The following first appeared in the National Post on July 2, 2013.
THREE EXCHANGES, NOT TWO: EXTRA COMPETITION WILL BENEFIT CANADA’S FINANCIAL INDUSTRY
TSX competitors a good thing
Monopolists classically overcharge their customers
Last month, to much fanfare, a group known as Aequitas Innovations announced its intention to start up a new Canadian stock exchange. Reading the press reports, one could be forgiven for thinking that Aequitas will be the only exchange in Canada other than the TSX and its satellite listing platform, the TSX-V.
In fact, since 2004, the Canadian National Stock Exchange (CNSX) has been listing small public companies, ETFs, government debt, and a number of other products. Perhaps because it is not owned by blockbuster investment banks and buy-side institutional investors, or perhaps because it caters mainly to public companies at the small end of the size spectrum, the press has been remarkably quiet about CNSX. But despite the lack of fanfare, CNSX has managed to list 197securities, and in the past year has added proportionately more new listings to its portfolio than either the TSX or the TSX-V. Its listed companies span the gamut of industrial sectors, including mining, oil and gas, technology, clean tech, life sciences, and diversified industries. Studies show that CNSX-listed securities have liquidity comparable to or better than the TSX-V. It is not therefore surprising that CNSX now competes head-to-head with the TSX-V for listings.
Thus, Canada will soon have three stock exchanges. Is this a good thing? Absolutely! At one time Canada had five exchanges that traded equity securities (Toronto, Montreal, Vancouver, Winnipeg, and Alberta). However, via two agreements between the stock exchanges in 1999 and 2000, that was reduced to two. The survivors were the Canadian Venture Exchange (or CDNX, an amalgamation of the Alberta, Vancouver, and Winnipeg exchanges), which got a monopoly in the listing and trading of junior equities, and the Toronto Stock Exchange, which got a monopoly in the listing and trading of senior equities. Montreal gave up its equities business but acquired a monopoly on derivatives.
Then, in 2002, the TSX bought CDNX, re-branding it as the TSX Venture Exchange, or TSX-V. That move reduced the number of equity listing (and trading) platforms to one. The consolidation continued when, in 2008, the TSX acquired the Montreal Exchange, re-branding the amalgamated enterprise as the TMX. Finally, in August of 2012, as part of the acquisition of the TMX by the Maple consortium, the TMX’s largest rival in the equities trading business (Alpha) was absorbed into the TMX. These developments have all had the effect of concentrating market power in the listing and trading businesses in the hands of a single commercial entity.
Proponents of monopolizing corporate mergers typically rely on the dual arguments that Canadian firms need to have sufficient capital, and be large enough to exploit economies of scale, to compete head-to-head with much larger rivals in other countries. But the stock exchange business is essentially an IT business, and economies of scale are exhausted at a relatively small size. Nor is a deep well of capital as critical to operations as it might be in industries such as banking, investment banking, and manufacturing. Moreover, it is well known that monopoly creates a deadweight social loss. Monopolists classically overcharge their customers. And there is increasing evidence that monopolies are much slower to innovate than firms operating in a competitive environment.
Recent experience on the trading side of the stock exchange business offers confirming evidence. As a result of regulatory changes that allowed TMX stocks to be traded off-exchange, a raft of aggressive and innovative competitors, such as Pure Trading, Chi-x, Omega, and Alpha began trading TMX stocks. The result was a flurry of innovation in the trading business unmatched at any time in Canada’s financial history – innovation that forced the incumbent, the TSX, to radically upgrade its own trading platform. Trading fees dropped dramatically, even as liquidity and speed of execution improved. Traders were also provided with a much broader palette of pricing models and order types from which to choose.
On the listings side of the business, competition is still in its nascent stages. CNSX currently has about 4% of the market by number of securities listed. However, CNSX’s percentage of the Canadian market is far smaller when measured by value of securities traded, since CNSX concentrates on listing small, entrepreneurial firms. It is not clear when Aequitas will be up and running nor what kind of market share it can expect. However, when the competition really heats up, it can only be good news for Canadian issuers, investors, and market professionals.
Indeed, consumer choice looks to be greatly enhanced insofar as the three exchanges will operate on somewhat different business models. TMX and its satellite automated trading system (Alpha) will provide a home not only for traditional retail and institutional investors, but for the high frequency traders (HFTs) that have so fundamentally transformed the trading business in Canada and around the world. HFT will also continue to play a major role in the TSX’s trading competitors, including Pure Trading, Chi-x, and Omega.
By contrast, Greg Mills, the Chairman of Aequitas, is quoted in a press release as stating that Aequitas will “create a level playing field for both retail and institutional investors by challenging certain predatory high frequency trading strategies which have impacted the quality of existing equity markets.” The release further states “latency arbitrage, rebate arbitrage and exploratory trading… impair the quality of execution for retail investors and for institutional investors.” Aequitas is clearly banking on both retail and institutional investors choosing to play in an HFT-free sandbox.
CNSX provides a business model that is uniquely focused on the needs of the small cap issuer and its investors. The model is grounded in a number of fundamental pillars. One is enhanced disclosure (over and above that required by securities laws) in order to ensure investor confidence. Another is a deep sensitivity to cost effectiveness. Small firms are typically cash-strapped and have market windows of opportunity that open and close quickly. For this reason, CNSX is committed to service that is timely, efficient, and highly expert. There are no requirements for expensive and time-consuming reviews of major corporate transactions, and, in general, listed firms and dealers pay fees that are lower than they will find elsewhere.
CNSX is also committed to issuer liquidity, and to this end has designed a market model that attracts the participation of traditional market makers. Liquidity is, in fact, as good or better than at the TSX-V. The presence or absence of HFT – the dividing line between the TMX and Aequitas – is not an issue for CNSX, since HFT have little interest in trading smaller companies.
In short, competition in the exchange business is good news for Canada. It promises benefits for all market players – even the exchanges themselves, which will be leaner, meaner, tougher, and, nam bonum patriae, better able to compete on the international stage.
