TMX-LSE: merger impossible?

The “history-making” stock exchange nuptials now under way have revealed once and for all how globalized capital markets have become. Just consider the United Nations of characters who masterminded the deals. Canada’s TMX Group, which is run by an American, announced plans last week to merge with the London Stock Exchange, of which a Frenchman is CEO. Shortly after that, the German Deutsche Börse AG, led by a Swiss executive, said it was in talks to buy New York’s NYSE Euronext, whose chairman hails from Holland. But all that intermingling in the boardrooms did little to prepare people for the idea that the Toronto Stock Exchange is about to become a whole lot less Canadian.

Since the deals became public, critics have worried about what they entail. A columnist in Montreal’s La Presse said the transaction with London marks “the beginning of the end for ultimate Canadian control” of the stock market. For some in the U.S., the overture from Germany for what the Wall Street Journal called the “citadel of American capitalism” stung particularly hard. Officially, the arrangement is a merger, but most see it as a takeover, and John Whitehead, a former co-chairman of Goldman Sachs Group, said the sale of the New York Stock Exchange is “an insult to all America,” while Jim Cramer, the host of Mad Money on CNBC, bemoaned, “Everything is for sale in this country.”

In presenting the offer from London, TMX Group CEO Thomas Kloet and LSE chief executive Xavier Rolet went to great lengths to present it as a “merger of equals.” But looking at the terms of the $3.2-billion all-share agreement, which would give the U.K. company control of 55 per cent of the combined business, Ontario Finance Minister Dwight Duncan said it doesn’t appear all that equal to him. Nor is he keen on the idea that Dubai, which currently owns nearly 21 per cent of the LSE, will have a major seat at the table. “I’m not sure I want them owning our stock exchange,” he told one newspaper. Duncan has the power to veto the deal, as does Quebec, since the TMX Group was formed after the 2008 merger of the TSX Group and the Montreal Exchange.

Looming in the background is the Harper government’s decision last fall to block Australia’s BHP Billiton from buying Potash Corp. amid a populist backlash. Potash was classified as a “strategic asset,” which raises the obvious question—if an abundantly available mineral buried beneath Saskatchewan is strategic, what does that make the country’s primary stock exchange?

Industry Minister Tony Clement, no doubt scanning his Twitter feed to gauge Canadians’ feelings on the matter, said Ottawa will review the merger. That didn’t come as a surprise, though. Under the Investment Canada Act, Ottawa must look at any foreign takeover deal valued at more than $299 million. The review will examine whether the deal will offer a “net benefit” to Canada, and the process could last at least as long as 10 weeks.

Clement has an incentive to drag this out as long as he can. Letting Washington weigh in first on the tie-up between Deutsche Börse and the NYSE would make his job much easier. If the German-U.S. deal gets the go-ahead, Clement can argue it would send a terrible message to foreign investors should Canada shut its doors to the British. On the other hand, if the U.S. government or regulators shoot down the Germans, Ottawa has cover to do the same. In other words, if you want to know how the TMX-LSE deal will play out, just watch Pennsylvania Avenue.

So far the proposed acquisition of the NYSE is more notable for what hasn’t been said, than what has. The response to the what many call a takeover bid has been akin to a loud yawn. Aside from a few outraged voices, there’s been nothing of the backlash one might have expected. Under the terms of the deal, which values NYSE Euronext at US$10 billion, Deutsche Börse, which has a market cap of around US$15 billion, will control 60 per cent of the seats on the combined company’s board of directors. The deal needs approval of regulators in both the U.S. and Europe, but experts don’t foresee any problems in Washington. In fact, the biggest concern lawmakers seem to have at this point is that the NYSE, otherwise known as the Big Board, should at least retain its name in the domestic market. At a news conference announcing the deal, NYSE Euronext chief executive Duncan Niederauer assured reporters he had no plans to start calling it “the Big Börse.”

That doesn’t mean the LSE-TMX deal is a slam dunk. Far from it. For a sense of the drawn-out battle that could play out in Canada, just look to Australia, which is embroiled in a parallel debate over foreign control of its stock exchange. Last October, the Singapore stock exchange offered US$8.3 billion in cash and shares to “merge” with the Australian Securities Exchange. The move triggered a backlash from critics who said Australia had already lost too many prominent companies to foreign takeovers. Bob Katter, an independent lawmaker in Australia, called the deal “lunacy.”

Months later, the two exchanges are still trying to win approval for the deal. This week, in a bid to appease critics, they tweaked the deal so that both Singapore and Australia have equal representation on the board. It doesn’t appear to have worked. A spokeswoman for Katter told Dow Jones the exchange must remain in Australian hands. “Any merger is still a foreign takeover,” she said.

At this point, Bay Street is divided on the issue. Shareholders in the TMX Group have come out in favour, saying the decision whether to tender their shares should ultimately be up to the company’s private investors, not politicians. “It’s unfortunate for us as a shareholder that the way this deal succeeds or fails is not going to be on economic merit,” the chairman of Mawer Investment Ltd., Jim Hall, told Reuters. Mawer controls 1.3 million TMX shares. “It’s going to be on political decisions and that’s a frustrating position to be in as a shareholder.”

At the same time, analysts argue the deal can be done in a way that keeps regulators and governments happy. “I don’t foresee any situation whereby Canadian regulators will have less control over companies that list on the Canadian market,” says one analyst who asked not to be named. “I’m confident it can be structured in a fashion to protect the identity of the Canadian market through proper regulation.”

But there have been concerns in white-collar financial services sectors, particularly in Ontario and Quebec, that the merger will result in less work for them on this side of the pond. That’s because foreign companies that would have listed their shares on the Canadian exchange may choose to do so in London instead, hiring bean counters and lawyers there. The Toronto Financial Services Alliance, which promotes the city as a global hub for the securities industry, has cautiously approved of the deal, but warned government must ensure the 300,000 jobs related to the financial services industry are protected.

For Mark McQueen, CEO of Wellington Financial, a Toronto venture capital firm, the deal spells nothing but trouble for small Canadian companies, which account for 90 per cent of the stocks listed on the TSX and TSX Venture exchanges. He fears small firms that don’t operate in the energy and mining sectors will be overlooked by analysts and fund managers once they’re combined with the 6,000 companies listed on the London Stock Exchange and its AIM venture exchange. “It’s sheer madness for small-cap companies,” he says. “The moment that access to capital diminishes, then invariably that’s bad for the economy.”

Some have argued the deal grants smaller Canadian companies access to deep pools of capital in Europe. But McQueen says history shows that probably won’t happen. Last decade, when the LSE launched AIM, Canadian firms flocked there to raise money. But many have since delisted or returned to Canada, he says, having discovered that investors in Zurich, London and Munich don’t have time for tiny Canadian stocks. “We’ve already had a test drive of this,” he says, “and the car crashed.”