Market merger:

Citing a need to be bigger in a more globally competitive market, TSX Group and the Montreal Exchange have agreed to consolidate their operations to form TMX Group.

TSX Group will pay roughly $1.3 billion for the MX, offering half a common share of TSX Group and $13.95 in cash for each MX share.

Officials say the newly created TMX Group will now have the resources and scale to create and promote new capital market products and high-value data services. The combination also creates an integrated, multi-asset class exchange group and strengthens Montreal’s position as the Canadian centre for derivatives expertise.

On a conference call on Monday morning, Richard Nesbitt, CEO of TSX Group, and Luc Bertrand, CEO of the Montreal Exchange, fielded questions from media about how the new TMX Group would function, and explained that investors using either exchange won’t notice many changes.

The Toronto exchange will continue to be the Canadian market hub for equity and cash trading, while the Montreal exchange will continue as the nation’s largest derivatives exchange. The head office of TMX Group will be located in Toronto. The head office of the MX and the derivatives trading will remain in Montreal.

The MX will also continue to manage the Montreal Climate Exchange as it develops into a market for exchange-traded environmental products in Canada. The Autorité des marchés financiers (AMF) will continue as the lead regulator for the MX’s operations; the Ontario Securities Commission will be the primary regulator for the Toronto Stock Exchange’s operations. Nesbitt will be the chief executive officer, and Bertrand will be the deputy CEO.

Bertrand said that the move to merge was necessary because of a market of increased international consolidation that puts the pressure on regional stock exchange operators like TSX Group and the MX to acquire a larger scale.

“The reality in our space is that globalization is unfolding at a very rapid pace. The complexity of the business going forward is not going to be lessened; it’s going to become more complex. There have been some mega-players that have emerged in the last few years such as NYSE and EuroNext,” Bertrand said. “If you’re going to be competitive, you’ve got to be bigger, you’ve got to be smarter and faster. Status quo was not an option either for Richard [Nesbitt] or myself.”

According to Bertrand, the MX adhered to its fiduciary duty to shareholders to see if there were potential suitors other than TSX Group. Ultimately, Bertrand said TSX offered the best opportunities. He stressed that merging with TSX allows the MX to continue to independently serve the Canadian capital markets.

“The fact is we are here in Canada. We have an obligation to provide a good service to the Canadian market,” he said. “If we can’t do that in our own country independently with who we associate ourselves with, those deals are not going to work that well.”

The all-Canadian solution also addresses some of the political sensitivities associated with a takeover of MX. A merger could also be viewed as a back door into the creation of a national securities regulator, undermining the legitimacy of the AMF. This could have a spillover effect, creating further debates about Quebec’s autonomy. Nesbitt and Bertrand were adamant that politics didn’t factor into the final decision to merge, and they intend to run TMX Group under the current securities regulation in Canada.

“We are regulated by the OSC for the Toronto Stock Exchange and by the Alberta Securities Commission for the TSX Venture Exchange and the Natural Gas Exchange. MX is regulated by the AMF and will continue to be regulated by the AMF,” Nesbitt said.

The AMF intends to conduct a hearing into the merger. Apparently, the deal is contingent on meeting some regional requirements; for example, 25% of TMX’s board of directors must be residents of Quebec.

“I’m not privy to all nuances and details, but my understanding is that there will be a rule filing followed by a hearing process. We’re comfortable with that process, and it is perfectly legitimate to conduct things this way,” Bertrand said. “With regards to discussion we may have had with policy makers, again in the spirit of our responsibilities of running a company that has a large public interest element, I’m sure everyone realizes we can’t operate in isolation.”

This has raised some questions about what TSX Group will do with some of its businesses that may conflict with the MX operation, in particular its partnership with the International Securities Exchange (ISE). Earlier this year, TSX announced the creation of DEX, a derivatives exchange that was scheduled to begin operations in March 2009. It would be 52% owned by TSX Group and 48% by ISE.

Nesbitt said the partnership with the ISE would have to be reevaluated.

“We have notified the ISE that we have entered into this relationship,” he said. “We will see where we go from here.”

So far, industry reaction has been mixed. Two of Quebec’s largest financial players, Desjardins Group and pension giant Caisse de dépôt et placement du Québec have differing views on the merger.

Desjardins, which was an advisor on the deal, says it was a positive development for the province of Quebec. Albans D’Amours, CEO of Desjardins Group, said the transaction reinforces the Montreal Exchange’s position on the Canadian derivatives market and gives it the exclusive rights to negotiating carbon credits and other offsets in the country.

“Thanks to this agreement, Quebec will expand its influence in a sector that is growing fast at the international level,” D’Amours stated. “Besides securing a select place for the Montreal Exchange in the Canadian exchange market and favouring the maintenance of a unique expertise and high-value-added jobs in Montreal, this agreement also ensures adequate Quebec representation at the new exchange board of directors.”

The Caisse, on the other hand, wondered if TSX Group would actually add any value to the MX’s currently existing operations.

“As a shareholder, we want to know whether the proposed merger is ultimately viable, given the emergence of many competitive platforms in the equity markets and the increasing share represented by Canadian companies interlisted on U.S. exchanges. This is especially important since the market for standardized derivatives is quite likely to grow significantly in the years to come,” said Henri-Paul Rousseau of the Caisse. “Over the years, the Montreal Exchange has developed leading-edge derivatives expertise. We would like to know what the Toronto Stock Exchange’s intentions are in this regard before we take our analysis further. A public debate is needed.”

Both Nesbitt and Bertrand expect a full review and hearings by Canadian regulators before the deal is approved. Full details of the amalgamation will be included in an information circular that will be mailed to MX shareholders on or about January 14, 2008.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(12/10/07)

Mark Noble