TMX-LSE: Will politics trump economics again?
The federal government has compiled quite a record of getting in the way of market forces and regulators shaping the future of Canada's economy. Yesterday, it was the Potash merger. Today, it's the CRTC decision on Internet pricing. And tomorrow, it might be protecting the Canadian financial marketplace once again.
After blocking BHP Billiton's hostile bid for Potash Corp., Industry Canada did not publish a detailed analysis of the proposed merger's broader economic impact, and one gets the feeling the government was mainly driven by the fear of a voter backlash in Saskatchewan. Regulating Internet access has quickly proved too politically charged for the government to start a useful discussion on what makes sense economically. It comes then as no surprise that Industry Minister Tony Clement has been quick to announce an official review of the merger proposal between the Toronto and London stock exchanges.
Presumably, the government is concerned with protecting Canadians from developments that don't have a net benefit for the domestic economy. So what's the motivation for the proposed merger of the two exchanges, and will the government find a net benefit? Economically, the merger seems like a marriage made in heaven. But it also feels like déjà vu, with politicians being opposed in the past to any move of globally integrating Canada's financial system.
The London Stock Exchange has been squeezed by the expansion of other exchanges that snatched market share from it through aggressive cross-border mergers. It failed in its attempts to build a competitive international derivatives exchange when the London International Financial Futures and Options Exchange, one of the leading commodity exchanges, was bought by its competitor, NYSE Euronext. And its merger with Deutsche Boerse to create a heavyweight in the exchange world went sour over how to organize clearing and settlement in a joint exchange. This has left the LSE facing an uncertain future, with a severe disadvantage against other exchanges that are more integrated across products, across trading, clearing and settlement and across different marketplaces.
The Toronto exchange has a lot to offer: It owns well-functioning derivatives and commodities exchanges. Its clearing operation run by the Canadian Derivatives Clearing Corp. vies to offer a consolidated infrastructure for Canada's financial market, ranging from clearing derivatives and repo financing to possibly equities and even over-the-counter transactions in the future. And it owns a state-of-the-art trading system for derivatives that it licenses out to other exchanges.
But the TMX has its own problems. There's competition from alternative trading venues nibbling at its profits, and it mainly has a strong footing in the niche of commodity oriented issuers. Thus, while protected from international competition, the potential for growth is limited.
A merger would immediately present an integrated exchange model and thus be a serious international competitor. Since both exchanges are leading in commodity stock issues, they would control this market segment. And the TMX trading and clearing technology, which arguably is a big revenue driver, could now be employed at a full scale.
Unfortunately, the situation reminds one of the issue of foreign competition in the banking sector - an untenable prospect for Canadian politics. Wouldn't a merger drive the exchange headquarters to London? This would certainly reduce Toronto's importance as a leading financial centre in North America. And what about being at the mercy of a foreign regulator - in this case, Britain's Financial Services Authority? Wouldn't this mean giving up crucial control in the financial sector, an issue we're struggling with on a national level already when thinking of a common securities regulator to which Quebec is strongly opposed.
Hence, economic benefits are pinned against political interest on the provincial level, and there will be immense pressure from Ontario and Quebec to block the merger. The federal government could side with these provinces and claim to protect a crucial part of the country's financial system from foreign influence - a convenient platform for the government to show it defends national interests.
But mining and energy companies that dominate the economy in Western Canada will profit immensely from the merger, by having better access to global capital markets. This could well give the merger a chance to succeed, since it helps the federal government to secure support in its traditional political strongholds.
The economics of the TMX-LSE merger makes sense. It creates value for the stockholders and gains for investors and companies, which are the exchanges' customers. Don't be surprised, though, if the political calculus of winning the next election gets in the way of the economics once again.
Thorsten Koeppl is an associate professor of economics at Queen's University.