Merger of TSX Group Inc. and Bourse de Montréal Inc.
February 24, 2009
This Technical Backgrounder summarizes the main findings of the Competition Bureau's ("Bureau") review of the merger of TSX Group Inc. ("TSX Group") and Bourse de Montréal Inc. ("MX").
This transaction involved the merger of Canada's two largest financial trading exchanges. Significantly, as described below, the predecessors to TSX Group and MX had already entered into a specialization agreement in 1999 whereby the TSX Group would be responsible for equity trading while MX would focus on derivatives trading. As a result, the Bureau found that competitive overlap did not exist between the parties primarily owing to the specialization agreement. The focus of the Bureau's review was therefore on the likelihood of a substantial prevention of competition following the expiration of the specialization agreement in March 2009.
As described below, the Bureau concluded, based on many factors, including a lack of competitive overlap, the likelihood of effective entry and effective remaining competition, that there were insufficient grounds at this time to challenge the merger before the Competition Tribunal.
Readers should exercise caution in interpreting the Bureau's assessment of this merger. Enforcement decisions are made on a case‑by‑case basis and the conclusions discussed in this backgrounder are specific to this merger and are not binding on the Commissioner of Competition ("Commissioner"). The legal requirements of section 29 of the Competition Act ("Act") and the Bureau's policies and practices regarding the treatment of confidential information limit its ability to disclose certain information concerning a merger investigation.
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On December 10, 2007, TSX Group and MX announced an agreement to merge their organizations and create TMX Group Inc. ("TMX Group"). The merger was subject to review by the Bureau, the Ontario Securities Commission, the Autorité des Marchés Financiers ("AMF") and, indirectly by the U.S. Securities and Exchange Commission in connection with the change in control of MX related to its ownership stake in a U.S. options exchange. Over the course of its review, the Bureau interviewed more than 40 industry stakeholders, including competitors, customers and government regulators. The Bureau also retained an external expert and communicated with foreign antitrust authorities.
In March 1999, the Canadian financial exchanges had entered into a specialization agreement that will expire in March 2009 (the "Specialization Agreement"). Pursuant to the terms of the Specialization Agreement, senior equity listings were consolidated onto the Toronto Stock Exchange ("TSX"), Canadian derivatives were consolidated onto the MX and junior equity listings were consolidated onto the Canadian Venture Exchange, which was subsequently acquired by TSX Group in 2001 and renamed TSX Venture Exchange ("TSX Venture").
The Bureau decided not to challenge the 1999 restructuring of the Canadian Stock Exchanges.Footnote 1 The Bureau's conclusions were owing to, among other things, a policy announcement by the Canadian Securities Administrators in 1999 that they intended to remove regulatory barriers that prevented the establishment of Alternative Trading Systems ("ATS").
TSX Group operated Canada's two largest national stock exchanges: TSX, serving the senior equity industry, and TSX Venture, serving the junior equity industry (together "TSX Group Platforms"). TSX Group also controlled Natural Gas Exchange ("NGX"), a North American exchange that trades and clears certain commodity contracts, and Shorcan Brokers Limited, an off‑exchange fixed income interdealer broker. In 2007, TSX Group had total revenues of approximately C$424 million on a consolidated basis.
MX was a Canadian derivatives exchange that offered trading in various Canadian derivatives products. Clearing, settlement and risk management services were provided to MX by the Canadian Derivatives Clearing Corporation ("CDCC"), wholly‑owned by MX. In 2007, MX had total revenues of approximately C$83 million on a consolidated basis.
Both parties primarily operated in trading financial instruments and related businesses. Financial exchanges facilitate the trading of financial instruments by matching buyers and sellers in an organized manner. When buying a financial instrument, customers value the liquidity of that instrument. Liquidity is the ability to re‑sell a financial instrument easily and in a way that does not impact upon its price. Liquidity is a function of the number of willing buyers and sellers of that instrument. Accordingly, exchanges with a greater number of buyers and sellers more readily trade liquid instruments, attracting additional buyers and sellers. The Bureau found that these network effects acted as a barrier to entry into the industry for the trading of financial instruments since, in order to achieve liquidity, entry must be made on a large scale with the ability to quickly attract buyers and sellers.
The Bureau segmented equities, derivatives and commodities traded on the parties' exchanges according to their respective inherent risk profile and the likelihood of demand substitutability.
The Bureau found that equities, derivatives and commodities had distinct risk profiles; as such, demand substitutability among them was limited. The Bureau concluded that these instruments were not competitive substitutes with one another and examined these three groupings separately. The Bureau's conclusions in respect of each group of instruments are set out below.
The Specialization Agreement had consolidated equity listings on TSX Group Platforms, and excluded MX from trading equities. The Bureau therefore considered the likelihood that the merger would lead to a substantial prevention of competition in equities markets if MX were precluded from competing with TSX after the expiration of the Specialization Agreement in March 2009.
Following a thorough examination, the Bureau did not find evidence that MX had significantly developed plans to enter any equities markets, or that MX would have been a particularly vigorous or effective competitor to TSX in respect of the trading of equities following the expiration of the Specialization Agreement in March 2009. Further, the Bureau found that at least one ATS, Alpha Trading Systems ("Alpha"), was poised to enter equities markets on a significant scale in the near future.
Alpha is an equities trading platform that was under development at the time of the Bureau's review. It is organized by nine of Canada's leading financial institutions,Footnote 2 which together represent a significant portion of the volume traded on TSX Group Platforms and MX. At the time of the Bureau's review, Alpha was poised to compete directly with the TSX Group Platforms; Alpha was launched on November 17, 2008.
The Bureau concluded that Alpha was likely to be an effective competitor to TSX Group Platforms. Given the fact that the largest customers of TSX Group Platforms planned to divert a significant portion of their volume to Alpha, the Bureau concluded that Alpha was likely to sufficiently overcome the network effect barriers to entry discussed above.
In all the circumstances, including the lack of an existing competitive overlap, and the likely entry of a significant competitor, the Bureau concluded that the merger was not likely to substantially lessen or prevent competition in any equities trading markets.
As discussed above, the Specialization Agreement in place since 1999 had prohibited the trading of derivatives contracts by TSX Group. Accordingly, as in the equities markets, the Bureau concluded that there was no overlap in the trading of derivatives, and focused its review on the likelihood of a prevention of competition following the expiry of the Specialization Agreement in 2009.
The Bureau learned that TSX Group and International Securities Exchange ("ISE"), a leading equity options exchange based in New York, had preliminary plans to create a new derivatives exchange, named DEX, once the Specialization Agreement expired. DEX was to be owned 52% by TSX Group and 48% by ISE, and would have been a direct competitor to MX in various derivatives markets. DEX was abandoned as a result of the merger and, as a consequence, the Bureau's analysis also considered whether the creation of DEX would likely have resulted in a substantial increase in competition in various derivatives markets, which was otherwise prevented by the merger.
By examining the respective inherent risk profile of the various derivative instruments, the Bureau identified four groupings of instruments with limited demand substitutability, which served as the likely product markets in respect of which DEX and MX would likely have competed in Canada:
- Single stock contracts;
- Index contracts;
- Exchange traded funds contracts; and
- Interest rate contracts.
Following a detailed review, the Bureau found insufficient evidence to indicate that DEX would have substantially increased competition in any of the relevant derivatives markets for several reasons, including those discussed below.
First, there were no meaningful business plans generated by TSX Group or ISE for the creation of DEX, indicating that the establishment of DEX was by no means assured.
Second, the Bureau determined that trading off the exchange in the over‑the‑counter ("OTC") derivatives markets provided a credible alternative to trading on an exchange for some of the market participants contacted, notably the large trading firms.Footnote 3
Third, some market contacts suggested that the network effects in these particular product markets would likely have caused DEX's entry to fragment the market as it competed with MX, thereby reducing liquidity. The Bureau found that, in other jurisdictions, entry into derivatives markets did coincide with substantial increases in trading volumes and liquidity, but that network effects caused this competition to be short‑lived as only one competitor was typically sustainable. The Bureau therefore considered that DEX was unlikely to substantially increase competition in derivatives trading owing to the barriers involved in overcoming the inherent network effects of the financial exchange industry.
Taking into account all of the information available and its own analysis, the Bureau concluded that, based on many factors, including those mentioned above, the entry of DEX was not likely to substantially increase competition in the trading of derivatives in Canada.
Clearing and settlement
Clearing and settlement are the means by which trades are executed so that buyers receive title to the instruments they purchase and sellers receive payment. These activities are performed by a clearinghouse, whereby the clearinghouse assumes the liability of default for both parties to a trade, acting as both the buyer and seller to every trade on an exchange. In its review, the Bureau viewed clearing and settlement as a necessary input to the trading of financial instruments and therefore analyzed any vertical integration between an upstream clearinghouse and a downstream exchange.
Specifically, the Bureau focused its review on the clearing and settlement of instruments traded on TSX Group Platforms; namely, the potential anticompetitive effects resulting from the common ownership post‑merger of TSX, TSX Venture and CDCC, the derivatives clearinghouse wholly‑owned pre‑merger by MX.
Specifically, prior to the merger, TSX, TSX Venture and existing ATSs used the Canadian Depository for Securities Limited ("CDS") for the clearing and settlement of equities. The Bureau considered whether, post‑merger, TMX Group would have an incentive to add equity clearing as a service offered by CDCC, and divert TSX Group Platform equity volume from CDS to CDCC. Through its investigation, the Bureau recognized that CDS is structured as an industry utility with efficiencies of scale operating on a cost recovery, not for profit basis. A loss of TSX Group Platform volume could cause CDS to raise clearing fees charged to unintegrated ATSs, thereby hindering the ability of existing and emerging ATSs to compete effectively with TSX Group Platforms.
The Bureau identified several mitigating factors that addressed this concern, such as the strong likelihood that Alpha would become a competitor in the equities trading market and that any changes to the business of CDCC would be subject to a review by security regulators. Also, given that Alpha's financial backers have a controlling interest in CDS, Alpha has an interest in maintaining clearing and settlement volume on CDS. Taking into account these factors, along with a number of others, the Bureau concluded that the merger was not likely to substantially lessen or prevent competition in any clearing and settlement markets.
Commodity contracts are various forms of contracts that derive their value from actual commodities. As discussed below, the Bureau analyzed various aspects of the merger as it relates to commodities markets.
TSX Group serviced commodities exchange markets through its wholly‑owned subsidiary NGX. NGX operated an electronic exchange and clearinghouse through which participants trade various commodities contracts.
MX held a 51% interest in Canadian Resources Exchange Inc. ("CAREX"), a relatively recently established joint venture that had plans to provide trading and clearing services for similar contracts as NGX, as well as some additional contracts.
Firm plans for CAREX's entry had not been determined at the time of the Bureau's analysis; however, given MX's 51% interest in CAREX, the Bureau assumed a scenario where CAREX would not enter the market as a result of the merger. The Bureau therefore examined whether the merger was likely to lead to a substantial prevention of competition by eliminating CAREX as a competitive entrant.
The Bureau defined commodity contract product markets based on the respective inherent risk profile of each contract, the type of settlement offered by the contractFootnote 4 and underlying commodity. Based on these criteria, the Bureau concluded that CAREX could have competed with NGX in respect of four product markets:
- The trading of physically settled natural gas contracts;
- The trading of financially settled natural gas contracts;
- The trading of physically settled electricity contracts; and
- The trading of financially settled electricity contracts.
The Bureau concluded that commodity exchanges in both Canada and the United States competed and therefore the relevant geographic market included both Canada and the United States.
Within the markets identified above, the Bureau found significant effective remaining competition following the merger. In addition, off‑exchange trading (where traders trade directly with one another outside the exchange) provided some competitive constraint to the on‑exchange trading market. As such, the Bureau concluded that it was unlikely that a substantial prevention of competition would in any event result in these markets as a result of the merger.
The Bureau also analyzed the potential for competition between CAREX and NetThruPut Inc. ("NTP"), a crude oil trading exchange that TSX Group has the option to wholly acquire in 2009. The Bureau's analysis specifically focused on the potential development of financially settled contracts on a relatively newly developed heavy crude oil stream, Western Canadian Select ("WCS"). Both CAREX and NTP have publicly expressed an interest in offering these types of contracts.
The Bureau concluded that any lessening of potential competition between CAREX and NTP for various WCS futures contracts was unlikely to be substantial. Among other factors, the Bureau considered that competition would likely only emerge following a significant growth in demand for these types of contracts, that effective remaining competition existed in the form of other exchanges that offer substitutable streams of heavy crude oil contracts, and that competition between the exchanges would likely be short‑lived owing to network effects in the industry.
Intercontinental Exchange, Inc. ("ICE") strategic alliance with Natural Gas Exchange
The Bureau's examination also considered another transaction; namely, an agreement between ICE, a significant electronic energy marketplace and soft commodities exchange based in Atlanta, Georgia, and NGX, a wholly‑owned subsidiary of TSX Group.
On March 28, 2007, NGX and ICE announced a technology and clearing alliance whereby certain natural gas and electricity contracts currently offered by NGX and ICE would be offered together on ICE's electronic commodities platform. While the transaction was not subject to pre‑merger notification under Part IX of the Act, the Commissioner has the authority to review both notifiable and non‑notifiable transactions. In the circumstances, the Bureau conducted a thorough review of the strategic alliance in conjunction with its review of this merger.
Pre‑agreement, NGX and ICE offered physically and financially settled natural gas and electricity contracts. As stated above, the Bureau found the relevant geographic market to include both Canada and the United States, with effective competition remaining in these markets following the strategic alliance. Further, off‑exchange trading provides some competitive constraint to trading on the exchange.
The Bureau concluded that the merger and the ICE/NGX strategic alliance would not likely give rise to a substantial lessening or prevention of competition in any of the relevant commodity markets.
As described above, the Bureau identified a number of areas where initial concerns arose regarding a prevention of competition, including certain markets for the provision of trading commodities and derivatives contracts. However, the Bureau also identified at least one poised entrant into a number of relevant markets and other effective remaining competitors. Overall, the Bureau determined that it was unlikely that the merger would lead to a substantial lessening or prevention of competition in any relevant market.
Pursuant to section 97 of the Act, the Commissioner has up to three years to file an application with the Competition Tribunal to challenge a merger that has been substantially completed, should the merger prevent or lessen competition substantially in any market.
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