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TSX trader watches the action (CHRIS YOUNG/Chris Young/CP)
TSX trader watches the action (CHRIS YOUNG/Chris Young/CP)

Eric Reguly

A merger that will only bring mediocrity Add to ...

The executives of the London and Toronto exchanges are pumping their proposed merger so hard that you wonder how either bourse managed to survive on its own. Together, apparently, they would be a world-beating marvel. Left to their own inadequate devices, they would fade away like old soldiers, or simply get squashed by the new breed of monster exchanges like the baby deer in the classic Bambi Meets Godzilla cartoon.

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Xavier Rolet, CEO of the London Stock Exchange, and Tom Kloet, his opposite at TMX Group, owner of the Toronto, Venture and Montreal exchanges, have done a thorough, if robotic, job of defusing most critics of the $7-billion deal.

The two men have convinced us that theirs would be a “merger of equals,” not a takeover by the LSE (if this is true, why is the TMX relegated to junior partner?); that the consolidation wave among exchanges demands a similar response from Toronto and London; that Canadian companies’ capital-raising efforts would become more efficient if they had access to a big, transatlantic market; that technology costs would come down, and technology quality up, if the two were to pool their resources; and that customers, from banks to mutual fund companies, are getting huge and logically only want to play on equally huge exchanges.

So there. To not merge is folly.

Lost in the arguments is that the TMX is a highly successful business, one that is perfectly tailored to the unique Canadian market. Why mess with a good thing?

Any national exchange is more than an electronic trading pit. Each, to a certain extent, is a specialized market that blends decades of culture, securities law, regulations and economic peculiarities and traditions into an organic whole.

Canada is more specialized than most developed markets if only because it is less diverse. The economy is driven by mining and energy, with a credible sideshow in financial services. The TMX has adapted itself exceedingly well to the Canadian economic reality.

There is no better place on the planet for a resources company to raise capital and move up the food chain, from the junior Venture market, whose flexible standards have worked wonders in getting startups going, to Toronto’s main board. Toronto has about 1,500 mining listings. London has fewer than 150 (though it does have the biggies, including Xstrata and BHP Billiton). So why exactly does the TMX need help in luring resources companies? It’s a world leader all by its little self.

International companies recognize the merits of TMX, which is attracting hundreds of foreign listings. The TMX even has 38 Australian companies, many of them in the resources industry. Rounding out the TMX’s attractions is a fine derivatives trading system and a clearing operation.

The LSE, by comparison, has been a story of missed opportunities. It has singularly failed to build a competitive international derivatives exchange. It is only now building a clearing system (it has been using LCH.Clearnet). It has turned down takeover offers that might have improved its competitive position and certainly enriched shareholders. Nasdaq tried to buy the LSE for £12.43 a share in 2006. The shares now trade at £9.

Executives who know both exchanges say the LSE is slower, more bureaucratic and more expensive than the TMX. Under Mr. Rolet, the LSE is fighting back and part of its competitive strategy is to buy the TMX.

The danger is that the LSE will come to dominate the TMX. Mr. Rolet, not Mr. Kloet, will be the merged exchanges CEO. The LSE will have control of the boardroom. In time, the LSE's DNA will colonize the TMX and that may not make the TMX a better midwife to the birth of Canadian companies. The TMX is the better exchange, no doubt. If it feels the urge to merge, why doesn’t it buy the LSE instead?

There is one other big reason why the LSE-TMX merger should be viewed with suspicion. If the deal is allowed to go through, the enlarged company will emerge as a lovely takeover target. On its own, the LSE is not a compelling purchase; note that no rival offer for the LSE has been launched even though the exchange is in play. With the TMX at its side, it becomes a far more attractive takeover proposition.

Let Mr. Rolet do all the work integrating the two exchanges, then – whammo! – watch a takeover offer land. Some Canadians are already uncomfortable with the prospect of their old colonial master taking control of the TMX. In a year, the TMX could be owned by an Asian, Middle Eastern or Latin American bourse with little respect for Canada's company-creation tradition.

The LSE-TMX merger is to be reviewed by Industry Canada to determine whether it passes the “net benefit” test. You can bet that the feds will be reluctant to kill the deal so soon after blocking BHP’s takeover of Potash Corp. of Saskatchewan. That would be a pity, because if there is one deal that needs to be examined from top to bottom, it is this one. Tampering with an exchange that is perfectly suited to Canada’s needs could bring no benefit at all to the country.

Follow on Twitter: @ereguly

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