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Prior to being named chief of TMX Group Inc. in July 2008, Chicago-native Tom Kloet spent time with the Chicago Mercantile Exchange, the Chicago Stock Exchange, the CBOE Futures Exchange, global brokers Fimat and Newedge, and the Singapore Exchange. As SGX’s first CEO, Kloet made a number of changes—opening its trading infrastructure, liberalizing commission rates, introducing ETFs and REITS, and expanding its derivative products—an aggressive focus on growth that he’s carried to Toronto. There, Kloet aims to better position the Toronto Stock Exchange and expand the TMX Group’s additional properties, the TSX Venture Exchange, a platform for emerging growth companies, and the Natural Gas Exchange, a physical clearing and settling house for energy-related products. Despite increasing trading competition in Canada and a financial crisis just south of its borders, Kloet is confident in his expansion strategy, pointing to Toronto’s recent merger with the Montreal Exchange as a starting point for a sophisticated, integrated cash and derivatives market. He spoke to us at length about his personal business philosophies and the group’s plans to bolster Toronto as a globally recognized exchange.

EM: How has your corporate background prepared you to lead the TMX Group?

Kloet: I’ve been around exchanges all my life, so I understand cash and derivative markets from an exchange standpoint. I also have a background with broker-dealers, particularly those that service a wide array of products. At Fimat and Newedge, we serviced everything from the cash equities markets to the listed futures markets to the OTC energy markets and everything in between, as well as inter-dealer brokers in fixed income. Because of my positions there, I have extensive experience with Canada and knew a little bit about this market before I came. I’ve learned a heck of a lot more about the market since I’ve been here, but I was prepared and understood quite a bit about what the structure was.

EM: You introduced an open infrastructure as CEO of the SGX. How does this reflect your business philosophy regarding trading systems?

Kloet: At the core, there are many things that an exchange sells, but at the forefront is access to its products through distribution. When I arrived in Singapore, the institution had long been wed to an exchange-built-and-vended workstation, which was the only way to enter the Singapore market. Even if you worked for an international broker-dealer with operations around the world, you eventually had to make a call to Singapore for somebody to put a trade in its order-entry terminal. We changed that philosophy to an open architecture and extended it even further to get the exchange to use a totally open API. So if you were, let’s say, a broker in Tokyo and wanted to put an order in, you could put it directly into the matching engine from there. That was a big change and reflective of the fact that my personal philosophy believes that the broader the distribution of products, the better.

EM: The TSX/Montreal merger was part of an overall move to strengthen Toronto’s position on the world stage. How has this goal since been reached?

Kloet: My personal thesis is that the cash exchanges, as we look at the market in 2009, must be linked to a derivatives exchange in order to continue to succeed. I don’t think there’s a very long future for cash-only markets. My thesis hasn’t concluded on the other side of that trade, whether a derivative market has to be linked to a cash market.

The success of the CME and the success of the CBOE and ISE and our own version of [the Boston Options Exchange] might prove otherwise thus far, so I’m not fully there on going the other way. But I think given the percentage of multiple value traded in the derivatives market, particularly where equity derivatives relate to the cash market, it’s a necessity now for cash markets to be associated with derivative exchanges.

So putting the derivative and cash market together in Canada was a necessary thing for the Canadian markets to remain competitive and relevant on the world stage. Also, it allows us to continue developing new products that link those markets, and many of those initial products will appear to be derivative centric.

EM: What types of new products have you introduced?

Kloet: We’ve announced the introduction of a volatility index, or a VIX product. We’ve also announced the introduction of a mini-futures product. Those would appear to be derivative centric and initially they are, but they will also fuel trading opportunities between the derivative and cash market that will increase volume in the cash markets and narrow the spreads. And they’ll make our markets as a whole more interesting to a variety of players, like algorithmic traders who trade between those markets. We’re succeeding at that, and the majority of our volume in the derivative market—particularly the interest rate derivative market at Montreal—is held by institutions outside of Canada. So I think that’s important proof that what we are really trading there are international products.

EM: Can you talk about your move to acquire a position in EDX London?

Kloet: That’s a further validation of the strategy we just talked about. We have a technology called SOLA, and our friends at the London Stock Exchange were quite interested in [using it] as the backbone for the development of EDX London. We don’t view ourselves as a technology vendor; frankly, that’s not where we want to go with the institution. But if we have some skill sets or domain knowledge that a potential partner exchange is interested in, we’re quite interested in using that domain knowledge or skill to help develop a new or existing market.

So what made sense for us was not to purely be a vendor to the LSE as a developer of technology for EDX, but to say, well, with what we’ve achieved at BOX—the Boston Options Exchange, where we are a technology vendor, the majority shareholder, and played a major part in developing that market—let’s see if we can do some of the same things at EDX but with a slightly different tactic.

We’re not selling them the SOLA version we have, but we’ll customize it and sell it to them with the source code. In exchange for that, we’re going to get cash. And we have agreed that, subject to due diligence regulatory approval, we will reinvest some of that as a minority shareholder in EDX.

The deal serves two important strategic aspects of what we’re trying to do. The more exchanges that use our derivative technology and help customize it, the better. The product will be better because it’s already shared by the LSE, the Italian Derivative Market, and Oslo. Second, we get to participate in the development of a derivative exchange attached to a significant cash exchange in Europe, so we’re pretty excited about that.

EM: Do you consider the new Alpha Trading System a competitor and if so, how have you been addressing that competition?

Kloet: We do consider it a competitor. At first blush it would appear that, if you looked at published market shares that we have, we haven’t faced the competitive pressure that maybe other exchanges have in the cash equities market. Start with the fact that we compete for listings with the New York Stock Exchange and NASDAQ and a series of other international exchanges, both for Canadian listings and non-Canadian listings. Then add to that the fact that some of our largest listed companies are cross-listed with the U.S. and European markets. You can see that we’ve had to keep our pencils sharp in terms of pricing and our technology sharp in terms of functionality to remain competitive.

What makes Alpha a unique competitor is that, from my perspective, it’s very much a re-mutualization. It reminds me a bit of BATs in the U.S. in that it’s a re-mutualization of some of the large users who have a homogeneous view of the market. And I think it’s always tough if one’s running a for-profit business and competing with utility models in a throwback to a mutualized exchange environment.

We’ve addressed the challenge by focusing on improving our product. In October, we announced another price change in our market, a decrease. We’ve decreased prices every year since the company went public, so we continue to remain competitive in pricing. We also improved the latency of our matching engine from 23 milliseconds a couple of years ago to a median rate in the five-to-six [millisecond] range. We’ve improved the latency, and that’s made us more competitive.

EM: You’ve said that the TSX doesn’t have as much of a commodity presence as you would like. What are you doing to change this?

Kloet: It’s something that we want to build. Our key presence in the commodity space is our ownership of an entity called Natural Gas Exchange. It’s a marketplace that does price discovery and ultimately clears and settles natural gas and electricity through the pipeline system in North America. We have a unique skill set in terms of the complex work of scheduling natural gas deliveries to North American pipelines, and we’re up to 13 hubs in the U.S., as well as a number of Canadian hubs. Hubs are the endpoint location for delivery of natural gas.

We’ve also partnered with ICE in terms of the trading, and that’s increased the distribution significantly. We’re in the process of completing the terms of an option that will allow us to acquire a crude oil entity called NetThruPut. Think of it as a Calgary-based cousin to NGX in the crude oil space rather than natural gas space. We’re very excited about that. It’ll add about 240 new products in crude oil to augment our positioning in natural gas. And we expect to complete that transaction in the second quarter.

So that’s the start of our commodity presence.

EM: How does the TSX Venture Exchange aid growth-stage companies?

Kloet: It’s a very unique property. We have a hundred-plus year history of supporting emerging companies with programs that mentor the companies and their CEOs through the process of becoming public. It’s a unique market because we give our issuers the opportunity to graduate to TSX when they’re ready.

In fact, of our 500 largest market cap companies, nearly 20% are Venture Exchange graduates. That ecosystem, if I can call it that, is a unique aspect to the TMX Group. We attach ourselves to these companies at a very critical point in their development, help them bring them to the public markets in an environment that has regulation—but maybe not all the aspects of regulation they might see in listing in the U.S. market—and we help them develop.

It’s a great opportunity for those companies to go to the public markets and develop without some of the things like Sarbanes-Oxley or an internal audit requirement or some of the aspects that you would expect a larger company to have, but it has a proportionate regulation associated with it.

EM: What kind of access does TSX offer American investors and how does that relationship fit into your overall growth strategy?

Kloet: We’d like to see a mutual recognition between the U.S. and Canada so that U.S. investors have complete access to our marketplace. We don’t have that yet. I know it’s something that our government is interested in, and clearly we at TSX would support that. But qualified accounts can gain access to our market through a number of our participating organizations that have U.S. affiliates or parents. Virtually all of the major U.S. broker-dealers have affiliates that are participating organizations in our market. But we’d like to see mutual recognition so that we can continue to distribute our securities in the equities market, down to the retail level.

EM: How has the U.S. financial crisis affected Canadian markets?

Kloet: We’re fortunate; our banking system is in significantly better shape. Our banks have been subjected to a higher degree of regulation. And as an American, I can say that—and I’m probably more independent on answering this question—they’ve also acted more carefully with respect to entering the various mortgage markets. So the banking system here, I think by most everybody’s—even President Obama’s—recent comments, are stronger and that’s clearly helped the financial sector and helped us institutionally.

I heard recently that the largest amount of trade between two countries is between Canada and the U.S., so to the extent that the U.S. economy has been slowed, it has definitely impacted our economy. Certainly, the number of IPOs is down. We’ve experienced the same shortage of IPOs as the NYSE or NASDAQ or the LSE, or any of the major exchanges around the world. But we’re starting to see an improved market in secondary financing. We’ve seen that in the financial sector with respect to the banks; we’ve also seen it in some of the mining sector areas.

In February, when we announced our financing statistics, I think the international media was pleasantly surprised to see the amount of secondary financing we’ve had. So there is some sign of light out there. That’s one thing that’s maybe a little bit different for us than it is for the U.S. marketplace. I’m optimistic that we’re going to see an IPO market come back.

EM: What are your top short-term priorities this year?

Kloet: I would say we have four. We made the $1.2-billion acquisition last year of the Montreal Exchange. I arrived in July and the team in front of me had done a good job putting together the framework for an integration plan, and then we spent my first four months developing an integration plan. Simply put, that plan has two components.

The first is to combine the support functions so that we have one finance function and one legal function across the institution. That doesn’t necessarily mean keeping everybody in one place, just merging them from a reporting standpoint. Then we’re going to physically move our datacenters. MX maintained a primary datacenter and a backup datacenter, and we’ll combine those at single locations in Ontario, at our primary site and a backup site.

This will save on costs, which is important from a corporate standpoint. But I’m more excited about the fact that from a market participant standpoint, if one of our member firms is collocating equipment to access our markets, to the extent that we have our servers for the equity matching engine and the derivative matching engine in the single location, being able to grant them access via single location saves them some money.

The second priority is the opportunity to further develop the derivative trading and clearing products. We own the clearinghouse for derivatives. We’re looking at clearing some OTC price discovered products through our clearinghouse, and we’re excited about the opportunities there. I think the third would be to fortify our position and enhance the equity markets.

And the fourth priority would be to expand our energy trading and clearing services along the lines of the NTP acquisition, plus the potential for developing some futures contracts around the energy sector.

EM: And what is your strategy for the long term?

Kloet: The biggest goals are to create that integrated marketplace where we introduce new derivative products to help our cash market products; and vice versa, to expand the array of clearing services we provide to include products where the price discovery was not on an exchange of ours. We prefer the price discovery to be on our exchange, but we’re open to the fact that price discovery can be in the OTC market, yet we can provide all the mediation and disciplines associated with clearing. The other is to continue to build the Canadian marketplace with a depth of products that are consistent with its economic positioning within the G-20 nations. We still have some work to do on further developing our product array there.

EM: Any closing comments?

Kloet: We have the third largest number of issuers in the world for an exchange group, and we cover a variety of industries. There are certain sectors that are stronger than others, but we really do have quite an interesting array of issuer types that I think investors reading your magazine would be interested in. And it’s all housed within a very well-regulated marketplace.