TSX revolution

Editor's note: this is one in a series of profiles of stock markets around the world. Please note that it presents TSX's perspective and omits other, possibly conflicting points of view.

Only a few years ago, many Canadian observers proclaimed the Toronto Stock Exchange dead in the cold, northern water. Hemorrhaging volume to US exchanges, threatened by ECNs and other 'off-exchange' venues, and crippled by a trading engine prone to breakdown, the TSE has been derisively labeled by critics as an irrelevant dinosaur lumbering to its demise in globalizing capital markets. The critics were probably right. But that was then.

Recent history has seen the exchange reshape its business in virtually every dimension. In just over a year (take that deep breath), it installed a new (so far flawless) trading engine; purchased and integrated the Canadian venture exchange (CDNX), thus solidifying its position as a national entity; became the world's first exchange to spin off regulatory services (into the new RS Inc) to avoid conflicts of interest with competitors; bought a 40 percent stake in CanDeal, Canada's dealer-to-client electronic trading system for institutional traders in debt market securities; reorganized internally to better define trading services and market data; and launched a new benchmark index. In the meantime, the exchange also introduced new products designed to increase liquidity and make it more competitive in the global battle for listings.

In fact, after 150 years of operation, never have the virtues of a competitive spirit been more valued - or more apparent - at the Toronto exchange. Driving much of the dynamism is a planned IPO and a grand experiment to transform the exchange from a broker-dealer cooperative into a flexible, customer-focused, market-oriented service provider. In tandem with its metamorphosis, the exchange has rebranded itself as TSX Group. Today, TSX Group, which includes the Toronto Stock Exchange, TSX Venture Exchange, TSX Markets and TSX Datalinx, collectively manages all aspects of Canada's senior and junior capital markets.

As president of TSX Markets, Richard Nesbitt is responsible for all trading on both the senior and junior exchanges while overseeing Datalinx, the exchange's data sales business. A former broker and past exchange governor, Nesbitt was brought in last year to introduce a business plan that offered better, faster and cheaper trading and market data services to the investment community - and ultimately cheaper capital costs to listed companies. His solution was pragmatic: Let the market decide.

'We are in a fully competitive environment and must offer multiple ways of trading,' declares Nesbitt. 'That has meant updating the TSX's competitive position in terms of trading functionality to best of class amongst exchanges around the world.'

Nesbitt says TSE management took a 'hard look' at the inroads that ECNs like Island, Archipelago and Instinet had made in traditional US stock markets. The idea spinning around management's gray matter was to integrate the attractive features of ECNs into an exchange environment and thus combat fragmentation.

'The difference between our approach and what has gone on in the US is that US exchanges have so far refused to provide that kind of functionality and so new competitors have formed to provide it,' comments Nesbitt. 'We want to be the central marketplace for all Canadians and all those wanting to trade Canadian stocks.'

To that end, the TSX has launched several products with ECN-like functionality. Following new cross-marketplace regulations in 2001, TSX Markets gives its participating organizations the option of having a unique firm identifier shown on an order (an 'attributed' order) or alternatively, remaining 'unattributed' or anonymous. This spring, TSX Markets introduced 'iceberg' order support, allowing investors to book their entire order while only displaying a portion of the size in market information and trading terminal displays. At the same time, TSX launched Posit Canada, an electronic order matching system that lets institutional investors trade anonymously and reduce market impact. Meanwhile, the exchange is working to implement a new process for the entry and execution of market-on-close orders that Nesbitt believes will result in increased liquidity and less volatility at the close.

In particular, the provision of new trading architectures is meant to keep liquidity-seeking buy-side accounts trading on the TSX rather than competitor exchanges. 'We want to provide issuers with value for their listing fee,' notes Nesbitt. 'That means more than just fancy ribbon-cutting sessions when they list; it means enhancing our marketplace so more stock can trade here.'

And stock has been trading. The TSX's new trading engine has been performing superbly with the exchange setting a new volume record June 11, 2002, trading 463 mn shares - 140 mn shares more than the previous high water mark. News like that heartens fund managers and brokers, who were forced to sit on the sidelines or reroute trades on interlisted stocks to US exchanges when the old system crashed.

Still, the interlisted stock phenomenon, while positive for Canadian companies, has threatened Toronto's liquidity for some time. Today, some 180 stocks trade on both the TSX and US markets. Nesbitt takes a philosophical approach, calling interlistings 'a fact of life'. 'When a company interlists, overall trading levels rise substantially,' he says. 'If we can get most of that trading, our total trading volume rises as well. Ten years ago, we did about 60 percent of interlisted trading. Today, although there are many more interlisted stocks, we still do about 60 percent of trading. So we have competed effectively on the interlisted side.'

Meanwhile, in an effort to further increase liquidity, the TSX has embarked on a sweeping reform of its market-making system. Key changes under review include assigning individual registered trading obligations for specific stocks to market-making firms and moving from the current system of minimum-guaranteed fills to having market-makers guarantee a two-sided market with a specific size and spread goal.

'It's a very open market where people can trade without a lot of interference from third parties,' concludes Nesbitt. 'We want to continue to reduce interference and allow investors to trade the way they want to.'

Ultimately, Nesbitt envisions the TSX evolving into a 'marketplace of markets'. 'I'd like to see as many ways of trading on the TSX as is commercially viable,' he states. 'I want to get away from the one-size-fits-all approach that says you must comply with our rules. Instead, we are asking people how they want to trade and we try to provide functional solutions that come together on the TSX in a fair and accessible marketplace.'

One size fits one

Getting away from a 'one-size-fits-all approach' has also been the attitude when it comes to corporate governance. In 1994 Toronto became North America's first exchange to produce corporate governance guidelines for listed companies. However, rather than enacting compulsory rules, the TSE model took a disclosure-oriented approach where issuers not following the guidelines would have to explain why in their annual report.

Best practices were recently refined and the TSX issued a new set of governance guidelines for comment in April. Among the updates: audit committee members must be 'financially literate', the definition of which is even now being hotly debated. But in the post-bubble climate of distrust, even these revamped guidelines are under review, and some might develop into outright requirements.

At the request of the Ontario Securities Commission, and in light of the requirements recently imposed by the NYSE and US federal legislators, the TSX is taking a second look at its proposed amendments. But Robert Fabes, the exchange's vice president of advisory affairs, indicates the TSX won't impose a one-size-fits-all approach on the whole of corporate governance.

'There may be some things fundamental to corporate governance which apply to all issuers. They may become actual requirements based on our review of our proposals,' says Fabes, whose group oversees what once was called compliance and reporting. 'But Canada's market is significantly different from those in the US. For example, the capitalization range of TSX-listed companies is much wider than that found on the NYSE. Telling a smaller company to ensure its board is mostly composed of independent directors [is difficult to impose].'

This summer, stock exchange officials from around the world touched down in Toronto for a gabfest to talk about corporate governance reform, among other themes. Fabes notes that European bourses, in line with their stance on accounting issues, favor what he calls the TSX's 'principled' approach to corporate governance. '[Europeans] believe having a set of guiding principles rather than prescriptive rules will ultimately lead to better corporate governance practices and make it easier to deal with potential abuses and non-compliance,' he says.

Beyond upgrading corporate governance guidelines, the TSX is also eyeing listing standards reform. In August, the exchange codified and proposed amendments to its ongoing listing standards. Among the issues under review are the TSX's standards for the granting of stock options. While the new standards are consistent with US initiatives - in that the exchange will require shareholder approval for virtually any form of executive compensation - Fabes says the TSX proposals go much further. 'We say that when you do get shareholder approval, those executives of the company who benefit from the compensation arrangements may not vote on the proposal,' he says.

EZ listing

Fabes' boss is Clare Gaudet, the TSX's senior vice president of corporate services. She is responsible for the listing business of the senior exchange, the TSE. Besides liaising with issuers on listing requirements and ongoing standards, she oversees business development, which encompasses new and existing relationships and emphasizes enhancing the listing's value from an IR perspective.

'To properly service issuers, we must facilitate all levels of interaction with the exchange,' says Gaudet. 'The role of IROs has increased dramatically in the last decade. So it is critical to support them with tools to help manage their relationships with investors and do their job.'

With that philosophy in mind, the TSX is planning to roll out the second generation of its popular TSEdge web-based market intelligence tool at the end of 2003. TSEdge provides issuers with real-time quotes, ownership data and consensus earnings estimates and lets them benchmark stock performance and fundamentals against peers.

'We've had good feedback from IROs on enhancements,' says Gaudet. 'The idea is to build something that adds value to a Canadian issuer's listing.' Listed companies also take advantage of a range of interactive web services that help promote their listing, such as the annual report ordering service and web site services. The TSX is also working on web-based issuer filing initiatives (the first of which is due in early 2003) that Gaudet promises will be well received by issuer personnel responsible for filing.

Gaudet says her department's staff work closely with colleagues in trading and market data to integrate services for listed companies. 'We recognize that issuers have choices,' says Gaudet. 'So we take a customer-focused approach. All we do is directed toward facilitating the issuer's dealings with us. And we want to get feedback on all the services we provide.' That effort is bolstered by a national team of regional managers working to better connect the exchange with listed companies and candidates for new TSE listings.

Gaudet points to the recently acquired venture market. 'Our coordinated, holistic approach to the marketplace makes it far simpler for issuers to graduate from the junior to senior exchange,' she says. Last year, some 30 percent of the TSE's 97 new listings came from the venture exchange.

Booming business

Indeed, despite the slowdown in overall capital markets, the TSE's new listing business has been booming, mainly because of the increasing popularity of special purpose issuers such as income trusts as well as exchange traded funds (ETFs). To date in 2002, some 70 percent of new listings have been special purpose and ETF issuers.

'The market creates products for given conditions and now it is creating special purpose funds and ETFs,' says Gaudet. 'We have been very successful fostering the listing of those kinds of products.'

The ability to foresee demand and nimbly satisfy it with precisely tailored products and services is the sign of a company destined to be around for the long term. Once teetering on the edge of oblivion, there's no doubt that with new incentives and new technology the TSX is better positioned to compete and prosper in North American markets and beyond.