Presented by the Canadian Bar Association’s (CBA) National Competition Law Section and

the Professional Development Committee of the CBA

Présentée par la Section nationale du droit de la concurrence de l’Association du Barreau canadien (ABC)

et le Comité du développement professionnel de l’ABC

MATERIALS / MATÉRIAUX

2012 Competition Law Fall Conference

Conférence annuelle d'automne 2012 en droit de la concurrence

PLENARY : Stock Exchange Mergers in Canada, the US and EU

Moderator / Animateur : John D. Bodrug, Davies Ward Philips & Vineberg LLP Panellists / Conférenciers : Paul Collins, Stikeman Elliott LLP Aaron Emes, Torys LLP Calvin S. Goldman QC, Blake, Cassels & Graydon LLP Margaret Sanderson, CRA International

September 20 - 21, 2012 | 20 et 21 septembre, 2012 Hilton Lac-Leamy | Gatineau, Québec

STOCK EXCHANGE MERGERS

CANADIAN BAR ASSOCIATION 2012 Annual Competition Law Conference

Gatineau, Quebec

September 20, 2012

John Bodrug Paul Collins Aaron Emes

Cal Goldman Margaret Sanderson

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RECENT EXCHANGE MERGERS • At least seven major proposed international stock exchange

mergers in last two years

• Maple Group acquisition of TMX/CDS/Alpha – a watershed event in Canadian financial markets

• Successful transactions apart from Maple Group: – Merger of the Tokyo and Osaka exchanges appears on track to close

early next year, having received regulatory approvals

– BATS/Chi-X Europe merger (two alternative clearing systems) cleared by UK Competition Commission in November 2011

– LSE acquired LCH.Clearnet, a clearing house, in April 2012

• However, Bloomberg reported that, in 2011, $37 billion in offers for publicly traded exchanges failed to complete, most for regulatory reasons. ($21 billion in equity value erased in 2011.)

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FAILED EXCHANGE MERGERS

• ASX Limited/Singapore Exchange - Transaction blocked under Australian foreign investment review legislation – April 2011

• NASDAQ/ICE bid for NYSE - Abandoned after U.S. DOJ said it would file a lawsuit to block the deal – May 2011

• LSE/TMX - Obtained Competition Bureau clearance but merger proposal withdrawn in June 2011 in light of insufficient shareholder support; ICA and securities reviews were ongoing

• NYSE/Deutsche Bourse - Divestiture order agreed to address concerns of U.S. DOJ (Dec. 2011); transaction abandoned after opposition by EC (Feb. 2012); DB is appealing the EC's decision

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TODAY'S PANEL

1. The Maple Group transaction

(a)Overview and background

(b)Securities law framework

(c) Competition law and process considerations

(d)Key economic issues in competition analysis

(e)Approach of the Competition Bureau

(f) OSC recognition orders

2. International exchange mergers

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TMX

• Toronto Stock Exchange (TSX) (OSC lead regulator)

– Listing and trading of senior equities

• TSX Venture Exchange (TSXV) (ASC/BCSC lead regulator)

– Listing and trading of junior equities

• Bourse de Montreal (MX) (AMF lead regulator)

– Trading of derivatives

• CDCC (AMF lead regulator)

– Clearing and settlement of MX traded derivatives, certain other

securities

• NGX (ASC lead regulator)

– Trading and clearing of commodities

• Shorcan (OSC)

– Trading of fixed income securities 5

KEY COMPONENTS OF THE BUSINESSES OF TMX, CDS AND ALPHA

• Clearing and settlement of equities and other securities

– Including clearing of all equities traded on TSX, TSXV

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KEY COMPONENTS OF THE BUSINESSES OF TMX, CDS AND ALPHA

• Trading of securities listed on TSX and TSXV

– ATSs limited to trading equities listed on exchanges (and certain other

securities)

• During the course of the transaction, consistent with

previously filed application, Alpha achieved exchange status

CDS (OSC/AMF lead regulators)

ALPHA (OSC lead regulator)

1. BACKGROUND AND TIMELINE OF MAPLE GROUP TRANSACTION

1999 Restructuring of Canadian exchanges (specialization agreement)

2001 TSX/Canadian Venture (now TSXV) exchanges combine under common ownership (Canadian Venture Exchange formed by 1999 merger of Vancouver and Alberta exchanges)

2008 TSX/Bourse de Montreal combine under common ownership

2008 ATSs launched in Canada (after revisions to securities laws to encourage them)

February 9, 2011 LSE/TMX announce proposed merger

May 15, 2011 Maple Group announces proposed bid for TMX, including proposed acquisitions of CDS and Alpha (formal bid launched on June 13) •Maple formed initially by nine financial dealers and pension funds; ultimately included 12

2. BACKGROUND AND TIMELINE OF MAPLE GROUP TRANSACTION

June 29, 2011 TMX and LSE abandon their merger proposal

July 18, 2011 Bureau issues SIRs to Maple Group

October 7, 2011 OSC and AMF publish notices and requests for comments with respect to Maple Group's applications for orders required to implement the proposed transactions

October 19, 2011 Maple Group completes responses to SIRs

October 30, 2011 TMX/Maple Group enter into support agreement

Nov. 18, 2011 Competition Act Part IX waiting period expires

Nov.-Dec. 2011 OSC and AMF public hearings

Nov. 29, 2011 Bureau expresses serious concerns about the likely competitive effects of the proposed transactions in the current environment, particularly in connection with equities trading and clearing and settlement services in Canada (potentially subject to regulatory changes and any commitments that Maple Group may make)

3. BACKGROUND AND TIMELINE OF MAPLE GROUP TRANSACTION

April 27, 2012 Bureau update in light of pending release of draft OSC recognition orders: "it is possible that measures contained in the draft recognition orders, if finalized and enforced, may materially change the regulatory environment such that the Bureau's serious concerns may be substantially mitigated"

May 3, 2012 OSC releases detailed draft exchange and CDS recognition orders for public comment; AMF releases final orders in relation to exchanges and asks for public comments on a CDS recognition order

May 24, 2012 BCSC publishes notice and draft recognition order and undertakings

June 4, 2012 Comments on May 3 notice filed with OSC by industry participants

July 4, 2012 OSC issues final recognition orders and AMF issues final recognition orders for CDS

4. BACKGROUND AND TIMELINE OF MAPLE GROUP TRANSACTION

July 4, 2012 Bureau issues no action letter and press release: "the measures contained in the OSC's final recognition orders materially change the regulatory environment sufficient to substantially mitigate the Bureau's competition concerns"

July 11, 2012 BCSC and ASC issue final recognition orders

July 31, 2012 91% of TMX shares tendered to Maple Group offer

August 10, 2012 Expiry of deposit extension period, following which 95.4% of TMX shares deposited under Maple Group bid; Maple Group renamed "TMX Group Limited"

September 14, 2012

Completion of plan of arrangement to merge Maple Group and TMX

1. COMPETITION LAW AND PROCESS CONSIDERATIONS

• Exchanges are highly regulated entities, e.g.:

– Ontario Securities Act (section 21(5)): OSC may, if it considers it in the

public interest, make any decision with respect to "any by-law, rule,

regulation, policy, procedure, interpretation or practice of a recognized

exchange"

– NI 21-101 prevents exchanges from charging fees that "impose any

burden on competition that is not reasonably necessary and

appropriate"

– Pre-merger recognition orders governed the operations of TMX and

CDS

• TMX's former recognition order required that TMX "equitably allocate" its

fees, such that its fees would not "have the effect of creating barriers to

access" (section 9)

• Competition Bureau took careful account of securities regulations in reviews in 1999 (exchange specialization agreement) and 2008 (TSX/MX merger) 11

2. COMPETITION LAW AND PROCESS CONSIDERATIONS

• Consortium bid

• Initially, Maple Group's bid was not supported by TMX

• Data challenges

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3. COMPETITION LAW AND PROCESS CONSIDERATIONS

• Equities trading – Reported TMX and Alpha shares of equities trading in Canada was not

illustrative of the degree of competition

• Many TSX-listed equities trade in large volumes on U.S. marketplaces

• Dynamic nature of competition in equities trading; for example

– Low barriers to entry/expansion and ease of switching

» several remaining ATSs with tremendous excess capacity

» potential entry/expansion by, e.g., major U.S. exchanges and ATSs

– No significant capacity constraints

– Rapid technological developments

– Sophisticated traders/customers

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4. COMPETITION LAW AND PROCESS CONSIDERATIONS

• Clearing and settling

– CDS highly regulated

• Existing recognition order required that: settlement fees be "equitably allocated" and "fair, appropriate and transparent"; not have effect of unreasonably creating barriers to access

• Bank of Canada also has oversight of CDS with a focus on systemic risk

– Pre-merger

• CDS owned by banks, TMX and IIROC, and operated on a cost-recovery basis

• CDCC, clearing and settlement provider for derivatives, owned by TMX

– Transaction efficiencies

• Transaction seen to enable more efficient and effective innovation and new product/service development

• Both CDS and CDCC require market participants to post capital to trade; integration permits cross-margining across asset classes

– Offsetting positions in equities and derivatives against each other decreases the amount of capital required to be posted for the same level of trading

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1. KEY ECONOMIC ISSUES

• Trading is a two-sided market

– Requires competition analysis to address likely effects on both suppliers and takers of liquidity

• Network effects

– Traders may want to use an exchange that other traders will use in order to complete a transaction

– Can affect customer willingness to switch to other venues if prices rise

• Foreclosure issue

– If the owners “preference” the merged entity does this foreclose volume to competing venues to the point that they are ineffective competitors?

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2. TWO-SIDED MARKET

• Trading venues facilitate trading by matching liquidity providers on one side to liquidity takers on the other side

– Liquidity taker = trader who accepts an offer to buy or sell at current prices

– Liquidity provider = trader who offers to buy or sell different quantities of equities at different price levels

• Many liquidity takers exist but there are fewer liquidity providers

– Therefore venues may pay a rebate to attract liquidity providers and may charge a fee to “take” liquidity

– In past, major dealers were both liquidity takers and providers, but now high-frequency traders are major providers of liquidity and dealers are more often liquidity takers

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3. TWO-SIDED MARKET (cont.)

• In the economics of two-sided markets:

– The price level is the sum of the prices on the two sides

– The price structure is the allocation of the price level across the two sides

• Market power exists when a firm can sustain supra-competitive margins for a significant period of time

– Price level significantly exceeds the competitive level

• Analysis of the merger must assess impact on each side of the market

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4. TWO-SIDED MARKET (cont.)

• Two sides of the market interact

– Active traders may want to be where liquidity is posted and liquidity providers may want to be where active traders will look

– Venues may vary “make” and “take” fees depending on whether they want to attract more liquidity providers (esp. HFTs) or active traders to achieve optimal balance

• Sum of prices on 2-sides is similar across venues

– TSX make rebate = -31, take fee = +35, so total = +4

– Alpha make rebate = -21, take fee = +25, so total = +4

– Chi-X make rebate = -25, take fee = +29, so total = +4

– BATS make rebate = -24, take fee = +28, so total = +4

– NYSE make rebate = -15, take fee = +22, so total = +7

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5. NETWORK EFFECTS

• Speed and likelihood of trade execution matter to traders

• Questions may arise about the extent to which more order flow (active and passive) moves to, or stays with, a single venue

– Sometimes referred to as “liquidity begets liquidity”

• At same time, securities regulation requires ubiquitous connections to all trading venues and adherence to “best price” or “order protection” rule for placing orders

• Technology advances reducing any network effects

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6. FORECLOSURE ISSUE

• Do Maple investors have an incentive to preference merged firm even if a rival venue offers a better price?

• If Maple investors were to preference TMX/Alpha, would this foreclose so much trading volume from rival venues as to leave them unable to provide effective competition post-merger?

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7. FORECLOSURE ISSUE (cont.)

• Technology changes with SORs allow for better price comparison and lower trading costs

• Ownership interest of each investor is small, so potential benefit in terms of share of TMX profits is unlikely to offset higher trading costs if preferencing occurs when rival venues offer better prices

• Further analysis of what would happen if preferencing did in fact occur found that merged firm would have strong incentive to maintain competitive prices to keep contestable volume and rival ATSs would not be foreclosed

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Competition Bureau

Perspectives

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• OSC: The Maple proposal represents a fundamental change

to the delivery of trading, clearing, settlement and depository

services to Canadian market participants

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KEY ELEMENTS OF OSC RECOGNITION ORDERS

TMX/TSX Order – Key Elements

• Governance

– at least 50% independent directors and at least 50% unrelated to

original Maple shareholders

– independent board chair

– one director must represent independent dealer community

– independent governance committee, majority unrelated to original

Maple shareholders, to approve board nominees

– regulatory oversight committee to monitor conflicts (including arising

from increased ownership concentration)

• Fee models/incentives

• Internal cost allocation model

– OSC to approve cost allocation model and transfer pricing policy

among TMX and affiliates (including CDS)

• Share ownership restrictions

– continued 10% ownership cap

• Conflicts of interest and confidentiality

– requirements for policies and procedures to identify and manage actual

or apparent conflicts of interest

• Enhanced oversight program

– regular communication and interaction with directors and management

– periodic reporting of activities and business development

– prior OSC approval of certain aspects of operations

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KEY ELEMENTS OF OSC RECOGNITION ORDERS

CDS Order – Key elements

• Governance

– 33% independent directors

– 33% participant reps (including IIROC nominee, additional nominee

unrelated to original Maple shareholders)

– unaffiliated marketplace rep

• Access

– provisions to ensure fair access to clearing services

• Fee models/incentives

• Risk controls

• Enhanced oversight

– similar to approach with TMX

AMF, ASC, BCSC

• each performed similar reviews, and included similar

provisions in their recognition orders as applicable

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KEY ELEMENTS OF OSC RECOGNITION ORDERS

OSC RECOGNITION ORDERS – PROVISIONS RELATING TO MARKET CONDUCT

Equities Trading – new recognition order includes enhanced fee regulation and restrictions on certain types of discounts or tying or bundling, examples of which include:

• Prohibitions on certain types of tying or discounts accessible only to a particular person

• OSC consent required for certain other types of conditional discounts

• Fee models with discounts or rebates accessible only to classes of market participants to be re-filed with OSC for approval

• New fees or fee models require OSC approval

• Within 3 years, Maple to conduct a fee review and report to OSC

• Trading fee regulation provisions stated to be derived from NI 21-101 and therefore applicable to all marketplaces, not just TMX Group

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OSC RECOGNITION ORDERS – PROVISIONS RELATING TO MARKET CONDUCT

Clearing and Settling – detailed CDS pricing model and fee schedule incorporated into new CDS recognition order

• Contemplates lower on-exchange clearing fees than under the status quo model at CDS

• Unit pricing – clearing fees charged per transaction; no volume discounts

• Prohibitions on certain types of tying or bundling

• OSC approval required for any changes to CDS fee schedule

• Fee setting process requires input from market participant committees

• Assurances of non-discriminatory access to clearing system

• CDS to conduct periodic fee reviews (including benchmarking) and report to OSC

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OSC RECOGNITION ORDERS – PROVISIONS RELATING TO MARKET CONDUCT

• Restrictions on certain Maple Group shareholders included in exchange recognition order – e.g.:

• Requirements to disclose interest in Maple Group to clients

• Restrictions on:

– Use of confidential information received from Maple Group,

– Coordination of routing of orders, or

– Incentives to employees for trading or listing on Maple Group exchanges

• Annual certification of compliance

• Also prohibits a person or group of persons acting jointly or in concert from owning more than 10% of Maple Group without regulatory approval

• Withdrawal of non-competition agreement among Maple Group shareholders

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Australian Review of Singapore

Exchange/ASX

• In October 2010, Singapore Exchange and ASX announced the first

of a series of global exchange mergers

– ASX is Australia’s main exchange and clearing house

– Singapore government has a substantial share in SGX

• In December 2010, ACCC gave competition law clearance because

“in Australia, SGX does not compete with ASX…”

• In April 2011, Australian government blocked transaction under

foreign investment law since merger was “contrary to the national

interest… [of] maintain[ing] the ongoing strength and stability of our

financial system”

– ASX operates “infrastructure that is critically important for the orderly and stable

operation of Australia’s capital markets”

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EU and US Review of Deutsche

Börse/NYSE Euronext

• In February 2011, Deutsche Börse and NYSE Euronext announced

global merger

– In US, would combine NYSE and DB’s 31.5% interest in DirectEdge, an ATS

– In EU, would combine (a) Frankfurt, Paris, Amsterdam, Brussels and Lisbon

equities exchanges, and (b) LIFFE and Eurex, leading derivative platforms

• In December, DOJ cleared merger with order to divest interest in

DirectEdge within two years

• In February, EC prohibited merger despite remedy offers

– EC found that merger would result in a significant impediment to effective

competition in trading of derivatives since LIFFE and Eurex were closest

competitors; EC did not identify concerns in equities trading

– EU found market was (a) limited to exchange traded derivatives, excluding OTC

derivatives, and (b) limited to Europe, excluding derivatives trading in other

countries (and different time zones)

– Parties offered remedies, but were unwilling to divest either LIFFE or Eurex

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US Review of Nasdaq & ICE/NYSE

Euronext

• In April 2011, Nasdaq and Intercontinental Exchange launched

hostile bid for NYSE Euronext

– Bid launched following Deutsche Börse and NYSE’s merger announcement

– Nasdaq and ICE position: competition is global, low barriers, dramatic growth in

off-exchange trading and extensive SEC regulation

• In May 2011, DOJ advised Nasdaq and ICE of intention to sue to

block, and parties abandoned their bid

• DOJ said Nasdaq and NYSE merger would substantially eliminate

competition in provision of:

– Corporate stock listing services in the US

– Open and close equity trading auction services in the US

– Real-time proprietary equity trading data products

– Off-exchange trade reporting collection

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UK CC Review of BATS/Chi-X Europe

• In February 2011, BATS agreed to buy Chi-X Europe

– BATS and Chi-X are two leading ATSs that trade European listed equities

• Competition Commission investigation found that significant

countervailing powers would ensure competition going forward

• Key findings

– Trading today is driven by the increase in speed in electronic trading

– HFTs have a “strategic interest” in, and the ability to, direct liquidity to an

alternative exchange in order to maintain competition in equities trading

– Connectivity by dealers to ATSs resulted in “very limited switching costs” since

smart order routers split orders between venues automatically

– Customers could “direct sufficient trading volume to a new exchange to provide

the initial support that would be necessary for… it to overcome the initial hurdles

of network effects”

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JFTC Review of Tokyo Stock

Exchange / Osaka Securities Exchange

• In November 2010, Tokyo Stock Exchange announced bid for

Osaka Securities Exchange and friendly merger agreed in late 2011

• JFTC approved merger in July 2012

– Parties found to be the only providers in separate market for listings in Japan, but

JFTC satisfied with establishment of independent advisory committee that must

approve all listing fees

– TSE found to account for 90% of stock trading in Japan, OSE is a weak

competitor and TSE owns sole provider of clearing and settling services, but (a)

emerging ATSs showing significant growth while proposed amendments to

securities rules would remove some restrictions on their use, and (b) TSE will

continue providing clearing and settlement on a non-discriminatory basis

– Markets for trading Japanese equity index futures found to be global; TSE and

OSE are the major competitors, but TSE/OSE committed to reducing license

fees to NYSE for trading relevant futures, permitting NYSE to extend its trading

hours for trading of relevant futures, and licensing NYSE for related products

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