The business of trading securities has changed dramatically in the past few years and the forces of corporate ambition, competition and regulatory preoccupations almost certainly guarantee it will change a great deal more. And following a string of demutualizations and reorganizations, the world exchanges are jockeying aggressively for position.

Stark evidence of the immediacy of the struggle came April 20, when the New York Stock Exchange announced plans to merge with the electronic trading system Archipelago Exchange, spin off its regulatory arm and emerge as a new public company, to be known as the NYSE Group Inc. (see story, below). Two days later, the Nasdaq Stock Market announced the acquisition of Instinet Group Inc. and its electronic trading system from Reuters Group PLC for $1.8 billion. And various exchanges in both the U.S. and Europe remain in play.

All this merger and acquisition activity is about competitive strategy — rivals seeking new markets to serve and new products to pitch as they grapple with the pressure to boost profits in what was traditionally a non-profit business.

As one of the first exchanges in the world to demutualize and go public, the TSX Group Inc. has a bit of a head start on other markets. Steve Kee, TSX director, corporate communications, says the NYSE’s move validates the TSX’s strategy to join the ranks of publicly traded exchanges. More to the U.S. point, consolidation is good for the TSX, he adds, because it removes competition and improves its position in the U.S. as an alternative market for trading Canadian equities.

But the TSX, too, is searching for ways to expand its highly profitable empire. In recent speeches, the TSX’s new CEO, Richard Nesbitt, has outlined the TSX’s big ambitions. First, speaking at the Economic Club of Toronto on March 31, Nesbitt fired a shot across the bow of the Bourse de Montreal Inc., indicating that the Canadian derivatives market is desperately underdeveloped, and that the TSX intends to get into the business once its 10-year non-compete agreement with the ME expires in 2009. The agreement was part of
the exchange restructuring in 1999.

Nesbitt maintains derivatives are one of the fastest growing sectors in global financial markets but Canada lags significantly behind. “We’re far smaller than we should be, given the dynamism of our cash markets,” he says, calling the shortfall “a missed opportunity of gargantuan proportions.”

Hence, the TSX intends to pursue the opportunity — aiming to combine cash and derivatives trading under the same roof, as a few of the big European markets do. “There are compelling reasons for this. The customers in the cash and derivative markets are the same people. They want to be able to trade derivative and cash products side-by-side,” he says.

If developing such capability isn’t challenging enough, there’s plenty of room for improvement in the Canadian fixed-income market. Canada lags far behind the U.S. in electronic trading: barely 5% of Canadian fixed-income trading is done electronically, vs 30% in the U.S. And that U.S. figure is expected to reach 60% by 2007.

“Being slow off the mark on electronic trading in bonds, in fact, explains a good deal of why Canada shows up in the statistics as having lower productivity in financial services,” Nesbitt says. He stresses that it’s up to the industry to improve electronic fixed-income trading, which, in turn, is necessary to build a strong derivatives trading capacity.

A Bank of Canada round table, however, disagrees. Last year it found that while competitive forces might eventually lead to a more accessible and transparent bond market, “change will occur more quickly if supported by regulatory action.” It noted that reform might not be imminent without regulatory action because the current system works well for dealers and large institutional investors. But regulators have shown little appetite for the task.

Either way, the TSX’s eagerness to get into the derivatives game is hardly surprising, since the worldwide use of derivatives has exploded in recent years. As well, this part of the business has yet to be commoditized the way equity trading has, so there are still healthy profits to be made.

Indeed, the International Securities Exchange Inc., which went public in the U.S. in early March in a US$181-million offering, boasts 43% pre-tax margins, according to a report by New York-based investment bank Sandler O’Neill & Partners LP. It estimates that the ISE will be able to expand its margins, even as price competition comes to the business, due to its low cost structure.