Before the proposed mer- ger of Toronto-based TMX Group Inc. and London Stock Exchange PLC can even face the crucible of competition, it will have to convince regulators and politicians that the deal makes sense.

Whether the business case for stock exchange consolidation is solid or not, the idea of Canada’s primary stock exchange falling into foreign hands has sparked some worried words from Ontario’s and Quebec’s provincial governments.

Quebec Finance Minister Raymond Bachand says the deal “raises important issues” for the economies of Quebec and Canada.

His counterpart in Ontario, Dwight Duncan, echoes that sentiment: “We need to understand the [deal’s] impact on Ontario and the Ontario markets… Above all else, our job is to protect Ontario’s and Canada’s interests.”

This sort of talk about defending provincial interests naturally raises the spectre of the federal government’s rejection of BHP Billiton Ltd.’s bid for Potash Corp. of Saskatchewan last year — and the feeling that the Potash case signals a willingness by Canadian governments to reject politically sensitive takeover deals.

The Potash case cuts both ways, however. Although it demonstrates that the federal government is willing to interfere with corporate deals, the move was so controversial that Ottawa could now be just as eager to allow foreign takeovers to demonstrate that Canada isn’t retreating into protectionism. The presence of a minority government, and perpetual talk of a federal election, makes the political calculus even trickier.

So far, the feds have been fairly noncommittal. When the TMX/LSE deal was first announced, federal Industry Minister Tony Clement had indicated that his office would look at how the Investment Canada Act applies. As Investment Executive went to press, the ministry had yet to decide whether to review the deal formally.

Nevertheless, political concerns are likely to weigh heavily on the deal’s demanding approval schedule. Not only does the proposed merger need to win support from the shareholders of both companies, it also needs the assent of Industry Canada; of the securities regulators in each of Ontario, Quebec, Alberta and British Columbia; as well as the blessing of Britain’s Financial Services Authority, Italian regulators and the U.S. Securities and Exchange Commission. (Italy is involved because the LSE owns the Borsa Italiana; the SEC, because of TMX’s ownership of the Boston Options Exchange.)

Regulators in both Ontario and Quebec have pledged to hold public hearings to examine the deal. Ontario Securities Commission chairman Howard Wetston has committed to “a full, transparent public consultation process, including a public hearing” as part of the OSC’s review of the proposed transaction.

At press time, the OSC had yet to schedule its hearing. It is still working on the timing and format, says Wendy Dey, the OSC’s director of communications and public affairs: “The OSC hopes to hold the hearings as soon as possible.”

Quebec’s Autorité des marchés financiers is similarly uncertain about the process it will follow, reports Sylvain Théberge, a spokesman with the AMF: “The structure is not yet in place, but it will be done in the next few months.”@page_break@The B.C. Securities Com-mission indicates that it’s too soon to say what form its review will take, and the Alberta Securities Commission hasn’t decided whether it will require a public hearing, saying it is considering how best to consult market players on their views.

“Our mandate is to protect Alberta investors and the integrity of our capital markets,” says Mark Dickey, senior communications advisor with the ASC. “Our examination will be undertaken with that mandate in mind.”

Chris Hamilton, an FSA spokesman, says there are no plans for hearings in Britain, adding that the regulator’s dealings with firms are generally confidential anyway.

So, the Canadian regulators will be the hurdle the proposed deal faces — or, more likely, the provincial politicians that give the regulators their marching orders.

In the past, securities regulators have proven to be willing to allow stock exchange mergers, subject to certain terms and conditions. For example, when the various regional exchanges were reorganized more than a decade ago — and ultimately acquired by the Toronto Stock Exchange — provincial regulators approved the transaction and agreed to a memorandum of understanding that left oversight of the junior market (now the TSX Venture Exchange) with the ASC and the BCSC.

Similarly, when the LSE bought the Borsa Italiana in 2007, the countries’ authorities worked out an MOU to guide their continued oversight of their respective exchanges.

For the TMX/LSE deal, the regulators’ approval is required for two reasons: to allow the LSE ownership of more than 10% of the voting shares of TMX and the Bourse de Montreal Inc.; and to amend the various exchanges’ recognition orders, which set out governance requirements, operational demands and other provisos.

In an effort to secure those approvals, the LSE is agreeing to certain conditions as part of the initial terms of the deal. For example, it pledges to adopt a governance structure that stipulates a certain number of Canadian directors, to keep certain operations in Canada and to maintain minimum employment levels — although those levels aren’t specified in the merger agreement; in addition, the other conditions are in effect for only four years and are subject to change.

Whether these promises are enough to placate Canadian political concerns remains to be seen. Bachand stresses that the Quebec government’s priorities are the development of the derivatives sector and the protection of jobs and technological expertise at the Montreal Exchange. Similarly, Duncan is intent on preserving Ontario’s position within the global financial services industry.

All of this also comes against the background of yet another push for a national securities regulator, which appears to be running into growing provincial resistance; B.C. has now changed tack and rejected the current federal proposal, expressing concern that it requires the provinces to give up too much autonomy.

This could cut both ways: provinces could see scuttling the deal or wringing greater concessions from the exchanges as ways to assert the importance of provincial jurisdiction. Or they could be willing to allow the merger — if only to show that the current system works and that there’s no need for a national regulator. IE