The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.

TMX Group Limited (TMX), best known for its operation of the Toronto Stock Exchange (TSX) and TSX Venture Exchange (TSXV), has long remained a virtually unrivalled monopoly in Canada. The company once had a 99.7% share of the market by value traded, which has since dropped to 67.4% in 2015. Recent technological advances and loosening regulations on exchanges and trading platforms have resulted in the emergence of competitors that are now challenging TMX’s monopoly. NASDAQ’s 2015 acquisition of Chi-X, one of the TMX’s largest competitors with 12.4% of Canadian trading volume, strengthens NASDAQ’s position in the Canadian market. This presents a threat to TMX’s entire business given the interrelated nature of the revenue sources and NASDAQ’s ability to leverage its international brand and large US presence.

TMX’s Revenue Streams

TMX’s main sales stem from listing, trading, and data, which represent 28%, 36%, and 26% of revenues respectively. Listing fees are comprised of one-time fees paid by issuers during initial public offerings and secondary offerings, as well as annual fees required to sustain listings. Trading revenues are fees paid by market participants for executing buy and sell orders in TMX’s markets. Data revenues are derived from subscribers paying for access to real-time data. While the listings only represent 28% of TMX’s revenues, attracting listings is a necessary prerequisite to generate future trading and data revenues. Thus, a loss in listings may put all three of TMX’s primary revenue streams under substantial competitive pressures.

Rise of Competitors

On December 1, 2001, federal regulators approved alternative trading systems (ATSs) to incentivize competition and innovation. ATSs are non-exchange markets where buyers and sellers of securities come together to transact. They cannot host listings themselves and must trade securities listed on other exchanges. At the time, barriers to entry were still relatively high due to the expensive technological investment necessary to create a successful ATS. However, advances in technology over time have made it cheaper and easier to create an ATS, gradually lowering the barriers to entry. Benefits for investors and traders include: lower transaction costs from the lack of overhead associated with traditional exchanges, extended trading hours, and investor anonymity, giving investors incentives to switch from TSX to these platforms.

While ATSs typically lack requisite industry knowledge, expertise, and personnel to apply for listing capabilities, NASDAQ may use Chi-X, an ATS, to gain stronger presence in the Canadian market before expanding into other offerings. NASDAQ has previously publicly stated its intention for this acquisition to be a launching pad for its trading business in asset classes other than equities. There is also speculation that the company has already applied for exchange status, which will enable it to establish a listing venue.

Comparatively, NASDAQ offers a wider investor base and global markets, while TMX offers lower costs and attractive corporate governance requirements tied to Canada. However, TMX would no longer have the competitive advantage of less onerous requirements if NASDAQ opens a Canadian office and receives regulatory approval. Additionally, cheaper listing fees represent a small portion of the cost of being a public company, essentially failing to provide a compelling value proposition over NASDAQ. Thus, before NASDAQ gains approval for its listings business, TMX should take measures to ensure it will not be significantly displaced by NASDAQ Canada.

TSX Venture Exchange

The TSX Venture Exchange (TSXV), another exchange owned by TMX, caters to junior companies looking for public capital and currently has 1,532 active listings. Companies listed on the TSXV typically have a higher propensity to later list on the TSX due to the easy transition from the TSXV to the TSX. Companies that graduate from TSXV typically benefit from cost savings and reduction of paperwork. Historically, this system has represented a significant source of new listings. Since 2000, 318 businesses currently on the TSX have “graduated” from the TSXV, representing 20% of total companies currently listed on the TSX.

Companies whose size or characteristics restrict them from listing on traditional exchanges can use alternative funding methods such as the Over-The-Counter (OTC) market, where stocks are unlisted and trade on a dealer network. However, the TSXV has a few notable advantages stemming from stronger investor protection and greater visibility. TSXV allows for companies to become public at an earlier stage of their life cycles, allowing for more liquidity and accessibility. Compared to TSX, TSXV Tier 2 companies, the earliest stage allowed on the exchange, require 93% lower net tangible assets and 75% less in pre-tax earnings. The exchange also enables issuers to raise smaller amounts of capital, avoiding early equity dilution. The easier access to capital and ability to raise smaller amounts of equity are in part attributable to processes unique to the Canadian market such as capital pooling companies (CPC), which act as investment vehicles to acquire a specific company. This is an option developmental companies can utilize instead of pursuing an IPO. Benefits include the ability to lower investor concentration and have more flexible equity offering structures. Together, these factors encourage and allow more junior issuers to list.

With 74 firms from the US currently on the TSXV, there is proven demand from companies outside of Canada. TMX and TSXV are appealing to particular companies due to their focus on natural resources. Exchanges usually serve a particular niche as they can offer better industry expertise and a large number of comparable companies; these are important criteria companies consider when choosing the exchange on which they list, as this ensures comparability of performance and improved analyst coverage. However, TMX’s current perception as a mining and energy focused exchange is also a significant barrier to diversification and expansion.

TMX and TSXV should shift their focus to technology, not only to combat the threat of NASDAQ, who has previously stated its intention to increase focus on attracting technology listings, but to capitalize on a fast growing sector. Moving into the technology space is also in line with TMX’s stated strategy and will provide diversification. However, technology listings are difficult to attract without more pre-existing technology listings already in place. This “chicken-and-egg” conundrum can be solved in the long-term via the TSXV, as smaller technology companies have fewer listing options.

The only other junior exchange that has generated significant interest on an international scale is the London Stock Exchange’s (LSE) Alternative Investment Market (AIM). With 40% of the 1033 listed companies operating in foreign countries, the exchange has already made inroads in its foreign listing strategy. However, TSXV offers better access to North American investors. Additionally, the self-regulated nature of the AIM has made its investor protection questionable. In contrast, being listed on the TSXV improves a company’s credibility given the level of due diligence conducted by Canadian regulators.US exchanges have largely avoided targeting junior companies because the Sarbanes-Oxley Act of 2002 mandates strict reforms to improve financial disclosures and accounting standards, ultimately leading to increased compliance costs. This makes the formation of an exchange focused on small and medium enterprises (SMEs) difficult given the lower cash flows SMEs typically have. Thus, the threat of NASDAQ and other US exchanges entering the SME space is low.

An Alternate Strategy

TMX’s next step should be to further expand internationally. Companies in developing countries can especially benefit from listing with TMX; TMX having a more established infrastructure offers greater analyst coverage, a wider investor base, and more accurate valuations. TMX should pursue expansion through strategic partnerships that allow for interlisting. Partnerships with exchanges save TMX from the costly and time-consuming marketing efforts of finding and attracting foreign companies to list on the TSXV. TMX can act as a gateway for companies from emerging economies around the world to access the North American markets. Listing on the TSX or TSXV offers the benefit of accessing North America capital markets while avoiding the heavy regulatory burden of Sarbanes-Oxley, but still having cultural and time zone similarities to the US.

This is similar to TMX’s existing agreement with the Santiago Stock Exchange to allow simpler and cheaper interlisting. However, TMX should be wary about its focus on mining. In creating these strategic partnerships, it has focused exclusively on this industry, which has further cemented its position as a natural resource centered exchange. Given the downturn in commodities, the Canadian economy is being pressured to diversify away from natural resources. TMX has also seen revenues decline from lower trading volume and delistings in this sector, contributing to lower market share. Through diversification, TMX would be able to mitigate against the downturn, offer investors a larger selection of companies, and better position itself to represent a more diverse Canadian economy. This should be achieved through open-ended interlisting partnerships to diversify from this niche reputation in the long term.

A particularly attractive market for TMX to pursue is India, with the majority of Indian companies choosing to list domestically. TMX should pursue a partnership with the Bombay Stock Exchange SME (BSESME). Although India has experienced rapid growth in VC funding, venture capital is less accessible in India compared to in the US, with only 110 technology-focused Indian incubators compared to nearly 700 in the US. By entering India, the TSXV can help bridge this funding gap. Additionally, there is an increasing trend towards accessing alternative methods of financing after the initial Series A. Having further equity offerings through venture capital would lead to further dilution, while having nascent business models prevent the companies from gaining access to bank loans. By taking advantage of CPCs, available through TSXV, companies will have lower investor concentration and founders will be able to retain higher ownership. This strategic partnership would allow both exchanges to streamline the process of interlisting companies.

The BSESME was created in 2012 and has succeeded in listing 125 companies to date, graduating 16 of these to the main BSE. Given that it has also experienced controversy surrounding rigged share prices and fraudulent corporations, the company would benefit from a partnership with a credible exchange like the TMX. Furthermore, only 36 of the companies on the BSESME are actively traded, indicating weak liquidity. A possible partnership structure would allow for both parties to benefit from interlisting opportunities and BSE to receive technological and managerial expertise to prevent the aforementioned issues from arising in the future.

While expanding internationally, TSXV may encounter dilution in the quality of its listings. Nominated Advisors (Nomads) can act as a safeguard to maintain integrity of TSXV’s listings. Nomads are currently unique to AIM, and a main attraction for companies looking to join the exchange. Nomads are generally boutique investment banks, or other professional firms, that serve as the facilitators of the regulatory regime of AIM. They are in charge of admitting companies to AIM, and then providing ongoing compliance checks and strategic advice. Not only do Nomads pay a fee to LSE to gain access to AIM, the advisory firms are paid for by the listed companies. It is mandatory for each company on AIM to pair with at least one Nomad whose core competencies complement the needs of the business.

TSXV should employ a similar advisory system, in order to compete with AIM for small and medium cap companies looking to list. These Nomads would add value to SMEs by using their industry expertise and previous experience with working with comparable companies. Furthermore, these advisors can help maintain the quality of the TSXV listings by guiding them to graduation, and preventing delisting scenarios.

These measures will allow TMX to move away from its natural resources dependence, and allow it to remain the dominant exchange in Canada.

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