TMX Group shareholders will have a lot to read over the next month.
Last week, the TMX Group released its management information circular for shareholders regarding the takeover proposal by the London Stock Exchange (LSE) announced in February. The release of the 731-page document comes a week after Maple Group Acquisition Corp., a consortium of Canada’s largest pension funds and the investment brokerage arms of four Canadian banks, decided to release directly to shareholders its proposal to acquire the TMX Group.
Both bids for the company that operates the TSX, the TSX-Venture and Montreal exchanges provide very different visions for the future direction of Canada’s main exchanges. The TMX-LSE merger envisions growth based on creating a cross-Atlantic entity that would expand the liquidity pool for listed companies and investors. The Maple Group proposal envisions growth based on consolidating Canada’s trading market with its clearing and settlement business.
Luc Bertrand, vice-chairman of National Bank Financial Group and a spokesman for the Maple Group bid, met with Business in Vancouver managing editor Timothy Renshaw and finance reporter Richard Chu to discuss the Maple bid and its next steps should it convince more than a third of TMX’s shareholders to vote against the TMX-LSE bid on June 30.
For a long time, many of us have had in our mind to create the silo model, where you have clearing services and trading services in the same company. Hong Kong is like that; the Australian Securities Exchange and the Deutsche Borse is like that. [In Canada], the next step is to bring in CDS, which does the clearing for the cash business. Clearing for the derivatives market is already there when we put the TSX and Montreal Exchange together to create the TMX Group.
The concept of the silo model in the exchange and clearing business is that it’s a very efficient model, if you can put it together. In some jurisdictions, it’s impossible. It would be very complex to put it together in the U.S. It just depends on how the industry has evolved in a given country. When the LSE deal was announced, for many of us, this was the last chance to try to put the silo model together. Because, once the LSE controls the TMX, it will be very difficult to say that the clearing corporation, CDS, could be controlled by an entity over which the Bank of Canada would have little or no oversight on the ownership.
If something goes wrong here in the marketplace, and it’s a bit of a mess, the regulator in London is going to react. You can bet your boots on that. They can’t leave it to the Ontario Securities Commission or all the other securities commissions in Canada, because they have the ultimate responsibility of the holding company. I fail to see how the Financial Services Authority in London will totally give up their oversight on the subsidiaries of the London Stock Exchange, and the TMX will become a subsidiary.
The silo model is good for broker dealers and for investors because you can create a lot of efficiency. You can get better control of risk management; you can get better use of collateral. Properly structured, it will continue to be under the oversight of the securities commissions; nothing changes from a regulatory standpoint.
One thing it would do is create a business solution for the over-the-counter market [which trades bonds and debentures]. That’s a big element of our decision to move ahead; by bringing the clearing corporation and cash markets together, we can create, for Canada, the right business solution for the over-the-counter markets, which are significantly larger than the exchange market.
For the Bank of Canada, which needs a business solution for the over-the-counter market, if we don’t develop a Canadian solution, the Canadian banks are going to go offshore.
I know that’s the argument they’re making. The reality is, the same language was used with the NYSE-Euronext merger and the Nasdaq-OMX merger some years ago to create those trans-Atlantic exchanges together. But have they worked from a business standpoint? Have they delivered on things like creating greater pools of liquidity and international reach and so on? The empirical evidence is no. You don’t have more Scandinavian stocks trading in the U.S., and you don’t have more stocks from Euronext on the NYSE. There have not been a lot of so-called synergies because of the combination of these things as is being promised by the London Stock Exchange. It’s a big leap of faith. The LSE has a grand name, a good brand, but its market share has been rapidly declining.
I’m very suspicious of these cross-Atlantic transactions. I’m very suspicious of transactions in the exchange and clearing space that are not under the same jurisdiction and regulatory framework. That’s where you lose a lot of opportunity to generate synergies, because one regulator will say you can do this, and the other regulator says you can’t.
If I were the CEO of the LSE, I’d be doing exactly what he’s doing now. He’s pushing ahead without spending a nickel, grabbing a nice company without paying a premium, which has a very strong balance sheet, so he can leverage the balance sheet and do another transaction.
I’m convinced that’s what’s going to happen here.
The Maple proposal also has a lot of debt
We are putting 2.9 times EBITDA [earnings before income taxes, depreciation and amortization], which is very reasonable, very manageable and is well below what the regulators will allow, which is four times EBITDA. The TMX generates a lot of free cash flow on a yearly basis.
We’ve been criticized by the CEO of the LSE that we are being “reckless” with the indebtedness we are putting on the balance sheet, but when you think about it, why would institutions [of the consortium], which are some of the strongest in the world, do an investment like this when it will hit their tier 1 capital according to the new Basel rules? They’re doing it out of the conviction that creating a silo is in the best interest of the market.
We do need competition bureau approval for the Alpha part. On the CDS part, we think it’s one where there will be no objection. In the group, there is a large percentage of ownership in both these assets.
No, but the intent between the ownership of the two assets amongst the group is to do that. That’s in the documents that constitute the consortium. So, to some extent, there is an agreement among the partners of Maple. With CDS and Alpha, there are other shareholders, but there are enough shares in the consortium to engage with so a transaction can happen.
That was a large part of the discussion with our consortium partners. We have hired counsel who gave us a thorough briefing on the competition bureau process and provided an assessment of the likelihood of the bureau giving us a favourable approval. And the conclusion was that we have a high likelihood of that. There is a process and we will go through the process.
But the analysis, with regards to the competition aspect, has to be done in the North American context. The bulk of the TSX/S&P 60 trades in the U.S. It doesn’t trade in Canada, so there’s tonnes of competition.
For anyone to suggest there isn’t competition if we amalgamate Alpha with the TMX Group, there is still Pure Trading, Omega. But the reality is there’s the Nasdaq and NYSE and they’re very, very aggressive. So in terms of fees and competition in general, it’s not as if we have a lot of luxury there to stay competitive.
The market is too competitive. We didn’t base our model to invest hundreds of millions of dollars to crank up fees in the North American context. Anyone who thinks that is not realistic.
I’m not troubled by the fact that we’ll have an exchange that operates in a world of mega-exchanges. You can point to a lot of businesses that do very, very well by being niche players in global businesses that understand their space and create great returns for shareholders. I think this is a prime example.
And I think this consolidation trend in the exchange space is nearing the end. A lot of people are starting to question the wisdom of these transactions and if they make any sense.
There are still a lot of things we can do with the over-the-counter market, the bond market, continue to build up the TSX Venture Exchange. I think we have just scratched the surface in developing the brand.
I’m still hopeful that they will talk to us at some point. But if shareholders reject the TMX-LSE bid on the 30th, we still need to determine if we have regulatory approval first before having a vote.
But, I repeat, the nine financial institutions would not go through all this if there was not a sense there was a strong case for the competition bureau.
The immediate, important thing is that we are successful in convincing shareholders that our arrangement is significantly superior and has a much higher likelihood of succeeding on a regulatory basis.