The uphill battle facing Toronto-based TMX Group Inc. and London Stock Exchange PLC in their quest to merge their stock-exchange operations is getting steeper. The deal is facing growing regulatory and political scrutiny, which is raising doubts the transaction will be approved.

On Feb. 9, the operators of the Toronto Stock Exchange and the London Stock Exchange announced an agreement to combine the two exchange groups in a “merger of equals.” If successful, the union would create a huge, transatlantic exchange business, listing more than 6,700 companies with aggregate market capitalization of $5.8 trillion.

For this proposed merger to become a reality, however, the proposal must win the support of multiple regulators and policy-makers. In the weeks since the announcement, the two companies have been informed that the transaction will be subject to a formal review by Canada’s federal government, which will assess whether the deal constitutes a “net benefit” for the country.

The proposed merger will also be assessed by the provincial governments in Ontario, Quebec, British Columbia and Alberta. These provinces each have their own regional interests to protect.

The proposed merger is unlikely to win approval under this extensive review process, says Alison Crosthwait, director of global trading research with New York-based brokerage firm Instinet Inc. , in a recent report, which adds that the Canadian government is likely to have concerns with the fact that the LSE would have a larger stake and more control of the combined entity.

“The fact is, [although it has been] presented as one, this is not a merger of equals,” the Crosthwait report says, noting that under the agreement, LSE shareholders would own 55% of the combined company’s share capital and eight of the 15 directors would be nominated by the LSE.

“Generally speaking, Canadian policy seeks to ensure Canada’s ‘ownership’ of its culture,” the report says. “As the TSX and the Montreal Exchange are important at both strategic and symbolic levels, we do not believe that the government will feel comfortable ceding control of either.”

Crosthwait’s report identifies some benefits for Canada resulting from the merger, such as improved access to international investors for Canadian issuers. However, the report concludes that such benefits will be outnumbered in the review process by potentially negative impacts, which will prevent the deal from passing the “net benefit” test under the Investment Canada Act.

The proposed merger could face additional opposition from the Province of Ontario, which also has the power to block the transaction. Ontario Finance Minister Dwight Duncan has voiced concerns over the possibility that stock-market consolidation could drive up the price of listings, hampering the ability of small and medium-sized Canadian businesses to access capital markets.@page_break@The Ontario government has established a non-partisan committee that will assess the impact of the proposed merger on Ontario’s economy, population, mining industries and financial services sector. The committee will hold at least four public hearings as part of its review, and expects to release its report by April 7.

“A legislative committee will have an opportunity to hear from Ontarians and others on the proposed transaction,” says Duncan’s statement, “and their review will be an important part of our input to the federal government’s Investment Canada Act review.”

Meanwhile, the Ontario Securities Commission has announced plans to conduct its own review of the proposed merger. The regulator oversees the operations of the TSX, and its approval is required for any party to acquire more than 10% ownership of the voting shares of TMX.

“The TMX/LSE transaction will require the commission to review a number of significant regulatory issues,” said Howard Wetston, chairman of the OSC, at an event hosted by the Economic Club of Canada in Toronto on Feb. 23. “Let me make it clear that we will review all aspects of the transaction — including the proposed structure — to ensure that we are satisfied that any changes are in the public interest.”

Other provincial securities regulators will also be weighing in on the proposed merger. The deal requires the approval of the Autorité des marchés financiers as the lead regulator of the MX; the Alberta Securities Commission as lead regulator of the Natural Gas Exchange and co-lead regulator of the TSX Venture Exchange; and the B.C. Securities Commission, which is the other co-lead regulator of the TSXV.

Says the B.C. government: “There may be a need for the BCSC to undertake some form of consultation with industry, flowing out of its oversight of the TSXV.”

The Quebec government has asked the AMF to hold public hearings on the proposed merger as part of its review of the transaction. “We will make sure that Quebec companies’ access to capital is maintained, or even improved,” said the province’s minister of finance, Alain Paquet, in a statement. “In addition, Quebec investors must continue to be well protected. Moreover, the expertise in derivatives of the MX must be protected and enhanced.”

Despite the long and rigorous review process the TMX and the LSE face, the two stock-exchange operators have expressed confidence in a joint statement that policy-makers will recognize the benefits of the proposed merger: “The companies have worked together to develop a set of undertakings that deliver clear benefits to Canada and Canada’s capital markets, while preserving financial regulation in Canada.” IE