" as much as possible.
Plus, the Monetary Authority of Singapore, Singapore's central bank, owns 23 per cent of SGX. Some Australians think that means they will have even less say in their national exchange post-takeover. In TMX's merger, the British government does not have a lot to gain.
Tim Kiladze