TMX Sees Dodd-Frank Pushing Debt to Exchanges

TMX Group Ltd. Chief Executive Officer Thomas Kloet
TMX Group Ltd. Chief Executive Officer Thomas Kloet said, “The fixed-income space is a natural space for us to look at. We have a relatively modest position in fixed income.” Photographer: Norm Betts/Bloomberg

TMX Group Ltd., owner of Canada’s equity and derivatives exchanges, will expand its offerings of fixed-income products as regulations drive trading to public markets, Chief Executive Officer Thomas Kloet said.

The new products are likely to be helped by the Dodd-Frank law in the U.S. and other regulations designed to reduce risk and increase trading transparency after the 2008 global financial crisis, Kloet said in an interview at Bloomberg’s Toronto office. The regulations create “enormous potential” for exchanges and clearing house operators, the 54-year-old CEO said.

“It’s a fundamental sea change, bigger than I’ve ever seen in the last 30 years,” Kloet said. “The fixed-income space is a natural space for us to look at. We have a relatively modest position in fixed income.”

The parent of the Toronto Stock Exchange, taken over by Canadian banks and pension funds September, is integrating businesses gained from the C$3.73 billion ($3.74 billion) deal. The merger brought Canada’s main equity exchanges and clearing services under one roof, adding stock exchange competitor Alpha Group and the Canadian Depository for Securities Ltd. clearing house.

TMX aims to attract more customers and accelerate fixed-income electronic trading with the new products. The firm already owns the Montreal derivatives exchange, as well as its Shorcan Brokers inter-dealer bond broker and a 47 percent stake in Inc., the fixed-income venue for Canadian government bonds and money market instruments.

‘Logical Move’

“It seems to be, to me, an extremely logical move,” Michael Smedley, who helps manage about C$1 billion at Morgan Meighen & Associates in Toronto including TMX shares. “It’s probably a great advance forward.”

TMX Group rose 0.8 percent to close at C$50.78 in Toronto. The stock has fallen 0.6 percent this month, compared with a 0.2 percent rise in the 44-company S&P/TSX Financials Index.

TMX received 43 percent of third-quarter revenue of C$171.5 million from trading and clearing of equities, fixed income, derivatives and energy contracts, according to company filings. Twenty-seven percent of revenue comes from providing market data, while 26 percent is from listing fees.

“The strategy is also a way of capturing flow that’s happening off the exchange, or over the counter,” said Shubha Khan, an analyst with National Bank Financial in Toronto. “That seems to be what they’re trying to achieve with this fixed-income push, and there’s a lot of upside there.”

Trading Slump

TMX has been hurt by a trading slump that has sapped revenue. The number of shares changing hands on the Toronto Stock Exchange dropped 21 percent for the first 10 months of the year compared with the same period a year ago, according to company statistics. Trading volume on the TSX Venture Exchange plunged 35 percent. In comparison, the number of contracts traded on Montreal Exchange rose 4.9 percent for the period.

Changing regulations may also create opportunities for takeovers, Kloet said.

“When regulatory change happens, there’s a host of opportunities that come out of that,” Kloet said. “That’s why I’m not willing to close the door and lock it and say, ‘no acquisitions for awhile -- small or large’.”

Kloet said his main focus is on integrating Alpha and the CDS clearing house into the company’s operations, though he’s not ruling out takeovers, whether they include smaller acquisitions such as its March purchase of Razor Risk Technologies Ltd., or more transformational deals.

“‘We are not going to put our head in the sand and ignore what’s going to happen in the marketplace,” Kloet said.

‘Strong Exchange’

Investors such as Smedley say TMX shouldn’t lose sight of acquisition opportunities.

“They should be exploring as much as possible the international opportunities because they are a very strong exchange,” Smedley said. “In particular in the resources sectors they have great global strength, possibly the best.”

Kloet cited Hong Kong Exchanges & Clearing Ltd.’s bid to buy London Metal Exchange as an acquisition he’s watching closely. At $2.2 billion, TMX couldn’t afford it, he said.

“The Hong Kong Exchange acquisition of the London Metal Exchange is a huge transaction,” Kloet said. “Don’t think for a second that we wouldn’t have been interested in that.”

Other exchange deals this year include London Stock Exchange Group Plc’s plan to buy a majority stake in LCH.Clearnet Group Ltd., Europe’s biggest clearinghouse, and Tokyo Stock Exchange Group Inc.’s $1.6 billion takeover of Osaka Securities Exchange Co.

“We’re in a period in history where things are moving very fast and they’re not going to wait for us to finish our integration,” Kloet said. “I feel a responsibility to the shareholders and the marketplace to seize opportunities if they’re out there.”

Primary Focus

TMX’s “primary focus” is enhancing Montreal Exchange’s futures products around fixed income, including Canada’s key interest-rate contract and Canadian government bond contract notes, Kloet said. That involves creating a fixed-income market-maker program where dealers offer firm bid and offer prices within the Montreal Exchange.

“That will allow people who want to manage risk from fixed income via our derivative markets to have an even more liquid market,” Kloet said. “We’ve been in the process of developing our marketplace there and it continues to grow.”

Montreal Exchange on Nov. 7 requested proposals from market participants to provide market-making of the S&P/TSX 60 Index Standard Futures contracts, starting in January, according to company filings.

“This is really a broader push into derivatives,” said Khan, who rates TMX a “sector perform.” “Given the regulatory changes that are afoot, that’s probably a right strategy, because derivatives are probably where the bulk of the growth opportunities lie.”

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