DBRS Confirms TMX Group Limited Ratings at A (high) and R-1 (low), Stable Trends

DBRS, Inc. (DBRS) confirmed the Issuer Rating and the Senior Unsecured Debt rating of TMX Group Limited (TMX or the Group) at A (high), and the Group’s Commercial Paper rating at R-1 (low). The trend on all ratings is Stable. The terms of the Senior Unsecured Debt rank it pari passu with bank debt (of which none is outstanding) and, consequently, it has been set equal to the Issuer Rating. The Group has appropriate liquidity backstops provided by well-rated banks to support its Commercial Paper program, which in turn supports the application of DBRS’s standard short-term to long-term rating mapping. This action follows a review of the Group’s performance and prospects.

In confirming the ratings, DBRS considers TMX’s strong franchise with leading domestic market positions across a diversified set of businesses, including exchanges and clearing houses. DBRS also views the Group as having strong risk management capabilities and governance, but notes that it continues to be challenging to manage risk across a large, complex and diverse organization. DBRS sees operational risk as the critical risk for TMX to manage, and continued investment in technology, infrastructure and information security are of the utmost importance. The ratings also incorporate TMX’s improving financial metrics, which now fall within levels that are appropriate for the rating range. Importantly, the Group has made progress with reducing its debt levels following the 2012 Maple transaction, which is contributing to lower leverage. As TMX anticipates that it will continue to pay down its debt with free cash flow, strong earnings generation remains critical.

TMX is the leading provider of listings, trading, clearing, settlement and depository services in Canada, with complementary information, product and technology offerings. In Canada, TMX is easily the pre-eminent player in many of the businesses where it competes, with significant market shares across a breadth of products within equities, fixed income, derivatives and energy markets. TMX can leverage this to deliver high-quality execution, facilitate capital raising and provide data services and analytics, amongst other things. While TMX is the leading player in Canada for many of its business activities, the Group faces competition from exchanges and other service providers looking to enter the Canadian market. Nevertheless, DBRS views barriers to entry as high. Critical to TMX’s continued business positioning is its ability to continue to advance and innovate its technology offerings, while further diversifying outside of the resource sector. From a supervisory perspective, TMX subsidiaries have extensive oversight by various regulators, including federal, provincial and foreign regulators, providing an additional level of scrutiny at the operating subsidiary level.

Risk management, reputational risk issues and governance are critical for TMX’s exchanges and clearinghouse operations. TMX uses various means to mitigate risk in its activities, including extensive controls, collateral agreements, margin arrangements, delivery versus payment processes, risk sharing by its members, the ability to assess members to cover losses and legal super priority positioning, which DBRS views as appropriate. TMX businesses do not actively take direct market risk, as they are not making markets or taking proprietary positions in the markets they facilitate. TMX appears to be successfully managing operational risk, as operational losses have not been notable.

From a structural perspective, TMX has a strong and stable shareholder base, with significant ownership by prominent participants in the Canadian investment industry. With no externally issued debt by its operating subsidiaries (excluding operating/clearing lines), DBRS’s analysis is generally done on a consolidated basis. DBRS considers that the importance of the Group’s operations, such as The Canadian Depository for Securities Limited (CDS) and the Toronto Stock Exchange, to the Canadian financial system could potentially prompt government intervention in the event of a major capital markets disruption; however, DBRS does not anticipate that the holding company, TMX, would benefit from such intervention.

DBRS views the Group’s financial metrics as satisfactory and improving. Earnings continue to demonstrate positive trends with the implementation of and execution on its strategic initiatives. DBRS sees the Group as well positioned to benefit from growing volumes given its highly scalable technology infrastructure. Positive operating leverage contributed to H12017 net income of $114 million and a return on average common equity of 7.0%. Revenues are supported by business and product diversity, though they remain highly reliant upon transaction volumes. DBRS would view positively continued growth of recurring revenues. A lower expense base is also contributing to the bottom line with cost-savings initiatives having largely been completed.

Debt levels have been reduced in recent years with leverage now within TMX’s target range of 2 times (x) to 3x (debt/EBITDA) and are also comfortably within DBRS’s range for the current rating level. Importantly, operational cash flows are sufficient to cover interest costs and improving as the Group continues to work toward simplifying and integrating its various systems and infrastructure to lower its cost base. Cash flows remain critical to TMX’s growth strategy.

RATINGS DRIVERS
DBRS views the Group’s ratings as well placed at the current level and sees any positive rating action as limited over the medium term. Continued successful execution of its strategy, including expansion outside of the resource sector and increasing recurring revenues, could add positive ratings pressure over the longer term.

If there is any perceived weakening of TMX’s franchise, indicated by a notable loss of market share or reduction in its critical scale advantages, this could negatively pressure the rating. Any change in the Group’s debt structure, resulting in structural subordination in TMX’s outstanding debt, would likely lead to a re-examination of the holding company’s debt ratings.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are the General Corporate Methodology, including the TMX-specific section in the Appendix (May 2017), DBRS Criteria: Rating Holding Companies and Their Subsidiaries (December 2016) and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (March 2017), which can be found at dbrs.com under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Lisa Kwasnowski, Senior Vice President
Rating Committee Chair: Michael Driscoll, Managing Director
Initial Rating Date: September 13, 2013
Last Rating Date: August 11, 2016

The rated entity or its related entities did participate in the rating process. DBRS did have access to the accounts and other relevant internal documents of the rated entity or its related entities.