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(SEBASTIAN DERUNGS)
(SEBASTIAN DERUNGS)

Eric Reguly

TMX-LSE better hope commodity bubble doesn't burst Add to ...

When Tom Kloet traipsed north from the United States in 2008 to become the CEO of TMX Group, owner of the Toronto and Montreal exchanges, a few of us thought: Here we go again, another fly-by American with a Wal-Mart smile determined to flog our prized corporate assets to foreigners.

Mr. Kloet always insisted this was not the case; he was not yearning to take the money and run back to Chicago. In an interview in London last month with The Globe and Mail, he said: "My job is not to dress this thing up for sale. It is to build the business."

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Is merging with the London Stock Exchange building the business? Or is it a sellout? Whatever it is, it certainly looks more defensive on both sides than an ambitious leap into global value-creation glory.

Mr. Kloet and his opposite at the LSE, Xavier Rolet, the Frenchman who replaced Canadian Clara Furse as the LSE's boss in 2008, are insistent on calling the deal "a true merger of equals." It is not. LSE shareholders will own 55 per cent of the transatlantic beast. Mr. Rolet will be its CEO and the LSE will have the luxury of nominating eight of the 15 directors.

Yes, Mr. Kloet will become president, and, yes, Toronto will emerge with co-head office status, with responsibility for primary markets (London will keep the glam international listings business). But still, power ultimately flows from the CEO's suite and that means Toronto, in time, will effectively become a branch plant, though no doubt one with far more responsibility than delivering Pacific salmon to the LSE's Christmas bashes.

Possible misconception number two is that the London-Toronto merger together is the greatest thing since stock exchanges gorged themselves on dot-com companies with no sales or business plan. The new group is being promoted as a listings, technology and data powerhouse that will inspire awe among rivals. In truth, the merger seems somewhat more mundane in scope. It is a massive, one-way bet on the commodities supercycle.

Together, London and Toronto will be the dominant resources bourse. The TMX already bills itself as the world's leading resources market. The TMX's main board, the Toronto Stock Exchange, and its junior market, the Venture exchange, are home to half of the world's mining companies, mostly of the small to medium-sized variety as well as an impressive list of oil companies.

The LSE has become a resources monster too. Mining and energy companies account for 34 per cent of the weighting of the companies on the benchmark FTSE 100 index, up from 29 per cent three years ago, when commodities were at their peak. The resources weighting is expected to increase later this year with the arrival of Glencore, the world's biggest commodities trader, and Russia's Severstal Gold.

The commodities cycle could indeed evolve into a supercycle, that is, a sustained rally fuelled by ever-rising demand in China and other emerging markets for everything from aluminum to zinc. If that happens, there is no doubt that the LSE-TMX combo will thrive, if only because resources companies, in their eternal hunt for investors and trading liquidity, would be cement-heads to list elsewhere.

But a few notable investors and economists think commodities are close to bubble status. Its bursting would wallop the LSE-TMX. While the upward commodities cycle could last for years and years, it's worth remembering that the bulls made the same argument in the middle of the past decade, only to see commodities strap on granite life jackets and plummet to the bottom of the sea in 2008. It is little exaggeration to say that China's commodities appetite, or lack thereof, will play a big roll in the new exchange's health.

That's not to say the merger makes no strategic sense. It does, partly because cornering the market in one industry - commodities - is better than cornering no market, and partly because there is an obvious cultural and political fit. The executives on both sides speak the same language, have the same values, right down to the blue pin-stripe suits, and seem committed to making the new group work. The TMX's sale to Hong Kong probably would not fly with the regulatory gnomes in Toronto, Montreal and Ottawa.

Still, the strategy may be more about defence than offence. Both exchanges are losing great dollops of trading market share in their home markets resulting from the rude arrival of alternative trading systems such as Chi-X. Neither wants to have to fight as hard for listings. They want, say, the South African gold miner to have no choice but to list on the world's premier exchange.

Both want to indulge in the margin improvements made possible by cost synergies. The touted revenue synergies are less apparent. Indeed, Numis Securities noted that the alleged £100-million ($160-million) in extra revenues within five years is equal to 56 per cent of the LSE's underlying profit last year. In other words, don't count on such ambitious revenue growth.

Toronto and London are stronger together than apart, to be sure. Whether they'll live up to the hyperbole doled out by the exchanges executives on Wednesday is an open question. In the meantime, their executives are praying to the commodities gods for ever-rising prices.

Follow on Twitter: @ereguly

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