Banks look to counter LSE’s TMX deal

This week a giant blue illuminated ball and electronic ticker tapes were inaugurated at the London Stock Exchange as the UK bourse launched a new market opening ceremony to kick off trading each day.

It was probably a welcome distraction for Xavier Rolet, LSE chief executive, from having to follow the progress of his planned “merger of equals” with TMX Group, operator of the Toronto and Montreal exchanges, thousands of miles away in Canada.

Unveiled three months ago, the LSE-TMX deal has been overshadowed by a bigger battle revolving around NYSE Euronext, the US exchange that owns the New York Stock Exchange. Although it agreed a $9.4bn combination with Germany’s Deutsche Börse, Nasdaq OMX and IntercontinentalExchange are pursuing a bid to snatch NYSE Euronext away.

Now Mr Rolet and his TMX counterpart, Tom Kloet, could be facing a possible counterbid for the TMX from a group of local financial institutions.

Banks opposed to the merger, led by Toronto-Dominion, Canadian Imperial Bank of Commerce and Quebec-based National Bank of Canada, are exploring other options for TMX with institutions such as pension funds, one person familiar with the discussions said.

He said the talks were prompted by a desire to build on TMX’s strengths rather than allow it to fall under the control of a foreign institution, such as the LSE. He noted that both Mr Rolet, a Frenchman, and Mr Kloet, an American, are foreigners with little appreciation of Canadian sensibilities.

Mr Rolet and Mr Kloet have stressed that the Canadian exchanges in the combined group would be run by Canadian residents; that the group would have joint headquarters in London and Toronto; and that the board would be made up of seven Canadians, five Britons and three Italians, from Borsa Italiana.

The banks have a sizeable stake in TMX’s fate, owning two-thirds of CDS Clearing and Depository Services, Canada’s main securities clearing house. TMX and a securities industry regulator own the remaining 33 per cent, and CDS is run as a non-profit partnership.

The banks, through their brokerage arms, also control Alpha Trading Systems, an alternative trading platform which has captured 19 per cent of the value of equities traded in Canada. The Toronto exchange’s share has slipped from 87 per cent two years ago to 65 per cent in the first three months of this year, as share trading has fragmented across venues, as it has in the US and Europe.

The banks see an opportunity in giving the exchange greater control of CDS.

Such a move would transform the clearing house from a low-margin, user-owned utility into a money-spinner along the lines of Deutsche Börse, which has its own clearing house in what the industry calls a vertical silo.

Exchanges that have their own clearer tend to have higher stock market valuations since they are able to collect clearing fees on the trades that are done on their platforms.

But the banks face some daunting obstacles. They have conflicts of interest stemming from their stakes in Alpha and CDS. The banks would gain a near monopoly over securities trading if they were allowed to control both Alpha and the Toronto and Montreal exchanges.

Mr Rolet said this week: “If there is another project out there that materialises we will see what it is.

“It will also highlight the benefits of our transaction. It is an exchange-to-exchange transaction which is by definition neutral.

“And the concept of certain clients or constituencies controlling an exchange raises a whole host of other questions,” he said.

Canadians have a love-hate relationship with the banks, respecting their stability while chafing at their size and influence.

Any TMX deal involving the banks would force politicians and regulators to choose between the potential rewards of creating a national champion and the risks of the banks abusing their extra power.

Tom Caldwell, a Toronto securities dealer whose company, Caldwell Financial, invests in exchanges, said a bid for TMX involving the banks “would be a terrible thing for Canadian markets”, adding that “exchanges should be neutral”.

The dilemmas facing the banks are already on display in the LSE-TMX deal. Royal Bank of Canada, the country’s biggest financial institution, and Bank of Montreal have publicly supported the LSE deal. But each is an adviser to one of the parties.

Still, Mr Caldwell said he would not be surprised to see a counterbid: “If the banks do come in, it depends on how they package it and the price.”