New TMX bid pits patriotism against peril of monopoly

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A bank-led proposal to buy TMX Group Inc. in a deal valued at $3.6-billion will hang on whether Canadian regulators can accept a return to the near-monopoly in stock trading that would result.

Nine banks and pension funds have teamed up as Maple Group Acquisition Corp. to make a takeover offer to TMX, the owner of the Toronto Stock Exchange and the Montreal Exchange derivatives system. Maple Group said Sunday it will offer $48 a share in cash and stock, trumping the value of London Stock Exchange Group PLC's proposed merger with the TMX.

The proposal is a response to concern by the banks that the LSE merger would reduce Canada's control over its capital markets. But patriotism alone won't be enough to get the deal done.

Maple Group said the transaction can go ahead only if competition and securities regulators give the go-ahead to merge TMX with two other businesses in which the big Canadian banks have a large ownership stake: Alpha Group, a new trading system that competes with the Toronto exchange, and CDS Inc., which handles the clearing of stock trades.

Alpha and CDS are linchpins of the transaction because combining them with the TMX is likely to make the company much more valuable and profitable. The pension plans in particular aren't merely interested in keeping the TMX Canadian-owned, sources said. They want to make money on the deal, and folding in Alpha and CDS is the key to that.

But TMX and Alpha are already the top two platforms for trading stocks in Canada, and if combined would have more than 80 per cent of the market - a level of dominance by one player that Canada hasn't seen for years.

That means regulators may have to choose between whether they are more comfortable with a TMX that has a big foreign-ownership component, as it would with the LSE merger, or an all-Canadian ownership group that raises significant questions about monopoly power and the potential for increased costs for investors.

The bank plan would be a step in the opposite direction of the rest of the world, where competition in stock trading is blossoming and cross-border mergers are common.

"They are going to have a lot of challenges with antitrust on the trading side," said Doug Clark, managing director of research at the Canadian arm of brokerage Investment Technology Group Inc.

Under the proposed deal, four banks would own 25 per cent of TMX. They are National Bank of Canada, Toronto-Dominion Bank, Canadian Imperial Bank of Commerce and Bank of Nova Scotia.

Five pension funds would own 35 per cent. They are Ontario Teachers' Pension Plan, Canada Pension Plan Investment Board, Alberta Investment Management Corp., the Caisse de dépôt et placement du Québec and Fonds de solidarité des travailleurs du Québec (FTQ).

The remaining 40 per cent would be owned by TMX's current shareholders, and would trade publicly. These shareholders would also receive $33.52 a share in cash from the consortium.

Another regulatory concern is CDS, a key part of the plumbing that enables a trade to be completed. CDS handles the electronic transfer of funds and securities between buyers and sellers after the trade has been matched.

CDS has operated as a non-profit industry utility that's owned as a partnership of the banks, TMX Group Inc. and a regulator. Folding it into TMX would enable it to charge more for clearing services, increasing profits. It would also likely give shares in the new company a higher price-earnings multiple, enabling the company to be a more aggressive acquirer. That might spell the end of cheap clearing services in Canada.

"A lot of people are concerned about CDS and is it going to move from a utility to a for-profit model," Mr. Clark said.

Maple's view is that there would still be plenty of competition in stock trading, from smaller alternative marketplaces in Canada such as Chi-X and Pure Trading, as well as from the New York Stock Exchange and Nasdaq in big inter-listed Canadian stocks such as Research In Motion Ltd. that trade on both sides of the border.

Similarly, with CDS, the Maple Group plans to argue that there's significant competition in the North American market from such venues as Depository Trust & Clearing Corp. in the U.S.

Luc Bertrand, a vice-chair of National Bank's securities arm, said in a release: "As like-minded investors, we believe there is an opportunity to create significant value by capitalizing on TMX's strengths to build a stronger integrated exchange and clearing group - and by doing so, to secure the future growth and ongoing integrity of the Canadian capital markets" Mr. Bertrand, a former TMX executive, was central to the negotiation of the deal, sources said.

Keeping the pension funds happy is crucial. Without them, the banks would look like they are simply trying to buy back what they lost when they sold TMX to the public in an initial public offering in 2002.

The pension funds will demand a return on their investment, signalling that the company that would emerge from the Maple plan won't be run just to favour the banks that own it, but as a commercial operation, said a senior banker in the Maple Group.

"We didn't want to go back to a private club, so the banks-only structure wasn't going to work," he said.

In an effort to ensure support government for the bank-led plan, the Maple Group consortium reached out to key players. For example, Ontario Finance Minister Dwight Duncan, one of the most vocal critics of the TMX-LSE arrangement, was briefed on the Maple bid Friday by TD chief executive officer Ed Clark.

Federal Finance Minister Jim Flaherty was also briefed. A spokesman for Mr. Flaherty declined to say whether the Maple plan will win the support of the federal government.

By contrast, Mr. Duncan was enthusiastic about the Maple plan, saying he feels Canada can play a leading role in the global consolidation of stock exchanges.

"That's one of the reasons I hated to see us lose control of our stock exchanges," he said in an interview Sunday. "I'm happy there's a second bid and I'm happy there's Canadian ownership."

Mr. Duncan said that the fact that the Caisse is involved signals that Quebec is onside as well. "The participation of the Caisse in particular indicates that the government of Quebec is supportive of the bid," he said in an interview Saturday. He said he spoke to Quebec Finance Minister Raymond Bachand over the weekend, and that Mr. Bachand also welcomes the alternative bid.