With regulatory approvals finally in the bag, the 12 financial institutions trying to buy TMX Group Inc. are on the cusp of securing the Toronto Stock Exchange operator they've sought for over a year.
Now the Maple Group consortium still must answer one critical question: Where's growth going to come from?
For months, shareholders wrestled with whether the deal would clear its regulatory hurdles, including approvals from four provincial securities commissions and Canada's Competition Bureau. After the last of these were granted on Wednesday, the focus is quickly shifting to long-term strategy.
TMX must address this issue because it will continue to have public owners. Although the 12 institutions that formed Maple Group are likely to take their majority ownership early in August, as much as 30 per cent of the company will continue to trade in open markets , which means management will still be accountable to outsiders.
Generating growth won't be easy. Because global financial markets are in a rut, asset managers have been sitting on their hands. Last quarter, equity trading volumes were down by 19 per cent on the TSX, and 43 per cent on the TSX Venture Exchange. Fewer trades mean fewer trading commissions for these exchanges, both owned by TMX Group.
That leaves two options for TMX executives, said Doug Clark, managing director at ITG Canada, a trading firm. "They either have to look elsewhere geographically … or they have to look at other asset classes."
Because the Canadian market is shrinking, markets such as the United States or Asia are more appealing. And because equity trades are less profitable, it might make more sense to double down on securities such as derivatives and fixed-income products.
TMX is already making moves, having entered talks to buy DirectEdge, the fourth largest U.S. stock exchange operator. DirectEdge has 9.3-per-cent market share south of the border, and many of Canada's biggest companies now have dual listings in both Toronto and New York.
There has also been chatter that TMX is looking to create a listings venue for small-capitalization companies in the United States, just like the Venture Exchange in Canada. Buying an exchange that's already up and running makes this a much easier task.
By pursuing DirectEdge, TMX is clearly making a bet on electronic speed trading. Until 2010, DirectEdge was solely an electronic platform that catered to high-frequency traders. TMX has also announced the release of its new Quantum XA servers that will allow for trades to be executed in mere microseconds.
Exploring new avenues like these will be key because Maple's concurrent purchase of Canadian Depository of Securities Ltd. may not be the saving grace many people hoped it would be. CDS "clears" trades, or settles them between buyers and sellers, and global stock exchanges that control their own clearing houses typically trade at higher valuations. Maple hoped owning CDS would give TMX a boost as well.
However, provincial regulators slapped strict restrictions on CDS clearing fees, forcing TMX to keep them at 2012 levels. This means that higher fees can't be used to offset lower trading commissions, nor can they help to pay back the debt load that Maple is tacking on to the buy the company. RBC Dominion Securities analyst Geoffrey Kwan expects TMX's net debt next year to be 3.3 times earnings before interest, taxes, depreciation and amortization.
Where TMX goes is still being shaped. But staying the course is not an option. "They certainly can't create growth within the equity space," ITG's Mr. Clark said. "They can't suddenly do something that's going to make the asset managers and pension funds trade any more."