The executive teams behind the proposed marriage of Toronto-based TMX Group Inc. and the London Stock Exchange PLC say the union would bring big benefits to issuers, traders and investors. However, some financial services industry experts are skeptical, noting that previous exchange mergers have fallen short of expectations.

Packaged as a “merger of equals,” the TMX/LSE union is expected to yield significant opportunities for more cross-listings between the exchanges, as well as a wider distribution network for their products and services.

A TMX/LSE union would form the world’s largest venue for listings in the natural resources, mining, energy and cleantech sectors. Its combined market capitalization would total $5.8 trillion and some 6,700 firms would be listed. The union would also create the biggest global hub for small and medium enterprises, with a total of about 3,600 SMEs listed on the TSX Venture Exchange and AIM, London’s exchange for venture companies.

Bigger is better in the exchange listings business because bigger exchanges mean more capital for issuers, as well as greater liquidity for traders dealing in new securities. “By being the largest exchange in the space of mining and natural resources,” says Thomas Caldwell, founder and CEO of Toronto-based Caldwell Financial Ltd. , “the merged group will attract new listings simply due to the magnitude of its size.”

Theoretically, the deal should give Canadian companies access to capital in parts of the world — such as Europe and the Middle East — that they could not access through the Toronto Stock Exchange alone, says Etienne Phaneuf, managing director, sales and trading, with Toronto-based ITG Canada Corp. , a subsidiary of New York-based Investment Technology Group Inc. “With the promise of cross-listings, it’s a bigger pool of capital.”

The merger should also help expand the fixed-income and derivatives businesses of both exchanges. Traders in Toronto would get increased access to the MTS Group, Europe’s largest bond trading market, in which the LSE holds a majority stake; the union would also give the TMX exposure to LSE’s Italian Derivatives Exchange Market. And the LSE would have more exposure to the derivatives platform of the Montreal Exchange, a subsidiary of the TMX.

“If the TMX and LSE can grow their revenue through this merger,” says Phaneuf, “shareholders will reap those benefits.”

But promises can be broken, he adds. Phaneuf says similar benefits were promoted when New York Stock Exchange Inc. merged with Amsterdam-based Euronext NV in 2006 to become New York-based NYSE Euronext. “They had said that cross-listings would be a benefit of the merger, and that has yet to be fully materialized.”

The TMX/LSE union may be more about reducing costs of the technology platforms of the two exchanges than anything else, says Phaneuf: “These companies spend a lot of money on trading technology. And by merging their technologies into one platform, they can save a lot of money.”

Executives at both exchanges are calling for cost-saving synergies, which will come from merging technologies in the derivatives and options businesses, to total $56 million within two years of the deal’s closure. Eventually, those cost savings could translate into lower fees for traders and issuers, says Phaneuf: “With so much competition in marketplaces due to [alternative trading systems], these mammoths have no choice but to lower fees to remain competitive.”

There’s little doubt traditional exchanges are under assault from ATSes. Merging is a “defensive” move that makes sense for both the TMX and the LSE, says Caldwell. ATSes are electronic hubs for strictly buying and selling securities and are cheaper to trade on than exchanges.

“By merging, they can better focus on opportunities in their listings businesses,” Caldwell says, “as opposed to competing with the ATSes on trading alone.”

ATSes arrived in Canada in early 2002, but it was the 2008 launch of Toronto-based Alpha Trading Systems LP that truly heightened competition. According to the Investment Industry Regulatory Organization of Canada, the TSX and TSXV have seen their combined share of the value of shares traded in Canada drop to 68% in the year ended Dec. 31, 2010, from 97% in 2008. Alpha’s share grew to 20% over the same period.

The domestic environment for listings will heat up soon, as Alpha had applied for exchange status with the Ontario Securities Commission in April 2010 and approval is likely. If that happens, Alpha will also begin competing with the TSX and TSXV for listings.

This situation makes the federal and provincial government approval of the TMX/LSE merger necessary for the TMX’s continued performance, says Caldwell: “They need to counter the domestic competition, and merging with the LSE is a way to do that.” IE