A marriage made in Jersey City, N.J.? Perhaps.
TMX Group Ltd, owner of the Canada-based Toronto Stock Exchange, is said to be eyeing the U.S. exchange market business and reportedly has Direct Edge, a New Jersey-based exchange, in its crosshairs. The driver of the deal would be TMX’s ability to bring emerging companies to the U.S. market through Direct Edge. TMX’s Venture Exchange specializes in taking small and emerging companies public, and the strategy would be to dual-list these companies.
The delay in TMX’s southern expansion stems from a change of control of its own. A consortium of Canadian banks and pension funds beat the London Stock Exchange to the punch to acquire TMX. The $3.7 billion deal is expected to close in the fourth quarter. Such a deal would also pump up the revenues of Maple, the buying consortium.
Thomas Caldwell, chairman and chief executive officer of Caldwell Securities and a TMX shareholder, said looking to expand in the U.S. to give emerging companies greater exposure to the global capital markets is a smart move. And the TMX’s Venture Exchange is a strong vehicle to do this.
The Venture Exchange began in November 1999 as the Canadian Venture Exchange and was purchased by TMX in 2001. It was established as a separate exchange from the main Toronto and trades only small and emerging growth companies. Its only competitor in this space is CNSX.
According to market data, Venture captures 25 percent of all trading in Canada, while its bigger brother the Toronto trades 60 percent of the market. Average daily trading volumes on Venture average between 120 million and 140 million shares. In comparison, CNSX trades an average of between 6 million and 8 million shares per day. Venture is the 800-pound gorilla.
Caldwell noted that Direct Edge has no listings business but has stated it wants to open one-making it a suitable place for TMX to gain access into the U.S. Also, he pointed to the recently passed U.S. JOBS Act, which is designed to promote investment, growth and trading of emerging growth companies-Venture’s specialty.
“I think Venture is the premier venture capital environment in North America and would be a great advocate and asset to the U.S. market,” Caldwell said. “America is killing its strongest asset-its ability to innovate and help small companies gain access to capital. There are just too many rules and regulations in the U.S. and costs small companies simply cannot bear at the present.”
By exporting its exchange model, Caldwell said, Venture can take its strong management team, technical know-how and financial resources to America and help both Direct Edge and emerging companies get access to the capital markets and generate more trading.
He added that the odds of a TMX and Direct Edge union are, in his opinion, 60-40 in favor of some type of deal.
TMX Group Ltd declined to comment for this story. Direct Edge-which is owned by Citadel, Goldman Sachs and Knight Capital-also declined to comment.
One Canadian buysider agreed that TMX’s prowess in listing small or emerging companies fits with Direct Edge’s aspirations to enter the listings business and carve out its own niche in the U.S.
“There is a synergy between TMX Venture and Direct Edge when it comes to listings,” the buysider said. “TMX can leverage their expertise and competitive advantage in small-cap listings and export it easily to the U.S. The U.S. simply doesn’t have anything like the Venture market, and the TMX has been looking for a U.S. platform to build a small-cap stock business to mirror what they’ve done in Canada.”
Even TMX competitors think an acquisition makes sense. Sean Debotte, director of business development at Toronto-based Omega ATS, a competing trading venue in Canada, agreed with both the buysider and Caldwell that TMX’s Venture system is well established and would be attractive to Direct Edge.
However, Debotte added, that would not be the only reason behind a union. The TMX investors would also benefit from the additional fee income received from Direct Edge, given Maple’s “cash lite” position after the Maple deal.
Debotte explained that there has been a large drawdown in exchange fee income as a result of new regulations that charge for message traffic. In the past, order senders were charged based on the number of messages that resulted in an actual trade. Now, the more order messages a firm sends, period, the higher the cost. This shift, Debotte said, has caused a 30 percent drop in Canadian trading volumes and affected exchange revenues. Buying either all or a portion of Direct Edge replenishes Maple’s coffers.
“Cash revenues could be a concern of TMX now post-Maple,” Debotte said. “Not only is there the drop in message fees, but there is also a price freeze on clearing fees as a result of the TMX/Maple deal. So the exchange might need to seek additional revenue streams to offset what they might not earn via clearing or message fees. Maple needs to find another way to generate money and keep shareholders happy.”
According to Debotte, Direct Edge’s 13 percent U.S. market share is equal volume-wise to the amount that trades in all of Canada’s lit markets. “This is why Direct Edge is an attractive target for them-just to get the order flow,” he said.
Furthermore, he added, a TMX/Direct Edge union would also allow the Canadian bourse to capture trading revenue from both sides of a trade for interlisted securities or provide an alternative place to list dually listed securities.
Currently, interlisted securities trade on the Toronto and either the NYSE or Nasdaq. The thinking goes that, by adding Direct Edge to the mix, a stock could be listed and trade there, too. There are about 180 interlisted stocks.
“Acquiring some portion of Direct Edge is advantageous for them-for getting liquidity from either new or existing listings,” Debotte said. “If they intend to create a new listings business, this gives TMX a chance to dual-list companies and even create a type of exchange arbitrage, and that will attract additional order flow, too.”
Despite the synergies and benefits of a union between the two North American exchanges, at least one professional said such a move could trigger a cross-border feud between the TMX and the NYSE or Nasdaq.
Doug Clark, head of market structure at ITG Canada and operator of dark pool Match Now, told Traders Magazine U.S. exchanges could view entry by the Canadians as a threat to their own listings business.
“If TMX tries to buy Direct Edge, NYSE could well say, ‘You’re stealing our listing business,'” Clark said. “It could prompt NYSE to go into Canada. Even Nasdaq.”
Clark pointed to the nature of the TMX deal, where Maple is paying all cash for TMX shares, has undertaken a lot of debt and is heavily leveraged. To incur more debt, in his mind, seems unlikely.
“To buy Direct Edge they’d have to issue more shares, and that will dilute the value of the company,” Clark said. “Paying cash or issuing shares doesn’t make a lot of sense.”
Clark added that TMX owns a majority stake in the Boston Options Exchange and could easily create its own U.S. equity marketplace if it wanted. “TMX is likely to take a look at Direct Edge, but at its current valuation I’d be very surprised to see this deal happen,” Clark said.
