Canadian law allows the government to reject foreign takeovers that don’t provide a “net benefit” to the country. The Ontario and Quebec securities regulators would also have to approve any sale of more than 10 percent of the voting shares of TMX Group Inc., owner of the Toronto Stock Exchange.

“Exchanges and the capital markets are viewed as national assets,” said Cameron Webster, a managing director at Sandstone Asset Management Inc. in Calgary, which oversees C$200 million ($201 million). “To the extent that a U.K. owner could be viewed as having influence on dictating rules of the market, that could potentially be a political football.”

The LSE agreed today to buy TMX for about C$3.2 billion in stock. LSE shareholders will own 55 percent of the company, while TMX investors will hold the rest, the exchanges said today in a statement. TMX shareholders will receive 2.9963 LSE shares for each they own, valuing the Toronto-based company at about C$42.88 a share, 6 percent more than yesterday’s closing price.

A sale to the London exchange would be the largest foreign takeover of a financial services company in Canada, where banks and insurers are protected by ownership limits.

Industry Minister Tony Clement, who would have to approve the deal under the Investment Canada Act, announced a review of the foreign investment approval process in November after his government blocked the proposed $40 billion bid for Potash Corp. of Saskatchewan by BHP Billiton Ltd.

Potash Bid

Clement and Finance Minister Jim Flaherty declined to comment on the stock exchange merger talks yesterday in Ottawa.

The government, which reviews any foreign bid worth more than C$312 million, said the proposed takeover of Potash Corp. didn’t provide a net benefit to the country. It was only the second blocked foreign takeover in 25 years.

Ontario’s securities act also prohibits a person or company from controlling more than 10 percent of TMX without approval from the Ontario Securities Commission. When TMX, then known as TSX Group Inc., bought Montreal Exchange in 2008, it agreed to give Quebec’s Autorite des Marches Financiers veto power over any sale, according to a TMX’s last annual report.

“Any potential takeover would have to be approved by two regulators, and if you layer on the fact that the government was so hesitant of letting go of Potash in the greater national interest, similar consideration could apply to TMX,” said Shubha Khan, a Toronto-based financial-industry analyst for National Bank of Canada.

Australian Exchange

Singapore Exchange Ltd.’s A$7.8 billion ($7.9 billion) bid for ASX Ltd., announced in October, has faced opposition from several Australian parliamentarians. Australian Treasurer Wayne Swan, who must approve the takeover, said in December he’s not convinced it would be in his country’s interest.

An LSE bid for Toronto Exchange, which was incorporated in 1878 and went public in 2002, would present a “very similar scenario,” said Jeff Fenwick, a financial-industry analyst at Cormark Securities Inc. in Toronto.

The exchanges will likely argue that regulation will ensure a combined exchange operates in Canada’s interests, Fenwick said. They will also note that alternative trading platforms including Chi-X Global Inc., which is owned by a unit of Tokyo- based Nomura Holdings Inc., and New York-based Liquidnet Inc. already operate in the country.

Not Comparable

Potash Corp. is not directly comparable to TMX, Sandstone’s Webster said. The fertilizer producer controls 20 percent of global potash capacity, according to the company’s website.

“Potash basically has control of an asset that’s a large proportion of a global market, whereas TSX is in a more- competitive marketplace,” he said. “The marketplace is starting to go away from them. I don’t think you can argue that it’s a national asset.”

TMX has lost market share of stocks trading in the last three years with the emergence of alternative systems including Chi-X, Pure Trading and Alpha Trading Systems.

The former monopoly had 72 percent of the Canadian market for trading at the end of December, down from 76 percent a year earlier, according to statistics from the Investment Industry Regulatory Organization of Canada. Alpha, whose owners include the six largest banks in the country, had almost 18 percent of the market by shares traded, up from 17.4 percent a year ago.