[Senate Hearing 105-628]
[From the U.S. Government Publishing Office]
S. Hrg. 105-628
INTERNATIONAL BANKING & FINANCE:
AN AMERICAN PERSPECTIVE
=======================================================================
FIELD HEARING
before the
SPECIAL COMMITTEE ON THE
YEAR 2000 TECHNOLOGY PROBLEM
UNITED STATES SENATE
ONE HUNDRED FIFTH CONGRESS
SECOND SESSION
on
ASSESSING THE YEAR 2000 PREPAREDNESS OF FOREIGN COUNTRIES AND DETERMINE
JUST WHERE AND HOW THE UNITED STATES MAY BE VULNERABLE
__________
JULY 6, 1998
NEW YORK, NY
__________
Printed for the use of the Committee
Available via the World Wide Web: http://www.access.gpo.gov/congress/
senate
50-137 cc U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1998
_______________________________________________________________________
For sale by the Superintendent of Documents, U.S. Government Printing
Office
Washington, DC 20402
SPECIAL COMMITTEE ON THE
YEAR 2000 TECHNOLOGY PROBLEM
[Created by S. Res. 208, 105th Cong., 2d Sess. (1998)]
ROBERT F. BENNETT, Utah, Chairman
JON KYL, Arizona CHRISTOPHER J. DODD, Connecticut,
GORDON SMITH, Oregon Vice Chairman
SUSAN M. COLLINS, Maine JEFF BINGAMAN, New Mexico
TED STEVENS, Alaska, Ex Officio DANIEL PATRICK MOYNIHAN, New York
ROBERT C. BYRD, West Virginia, Ex
Officio
Robert Cresanti, Staff Director
Andrew Lowenthal, Acting Minority Staff Director
(ii)
C O N T E N T S
------
OPENING STATEMENT BY COMMITTEE MEMBERS
Hon. Robert F. Bennett, a U.S. Senator from Utah, Chairman,
Special Committee on the Year 2000 Technology Problem.......... 1
Hon. Daniel Patrick Moynihan, a U.S. Senator from New York....... 2
CHRONOLOGICAL ORDER OF WITNESSES
John Westergaard, editor and publisher, Westergaard Online
Services, Inc.................................................. 3
Ernest T. Patrikis, first vice president, Federal Reserve Bank of
New York....................................................... 8
Richard R. Lindsey, director of division of market regulation,
U.S. Securities and Exchange Commission........................ 12
William A. Bautz, senior vice president and chief technology
officer, New York Stock Exchange............................... 22
Peter A. Miller, chief information officer, J.P. Morgan.......... 24
Tanya Styblo Beder, principal, Capital Market Risk Advisors, Inc. 30
Howard Rubin, chief executive officer, Rubin Systems, Inc. and
chair, Department of Computer Science, Hunter College.......... 33
APPENDIX
Alphabetical Listing and Material Submitted
Bautz, William A.:
Statement.................................................... 22
Prepared statement........................................... 43
Beder, Tanya Styblo:
Statement.................................................... 30
Prepared statement........................................... 47
Bennett, Hon. Robert F.:
Opening statement............................................ 1
Prepared statement........................................... 50
Lindsey, Richard R.:
Statement.................................................... 12
Prepared statement........................................... 50
Miller, Peter A.:
Statement.................................................... 24
Prepared statement........................................... 60
Moynihan, Hon. Daniel Patrick: Opening statement................. 2
Patrikis, Ernest T.:
Statement.................................................... 8
Prepared statement........................................... 63
Rubin, Howard A.:
Statement.................................................... 33
Prepared statement........................................... 80
Westergaard, John:
Statement.................................................... 3
Prepared statement........................................... 84
Additional Material Submitted for the Record
Statement of Treasury Deputy Secretary Larry Summers............. 90
INTERNATIONAL BANKING & FINANCE: AN AMERICAN PERSPECTIVE
----------
MONDAY, JULY 6, 1998
U.S. Senate,
Special Committee On the Year 2000
Technology Problem,
New York, NY.
The committee met, pursuant to notice, at 10:10 a.m., in
the Ceremonial Chamber, U.S. Courthouse, 500 Pearl Street, New
York, NY, Hon. Robert F. Bennett (chairman of the committee),
presiding.
Present: Senators Bennett and Moynihan.
OPENING STATEMENT OF HON. ROBERT F. BENNETT, A U.S. SENATOR
FROM UTAH, CHAIRMAN, SPECIAL COMMITTEE ON THE YEAR 2000
TECHNOLOGY PROBLEM
Chairman Bennett. Good morning. Welcome to the second
hearing of the Senate Special Committee on the Year 2000
Technology Problem. I want to express particular thanks to
Senator Moynihan for inviting us to this hearing in this lovely
city on a lovely summer day, and these magnificent
surroundings. I appreciate Senator Moynihan's hospitality and
his leadership in putting together today's panel of witnesses.
As we have divided up the committee assignments, Senator
Moynihan has taken on the assignment of working on the
financial services industry, and we are very glad to have
someone with his background and expertise handling this
particular area.
As I flew here from Salt Lake City yesterday, I shared a
seat in the airplane with the head of one of Utah's principal
financial institutions. He was on his way to Istanbul where
they were looking at a joint venture activity, and in the
course of the conversation, the Year 2000 came up, it always
comes up in every conversation I have these days, it seems. He
said the obvious, but I think it's the theme for today's
hearing. He said, ``We know a great deal about the problem, and
what scares me to death is what we don't know about the problem
and where it can rise up to bite us.'' He said, ``We will be
ready in all the ways that we can, and we're still very much
concerned about having problems.''
I got involved in this issue about a year ago as chairman
of the Subcommittee on Financial Services and Technology in the
Senate Banking Committee, held the first hearing to talk about
the readiness of the banking community for the Year 2000 and
when I got through with the hearings, Senator Dodd, who had
stayed through the whole proceeding said to me, ``Mr. Chairman,
we need another hearing,'' and of course he was absolutely
right. We not only had other hearings, but we have a committee
created by the Senate to go beyond the jurisdiction of the
Banking Committee.
Out of that series of hearings in the Banking Committee, I
have come to the conclusion that financial services in the
United States are probably in pretty good shape, and that we
are looking at getting most of our problems under control. I
have also come to the conclusion that when you go beyond our
shores and talk about what might happen worldwide, it's time to
get very, very nervous, and so the witnesses that we have this
morning are going to tell us either that we're right in our
assumption that everything is OK, or will be OK in the United
States, or that we still have much to do, but I'm looking
forward to having them give us their assessment of what things
are going to be overseas and the interaction between the United
States and financial services abroad.
We have a panel of expert witnesses to help us consider
this issue, and we're grateful, as I say, to Senator Moynihan
for putting this panel together. Senator, thank you so much,
and we're glad to hear whatever comments you might have.
OPENING STATEMENT OF DANIEL PATRICK MOYNIHAN, A U.S. SENATOR
FROM NEW YORK
Senator Moynihan. I'm glad to welcome you to New York, to
our new Federal Courthouse here in Foley Square. It is an
attractive room and it has light, which is what we're going to
shed on this subject.
To say, sir, that my understanding of the matter is very
much yours, that our institutions domestically are going to be
probably all right, but their associated activities overseas
could bring them real problems. I know that Chairman Levitt of
the Securities and Exchange Commission feels that and of course
we're going to have Dr. Lindsey talking about that this
morning.
Just a quick background for me. I'm very pleased that our
first witness will be John Westergaard, who is an old and dear
friend, and who brought this to my attention and to the
attention of people who subscribe to his on-line services. I
had legislation in the last Congress and this year I have S.
22, legislation posing a National Commission on Y2K. We have a
National Commission finally in your person.
My question is, however, time is running very fast. We
don't have until the Year 2000. We have until sometime early
next year, because companies need to start testing soon. Our
witnesses can give us some sense of that moment in 1999,
because I think that would help us.
With that said, we'll get on with our hearing.
Chairman Bennett. Thank you. I will say that in that first
hearing to which I referred, we were told that if the banking
system did not have the Year 2000 conceptually solved and all
of the factions ready to go by September of 1998, it would be
too late. I asked why that's so, and they said because we're
going to have to have the ensuing year for testing purposes,
and we can really only test on weekends when we can shut the
system down and put the new software on the computer and that
gives us about 60 days worth of weekends, and 60 days is a
pretty scary, short period of time. So I say that in advance,
just in case there's any witness listening who is prepared to
contradict that or reaffirm that.
Senator Moynihan. Good benchmark.
Chairman Bennett. OK, thank you. Mr. Westergaard, if you
would come, please, we would be delighted to hear you, sir.
STATEMENT OF JOHN WESTERGAARD, EDITOR AND PUBLISHER,
WESTERGAARD ONLINE SERVICES, INC.
Mr. Westergaard. Thank you. Good morning. Can everybody
hear all right?
Chairman Bennett. Yes indeed. These speaking machines, as
Senator Thurmond refers to them, are much better than they are
at the Senate.
Mr. Westergaard. Thank you for inviting me here today. My
name is John Westergaard, I am founder, editor, and publisher
of Westergaard On Line Systems, a publisher of Internet
webzines, which is cybertalk for magazines on the Internet. We
also conduct investment conferences and have so for 21 years.
We publish Westergaard Year 2000, a daily webzine providing
information and analysis of the Year 2000 millennium bug, which
I will refer to here as simply Y2K. Westergaard Year 2000
publishes several dozen expert columnists who regularly
contribute commentary covering virtually all aspects of the Y2K
problem.
Westergaard Year 2000 is published as a not for profit
public service under the editorship of Adam Kaplan, who is
here, and his assistant editor, John Yellig, who is also here.
Its Internet address is www.y2ktimebomb.com. It receives
thousands of visitors daily from some 80 countries and is
recommended as a Y2K resource by the World Bank and Federal
Reserve, among others.
I understand of course that the focus of this hearing is to
be the international financial and economic aspects of the Y2K
problem. I'll get to that. But first allow me to state some
views with respect to the handling of Y2K compliance by the
Federal Government from a perspective of having observed the
issue develop at close hand for the past 2\1/2\ years.
I do so because the main point I hope to impress upon this
committee is the need for the President, the Department of
Defense, our United Nations representatives, and the Secretary
of the Treasury, among others, to exert leadership in alerting
the world to the Y2K problem and to provide technological
assistance in achieving date compliance. And I have to say the
evidence to date is not encouraging in that respect.
I fear historians will not treat the Clinton administration
well for its management of a crisis which promises to be the
defining event of the second term. Congress will fare better
thanks in main to Senators Bennett and Moynihan of this Special
Committee who have played early leadership roles in sponsoring
Y2K awareness, and to Congresspersons Steve Horn and Carolyn
Maloney for the excellent hearings of their Committee on
Government Reform and Oversight.
On the executive side, and again we follow this very
closely on a day-to-day basis, the agencies testifying
immediately following me here today, the Federal Reserve, and
the SEC, have been well ahead of the curve on this issue. The
General Accounting Office, GAO, has done outstanding work.
The Office of Management and Budget, on the other hand,
appears to have focused on papering the problem over and has
hampered Y2K remediation programs at the State level by
projecting absurdly low Federal estimates of remediation costs.
This has caused supplemental budget requests of State officials
to appear high in contrast, invoking thus the skepticism of
State legislators.
The most egregious Y2K compliance offender, considering the
strategic importance of its mission and the vast resources and
planning abilities available to it, has been the Department of
Defense. As recently as last week, the GAO issued a report
sharply critical of the Navy's compliance status. The Army and
the Air Force are also in serious trouble over Y2K. As for the
media, with the exception of the Washington Post, USA Today,
and the Financial Times of London, the general press here and
abroad has failed miserably in addressing the crisis. As
recently as November, for example, the Los Angeles Times was
calling Y2K basically a hoax, ironically at the very time, this
was the lead front page, right-hand column story, ironically at
the very same time that their internal operations people were
struggling over allocating resources to meet compliance
deadlines.
The Wall Street Journal's coverage has been abysmal. I was
told last year by a Journal reporter that his editors weren't
interested in the Y2K story because it had already been told.
That's the equivalent of reporting the attack on Pearl Harbor
on Monday morning, December 8, 1941 and then advising readers
the next day, oh, that story? We told you yesterday there's a
war on.
Y2K may not be a war, but neither is it a one-day story. It
is an event that will encompass 6 years, by my count, from 1996
through 2002, and of course earlier, there will become cleanup
I'm sure later. Think of it as a plague, an electronic bubonic,
what I call it.
However extreme my comments may appear, let me assure the
committee that my view of the Y2K is not apocalyptic. There
will be a worldwide Y2K recession, but there have been
recessions in times past. The world has survived them and often
been the better for the experience. I am in fact a congenital
optimist and have great confidence as to the ability of the
U.S. Government, the business community and the financial
community to eventually work their way through Y2K.
I foresee a period encompassing the first 6 months of 2000
as being equivalent to the first half of 1942, Pearl Harbor to
the Battle of Midway, during which the U.S. mobilized for war.
Enormous positive energy and creativity was unleashed then and
I expect the same to happen this time.
I come here today not as a computer expert by any means,
but as an investment strategist who has a history of spotting
financial and economic trends early. That's not because I'm
smart. It's because I have published investment research on
emerging small companies for 40 years run by entrepreneurs
typically engaged in promoting new business opportunities. I
have thus tended to have an early look at new trends. It was
just such an entrepreneur seeking new research sponsorship and
capital, Bob Gruder of Alydaar Corporation, who introduced me
to Y2K in December, 1995. I immediately took the matter to my
friend of 40 years, Senator Pat Moynihan, who was incredulous
as was everyone then and as many still are, but in keeping with
his academic discipline, the Senator requested that a study be
prepared by the Congressional Research Service.
CRS reported back within a few months substantiating in
full the issues I had raised. As an aside, is it not curious
that the two legislators who were first to recognize and take
action on Y2K are former college professors; Senator Moynihan
and Congressman Horn? Perhaps we should be electing more
college professors to public office. Isn't it also curious that
others in Washington who have quickly grasped the Y2K issue
have backgrounds in business, to wit, Senator Bennett and SEC
Chairman Arthur Levitt? Perhaps we should be electing more
business people as well.
Senator Moynihan advised the President of Y2K by letter in
July, 1996 and recommended appointment of a Manhattan Project-
style Y2K Czar to direct Federal compliance. A perfunctory
response, at least I call it that, was received in November,
not directly from the President, but from Frank Raines at OMB.
The Senator then arranged a meeting with Secretary of the
Treasury Bob Rubin and Assistant Secretary Larry Summers on
December 14, 1996 in which I participated. Rubin and Summers
were generally aware of the problem. We learned that Treasury
was then budgeting circa $75 million for Y2K, I don't recall
the exact number. According to a recent report, the figure in
just 15 months has blossomed to $800 million. And that doesn't
include the agencies for which it is responsible.
The first public----
Chairman Bennett. If I can interrupt you, sir, I had dinner
with Secretary Rubin 2 months ago and he told me the number at
Treasury, not including the IRS, was $1.4 billion.
Mr. Westergaard. Not including IRS?
Chairman Bennett. Not including IRS, so it has gone up, as
you've indicated, very rapidly. Excuse me.
Mr. Westergaard. The first public acknowledgement of Y2K,
to my knowledge, by the White House occurred on August 15,
1997, a full year after the Moynihan letter, when the President
stated at a press conference that Americans need not worry
about the computer clock problem. The appointment of John
Koskinen as Federal Y2K Czar in February of this year was the
first sign that the White House is taking the Y2K matter
seriously, as far as I know.
Senator Moynihan and I met with Mr. Koskinen at the end of
March and I am pleased to say that he left me and I believe the
Senator with a comforting sense that an adult has been placed
in charge. I believe Mr. Koskinen occupies the fourth most
important position in America today after the President, Fed
Chairman Greenspan and Treasury Secretary Rubin.
So what should the Senate be looking at and thinking about
in respect to the Y2K problem as it relates to international
economic and financial considerations? I will make a few
predictions employing inferential analysis to create three
``what if'' scenarios. Given the speculative nature of
Westergaard scenarios, they are as often wrong as they are
right, but you can be sure they are never in doubt.
Scenario No. 1: Does Y2K reflect God's will? At year 1000,
Europe was engulfed with random violence and fear that the
world would end. Out of this chaos emerged a new social order
as Christianity spread through Northern Europe. Russia
converted in 988, followed by Poland, Norway, Iceland and
Greenland in 999-1000. By way of background, I refer the
committee to James Reston, Jr.'s recently published ``The Last
Apocalypse: Europe at the year 1000 A.D.''
Saddam Hussein will interpret Y2K as retribution from an
Almighty aimed at punishing technological infidels. He will
interpret it as a call to attack Kuwait and Saudi Arabia. He
will assume, with good reason, that Y2K will leave the U.S.
military incapable of mounting a large scale military response.
The financial and economic impact of a move south by Saddam
in the beginning of the Year 2000 will be chaos in the world
petroleum market, sharply higher oil prices, inflationary
pressures and consequent strains on international banking and
industrial systems of unpredictable magnitude.
My recommendation: The Department of Defense should be
directed to prioritize Y2K compliance to mission critical
systems needed to meet another Saddam challenge. It will be
prudent to move troops into the region in late 1999 to counter
the risk of continuing Y2K complications following the
millennium turn would render impossible a timely response to
Saddam.
Scenario No. 2: World recession 2000. To understand
business cycles, consider traffic backing up 20 miles on the
New York State Thruway as drivers rubberneck even the most
minor accidents. That is analogous to what will happen to the
world economy in 2000. It will back up as transactions of every
type, shipments of goods, travel, communications, payments, you
name it, will slow down, even if only fractionally. It is
improbable that a worldwide recession can be avoided under such
circumstances. The question isn't will there be a recession, it
is how bad will it be?
Recommendation: For example, a slowdown in health care
reimbursement systems worldwide will leave hospitals and other
caregivers short of cash to pay employees, of which there are
some 10 million in the United States alone. Emergency funding
will be required to provide systemic liquidity. Appropriate
legislation needs to be prepared now for introduction in 1999
in the United States and worldwide to provide emergency
liquidity to the health care system. The United States with the
world's most advanced and respected health care systems should
exercise leadership in alerting health care officials worldwide
to the risk of slow payments and to potential Y2K-related risks
in the application of medical devices. Certain devices will be
non-functional due to non-compliant software and non-functional
chips.
Upcoming confirmation hearings of Richard Holbrook to the
post of U.N. ambassador will provide the Senate with a forum
for recommending that an active role be taken by the U.S.
delegation and alerting member states, the World Health
Organization and other U.N. agencies to the Y2K issues. I have
no idea how active and how knowledgeable or not the United
Nations organization is on this issue, but I think some focus
in that area is appropriate.
Chairman Bennett. I'm just pointing out the red light is
on.
Mr. Westergaard. Am I running too long?
Chairman Bennett. If you're ready to sum up.
Mr. Westergaard. One more page.
Scenario No. 3: Brownouts and blackouts. There will be spot
shortages of worldwide electrical power. Nuclear generating
plants will be shut down to allay public fears of meltdowns.
The French economy with its proportionately large 40 percent
reliance on nuclear power will be hard hit.
Recommendations: Conventional power generating plants are
less computerized than one might suspect, but there will be
minimum brownouts in the United States and worldwide in 2000.
The nuclear issue will be resolved by shutting down nuclear
plants over millennium weekend and bringing them back on stream
one by one to assure the public that plants are safe. The
Department of Energy needs to take a leadership role in
promoting Y2K awareness of energy related Y2K issues
domestically and abroad.
Just in closing, these scenarios represent no more than a
passing insight into the Y2K problem. I have not touched on
Japan, the second largest economy, which remains in abject
denial over Y2K, nor China with the largest population. China,
on the one hand, benefits from a proportionately low level of
computer dependency, but suffers from employing large amounts
of pirated software, leaving it without access to vendor
assistance for remediating code.
I could go on for the rest of the morning. More than a
thousand pages of information, research, analysis and
commentary covering every aspect of the Y2K problem can be
found at our webzine, Westergaard Year 2000
www.y2ktimebomb.com. I trust the committee and its staff will
employ this resource, register for our free daily E-mail alert
service and feel free to contact me and the editors via E-mail
or phone any hour, any day, anywhere.
[The prepared statement of Mr. Westergaard can be found in
the appendix.]
Chairman Bennett. Thank you very much. I assure you, we are
in touch with your web site. The staff checks there on a daily
basis.
I have one comment on your very excellent presentation. I
have visited two nuclear plants here in the United States,
because I have the same concern that you do, and I've come to
the conclusion that conventional wisdom to the contrary, the
nuclear plants probably present less of a Y2K problem than the
other plants. The reason being, No. 1, they are the most
heavily regulated of all of the power producing plants in the
United States, and therefore felt the pressure from not the
Department of Energy, but from the Federal Regulatory
Commission and the Nuclear Regulatory Commission, who have
inspectors in their plants all the time. So in that sense
they're a little bit analogous to the banks that are under
pressure from the Fed and the FDIC, and they have perhaps a
better handle on the Y2K issue than some of the other
utilities.
Second, perhaps because of their sense of perceived or real
persecution in the energy-generating business, they formed
something of a club. The nukes talk to each other, and share
information. They recognize they have a public perception
problem, everyone is concerned the nuclear energy system is
going to melt down to China, and so they work harder at
redundancy and safety, and they talk to each other for that
public relations purpose and as a result there's been a better
exchange of information between nuclear power generators in
this country than there has been from some of the others. So I
came away from that experience saying the nuclear power plants
are in better shape than I thought they were, and that the
problem of brownouts and blackouts, which I think is a very
real possibility, will come in large part, from other sources
on the power grid.
Mr. Westergaard. I agree with everything you're saying. I'm
just suggesting that the public, there will be a public clamor
to shut down nuclear energy for some period of time, that there
will be enough scare stories out there that the nuclear power
plants will probably be wise to shut down.
Chairman Bennett. OK, I get that distinction. Senator
Moynihan?
Senator Moynihan. No, that's interesting and reassuring.
It's not the worst thing to have some reassuring news. Thank
you, Mr. Westergaard, thank you, John.
Chairman Bennett. Thank you very much, sir. We appreciate
it.
All right, we are now at 10:30. We have three additional
panels. Senator Moynihan suggests, and I concur, that we allow
each of the additional panels a half hour. We have two
witnesses per panel, so that would mean perhaps 10 minutes, 12
minutes for opening statements and then some time for questions
and discussion afterwards.
So first, we have Ernest Patrikis, first vice president of
the Federal Reserve Bank of New York and Dr. Richard Lindsey,
director of the Division of Market Regulation at the U.S.
Securities and Exchange Commission. Gentlemen, we are grateful
to have you both here and appreciate your willingness to give
us your insights. Mr. Patrikis, we'll go with you first.
STATEMENT OF ERNEST T. PATRIKIS, FIRST VICE PRESIDENT, FEDERAL
RESERVE BANK OF NEW YORK
Mr. Patrikis. Thank you. Good morning, I'm pleased to be
here before the committee today to discuss the progress of
foreign financial markets in addressing the Year 2000
technology problem. I'm appearing in my capacity as chairman of
the Joint Year 2000 Council, which is sponsored jointly by the
Basle Committee on Banking Supervision, the G-10 Central Bank
Governors' Committee on Payment and Settlement Systems, the
International Association of Insurance Supervisors and the
International Organization of Securities Commissions, which I
will refer to as the sponsoring organizations.
This morning I'll summarize the information provided in my
submission to the committee.
Who is at risk from the Year 2000 bug? All organizations
that are dependent on computer software or embedded computer
chips are at risk. I believe this definition encompasses all
significant financial institutions and markets worldwide. All
countries of the world, therefore, have a Year 2000 problem.
That must be the starting point for any discussion of the
global scope of the problem. No countries have the same Year
2000 problem. For example, the United States is one of the
world's biggest and long-standing users of computers. Our Year
2000 problem is, therefore, larger than almost anyone else's.
It is a very positive development that so much good work is
being done in the United States, especially within the banking
and financial sectors. Should we be concerned, however, about
the readiness of other foreign financial markets?
Could a lack of preparations of foreign jurisdictions have
an impact on the financial institutions of the United States?
Inevitably, the answer is yes, although the extent of that
impact is difficult to assess at this time with any degree of
confidence. To provide a context for understanding these
issues, I'd like to briefly discuss some key linkages that
exist within the systems that are used by financial market
participants to undertake their transactions. As an example,
consider the daily financial market activities of a
hypothetical U.S. based mutual fund holding stocks and bonds in
a number of foreign jurisdictions. Such a mutual fund would
likely execute trades in relationship with a set of securities
dealers, who themselves might make use of other securities
programs, including some inside the United States. In addition,
securities trading in most countries is reliant on the proper
functioning of the respective exchanges, trading systems and
financial information systems, as well as the national
telecommunications infrastructure on which these systems
depend.
For record keeping and settlement purposes, our
hypothetical mutual fund would also likely maintain
relationships with one or more global custodians who themselves
typically maintain relationships with a network of
subcustodians located in various domestic markets around the
world. Actual settlement of securities transactions would
typically occur over the books of a domestic securities
depository. Payment for foreign exchange transactions on behalf
of the mutual fund would involve use of correspondent banks for
both the U.S. dollar and other currencies.
These transactions would typically settle over the books of
domestic wholesale systems, such as the Clearing House
Interbank Payments System, CHIPS, or Fedwire in the United
States and the new TARGET system for the euro. Correspondent
banks also heavily depend on the use of cross-border payments
messaging through the network maintained by the Society for
Worldwide Interbank Financial Telecommunications, SWIFT, to
advise and confirm payments.
To provide some sense of the magnitudes involved here,
consider that the Fedwire and CHIPS systems process a combined
$3 trillion in funds on an average day, split roughly in half
between the two systems. While SWIFT itself does not transfer
funds, its messaging network carries over 3 million messages
per day relating to financial transactions worldwide.
I would not like to debate Senator Bennett on this issue,
but rather embellish it. In Fedwire, depository institutions
can test the Year 2000 issue with us every day. There's a
separate computer set aside for us, and weekends are designated
test dates which can also be coordinated test dates. We're
trying for a worldwide coordinated test using SWIFT, Fedwire,
CHIPS, DTC, so I would differentiate today between a specific
day set aside for specific testing, and generally available
testing every day of the week, which we encourage institutions
to do sooner rather than later.
The many interconnections of the global financial
infrastructure imply that financial market participants in the
United States could be affected by Year 2000 disruptions in
other financial markets. In assessing the scope of any such
potential problems we should be realistic in accepting that
some disruptions are inevitable. The problem simply affects too
many organizations and too many systems to expect 100 percent
readiness will be achieved throughout the world. Today it would
be impossible to predict the precise nature of these
disruptions. However, we do know that financial markets have in
the past survived many other serious disruptions, including
blackouts, snowstorms, ice storms, and floods.
Can financial markets supervisors and regulators help? Yes,
but there are limits on what we can accomplish either
individually or collectively. Only firms themselves have the
ability to address the Year 2000 problems that exist within
their own organizations. Only firms working together can assure
that local markets will function normally. Supervisors and
regulators cannot guarantee that disruptions will not occur.
What can supervisors do? At the international level, each
of the major financial supervisory organizations developed
action plans during 1997 for their respective areas of
interest; banking, payments and settlements, securities,
insurance. Yet when these organizations co-sponsored a Global
Conference on the Year 2000 Problem this April in Basle, they
realized it made sense to combine forces and coordinate their
activities to ensure their messages were getting through loud
and clear throughout the world. It was at this point that the
Joint Year 2000 Council was formed. The Council consists of
senior members of the four sponsoring organizations. Every
continent is represented by at least one member of the Council.
The Secretariat of the Council is employed by the Bank for
International Settlements.
The mission of the Joint Year 2000 Council has four parts:
First, to insure high level attention to the Year 2000 computer
challenge within the global financial supervisory field.
Second, to share information on regulatory and supervisory
strategies and approaches. Third, to discuss possible
contingency measures, and fourth, to serve as a point of
contact with national, international, and private sector
initiatives.
The G-7 finance ministers have recently called on the Joint
Council and its sponsoring organizations to monitor the Year
2000 related work in the financial industry worldwide, and to
take all possible steps to encourage readiness. The Council has
met twice since being formed in early April and plans to meet
frequently, almost monthly, between now and January 2000.
We have also formed and met with a consultative committee
intended to enhance the degree of Year 2000 information sharing
between the public and private sectors. While the Joint Year
2000 Council will not be in a position to ensure Year 2000
readiness in every financial market worldwide, I believe we
will play a positive role in three areas: Raising awareness,
improving preparedness, and contingency planning. To help raise
awareness of the Year 2000 efforts underway globally, we will
maintain an extensive worldwide web site, including a web page
for each country in the world where Year 2000 activities and
contacts for that country will be available. The presence of
these country pages is intended to assert peer pressure on
those countries where more vigorous action is needed.
The Joint Council will be taking initiatives to improve
preparedness, and providing support for the concept of a
national level coordinating body for the Year 2000 problem. The
Joint Council plans to issue a paper within the month aimed at
improving supervision and readiness worldwide from a level of
general awareness to a specific concrete program of action
overseeing Year 2000 preparedness. We will develop a Y2K self
assessment tool to be used broadly by the financial industry in
every country.
While there is still not enough information on the
preparedness of financial institutions to be able to make
confident statements about the state of global preparations in
any detail, we hope to be able to use the Joint Council as a
means of gathering a better picture of the state of local
preparations and help to direct resources and attention to
those regions where more efforts are needed. In these instances
our first step would be to work through the relevant financial
supervisors and regulators and to also involve multilateral
institutions, such as the World Bank, to help increase national
attention on the issue. I note that the government of the
United Kingdom has given 10 million pounds to the World Bank to
help fund these efforts.
The Joint Council will also encourage all firms and
institutions active in the financial markets to engage in
internal and external Year 2000 testing. Testing is the most
critical element of serious Year 2000 preparations. We will
build on existing efforts to develop and publicize information
regarding testing of major payment and settlement systems
around the world. We will collect information regarding
industry wide tests of all aspects of the trading and
settlement infrastructure worldwide and we'll use this as an
exercise in peer pressure. It will be clear which countries do
not respond to our requests for information on their testing
programs. The Joint Council will also develop a series of
documents to help countries set up testing programs as rapidly
as possible.
The third major role of the Council will relate to
contingency planning. We will develop a paper on this topic for
the benefit of the global financial supervisory community. This
paper will seek to address firm level contingencies as well as
issues of market-wide contingencies. Contingency planning
involves a series of elements, many of which must be put into
place well before January, 2000. For example, we must consider
the many possible sources of disruption and determine what
approaches would be available to limit their impact. The sooner
such thinking occurs, the more opportunity we have to plan
around the possible disruptions. Of course, we will not be able
to predict each source of disruption, but our work in this area
should help us deal better with disruptions.
Much more work is needed on contingency planning for the
Year 2000, especially at the international level. Once we get
beyond the early fall of this year, I believe these efforts
will begin to receive much greater focus and attention, and
will dominate our discussions of the Year 2000 in 1999.
In closing, I would like to thank the committee for the
opportunity to appear and submit a statement on this issue. I
hope the efforts of the Joint Council will help make a
difference in the state of Year 2000 preparations of the
international financial community. Realistically, however, I
believe that it is important to realize our concern must be
with the system as a whole. At this point, I believe we are
doing everything possible to limit the possibility that Year
2000 disruptions will have systemic disruptions in our markets.
But we must work cooperatively in the time that remains to
insure that this threat does not become more concrete.
And, Mr. Chairman, I would like to end my remarks by
commending the committee for organizing these hearings on
foreign international markets in addressing the Year 2000
technology problem. Thank you very much.
[The prepared statement of Mr. Patrikis can be found in the
appendix.]
Chairman Bennett. Thank you very much.
Dr. Lindsey.
STATEMENT OF RICHARD R. LINDSEY, DIRECTOR OF DIVISION OF MARKET
REGULATION, U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Lindsey. Good morning, Senator Bennett, Moynihan. I
appreciate the opportunity to testify today on behalf of the
Securities and Exchange Commission about the steps it has taken
to ensure Year 2000 compliance in the securities industry and
publicly held companies. The Commission has prepared a written
statement and I ask that it be included in the record of these
hearings.
Chairman Bennett. Without objection.
Mr. Lindsey. It has become clear that most of the world's
computer systems need to be modified before January 1, 2000. In
the U.S. securities industry, the scope of the Year 2000
challenge is magnified by several factors: The industry is
enormous. There are over 8,300 registered broker dealers, 1,100
investment company complexes, 1,248 transfer agents and 24
self-regulatory organizations, including the Exchanges, NASD,
and clearing agencies.
Second, the industry relies heavily on information
processing technology and finally, industry participants are
highly interconnected, both within the United States and
globally.
For these reasons, the commission views the Y2K problem as
extremely serious and one that requires an industry-wide
solution. If the securities industry fails to properly assess
the extent of the Y2K problem, or fails to remediate systems
that are not compliant, there is a potential to endanger the
nation's capital markets and the safety of the assets of
millions of investors. Nevertheless, based on the information
we have received so far, the SEC believes that the securities
industry is making substantial progress towards addressing
systemic risks to the U.S. financial system as a result of the
Y2K technology challenge.
We've stressed to the securities industry how important it
is to be compliant on time and that we will have zero tolerance
for those entities that do not exert the necessary effort. In
the securities industry, just like any other business, the
compliance process has five phases; awareness, assessment,
remediation, testing and contingency planning. Let me briefly
mention the commission's efforts in each of these areas.
Throughout 1996 and early 1997, we focused on raising the
awareness of the Y2K problem in the securities industry and the
need to fix it. Through our efforts, combined with those of the
SRO's and the Securities Industry Association, extraordinary
steps were taken to alert the securities industry to both the
scope and the nature of the problem. During the past year, the
commission shifted its focus from educating members of the
industry to monitoring and encouraging their progress in
solving the problem. We monitor their progress through direct
oversight and examinations, as well as through collaboration
with self-regulatory organizations and industry groups.
The commission set 1997 as the target date for the
remediation phase to be done. Testing is the next hurdle in the
schedule and is to begin this month. The securities industry is
based on an extraordinary interdependence of a great number of
participants--broker dealers, exchanges, depositories, transfer
agents, banks and suppliers of market information, among
others, must all exchange, process, balance, confirm and settle
millions of transactions every trading day. The interdependence
among participants in the securities industry means that
coordinated industry-wide testing is essential. In recognition
of this, the SIA undertook to construct an unparalleled
industry-wide testing program. Testing will not only tell us
how well the industry is prepared for the Year 2000, but also
help identify trouble spots for developing contingency plans.
Finally, there is contingency planning. No matter how much
progress the industry makes in addressing the Y2K issue, it is
virtually certain that some problems will not be discovered or
will not be remediated in time. Consequently it's imperative
that well defined contingency plans be formed to minimize the
disruptive effect of these failures. Industry-wide efforts for
contingency planning are being coordinated through a
Contingency Planning Working Group, which is jointly sponsored
by the Federal Reserve Bank of New York, the SIA, and the New
York Clearing House. The working group was formed to share
information on the industry's Y2K compliance efforts and to
address potential systemic implications.
Let me now move to the current status of the various
participants in the securities markets. Because they play a key
role in both operating the nation's securities markets and in
overseeing the companies and individuals who participate in
those markets, the SRO's readiness for Year 2000 is
particularly critical. The SRO's, which include the exchanges,
clearing agencies, and the NASD have completed the awareness
and assessment phases of the Y2K process. They are all far
enough along in the remediation process to begin the first
phase industry testing next week.
Broker dealers are the primary intermediaries between
investors and the securities markets. For that reason, we have
made it very clear to broker dealers that Y2K failures will
have severe consequences. Any broker dealer that cannot
maintain accurate books and records or cannot determine its net
capital requirements because of a Y2K failure, could be subject
to closure and the transfer of its customer accounts to another
broker dealer. Under the U.S. system of self-regulation, the
primary oversight responsible for broker dealers resides with
SRO's. To monitor broker dealer compliance efforts, the SEC has
worked closely with the NASD, the NYSE and the SIA. Data
obtained by the NASD and NYSE show that broker dealers have
made significant but uneven progress. Current data suggests
that slower progress has been made by some smaller firms. Going
forward, the SEC and NASD staff will closely monitor the firms
that appear to be lagging behind in their Y2K compliance
efforts.
The commission staff is also engaged in ongoing efforts to
evaluate the Y2K readiness of investment advisers and mutual
funds. These efforts include on-site Y2K examinations and
coordination with industry groups, such as the Investment
Company Institute. Similarly, commission staff has examined
non-bank transfer agents for Y2K compliance. The commission
believes investment advisers, investment companies, and
transfer agents have made progress toward its Y2K goals, but
significant work remains to be done.
The adequacy of Y2K disclosure by public companies is
another area of concern for the commission. Our regulatory
framework requires public companies to disclose material
information about themselves to the public. It is only through
disclosure that investors are able to make informed investment
decisions. Last year the commission staff issued a legal
bulletin to remind public companies that the disclosure
requirements under the Federal securities laws applies to the
Y2K issue, and in January, the staff updated that bulletin to
provide even more guidance. In addition, the commission has
said that it intends to publish an interpretive release that
sets forth its views regarding the application of SEC
disclosure requirements to the Year 2000 issues. Chairman
Levitt also plans to mail a letter to the chief executive
officer of public companies reminding them of Y2K issues and of
their disclosure obligations.
The globalization of the securities industry underlies
perhaps the most difficult Year 2000 challenge. International
efforts are a significant area of concern for the SEC. The work
that remains to be done in South America, Africa, Asia, the
eastern block countries, and certain European countries is
enormous. Nevertheless, the SEC is doing what it can. Our
primary means of encouraging other countries and foreign
regulators to deal with the Year 2000 problem is through the
SEC's membership in the International Organization of
Securities Commissions or IOSCO.
Other international groups are also working on resolving
the Y2K problem, including the BASLE Committee on Banking
Supervision. In addition, internationally there is a forum, the
Joint Year 2000 Council of which my co-panelist Ernest Patrikis
is Chairman. The Joint Council has undertaken to serve as an
information clearinghouse on Year 2000 issues, and to serve as
a locus for international coordination of Year 2000 testing
programs and contingency efforts. In addition, a number of
banks and investment firms have formed The Global Year 2000
Coordinating Group.
Despite the efforts underway by global organizations,
international Y2K efforts remain an area of significant
concern. Risks from Y2K non-compliance abroad must be a major
focus of contingency planning for U.S. firms.
In closing, the commission, the SRO's, the industry
organizations, and other market participants are devoting
extraordinary time and resources to assessing and repairing our
computer systems so they're prepared for the century date
change. We are optimistic that if we continue emphasis on
achieving domestic Y2K compliance and where we can help,
international compliance, the securities markets will be
prepared for the Year 2000.
[The prepared statement of Mr. Lindsey can be found in the
appendix.]
Chairman Bennett. Thank you very much. Mr. Patrikis, I
would appreciate if you would comment on the impact of the euro
on this issue. As a layman and a businessman, it's my
understanding that the decisions are made separately by
different bodies. Nonetheless, the decision to implement the
euro in 1999 coming on the heels of the challenge of the Y2K
problem in 1999 in the Year 2000 put an enormous, if not
unbearable strain on the IT capacity of the various firms,
particularly those involved in currency trading.
If I were running a business and people had come to me and
said, No. 1, we need to make a change as substantial as the
euro change and No. 2, it's coming on the heels of pressure
from outside the company, I would say let's postpone the euro
change until the other one has been absorbed and when I made
that suggestion, people above my pay grade, they said, oh, it's
far too late, you can't possibly do that.
Senator Moynihan. Mr. Chairman, may I ask a question?
Chairman Bennett. Sure.
Senator Moynihan. Who could possibly be above the pay grade
of a U.S. Senator?
Chairman Bennett. Well, in the international arena I'm sure
there are some.
I still have a great sense of foreboding that the
preoccupation with getting everybody's computer changed to
being able to do currency trading in euro futures, I understand
the euro itself will not start circulating in 1999, but trading
in euro futures in some cases has already begun, and certainly
will be formally under way in January of 1999.
Is this in fact a contributory problem, or as someone
suggested to me, is it a serendipitous event, where people, as
long as they're working on the computer, changing it to deal
with the euro will while they're there deal with the Year 2000
problem? What concerns should we have by virtue of the
convergence of these two events?
Mr. Patrikis. Let me see if it's possible to agree with
everything you've said.
Chairman Bennett. You're beginning to sound like you're
running for the Senate yourself.
Mr. Patrikis. Yes, I think there is some concern that there
aren't enough people with the technical skills to do all the
Year 2000 work period, today, even if there were no other
changes, so I think what we're going to see in the United
States, I know we're going to see it for Fedwire--we're making
no major changes in 1999. I'm hoping that supervisors and
regulators don't make rule changes in 1999, that we don't
change reports that have to be submitted electronically. We
want to take the burden off people to make changes in 1999.
As to the euro, it's not just a European problem. Our
investment banks, of which all the major players are in Europe,
are also going through the process of changing for the euro.
It's not that hard a change compared to the Year 2000 change,
but a lot of systems have to change. There is a question of
whether firms are able at the same time they're making changes
in their systems for the euro to be able to make changes for
the Year 2000. Some of that can be done, but overall the
concern is that yes, many European firms would be better off if
they didn't have the euro coming and they would be able to
devote more resources to Year 2000.
But we'll also have January 4, 1999 as a mini experiment to
help us look forward to January 3, Year 2000 in terms of what
problems will surface. How is the market able to cope with
those problems, how well is the contingency plan being done for
the euro if things don't work out right? So even if there's
something a little negative there, we should be able to turn
that into a positive.
But I think overall the constraints of having enough
qualified people is a worldwide problem. Speaking of Mr.
Guzman, who is the Superintendent of Supervisory Institutions
in Chile, his concern in Chile is do we have enough people with
the skills to be able to make the changes. Are the firms in
those countries competing for staff members? To be a youngster
with the skills for systems to make these changes is to really
write your own ticket, so that's the major problem, only
exacerbated a bit by the euro.
Chairman Bennett. I'm going to ask you an unfair question,
but we get asked unfair questions all the time.
My sense of things is that there are only five countries
with a really high level of awareness and effort going on with
respect to the Year 2000. I list them in no particular order.
United States, Canada, United Kingdom--now with the involvement
of Tony Blair--Australia, and the Netherlands.
Here's the unfair question: Would you put Japan into a
ranking somewhere? This is the key economy in Asia, this is the
economy that's now in difficulty in Asia and we're all worried
about the Asia flu generally, but if Japan catches the Asian
flu, we are in real difficulty. If Japan has a major Y2K
problem, the earlier witness said they're in denial on Y2K, I'd
like you to comment on Japan.
Mr. Patrikis. I can't answer the question in terms of
giving you a precise statement as to the status of
preparations. We do have a member of the Ministry of Finance on
our Council. He's assured us that Japan is working on it, that
the various official organizations are working on it. The
Global 2000 Coordinating Group recently held a meeting in Hong
Kong, with many there from Japan. I think I got, at least from
the telephone conversation I had with people who attended that
meeting, the view that they are working on it, perhaps not the
same way we are. There's a question of whether their approach
to resolving the problem is different than ours. The one thing
I would totally discard is the thought that well, since we use
a year system that's based by the year the Emperor has been in
power, that we don't have the same problem as everyone else,
that this is the X year of the Chrysanthemum dynasty. That's
hogwash. They have the same problem we do. But the sense of the
matter is they are working on it, but I couldn't say they're at
a level that we are, but I can't say that anyone is at the
level that we are.
Chairman Bennett. Do you have any country you might
nominate for the list I've just given you?
Mr. Patrikis. Well, you know, just throwing something out
offhand, one member of our Council is from Saudi Arabia. He's
well aware of the problem, and what needs to be done. I said we
were going to have web pages for each country, those web pages
are going to have utilities, telecommunications. He said, well,
what about desalinization? So I think there are some countries
out there that have done an awful lot of work.
As I said in my statement, we're not able to ferret that
out now, but as we get people to submit information on our web
page, people will go to www.bis.org and hit the Joint Council
button. If there's no information on, say, an electric utility
in that country, you can assume there's a problem. If they're
not saying how they're doing the testing and the testing has
been completed, that's how we thought we would ferret it out,
make it available to everyone, put on some pressure.
We did it on the payments and settlement systems by having
each system put out on the page that we have at BIS how they're
doing on their testing schedule. That really would show how
well they're doing and if a major system were not on the page,
then we would encourage people to go to the system and say
you're not up on the page, you must be behind and put pressure
on them.
Chairman Bennett. One last question, then I'll turn to
Senator Moynihan. One of the things I'm trying to do in this
committee is to look horizontally, because virtually everybody
with respect to Y2K stovepipes his or her own organization or
country or industry. I would be concerned about the
telecommunications systems in some of the countries you're
looking at, and the dependence that your broker dealer would
have or your clearing house or your regulatory body might have,
if the phone system goes down, you could have all of the
computers just on, and the markets still fail to function. In
your attempt to get a handle on how stable the international
financial community is, do any of these organizations that you
have listed here, and it's a very impressive list, pay
attention to whether or not the power grid is going to fail or
the telecommunications. If you can't get a dial tone in
Singapore, for example, has anyone with respect to Y2K
challenges that you're aware of looked at those issues?
Mr. Patrikis. Well, first is SWIFT, which is a
communications system owned by commercial banks of the world
and SWIFT has linkages to all countries. Therefore, it's
dependent on the telecommunications of those countries. SWIFT
will be one source of information on how well firms are doing.
One of the problems has been--I'm an attorney--attorneys
advising clients about not disclosing too much, so that people
will not be able to come back and say, oh, you lied on your
statements. Even here in the United States early on there were
problems with the telecommunications carriers. They've become
far more forthright on the status of their remediation efforts
and testing, and we're seeing that now, but SWIFT will also
provide this information. Also the International
Telecommunications Union is a member of our Joint Council, and
the representative who attended the meeting said that it was
going to come out with a listing of how well its members are
doing around the world in terms of their efforts on remediation
and testing. So I think, yes, that that is the case and we all
know. Electric utilities, again on our web pages, we would list
telecommunications, electric utilities, because they are so
important. That's the lifeline of the banking system.
Chairman Bennett. Senator Moynihan.
Senator Moynihan. Thank you, Mr. Chairman. Just a comment
on your euro question. Tomorrow the Senate will take up the
conference report on the Internal Revenue Service Reform bill
and we'll be having about 4 hours of talks. The Finance
Committee has been holding these hearings, and we came up with
half dozen more things that we wanted to change in the IRS, and
Mr. Rossoti, the new Commissioner, wrote us a seven-page letter
saying, please, I'm happy to do any of those things, but I
can't do them until after the Year 2000 is taken care of. I've
got to do that first, and we sort of, we split the difference,
but we did recognize the problem. I think the euro question is
a real one, and I'm sure that Mr. Patrikis would not mind if we
suggested that you go back and talk with your colleagues. I
think there are some Europeans who would be happy to put it
off.
I'm impressed by the amount of organization you have, but
I--you know, time is running so fast. The Securities and
Exchange Commission sent letters saying if you mess up on this,
we'll just take your license away, is that basically what you
did?
Mr. Lindsey. That's basically correct.
Senator Moynihan. You can tell them, ``You're no longer a
broker.'' How do you feel about the response you're getting?
Mr. Lindsey. Well, I think the securities industry is
working very hard on it. We've also just last week adopted a
rule that we proposed earlier that requires reporting by broker
dealers.
Senator Moynihan. Requires reporting. Yes. I think the
chairman has been interested in this. What do you require?
Mr. Lindsey. It's a requirement for a management report
that both outlines what the progress is in terms of Year 2000
remediation, where they stand in terms of budgeting, where they
stand in terms of remediating----
Senator Moynihan. Is that to forearm, in effect?
Mr. Lindsey. There are two facets. It depends on which size
you are. If you have $100,000 in net capital, which is the way
we look at firms, there's a two part form. For smaller firms,
there's one form, where you go through and mark boxes that
indicate where you are in different stages of progress, so this
will be computerized.
As I already said, there are a large number of entities
that are involved in this. The second form requires a
management discussion in terms of where they stand in their
remediation, what they're doing.
Senator Moynihan. So you're trying to get the awareness and
one of the ways to get their attention on this is say, you
know, we're the ones who keep you in business, we can put you
out.
I have to say, Mr. Chairman, that the Chairman Levitt has
really been about the most proactive of our national officials
in this matter. He's been writing letters from 1996, was that
the first time?
Mr. Lindsey. The first letter went out in 1997.
Chairman Bennett. 1997. Well, that's a lot, that's ahead of
just about everybody else. You should be pretty proud of
yourselves. I hope you are, I hope it works out.
Mr. Lindsey. We're still trying to make sure we're ready.
Senator Moynihan. Can I just ask one last question? When do
you have the point of no return? That's not quite the right
image. When is it too late? If you haven't done it by then it's
too late, you'll never get it done.
Mr. Lindsey. Well, I think it depends on the type of broker
dealer or type of entity you are. So we care primarily about
are what are known as the clearing broker dealers. There are a
little over 300 clearing broker dealers. Those are the ones
that stand to clear and settle every transaction.
Senator Moynihan. The ones down here.
Mr. Lindsey. Many of the larger firms that you would know
of are clearing broker dealers. Most of them are well along the
remediation phase. What we would get from a report that we
would have both this year and in April of next year is a better
sense, a more precise sense of where they stand. If we are
looking at a clearing broker dealer that would not be ready
going into fourth quarter of 1999, then we would start to make
preparations for the relocation of accounts. But I would not
expect any broker dealer to be there.
Senator Moynihan. I've been looking at these very nice
tables that you have been showing us, the 100 percent complete
and then zero, and there are not many people who have got this
all done yet.
Mr. Lindsey. That's correct.
Senator Moynihan. And you think by the last quarter of
1999.
Mr. Lindsey. 1999. If you look at most of these entities,
most of these entities are targeted to be completed towards the
last quarter of 1998.
Senator Moynihan. I said 1999. You said 1998.
Mr. Lindsey. I said if they were not ready going into the
last quarter of 1999, then we would start to look to relocate
customer accounts.
Senator Moynihan. So the last quarter of this year is when
this has to be done or in your judgment those people that are
not compliant shouldn't be----
Mr. Lindsey. No, that's not what I'm saying.
Senator Moynihan. Don't let me tell you what you're saying.
Mr. Lindsey. What I'm saying is last quarter of 1998 is
when those entities are targeted to be done. There will be
testing going on through 1999. We fully expect, one of the
basic reasons for the test is to find out where things go wrong
and people will have to go back and do some additional
remediation and testing.
Senator Moynihan. But they'll have time and space to do it?
Mr. Lindsey. That's correct. If we start to move into the
last quarter of 1999 and if there are firms that are not ready,
we will have been making plans to start to move those accounts
outside.
Senator Moynihan. One last question, if I can. Just help
me. To move those accounts, tell a layman what you mean by
that?
Mr. Lindsey. We find a broker dealer that is Year 2000
ready, that has the ability to handle the accounts, and we have
the customer funds transferred to those firms.
Senator Moynihan. Thank you. Very impressive.
Chairman Bennett. Thank you. I agree with Senator
Moynihan's comment about Chairman Levitt, but I'm afraid I am
going to prod you a little in another area.
I introduced legislation that would require any publicly
held firm to disclose where it was with respect to Y2K, are you
familiar with that? You made reference to it in your testimony.
Chairman Levitt came to me early this year and asked me not to
push my legislation, he said, frankly, it would take too long
and he makes a very valid point. By the time legislation goes
through the Congress and the appropriate commenting periods and
so on, we would run out of time. He said we can take care of
the regulation. You've referred to the efforts the SEC has
made.
We held a hearing in the subcommittee of the Banking
Committee and found that the response to those efforts has been
abysmal. We were then told that the SEC, as you referred to
again in your testimony, was going to give an interpretive
release that would raise the temperature a little and cause
some more responsible reaction on the part of publicly owned
companies. My question is where are we on that timetable? That
was 5 weeks ago that we held those hearings and those promises
were made. You've repeated the promises here today. Can you get
a little more specific rather than assume?
Mr. Lindsey. My understanding--well, I can never commit to
a particular date from the commission, but my understanding was
that Commissioner Unger testified that we could do it in
approximately 2 months. I believe that that timeframe is still
accurate.
Chairman Bennett. What about Chairman Levitt's letter to
the CEO's? That doesn't take 2 months to put together.
Mr. Lindsey. No, I think they're drafting that letter
today.
Chairman Bennett. OK. What about multinational companies
whose stocks are held by American pensioners? I focused on that
legislation, too. People who put their money into a teachers
pension union, think it's all going to be in AT&T and DuPont or
General Motors, don't think in terms of the international
impact on these multinational companies that still have the
stereotype of a blue chip stock to retire in America. What kind
of reporting will be required? We've talked about that, I'm
giving you an opportunity to just further----
Mr. Lindsey. I think there are probably three possibilities
that we're talking about here. One is the U.S. company that
does multinational business, and of course they would have the
same reporting requirement as any other U.S. company, regarding
their Y2K issues.
Chairman Bennett. I'm thinking more in terms of holding
foreign stocks, traded in foreign exchanges.
Mr. Lindsey. The second category, which again is not what
you're talking about, is the fact that there can be foreign
companies that are trading in the United States. If those are
registered companies, they would again have the same types of
reporting requirements that U.S. companies do, so those
requirements apply to anything that's registered, regardless of
where it's domiciled.
The third has to do with investments in foreign companies
by either pension plans, mutual funds, et cetera. The mutual
fund advisers of course have responsibility for being aware of
investments and making disclosures associated with that in the
prospectuses that the mutual funds put out.
Chairman Bennett. Let me come back to one last question,
then we will move on and thank the panel.
I focused on Japan. Let me ask another country-specific
question, Mr. Patrikis. Russia has serious problems. One of the
senior nuclear scientists in the former Soviet Union said we
will solve the Year 2000 problem by waiting until 2000 and then
when the hits come, we will know where the remediation will be
required. Is there any other country on your scope that has
that kind of a view where there's a substantial American
investment? I hope we can talk the Russians out of that
particular notion, but is there any country that particularly
concerns you, instead of playing guess what the teacher wants,
and have me prompt you in one country or another, I give you
carte blanche. Is there a country where there are American
investments where you have a primary concern?
Mr. Patrikis. Well, I was troubled by that quote when I
read it, too, in the papers. All I would say is just imagine
being a commercial banker or investment banker in Southeast
Asia going through the financial crisis today. Regarding Year
2000, you have top priority in view of the depreciation of the
currency, do you have enough money to do what you need to do,
to first even see what you need to do? I think the
organizations, the IMF and the World Bank have a great role to
play here. The Bank for International Settlements is also
playing that role.
The World Bank is developing a tool kit that can be used by
organizations, both the supervisors and the official side, so
firms will be able to come along. I would say in that part of
the world they probably need all the help they can get and the
financial assistance they can get from the international
organizations to move it along. I mean, they're just worried
day-to-day, how can we keep it together, keep our markets
moving efficiently, so if there would be more help from that
front coming from those organizations. And they are actively
involved. I was impressed with the program the World Bank is
developing. I think we'll find that very helpful.
Chairman Bennett. Thank you very much.
Senator Moynihan. Could I say something? I was impressed to
learn that the British have given 10 million pounds to the
World Bank. We haven't done anything like that.
Mr. Patrikis. Correct.
Senator Moynihan. We have not.
Mr. Patrikis. No.
Chairman Bennett. Well, thank you very much. We appreciate
your presentation.
Chairman Bennett. The next panel, William A. Bautz, senior
vice president and the chief technology officer of the New York
Stock Exchange and Peter Miller, chief information officer at
J.P. Morgan. Gentlemen, we're grateful to have you here. Mr.
Bautz, we'll start with you.
STATEMENT OF WILLIAM A. BAUTZ, SENIOR VICE PRESIDENT AND CHIEF
TECHNOLOGY OFFICER, NEW YORK STOCK EXCHANGE
Mr. Bautz. Thank you, Senator. Senator Bennett, Senator
Moynihan, and members of the committee, I'm honored to be here
with you to discuss the impact of the Year 2000 problems. We
view the dimensions of this problem as huge with potentially
disastrous global consequences to both business and government
if it's not fixed. As the world's foremost securities market
the NYSE is taking a leading role in promoting awareness of the
Year 2000 computer problems among our 3,700 listed companies,
which includes 350 non-U.S. companies, the securities industry,
and the other capital markets throughout the world. We've
worked hard to assure that our own systems will be Y2K
compliant far in advance of the turn of the century. However,
as important as our market is, and it is only one
interconnected component of a global market, you pointed that
out, Senator, much remains to be done to insure that all of the
international capital markets are prepared to move smoothly
into the next millennium. Our goal is to insure the first
business day of the Year 2000, Monday, January 3, will be just
another trading day around the world.
The NYSE would like to commend you, Mr. Chairman, for your
leadership in calling this meeting and I would concur with the
recent statements of Dr. Andy Grove that congressional
oversight hearings helped play a critical role in the raising
of the profile of this problem and give heightened urgency to
remediation efforts.
The potential impact of the problem on domestic and
international markets are profound. With the world economy so
dependent on computer technology, you cannot overestimate of
the impact of the systems ceasing to operate on January 1,
2000. The Securities Industry Association refers to solving the
Year 2000 problem as the biggest business technology effort the
world has ever experienced. Because of the interdependency of
the world international markets, there is no concept of merely
an isolated problem if a major market, financial setup or
market participant is not prepared for the new century. Just as
we cannot overestimate the ramifications of the Y2K problem, we
can also not overestimate the costs of remediating the problem.
Estimates have ranged from $500 to over $1,000 per affected
computer program. Such a conversion process would cost a medium
sized company over $4 million. Some estimates place the cost of
the Y2K compliance in the United States at over $200 billion
and worldwide as high as $600 billion. Such estimates are
constantly being revised upwards.
At NYSE we're addressing the Year 2000 issues on multiple
levels, beginning with the direct impact on the NYSE itself,
and extending to international capital markets, then
coordinating efforts with our member firms, over whom we have
oversight responsibility and our listed companies, which
include a dominant share of the world's major corporations.
After discussing our activities on each level, I will
conclude by offering our perspective on the role of government
in the Y2K issue.
One: Over the last decade, the NYSE invested more than $1.5
billion in new technology to provide for greater capacity and
to install next generation hardware and software. As we
implemented this new technology, we made many of the necessary
Y2K changes. Most of the technology conversion is complete,
tested and in operation. As to our other background systems,
our non-trading related systems, we have a comprehensive plan
to fix, repair or retire non-compliant systems. We're currently
on schedule to have the NYSE mission critical systems in
production by December 31, 1998.
We estimate that our costs to achieve Year 2000 compliance
will be approximately $20 million, and I might add that our
systems are not necessarily very date dependent, so our problem
is a lot easier than a lot of other people's, and we're still
spending over $20 million to fix it. In large part our $1.5
billion investment in new technology over the last decade
provided us with the ability to address this problem at an
early date and reduce our costs.
Installing Y2K compliant systems is only one step in the
process. Proper testing is equally important. We constantly
test our new systems and we test the hardware and software that
our vendors provide to us. Our testing program includes
connectivity tests with our member firms. For example, Merrill
Lynch or Bear Stearns, end to end tests with our industry
partners, NSCC and the Depository Trust Co. and participation
in industry-wide data testing sponsored by the Securities
Industry Association, which starts next Monday. Beginning in
March 1999, industry-wide testing will occur on weekends with
all of our member firms, all the U.S. markets, and all the
securities industry utilities.
With regard to Y2K compliance among the world's capital
markets, we're addressing this issue on a variety of fronts. In
October 1997 we issued a memo detailing the Y2K issues to a
subcommittee of the International Federation of Stock Exchanges
and also submitted a copy of a proposed survey to help the
Association collect relevant information from its members.
Acting in close collaboration with both the SEC and SIA, we
raised Y2K issues with the International Organization of
Security Commissions, IOSCO, where NYSE Group Executive Vice
President Ed Kwalwasser serves as chair of the Year 2000
Subcommittee. Following presentations in Taipai in November
1997, a member survey was distributed to representatives in
Europe, Asia, South America, and Canada.
More than 300 of the nation's broker dealers are NYSE
member firms for whom we have primary oversight authority.
These broker dealers carry and clear transactions for
approximately 91 percent of all customer accounts obtained by
U.S. broker dealers. We have woven Year 2000 compliance into
our surveillance and financial and operational examination
programs. In May 1997, we advised our member firms that they
should designate a senior official to have primary
responsibility to oversee the firm's Year 2000 project, that
they should complete remediation efforts by December 1998, in
order to be prepared for industry-wide testing scheduled in
1999.
Senator Moynihan. Did you say December 1998?
Mr. Bautz. Yes, 1998, and be prepared for testing in 1999.
Last December we conducted two Year 2000 surveys with our
member firms, vendors, correspondant brokers, and other firms
within the NYSE. With few exceptions, we were generally pleased
with the results of the survey. We now conduct quarterly
discussions with our members firms to monitor their progress.
Once a firm is Year 2000 compliant, the NYSE will request a
written confirmation of that compliance from the firm's chief
executive officer.
With regard to our listed companies, last year we brought
together the CEO's of a number of our listed Companies to meet
with the SEC to discuss the issue of correcting the Year 2000
problem and related disclosure obligations. We worked closely
with the SEC Division of Corporation Finance to make sure our
listed companies receive and understand guidance.
We are preparing disclosure material on the Year 2000
problem to focus on steps to address that problem. Analysts,
shareholders, customers, and competitors will review these
disclosures, and the marketplace will help to determine whether
a company is adequately addressing this crucial area. Failure
to take the necessary steps will not only result in a potential
catastrophic consequences when the calendar turns at the end of
December 1999, but it will also adversely affect the company's
stock price and its customer base if the market judges that the
company is not devoting the necessary time and resources to
this project.
As hard as we worked on this issue, we recognize the
private sector alone cannot address it. The SEC played a
critical role both with respect to disclosure by public
companies and through its oversight of securities industry
participants. Additionally, we applaud the leadership of the
Senate in creating a special Subcommittee to specifically
address the Y2K challenge, as well as other Senate and House
Members who have brought attention to this important issue. We
also commend the President for creating the Year 2000 Task
Force to oversee the Federal Government's Year 2000 conversion
progress. The creation of this task force and the requirement
that glossary cabinet members respond to the President's
inquiries will help insure that the Federal Government will be
able to cross the bridge into the next century.
Thank you again for the opportunity to present this
testimony. I'll be happy to answer any questions. Thank you.
[The prepared statement of Mr. Bautz can be found in the
appendix.]
Chairman Bennett. Thank you. Mr. Miller.
STATEMENT OF PETER A. MILLER, CHIEF INFORMATION OFFICER, J.P.
MORGAN
Mr. Miller. Good morning, Mr. Chairman, members of the
committee. Thank you for the opportunity to address this
important issue. My name is Peter Miller, I'm the chief
information officer of J.P. Morgan and have been involved with
the Year 2000 problem since 1995. My remarks today will focus
on the nature of the Year 2000 problem, a risk management
approach to solving it, and the need for industry to industry
collaboration, as well as international cooperation.
Let me begin by saying that the Year 2000 problem, or the
millennium bug as it is sometimes referred to, is an issue that
we at J.P. Morgan consider of paramount importance to our firm,
the financial service industry, and the United States and world
economies. No other event in history will so thoroughly expose
the vulnerability of our living and working in a world so
interconnected by computers and telecommunications.
The problem as we see it is not really a technological one,
although technology lies at the root of both the problem and
solution. Correcting the two digit dating systems, which in
their present form cannot tell one century from the next, is
easy. Rewriting code as a technological matter is relatively
straightforward. The real problem and the real danger can be
summed up in two words; logistics and dependency.
The logistical problem is that millions of computers are
involved, a huge undertaking in and of itself. Making the task
even more daunting are the intricate, complex, and pervasive
interdependencies among the computers and computer networks
that populate the world today. It is not enough that every
computer, software application, and embedded chip affected by
the Year 2000 problem be fixed. They must be fixed in a way so
they remain compatible with all the other devices with which
they interoperate. The financial industry offers a perfect
illustration of the enormous size, scope, and complexity of the
problem.
Finance today is a global business, where almost
unimaginable sums of money are in a constant state of
electronic flux, and interdependency is particularly acute,
given the networked nature of market participants. We have
already seen harbingers of what might be in store. The New York
Mercantile Exchange and Brussels Stock Exchange have both
experienced date-related operating failures. Although these
problems were relatively small in scope, the scale of the issue
becomes magnified when you consider all the world's financial
institutions will find themselves tested on the same day. At
the extreme, the price of failure could be systemic breakdown.
Yet it is not enough for the world's banks, stock
exchanges, and clearing houses to have their respective houses
in order. It won't do them any good if their transaction
processing systems are ready, but they cannot relay information
to clients, creditors, regulators, and payment and settlement
systems because of breakdowns in telecommunications networks.
And imagine if all the banks and telecommunications companies
are set to perform on January 3, 2000 but their employees can't
get to their desks because the elevators don't work. Simply
put, our networked world is only as good as its weakest
connection.
Typically, the barriers to Year 2000 compliance come down
to four things: Time. This is a problem with an immovable
deadline. Money. For some, compliance may not be economically
possible. Skills. Even if you do have the money, you still need
to find people who can fix the problem. And competing
priorities. If focus is on other issues, the likelihood
increases that the Year 2000 problem simply won't get fixed.
So how does one combat such an enormous and insidious
problem? At J.P. Morgan we have applied a comprehensive risk
management approach, and in our measured opinion things will go
wrong. Statistical probability tells us that the logistics and
dependencies involved almost certainly dictate some level of
failure. So the question is not if things will go wrong, but
how many things will go wrong. Therefore, we believe the best
course of action and probably the only one, given time, cost,
and skill constraints, is to identify the most critical
situations, fix them first and then move down the chain of
priorities.
Firms that will do the best will be ones that put their own
house in order, coordinate their activities with their trading
partners, and prepare contingency plans in the event that
unexpected failures occur.
At J.P. Morgan we began discussing the Year 2000 problem at
senior executive levels in 1995. Early the following year with
the full commitment of Sandy Warner, our chairman and CEO, we
launched a firmwide initiative. The commitment of senior
management was crucial, for without it we would never have been
able to muster all the resources necessary to attack the
problem. With 600 people working on the initiative at its peak,
we have estimated that the total cost of making the firm Year
2000 compliant is $250 million.
Paula Larkin, a senior manager at Morgan, is charged with
overseeing and coordinating all of the firm's Year 2000
efforts. To date, these efforts have included raising awareness
throughout the firm, conducting a comprehensive analysis of the
problem and its many impacts, putting in place a complete end
to end methodology and certification process and applying the
lessons learned broadly across the firm so as to reduce costs
and risks while accelerating progress. By year's end we expect
to have all of our critical applications and products tested
and certified as Year 2000 compliant.
The importance of testing cannot be overstated. Our
remediation efforts have shown the problem to be pervasive and
not always obvious. For example, our testing of one product,
which the manufacturer said was Year 2000 compliant, found that
while the product could handle the changeover on January 1, it
had not been programmed for the fact that 2000 is also a leap
year. The lesson here is that nothing can be taken on face
value.
With our internal testing and renovation well under way,
much of our effort is currently focused on addressing external
dependencies, both inside and outside the financial services
industry. This has involved identifying and assessing Year 2000
exposures as posed by clients, counterparties, exchanges,
depositories, clearing houses, and correspondent banks as well
as by power, telecommunications, and other utilities.
Key to this effort has been the coordination and
collaboration with others in the industry, namely competitors,
exchanges, the Federal Reserve, and trade associations. For
example, Morgan has been working with the Securities Industry
Association, the New York Clearing House, and others for the
past 2 years on this issue. Through various committees, the SIA
has been promoting awareness, developing testing guidelines and
coordinating industry-wide testing efforts. J.P. Morgan and 28
other securities firms are currently engaged in piloting the
tests that will be used early next year.
The work of SIA and other organizations like it have helped
place the U.S. financial services industry into a leadership
position in terms of Year 2000 readiness. The U.S. financial
services industry is ahead of its peers abroad and also appears
to be head of all other industries. To the best of my
knowledge, financial services is the only industry conducting
integrated testing to identify readiness and identify issues
ahead of time.
But for financial services companies, the need for
vigilance must extend beyond their own industry. The ripple
effect from a large disruption in another industry, such as
telecommunications, transportation, or power, can have severe
consequences for the financial sector. As a result, J.P.
Morgan, on its own and in conjunction with other industries, is
trying to understand the risks faced by service providers and
the programs they have in place to mitigate these risks.
To mitigate the risks, the free flow of timely and accurate
information is essential. Traditional barriers must be broken
down for sharing of best practices. The Government can play a
key role here through influencing legislation to promote
cooperation and information sharing across industries. This
cooperation collaboration also needs to extend beyond the
borders of the United States.
For Morgan, with operations in more than 30 countries, the
need for global attention to the Year 2000 problem is clear.
The ultimate goal is to demonstrate industry readiness through
integrated testing with all major participants in all major
market locations. Progress is being made but much more work
remains to be done.
Dependencies with potential cross border implications are
of particular concern in the international arena. Disruption in
a key market could prevent the settlement of trades or movement
of cash and securities, which in turn could affect credit and
liquidity. Were a major international investment bank to find
itself in a position where it could not receive or deliver cash
or securities, the consequences could have a ripple effect on
the world economy.
Our assessment of global readiness places the United States
ahead of all other countries. Preparedness in Europe varies
country by country. Thanks in a large part to the work of the
British Bankers Association, the United Kingdom ranks in the
top spot. Trade associations are active across the entire
continent, but the entire Year 2000 effort had been hurt by the
time, energy, and attention being devoted to the European
Monetary Union.
Asia ranks behind Europe. Here the biggest threat is posed
by the downturn in the regional economy. Strong progress,
however, has been made in Japan over the last 6 months due in
large measure to the efforts of the Japan Securities Dealers
Association working with the Ministry of Finance.
Action has generally been lagging in Latin America.
However, variations exist within the region. Mexico is proving
to be a leader. Currently the SIA is making use of work done in
the United States to provide best practices in other locations.
On a global front, a recent positive development has been
the birth of the Global Year 2000 Coordinating Group. This
group raises awareness, identifies resources, and coordinates
initiatives on an international basis.
To close, I would like to reiterate a couple of key
messages. The problem is serious. Things will go wrong. And the
companies, industries, governments, countries, and regions that
will be most successful in addressing the problem will be the
ones that: Get a firm handle on internal issues that are
particular to them; address the critical external dependencies
that affect them; work collaboratively with others to share
information and maximize resources; and put in place
contingency plans that guard as much as possible against
unforeseen events.
Addressing this problem will take hard work and for the
most part, it's a thankless task. Success will be defined not
by some great discovery but by minimal disruption. The
financial services industry has made considerable progress to
date and is well positioned. However, the test in all this lies
in the strength of the weakest link, wherever it may be.
I thank the committee for the opportunity to share my
thoughts and look forward to working with it and others to
bring this issue to the most uneventful conclusion possible.
[The prepared statement of Mr. Miller can be found in the
appendix.]
Chairman Bennett. Thank you. I appreciate the comments of
both of you. First, a housekeeping item. I remind all witnesses
to please make sure the committee has electronic copies of
their testimony and be aware they may be asked additional
questions in writing by other members of the committee who
couldn't be here at this hearing.
Now, you made a reference, Mr. Miller, to external
dependencies, and one of your major external dependencies, of
course, is the U.S. Government. That is what Mr. Koskinen's
task force is working on, the committee heard from him, I have
a weekly conversation with him, either face to face or by
telephone every week to see if we're coordinating what we're
doing with what the executive management is doing now.
Have you made any effort or are you aware if anyone has
made an effort to put a critical path risk assessment model in
place with respect to not only our Government, but with any
other Government in the world? Have you looked at how that
external dependency could hurt you in another country?
Mr. Miller. Of that I'm not exactly sure. I understand the
global coordinating group is going through a very thorough
evaluation of contingency implications. Of that I think an
important factor is to look at the likelihood of the impact of
potential problems and to be able to avert those in the best
way possible.
Chairman Bennett. Did you have a comment on that, Mr.
Bautz? You are a little more locally focused as the New York
Stock Exchange, but----
Mr. Bautz. I guess our primary interface on the
international level is to look to groups like the FIBV, IOSCO
and our principal work there has been to raise awareness and
make sure that we can provide whatever assistance we need to
our sister exchanges. There's a steady stream of people coming
to see what we've done, what the risk factors are, these
things, so we've seen a reasonable number of people coming
through to ask us what our experience has been.
Chairman Bennett. I will ask you the same unfair question.
Is there any stock exchange that makes you very nervous at the
moment?
Mr. Bautz. Difficult to answer that question, because we
don't deal with them on a day-to-day basis, but the good news
is we made a presentation at the FIBB meeting in Brussels a few
weeks ago, the general sense there is that the awareness level
has gone up there really dramatically from the last time we had
this set of meetings. It's the principal focus of meetings that
we were here, both the SIA and NYSE made presentations to the
panel, so there was a lot, four other international exchanges
spoke as well. So the awareness level is going up.
The issue that I think we have to focus on is whether or
not there's going to be enough time to complete all the things
that need to be done. Some people are coming fairly late to the
party. The effect of having a smaller stock exchange somewhere
with a problem is not that great; France, Germany, and England,
obviously, the stakes are a little higher. I think the people
are well aware of what's going on, they're working to fix that.
Chairman Bennett. It is late. I tell people somewhat
facetiously, I know how to start the Y2K problem, start in
1995. Senator Moynihan.
Senator Moynihan. Sir, yes. Mr. Bautz, talking about the
SIA statement that this is the biggest business technology
effort that the world has ever experienced, and I can't avoid
the sense that it's not 1995. Did I hear you say, Mr. Miller,
that you want to be finished all your work by December of this
year, so you can test it in the year that follows?
Mr. Miller. We indeed want to be finished with all our
critical applications by the end of this year, to be ready for
testing.
Senator Moynihan. Haven't we been hearing something like
that from all of our witnesses, that you better be ready by the
end, do what you have to do to have it done by the end of this
year?
Chairman Bennett. That's right, and if you don't, you
better start making your contingency plans. One of the
witnesses in one of our other hearings said if you're not ready
by the end of this year, stop and put all your focus on
contingency plans, because you're not going to get ready.
That's a pretty Draconian kind of statement and I wouldn't
presume to tell any CIO that's what he or she ought to do, but
that's at least one comment.
Senator Moynihan. I think we're getting a convergence here
of judgments from people who hadn't heard that testimony. Would
you agree, Mr. Bautz?
Mr. Bautz. I think that you would be foolish not to get it
done by the end of this year. The amount of things that can go
wrong, the interdependencies on the other parties, you
absolutely should do as much testing as you possibly can. The
key to all of this is testing. The amount of effort that the
SIA has put into constructing and orchestrating this particular
industry test is unprecedented, I think, in the SIA's history,
and we are businesses that worry about how well do the moving
parts work well together. A tremendous amount of industry
effort is going into this.
Senator Moynihan. Can we all agree that it's now July?
Mr. Bautz. Yes.
Senator Moynihan. There's less than a half a year.
Mr. Bautz. I think I can agree with that, yes.
Senator Moynihan. It's less than half a year's time.
Mr. Bautz. Yes. Well, we, as I said, next Monday, we will
be starting with 15 firms to test end to end through the New
York Stock Exchange, through the clearing corporation, through
the settlement agencies, for a whole range of products in this
country, so the major organizations are in place to do this
testing end to end.
Senator Moynihan. Well done, but Argentina, Indonesia?
Trident submarines? Good God.
Chairman Bennett. Well, I would just comment. I spoke
earlier about being at nuclear plants. The first nuclear plant
that I went to, the chief information officer laid out her time
line for her company, and she had 15 percent of the total time
for actual remediation, and 70 percent for testing. And I've
checked and found that's about right among people who are
informed on this, so someone who thinks he's going to have this
solved by having new software packages delivered to him in
October 1999, and he'll put them in and test them for a 1 or 2
weeks, is courting disaster.
Senator Moynihan. Thank you.
Chairman Bennett. Thank you. Thank you both, appreciate it
very much.
Chairman Bennett. Now, panel No. 4, we have Tanya Styblo
Beder, who is principal, Capital Market Advisers, Inc. and Dr.
Howard Rubin, chair of the Department of Computer Sciences at
Hunter College. We thank you both and you get to in the style
of the New York Yankees, bat cleanup here.
Ms. Beder, we'll hear from you first.
STATEMENT OF TANYA STYBLO BEDER, PRINCIPAL, CAPITAL MARKET RISK
ADVISORS, INC.
Ms. Beder. Chairman Bennett, Senator Moynihan, and members
of the Special Committee. I am pleased to appear today to
discuss the progress of financial firms, both foreign and
domestic, in managing the Y2K problem as part of the Special
Committee's consideration of this topic. My name is Tanya
Styblo Beder and at present I am a senior partner and one of
the original founders of Capital Market Risk Advisers, a firm
specializing in independent risk assessment, valuation and risk
oversight implementation for all types of financial operational
and strategic risks. CMRA's clients include banks, broker
dealers, insurance companies, pension funds, mutual funds,
hedge funds, thrifts and credit unions, custodians,
corporations, rating agencies, and financial software firms in
the United States, Europe, Asia, Australia, New Zealand,
Mexico, and Canada.
CMRA's work is both reactive and proactive. For example, we
assess and contain existing risk problems that cause firms to
bleed money as well as evaluate and implement programs to
manage both current and future exposures related to market
risk, credit risk, operational risk, derivatives risk and model
risks.
My testimony today is based on my experience with financial
institutions around the world since the late 1970's. My opening
remarks will summarize my more detailed statement, I ask that
my detailed statement be entered into the record.
Chairman Bennett. Without objection.
Ms. Beder. Y2K is the most crucial issue facing every
financial institution in the United States and is one of the
top two or three issues facing institutions in other countries
around the world. With only 18 months to the turn of the
century, I feel that financial institutions and the global
systems that process their transactions around the world are
far from compliant. Nonetheless, I do not join those who
predict a huge global recession or prolonged mayhem in
financial markets.
This is not a small statement for me to make, for as
recently as a year ago I was very much afraid that Y2K would
bring dire consequences to the financial sector. My fledgling
optimism for the financial firms in the United States is based
on my observations of increasing momentum to implement
contingency plans that lower risk during the critical period.
Y2K is big, pervasive, and global. Spending to solve the
technological aspects is expected to run as high as $600
billion and the cost of business continuity issues,
interruptions due to Y2K, is estimated as high as a trillion.
The total spending necessary to deal with Y2K will exceed the
amount the United States spent, adjusting for inflation,
fighting the Viet Nam conflict, $500 billion, but with luck
will not reach the amount spent during World War II, $4.2
trillion.
Analyzing Y2K is like peeling an endless onion. Each layer
of issues leads to another layer, often involving greater
degrees of interdependence between players in all three facets
of the economy: Financial firms, nonfinancial firms, and public
sector.
While a great deal remains to be done, my recent review of
dozens of key market players including banks, broker dealers,
pension funds, mutual funds, custodians, and corporations in
major capital markets around the world indicates an increase in
the amount of resources devoted to Y2K technology issues as
well as to business continuity issues.
Battle plans of individual institutions have evolved along
the three primary dimensions: Y2K exposures under the firm's
control, Y2K exposures to others, and contingency plans for Y2K
exposures outside the firm's control.
In general, large and medium sized financial firms in the
United States and Australia have analyzed and are on track to
address Y2K problems under their control. Examples of such
exposures include internal systems, such as PC's and
mainframes, embedded system devices such as elevators and
security systems, businesses processes such as settlement and
clear activities or the issuance of pension or annuity checks
and computer code.
Large financial firms both in the United States and
Australia also are reviewing in detail their exposures to
counterparties in financial transactions, including loan and
investment portfolios, and to their supply chain. Firms
typically conduct the review of outside vendors by a survey or
questionnaire. Typically only 25 percent of the surveys are
returned with response information and fewer than 10 percent of
those returned are accurate.
This disappointing news from vendors has moved financial
firms to consider implementing financial transactions designed
to reduce exposures and particularly cash flows from the
December 1999 through March 2000 period. Examples are
contingency plans that envision completing year end portfolio
trades by December 15, 1999, amending loans or entering
derivatives with customers and counterparties to move cash
flows out of the December to March period, and contingency
planning for malfunctions in the wire transfer, settlement,
credit card, ATM and other critical systems.
Although preparations are well underway in the United
States and Australia, the story is quite different in other
countries. Regulators around the world continue to encourage
and demand Y2K efforts by financial firms, but there is wide
agreement that financial firms in Asia are far more concerned
with whether they survive until 2000, an issue we have named
IF-2K, rather than Y2K systems issues.
Moody's recently reported that 49 major Japanese banks
planned to spend $249 million as a group on Y2K compliance.
This amount is only a fraction of Citicorp's planned $600
million program and only equal to Chase's and J.P. Morgan's
planned $250 million.
Financial firms in Europe are so absorbed by the system
challenges posed by European monetary union that non-EMU
projects, including Y2K conversion, are commonly suspended or
postponed. A parallel situation exists in the United States
with some firms so absorbed by the system challenges of Y2K
that they have placed moratoriums on non-Y2K projects, such as
dealing with a single currency in Europe. This will have
ramifications for our financial system in the future.
The Brazilian financial sector is slow. As in Asia, South
America is more concerned with economic health than Y2K. Russia
and Eastern Europe is a financial black hole, especially given
the significant variation in regulatory oversight.
There is, however, some good news to report. In the United
States financial firms continue to reduce their exposure to the
financial firms in Asia and Europe either through selling the
assets they hold or via some combination of financial
transaction amendments and derivatives. In Europe, the happy
news is that EMU conversion poses system challenges similar to
Y2K, hopefully shortening the time that will be required to
attain Y2K compliance.
My statement closes with eight areas that keep Y2K chiefs
up at night, and merit focus by the Special Committee on the
Year 2000 Technology Problem. I will now summarize five of
them.
The first is telecommunications and energy. Most large
financial firms conduct 80 percent of their transactions
electronically and 25 percent or more of their transactions in
the interbank market. To summarize the remarks by many Y2K
chiefs in this area, ``we don't have a clue.'' This leads me to
conclude that reliability on telecommunications is a Y2K wild
card.
The second is exposure to the middle market. Companies in
the Fortune 500 plan to spend an estimated $11 billion on Y2K
fixes, which includes $3.5 billion by the largest financial
firms and are focused seriously on business continuity. The
Gartner Group study of 6,000 companies in 47 countries
indicated that 30 percent of all companies and governments have
not started on Year 2000 compliance efforts, but that 88
percent of the laggards were companies with fewer than 2,000
employees. Small companies are more likely to be able to
operate manually and to be able to manage their full supply
chain in a crisis. But middle market companies are likely too
complex to operate manually and probably have not devoted
sufficient resources to Y2K and so are another wild card. Some
analysts predict that up to 20 percent of middle market
companies will have a problem with Y2K leading to significant
increases in bankruptcies of currently healthy firms.
The third is information sharing. Even though a great many
Y2K problems have been solved, information sharing among
parties who stand to benefit from others' knowledge is hampered
by the fear of litigation. During my review, several Y2K chiefs
commented, ``We are happy to discuss Y2K, however, under legal
advice, there will be issues that we will not be able to
discuss, at least not on the record.'' Future litigation costs
around Y2K are estimated to range between $1 trillion and $4
trillion, an amount over and above the $1.6 trillion estimate I
mentioned earlier for technology fixes and direct business
losses. Perhaps a wartime profiteering limitation should be
considered for litigation costs, or maximum allowable damage
levels in order to promote the sharing of information.
Fourth, and an additional concern for many Y2K chiefs, is
the potential for fraud. Some firms have corrected hundreds of
millions of lines of code using automated software sniffers
versus manual intervention. Those who have relied on manual
code correction are more susceptible to fraudulent transfers or
other sabotage that may cause harm at future dates. Given the
pressure of completing Y2K fixes, few firms have the luxury of
checking each manual change to their source code or other
software.
Fifth is liquidity. Thirty-eight percent of IT
professionals say they may withdraw personal assets from banks
and investment companies just prior to the millennium to
protect their personal finances from Year 2000 failures. If
financial institutions implement contingency plans that prevent
use of electronic systems and consumers thus have to withdraw
extra cash to avoid the risk of credit card and ATM failures,
for example, to cover their holiday spending in December 1999,
how much additional liquidity will the banking system need?
Thank you, and I welcome any questions that you have.
[The prepared statement of Ms. Beder can be found in the
appendix.]
Chairman Bennett. Thank you. Before we go to Dr. Rubin, I
raised the same issue with Chairman Greenspan and he told me,
if my memory serves, and it usually doesn't, but that the Fed
was planning to have an extra $80 billion in cash available
during that holiday week period for just the particulars that
you have commented on. Whether that will be enough, I don't
know, but the Fed is also thinking about liquidity and planning
to have additional cash available for those that get nervous
about it. Dr. Rubin.
STATEMENT OF HOWARD RUBIN, CHIEF EXECUTIVE OFFICER, RUBIN
SYSTEMS, INC. AND CHAIR, DEPARTMENT OF COMPUTER SCIENCE, HUNTER
COLLEGE
Mr. Rubin. I thank you for the opportunity to testify
before the committee. My first suggestion is you get every
company CEO lights like that. Put it on their desk.
Chairman Bennett. It makes the witnesses nervous, but
doesn't do anything for Senators.
Mr. Rubin. Second, even using my finest New York talking
techniques, I probably can't get through the whole statement,
so I'd like to give you an abstract of some of my comments.
Chairman Bennett. Your full statement will be included
without objection.
Mr. Rubin. First of all, this is an issue that I focused on
for many years. I've established a Global Research Network now
with about 16,000 individuals and 5,000 or so companies in
about 50 countries from which I collect data and in general I
look at interpreting global trends and I also work as a
consultant to some of the largest companies in the United
States. And with regard to the testimony today, I will confine
my comments to specific areas of interest to you, which are the
progress of foreign financial companies and also the state of
U.S. financial markets themselves and other risks that are out
there.
My fundamental position on this matter is really quite
simple. No. 1, with all the research I've done, it's quite
clear that no one can accurately predict what will happen, and
as Peter Miller says, this is really an issue of risk
management.
No. 2, no institution stands alone, so looking at
individual institutional progress really doesn't mean very
much, and progress indicators by themselves are among the wrong
things to be looking at. Because institutions can't stand
alone, there's no institution immune to disruption of business
transactions as they flow around the world and influences of
this disruption are more than the financial sectors themselves.
We have to deal with utilities, our water, basic infrastructure
and transportation.
Something else the committee I believe should think about
in the general overview is the Year 2000 problem has both
direct and indirect economic consequences. The direct
consequences is disruptions and problems that we're talking
about here. The indirect consequences have to do with the
economic diversion of resources and funds to deal with this
problem, and quite simply, I don't want to imply there's a
linkage between technology investment and business performance,
but in the mid-1990's for every dollar a company spent on
information technology in the United States, they supported
about $150 dollars in gross revenue. Y2K technology is taking
25 cents outs of that dollar. That's 25 cents not going into
revenue, support, growth, and profit and that's what I mean by
a second order effect and that's absolutely critical to look at
in my view. With euro on top of that, hitting a subset of
companies that have to deal with that, so it's taking away from
the ability of companies to grow and move forward, so there are
first and second order effects.
Therefore, I believe whether or not an organization
believes it is Year 2000 safe or Year 2000 compliant, it's
imperative that assessment of Year 2000 risks be made and act
to abate any that are identified.
There are really three categories of risks that are out
there. One category of risk is what I call the known knowns.
Those are the things we know that we know or at least think
that we know based on surveys. Then there are the known
unknowns, the things we know we don't know, but we'd like to
find out about and a lot of testimony was around that.
The most interesting category is what we call the unknown
unknowns. Those are the things that we don't know we don't know
about right now that everybody has to be prepared to deal with.
So as a backdrop of discussing my picture of foreign financial
companies, let me give you a snapshot of known knowns. A lot of
this is in the table that's on page 2 of my testimony.
Based on global estimates we've had, I've tried to take a
look at what countries may not be able to bear the burden of
Year 2000, how much GDP impact would it have in terms of
diversion of GDP resources. The heavy hitters are Russia,
Mexico, Brazil, Portugal, Korea. Countries that have the least
impact of looking at Year 2000 spending as a percent of GDP,
countries like China and India.
If we look at what countries have work in progress,
countries like the United States, UK, and Canada, some of the
ones you point out, have the most work in the pipeline. If we
look at China, Mexico, and Brazil there's the least work in the
pipeline. And in terms of what I call a schedule indicator, a
schedule indicator doesn't mean I have 27 percent of my work
done. Suppose a company tells me 80 percent of their work is
complete now, but at this point according to their plans it
should have been 95 percent, they're not doing very well. So I
look at ratio of what's done versus what they plan to have
done, assuming they had plans, the countries from where I have
data that seem to be in the worst shape with regard to this are
Mexico, Spain, and China could be on that list again. That's a
little bit of the result of what I think are known knowns.
There are lots of surveys around about what's going on, my
friends at Capers Jones in the UK did a survey, built the
millennium index. In the European market, some of the greatest
risks are Germany, Italy, Belgium, Finland, and the UK and
they've identified those same group of countries rather as
being generally late, not only are they slipping in terms of
the amount they spend, they're slipping in terms of when
they've started. By the way, in terms of the U.S. industry
picture and trying to take a look at who is in really good
shape, it looks like the software industry, financial services,
manufacturing, and telecom are moving, although there are a lot
of unknowns, as we discussed before in the hearing with regard
to telecoms.
We have monitored schedule slippage in the areas such as
transportation, utility companies and that's why I have great
concerns about beyond the financial sector, looking at impacts
on them from other areas. In terms of what's happening with
this problem, as we get closer to the deadline, things keep
moving around. Some the big data I have from the latest survey
that I just closed June 30 on page 4 is companies are
continuing to underestimate the Year 2000 problems, numbers are
going up. However, the number of companies that have activated
have gone up, 86 percent of the companies are now doing
something about Year 2000. The number focused on contingency
plans has jumped from 3 percent to 72 percent. But when you ask
them what's in those contingency plans, you can't find out very
much.
There's a lot of activity. I don't know about content here.
Fourty percent of those surveyed had some kind of date related
incident that they've reported.
So United States and some of the global picture, let me
move on to the progress of foreign financial companies, this is
sort of the known knowns and bordering on the known unknowns.
It looks like that project starts outside the United States are
late, spending estimates and rates are lower than experienced.
In eBANKER surveys, more than half the companies had nothing to
report. So there are a lot of known unknowns out there and
unknown unknowns out there.
What I think really has to be done is that this committee
has to adopt a composite Year 2000 tracking and risk management
viewpoint. You have to move to encourage mechanisms to share
information, mechanisms to force companies to focus on scenario
analysis. The question for companies today is what alternatives
have they focused on for different scenarios. In New York City
you know if there's a blizzard you have ways of your folks
getting to work. What are the set of questions a company must
be able to answer, running from a failure within their company
to a failure within a counterparty, to a multipoint,
multinational failure of infrastructure, utilities, and
everything else.
So the scenarios are critical. So I think my final
observation is along those lines is somewhat contrary to the
pure focus of this hearing. This is not a stand alone company
or industry issue, it's a network issue. The most difficult and
critical of the Year 2000 risks are the unknown unknowns or
cross industry failures and we will not know what all these are
ahead of time and I think it's critical that we move companies
to a point where they have all these scenarios, and the key
question to ask them has to do with one of preparedness; having
looked at scenarios, be prepared to act on them and to have
some degree of surety on the problem where we can. Thank you.
[The prepared statement of Mr. Rubin can be found in the
appendix.]
Chairman Bennett. Thank you very much. Using the phrase the
Senior Senator from New York would recognize from the previous
circumstance, the best time to escape is immediately after
you're captured, and I'm told that my memory has failed me, the
$80 billion figure came from somebody other than Chairman
Greenspan. My memory tells me he used it, the Fed has called to
complain about my using it and putting it in his mouth, so I
will quickly take it out of his mouth and out of mine, too, to
try to find out.
Senator Moynihan. I've been planning to put $80 billion
aside.
Chairman Bennett. Let's leave that to when we get to it.
I'm interested, Ms. Beder, in your reference to fraud.
Because that's something frankly we have not focused on, at
least in the various jurisdictions that I've had. I'm told that
a Mafia run firm started a contract to fix the company's Y2K
problem, and instead of fix, they used their opportunity to
move lots of money from one account into the other in the name
of fixing the problem. Fortunately, they got caught, but I
think that is an issue that needs to be highlighted here, and I
thank you for raising it with us. It corresponds with hearings
we've had with respect to the challenge of the Defense
Department and one of the Defense Department problems has to do
not only with the Y2K remediation difficulties, but with the
exposure that comes from sabotage in the defense establishment
by virtue of computer attacks and computer sabotage, since the
entire Defense Department is dependent on computers.
And Dr. Rubin, the Defense Department has exactly the same
concerns you do with respect to the interdependancy. They
pointed out that when someone picks up a telephone to make a
call to the commander from the Pentagon, they're dependent on
Atlantic Bell for that call to go through. In the old days when
the Defense Department was hard wired from every establishment,
from one to the other, are gone, and now they depend upon
service from the same suppliers that security firms and others
would be dependent upon. So your point about the
interdependability of this situation is a good one and I'm glad
that you raised it.
Senator Moynihan.
Senator Moynihan. I wonder if I would be wrong in thinking
that our two closing witnesses are the most bearish today,
possibly because you don't have any institutional affiliations.
Chairman Bennett. I heard Ms. Beder make a very bullish
statement about her previous position.
Senator Moynihan. Neither of you think that we're doing
very well.
Ms. Beder. I guess the more important point to me is that I
think we've acknowledged the reality that you actually can't
find all the places where Y2K might impact you, and with
respect to things like testing, as people have started that
process and right away many of the firms reveal, large
financial firms don't expect their process to be fully complete
until the second or third quarter of next year and that's
primarily because they're running into problems like rolling
huge databases of assets and transactions forward, and I can't
underscore the importance of doing that properly.
For example, some of the testing that Japan has planned
places no requirements on the financial institutions as to how
they are conduct their testing for the virtual trades that are
planned to happen on December 20 of this year. So I suppose
that my bearishness on the one hand is over the realization
that it's probably a problem that no one could foresee all of
the dimensions of it. I think my optimism comes from the fact
that people have very heavily focused on contingency plans to
reduce their exposure for limited trading volumes for that
period, to moving cash flows, and doing things that will help
them to let other people be the guinea pigs.
Mr. Rubin. I would like to say although I have no
affiliations as an employee, I've worked with some of the
largest companies on this issue. I see the largest companies in
the United States are heavily mobilized, they have very
comprehensive program offices and they're look at multiple
dimensions of the problem. However, in terms of position, and I
gave the impression here, every company is probably behind what
they would like to be, but the real issue is that we are where
we are, there are some things we may be able to do, companies
are talking about tax credits, things for people moving
forward, penalty things, people not being able to become
brokers, we're looking at ways to accelerate progress.
But the real issue is no matter what level of progress
there is, removing someone's license to do something, doesn't
move things along, the Year 2000 crisis, it doesn't help the
global economic situation. So we are where we are, there's a
need to do risk management and contingency planning.
And the final statement in my statement say this problem
and the results of this matter are a matter of choice. We have
a choice to be able to focus on the risks and move to abate
them based on reality in the current position or clear
communication, or we have a choice to ignore them. The largest
companies are taking the choice to move forward and we need the
global encouragement to move this forward on a larger scale.
Chairman Bennett. The global encouragement. So you're not
at all excited about any foreign markets?
Mr. Rubin. What's necessary now, it's hard to use
definitive words here, but you started to hear some of the
testimony about the Joint Council of regulators, pressure is
being put, visibility is given to the issue, whether or not
these folks have a level of visibility, it has to feed into the
scenario analysis. You have to decide country by country,
market by market, what if they're not there, what if they can't
process, what do you do in that case.
This is a storm, you have a forecast, we don't know where
the cells are that are going to hit with dramatic activity, we
can get on the highway and pull out, take your choices, and
those are what everybody is faced with, and those are the
things that have to happen in the global economy of our
financial markets. If the worst will happen, what will you do,
if the best will happen what will you do, because no one really
knows what's going to happen.
Senator Moynihan. Could I ask, Mr. Chairman, since you
mentioned this, would it be imposing to ask Dr. Rubin, could he
give us something in writing about scenario analysis?
Mr. Rubin. I'd be pleased to do that.
Senator Moynihan. It's something you obviously worked at.
Mr. Rubin. Also, I know that the Global 2000 Committee has
published a document on that, so you might be able to request
that from the appropriate resources. I'll be glad to do so.
Senator Moynihan. Your colleague there mentioned the
Gartner Group.
Ms. Beder. Yes.
Senator Moynihan. Do they have a study. Could you provide
the committee with a copy of the Gartner Group report?
Ms. Beder. Certainly.
Mr. Rubin. One of my affiliations is with Gartner Group, so
we'll supply a copy, too. A meta group.
Chairman Bennett. We're in contact with the Gartner Group.
It's located in Connecticut, so that explains it.
Senator Moynihan. Thank you very much, Mr. Chairman, and
thank you for a wonderful, excellent panel.
Chairman Bennett. Let me just, Dr. Rubin, if I could hold
you for just a minute or two more.
Mr. Rubin. My lights are off.
Chairman Bennett. As I say, the lights intimidate the
witnesses, but they mean nothing to senators.
I'd like your reaction and if you have none here, your
reflections, consequently, so you might send us something, on
an issue that I'm only recently becoming aware of, that is, how
long is this going to last after the Year 2000? I focus on the
fact that litigation will go on for decades after the Year
2000, as people sort out the various lawsuits and who's
responsible. In the style of Dickens' Bleak House, there are
lawyers who are planning to spend their entire careers
litigating Year 2000 problems and maybe their children and
grandchildren as well.
But the more I look into it, the more I realize that many
of the remediation efforts that are going forward are in fact
not long-term fixes, they are short-term bridges to get us past
January 1, 2000, so that the firm can continue to operate, but
we'll still require skills and money and effort under that
bridge to see that the debris is cleaned away and things are
made so that they work properly.
Mr. Rubin. There are a few ways this problem could be
looked at. In general, Peter Miller used the word very nicely
about the critical systems of particular companies. He was
taking a look at what companies are getting done. Companies
with good plans are probably on the order of getting 65 to 80
percent of their total systems converted, assuming there's a
subset of their critical systems. That means there may be a
residual equal of 50 percent of their problem to be treated
after the Year 2000.
Other points in the history of computing, systems people
are optimistic. One of the reasons they assumed we wouldn't
have this problem is because people would by new systems, so
the latent demand after this problem, critical systems have to
be addressed, the ones that are needed in a hurry, critical
bridge will have to be addressed, but then the latent demand of
companies for new systems which was forestalled by this crisis
will show up, so it's hard to tell what the ripple effect of
this will be, so people are talking 3 to 5 years, but it will
get diluted by new opportunities and everything else.
Clearly there will be some crossover. You have to
understand in 2005 we will spend on technology in 1 year twice
what the world spend in the 1980's. One year will be worth an
entire decade twice over again, and that will converge with
Year 2000 remediation, cleanup, and we'll start moving off
again.
Chairman Bennett. I somewhat optimistically told Senator
Lott when this committee was created that we would of course be
willing to go out of existence shortly after January of 2000. I
know that there's nothing more permanent than a temporary
government program, but I was hoping we could be the exception.
Now I'm beginning to think that the country, whether Senator
Moynihan or I are involved or not, is going to continue to face
economic consequences for this for literally years after
January 2000. Would you agree with that?
Mr. Rubin. I would say get a technology level cabinet
position. There's no place for technologies in the cabinet, and
it's an integral part of society and business, and this is just
coming from me as a person, but that's why business scrambled
to deal with this. This has no home and technology is an
interwoven fabric of our next millennium.
Chairman Bennett. One of the unknown unknowns, therefore,
is the amount of economic drag that will be created after
January 2000 in terms of slowing down growth, not only in this
country but around the world.
One last question. I'm on a fishing expedition here, but
when I have good witnesses I love to do that.
Mr. Rubin. Thank you.
Chairman Bennett. Do you have any view as to what the
wealth transfer impact of the Year 2000 would be? Let's go back
to the analogy of the oil crisis that occurred in the mid-
'70's. That produced an enormous wealth transfer with the money
going out of Europe and Asia to a lesser extent, but still
significant out of the United States into the pockets of sheiks
and desert principals in the Middle East. It went from there to
banks in Switzerland and some of it to casinos and over time
has been recirculated back into the economy, in the world
economy, but in that immediate period of time, there were
hundreds of billions of dollars that transferred into the
Middle East by virtue of the oil shock.
I suppose it's in your category of unknown unknowns, but I
saw in the Mexico crisis which Senator Dole assigned me to
handle for him, the speed which in today's world that money
came out of Mexico as soon as that crisis developed. It wasn't
a case of people walking through airports with attache cases in
their hands with pieces of paper, it was a couple of key
strokes electronically, and the wealth transfer out of America
could be accomplished in a matter of hours.
Now, have either of you given any thought to what could
happen around the world in terms of foreign investment coming
out of particular economies in a wealth transfer that could
cripple countries?
Mr. Rubin. There's two levels of wealth transfers that are
happening here. When the Year 2000 crisis became recognized,
the global software economy changed. That's where work is done
and how money is papered versus technology. Suddenly the gates
opened up in India and people tried to send work offshore. So
the global distribution of technology work changed in the very
short-term.
This is not exactly the question, but there are a whole
bunch of market dynamics here, because U.S. companies trying to
offload their load started moving work to India, not in a
negative sense, people taking the opportunity to be offshore
suppliers started to fill the void for a labor market and
absorb that, you see that in a couple of these reports.
I would probably refer the financial question to people on
the other panels, but one piece, you can clearly see that in
terms of competitive advantage, from testimony you heard,
global financial services firms that are able to cope with the
problem, able to line up with end to end transaction processing
and do their contingency planning will be in a position to
either absorb work, absorb the financial transactions, move
work to other markets, bypass markets. There's a mobile market
going on, you start to see mergers and acquisitions. What the
market looks like, I don't know, I think it's very insightful.
Two levels, the technology underneath it will move and the
financial markets, so I would refer to other panelists some of
your financial questions.
Ms. Beder. I guess I would tackle it on a different level
and say this is precisely the question that one has to ask if
you are a global institutional investor or a pension fund and
you have a portfolio of all kinds of stocks and bonds that are
supposed to meet your future liability schedules or if you, for
example, are a banking institution who has a portfolio of loans
and other transactions, and I think the whole question is, what
happens to the value of that portfolio, therefore, to the
health of your ability to meet your liabilities, the pension
fund or as a mutual funds in terms of the owners of your shares
or as a bank in terms of your quality, and the simple answer is
there will be a huge wealth transfer, because in each one of
the industries it's probably the case that whoever some of the
leaders are now may stumble and fall and other people will take
the opportunity with Y2K glitches, primarily on a business
continuity level to become new leaders.
Much of that is a wealth transfer within the economy rather
than necessarily across the borders, I believe, and I also
believe that the Y2K impact may be very small, not because
people have felt that Y2K is a reason to pull their money out
of Asia or South America, or frankly a lot of Europe because of
the uncertainty of the European union, because they're doing
that for the economic situation, the uncertainty already, so I
tend to think the wealth transfer will be far more within the
country, but it will be very significant, there will definitely
be banks, pension funds and mutual funds that get into trouble.
Chairman Bennett. Thank you.
Senator Moynihan. Sir, I think we've had a wonderful
morning, and very much thank all the witnesses that came here
with careful statements and I get more concerned about this all
the time. I'm glad your committee is up and running, and this
might be the only thing between us and chaos.
Chairman Bennett. Well, let's hope it is. I say to people,
my fondest dream will be to open a newspaper and it probably
will just be in my home town because no one else would care,
but my fondest dream would be to open a newspaper on say the
5th or 6th of January, 2000 and have an editorial saying
Senator Bennett was an alarmist because look, everything went
smoothly and there are no difficulties, and we should censure
the Senator for having been so excited about something that
turned out to be nothing.
Senator Moynihan. Mr. Chairman, we know things are going to
go well in Salt Lake City. They always go well in Salt Lake
City. Isn't that right? Statistics prove it.
Mr. Rubin. If you'd like it proven, we can arrange it.
Chairman Bennett. I just thought that as the efforts of all
of us on the committee and in the Congress, there will be a
minimum of disruption, but I'm afraid I'm with those who say in
spite of our very best efforts, the unknown unknowns, if
nothing else, and the known unknowns are enough to keep me
worried at night.
I very much appreciate the hearing, I appreciate the
hospitality of the good people of New York, Manhattan, and the
high quality of witnesses, Senator. We thank you for that. The
hearing is adjourned.
[Whereupon, at 12:20 p.m., the committee adjourned.]
A P P E N D I X
______
ALPHABETICAL LISTING AND MATERIAL SUBMITTED
______
Prepared Statement of William A. Bautz
Chairman Bennett, Senator Dodd, Senator Moynihan and Members of the
Committee. I am William A. Bautz, Senior Vice President and Chief
Technology Officer of the New York Stock Exchange (NYSE or Exchange).
Thank you for providing me with this opportunity to discuss the impact
of the Year 2000 computer problem, as well as potential solutions to
address this problem. We view the dimensions of this issue as enormous,
with potentially disastrous global consequences to both business and
government.
As the world's foremost securities market, the NYSE is taking a
leading role in promoting awareness of the Year 2000 computer problem
among our 3,700 listed companies, which include 350 non-U.S. companies;
the securities industry; and other capital markets throughout the
world. We have worked hard to assure that our own systems will be Year
2000 compliant far in advance of the turn of the century. However, as
important as our market is, it is only one, interconnected component of
a global market. Much remains to be done to ensure that all the
international capital market participants are prepared to move smoothly
into the next millennium. Our goal is to ensure that the first day of
the Year 2000--January 3, 2000--will be just another trading day
throughout the world.
At the outset, Mr. Chairman, I would like to commend you and your
colleagues, for fostering public awareness of the Year 2000 problem.
The Special Committee can devote the necessary time and energy to
directly address the problems presented by the Year 2000 and develop
solutions for both government and the private sector to work together
to overcome the challenges of this technological challenge. I would
concur with the recent statements of Dr. Andrew Grove of Intel, that
Congressional oversight hearings play a critical role in raising the
profit of this problem and give heightened urgency to remediation
efforts.
The potential economic impact of the Year 2000 computer problem on
our domestic and international markets is profound. With our world
economy so dependent on computers and technology, we cannot
overestimate the impact if a substantial portion of our automated
systems malfunction--or possibly cease to operate--on January 1, 2000.
Because of the interconnectivity of the world's financial markets,
there is no concept of merely an ``isolated'' problem if a major
market, financial center or market participant is not prepared for the
new century.
The Securities Industry Association (SIA) refers to solving the
Year 2000 computer problem as ``the biggest business-technology effort
that the world has ever experienced.'' Estimates vary on what it will
cost to address the Year 2000 situation. One estimate is that it could
cost from $1.00 to $1.50 per line of code--the equivalent of $500 to
over $1,000 per affected computer program. Such a conversion process
could cost even a medium-sized company over $4 million. Another
estimate places the cost on business and the public sector in the
United States at $100-$200 billion and the worldwide total at $600
billion. These estimates constantly are being revised upwards.
nyse efforts to address the year 2000 computer problem
At the NYSE, we are addressing the Year 2000 issue on multiple
levels, beginning with the direct impact of this issue on the NYSE
itself, and extending to the international capital markets; our member
firms, for whom we have oversight responsibility; and our listed
companies, which include a dominant share of the world's major
corporations. These multiple levels of response are necessary because
we are part of global industry that can best address the year 2000
jointly--through collaboration and information exchange. After
discussing our activities on each level, I will conclude by offering
our perspective on the role of government.
the nyse and the securities industry automation corporation (siac)
The NYSE first made addressing our own Year 2000 issue an Exchange
priority in 1996. At that time, we designated our data-processing
subsidiary, SIAC, as coordinator of our efforts to address the issue.
SIAC has responsibility for addressing our mission-critical trading and
regulatory systems, while we are handling internally our administrative
systems. I am personally responsible for our internal Year 2000
compliance efforts and for coordinating these efforts with SIAC.
Our preparations have progressed as we have introduced new
technology and taken a range of other readiness measures. Over the last
decade, the NYSE invested more than $1.5 billion in new technology to
provide for greater capacity or to install next-generation hardware and
software. As we implemented this new technology, we made many of our
necessary Year 2000 changes. Most of this technology is complete,
tested and in operation. The remaining portions will be finished by the
middle of this year. As to other systems, we have a comprehensive
program to fix, repair or retire non-compliant systems. We currently
are on schedule to have our mission-critical systems in production by
December 31, 1998.
We estimate that our cost to achieve Year 2000 compliance will be
approximately $20 million. However, this is only the ``direct'' cost,
and does not include any of the overall costs of our technology
upgrade. In large part, our $1 billion investment over the last decade
has provided us with the ability to address this problem at an early
date and to reduce our total cost in achieving compliance.
Installing Year 2000-compliant systems is only one step in the
process. Equally important is proper testing of our systems. We
constantly test our new systems internally, and we test the software
and hardware that our vendors provide us. Following this internal
testing, our next step is to test with our member firms and the rest of
the investment community. Our testing program includes connectivity
testing with our member firms, end-to-end functional tests with our
industry partners, the SEC and the Depository Trust Corporation, and
participation in the industry beta test sponsored by the SIA in July
1998. In this regard, we have already begun testing between ourselves
and individual member firms, and our testing program will continue
throughout this year and all of 1999.
The next significant step in the testing process will be ``beta
testing,'' which is scheduled for July of this year. Under the
leadership of the Securities Industry Association, the beta testing
will consist of 15 to 20 member firms and all the securities markets.
Not only will this test cover all products, it also will cover all
aspects of the trade-processing system, from order entry to clearance
and settlement. The test will simulate trade-processing for four
trading days from December 29, 1999 through the first trading day of
January 2000. The beta test will check both the NYSE and member-firm
systems for programming bugs, while also verifying that the test itself
is effective.
Following the beta testing, we plan to participate in industry-wide
testing in 1999. By this time, all of our systems should be Year 2000
compliant. This round of testing will include all our member firms, all
U.S. markets and all securities industry utilities. We will conduct
these tests on weekends, with all participants in the testing using
Year 2000-compliant production platforms. The first of these industry-
wide tests is scheduled for March 1999.
international capital markets
The NYSE is working on a number of different fronts with
international industry organizations to address Year 2000 issues. In
October 1997, Edward Kwalwasser, Group Executive Vice President of the
NYSE, presented a memo detailing Year 2000 issues to the regulatory
subcommittee of the International Federation of Stock Exchanges (FIBV),
and also distributed a copy of a proposed survey designed to help the
FIBV collect relevant data from its members. These documents were
subsequently assigned to the technology subcommittee of the FIBV.
The NYSE, acting in close collaboration with the SIA, has also
raised Year 2000 issues with the International Organization of
Securities Commissions (IOSCO), where Mr. Kwalwasser serves as chair of
the Year 2000 subcommittee. Following presentations at IOSCO's general
meeting in Taipei in November 1997, a member survey was provided to the
subcommittee's vice chairs for Europe, Asia and South America. A copy
of the survey was also made available to the Canadian Dealers
Association.
Earlier this year, the Bank for International Settlements (BIS),
jointly with the Basle Committee on Banking Supervision, the Committee
on Payment and Settlement System, the International Association of
Insurance Supervisors and the International Organization of Securities
Commissions, sponsored a global roundtable on the Year 2000. Their
discussions confirmed that the Year 2000 issue must remain a top
priority of senior management and that public and private bodies should
coordinate their focus on issues and approaches.
The sponsors recognized the complexity of the issue and recommended
that financial market supervisors around the world implement programs
to coordinate Year 2000 readiness. To provide greater market
transparency, they called on all market participants to share critical
information and they formed a ``Joint Year 2000 Council,'' comprised of
senior members of each organization to coordinate their efforts. These
efforts include strengthening and widening of external testing
programs; improving information sharing among market participants,
their vendors and service providers; establishing market conventions
and procedures for dealing with potential contingencies; and
reinforcing the role of oversight bodies such as supervisors and
auditors.
nyse member firms
More than 300 of the nation's broker-dealers that deal with the
public are NYSE member firms, for which we have primary oversight
responsibility as their ``designated examining authority'' (``DEA'').
These broker-dealers carry and clear transactions for approximately 91
percent of all customer accounts maintained by U.S. registered broker-
dealers. We have woven Year 2000 compliance into our surveillance and
examination program for these firms. As part of our monitoring process,
we have created an internal Year 2000 surveillance committee to
coordinate our relevant surveillance and examination efforts. NYSE
member firm regulation staff members contact each of our member firms
quarterly regarding the member firm's Year 2000 compliance efforts. In
addition, we include Year 2000 readiness as part of our annual
financial and operational examinations. Our efforts are focused on
trying to ensure that our member firms are prepared for the industry-
wide testing scheduled for early 1999.
Last May, we sent a memo to our member firms on the Year 2000
problem. In that memo, we advised each firm that it should designate a
senior official as having responsibility to oversee the firm's Year
2000 project. We further advised the firm that it should identify the
scope of its Year 2000 problem and that it should allocate the people,
time, and money necessary to address the problem. The memo stated that,
realistically, the Year 2000 project should have a target completion
date of December 1998, with 1999 available for system testing and
adjustments.
Our May 1997 memo also asked member firms to complete a survey
regarding their Year 2000 plans in an effort to determine their
preparedness. While we generally were pleased with the results of the
survey, we identified a few firms that needed to focus more closely on
this problem. In late 1997 we conducted a second survey to determine
the readiness of vendors, correspondent brokers and other third parties
that interface with NYSE member firms. In reviewing the responses to
this survey, Exchange staff noted some minor problems, which staff
members have discussed with member firms.
The Exchange has used these two surveys to establish generic
milestones. As part of the quarterly discussions with member firms,
Exchange staff discuss the firms' progress towards meeting these
milestones. These discussions also include updates on the milestones
the firms themselves have established, as reported in the first survey.
Once a firm indicates that it is Year 2000 compliant, the Exchange will
request a written confirmation of that fact from the firm's chief
executive officer.
The SEC also is currently considering on an expedited basis a
proposed change to its record-keeping rules to require broker-dealers
with $100,000 or more in net capital to file two reports on Year 2000
readiness. These reports would cover such areas as the broker-dealer's
plans to address the issue, the progress in meeting those plans and any
contingency plans for any problems that may arise. The NYSE welcomes
this effort, which will provide yet another surveillance and compliance
tool.
NYSE member firms would need to file these reports both with the
SEC and with the Exchange, as the broker-dealer's DEA. The first report
would be due 45 days following adoption of the rule amendment and the
second report would be due within 90 days of the broker-dealer's 1998
fiscal year-end financial statements. The SEC would require a broker-
dealer's public accountant to file an attestation with the second
report giving the auditor's opinion as to whether there is a reasonable
basis for the broker-dealer's assertions in that report.
These reports will provide both us and the SEC with comprehensive
information on Year 2000 compliance efforts. In addition, the
requirement for two reports will provide a basis to judge the progress
of broker-dealers in developing and implementing Year 2000 compliance
programs. If the SEC adopts these rule amendments, the NYSE will be
coordinating closely with the SEC and the other DEA's to implement the
reporting requirements.
the securities industry
The SIA has taken a leadership role in efforts to achieve Year 2000
readiness in the securities industry generally, working not only with
the NYSE and our member firms, but also with all the securities
markets, broker-dealers, vendors and other service providers. With the
support of the NYSE, the SIA has organized conferences and seminars
around the country to educate market participants on the problem and to
keep the industry informed about the latest developments in the area,
including testing schedules.
Under the auspices of a Year 2000 steering committee, which
includes senior industry members such as Robert Britz, Group Executive
Vice President of the NYSE, the SIA has established numerous working
committees to address specific aspects of the problem. These committees
include groups focusing on, among other things, data management,
testing, exchanges and utilities, third-party vendors, legal and
regulatory issues and international issues. The SIA has also formed an
international group to promote Year 2000 readiness in other countries,
where this issue may not have the same high priority as it does in the
United States. Other issues, such as preparing for the conversion to
the ``Euro'' currency, may be crowding the agendas in other markets.
The SIA subcommittees meet regularly, both in full committee and in
focus groups. These committees have been pivotal in moving the industry
towards Year 2000 readiness. Information on these committees, including
meeting schedules and minutes of past meetings, are publicly available
on the World Wide Web, which serves as a valuable source of industry
information on the problem.
The discipline of this coordinated approach to addressing the Year
2000 problem demonstrates how an industry can work together to achieve
a common goal. As was mentioned above, this approach is also being
brought increasingly to the international level.
nyse listed companies
As to listed companies, in addition to holding several hearings on
this issue, Senator Bennett has introduced S. 1518, which would require
publicly traded companies to disclose their Year 2000 progress in their
annual Form 10-K filings with the SEC. Last year, the NYSE brought
together the SEC and representatives of our listed companies to discuss
this legislation, as well as the broader issue of correcting the Year
2000 problem. We have continued to work closely with the SEC's Division
of Corporation Finance and its director, Brian Lane, to ensure that our
listed companies receive and understand the division's staff bulletins
on this issue. Our listed companies need to appreciate that Year 2000
remediation is likely to be material to their businesses, and that they
should disclose to their shareholders and customers their progress in
the conversion process.
In this regard, the SEC staff has issued Staff Legal Bulletin No. 5
on Year 2000 disclosure. The bulletin reminds public companies and
other SEC registrants that they must consider disclosure regarding
costs, problems and uncertainties associated with the Year 2000. The
staff originally issued the bulletin in October 1997, and revised it in
January of this year, emphasizing that if a company has not made an
assessment of its Year 2000 issues--or has not yet even determined
whether it has material Year 2000 issues--the disclosure of that known
uncertainty is required.
The discipline of preparing disclosure material on the Year 2000
problem will help focus a company on the steps it needs to take to
address the problem. Analysts, shareholders, customers, and competitors
will review these disclosures, and the marketplace will help determine
whether a company is adequately addressing this area. Failure to take
the necessary steps will result not only in potentially harmful
consequences when we turn the calendar at the end of December 1999 (if
not before), but it will also adversely affect a company's stock price
and customer base if the market judges that it is not devoting the
necessary time and resources to this project.
the role of government
Even with the current attention to addressing the Year 2000
problem, we recognize that this is an area that the private sector
cannot address alone. As noted above, the SEC has addressed this area
both with respect to disclosure by public companies and through its
oversight of participants in the securities industry.
In addition, government performs a vital task by calling attention
to the problem and reinforcing the need for prompt action in both the
public and private sectors. In particular, hearings such as these
surface important issues that require coordinated effort to resolve. We
commend the leadership of Senate Majority Leader Trent Lott for
creating this Special Committee to address the Year 2000 Technology
Problem. We commend the efforts of the Special Committee and its
Chairman, Senator Bennett. We also applaud President Clinton for
creating a Year 2000 task force to oversee the federal government's
Year 2000 conversion progress. The creation of this task force and the
requirement that cabinet secretaries respond to the President's
inquiries about the progress of cabinet departments and federal
agencies will help ensure that the federal government is able to cross
the bridge into the next millennium.
Thank you for the opportunity to present this testimony.
__________
Prepared Statement of Tanya Styblo Beder
Chairman Bennett, Senator Moynihan and Members of the Special
Committee: I am pleased to appear today to discuss the progress of
financial firms--both foreign and domestic--in managing the Y2K problem
as part of the Special Committee's consideration of this topic. My name
is Tanya Styblo Beder and at present I am a senior partner and one of
the original founders of Capital Market Risk Advisors, a firm
specializing in independent risk assessment, valuation and risk
oversight implementation for all types of financial, operational and
strategic risk. CMRA's clients include banks, broker-dealers, insurance
companies, pension funds, mutual funds, hedge funds, thrifts and credit
unions, custodians, corporations, rating agencies and financial
software firms in the United States, Europe, Asia, Australia and New
Zealand, Mexico and Canada. CMRA's work is both reactive and proactive:
For example, we assess and contain existing risk problems that cause
firms to bleed money, as well as evaluate and implement programs to
manage both current and future exposures related to market risk, credit
risk, operational risk, derivatives risk, and model risk.
My testimony today represents my personal views, based on my
experience with financial institutions around the world since the late
1970's. My opening remarks will summarize my detailed statement. I now
ask that my detailed statement be entered into the record.
general findings
Y2K is the most crucial issue facing every financial institution in
the United States, and one of the top two or three issues facing
institutions in other countries around the world. With only 18 months
to the turn of the century, I feel that financial institutions and the
global systems that process their transactions around the world are far
from compliant. Nonetheless I do not join those who predict a huge
global recession or prolonged mayhem in the financial markets. This is
not a small statement for me to make, for as recently as a year ago I
was very much afraid that Y2K would bring dire consequences to the
financial sector. My fledgling optimism for financial firms in the
United States is based on my observations of increasing momentum to
implement contingency plans that lower risk during the critical period.
Y2K is big, pervasive and global. Because information is a such
vital resource for the U.S. economy, the potential impact on
individuals and public and private entities compares to that of the
asbestos and oil crises over the past 25 years. Spending to solve the
technological aspects is expected to run as high as $600 billion, and
the cost of business continuity issues--interruptions due to Y2K--is
estimated as high as $1 trillion. The total spending necessary to deal
with Y2K will exceed the amount the U.S. spent, adjusting for
inflation, fighting the Vietnam Conflict ($500 billion) but with luck
will not reach the amount spent to win World War II ($4.2 trillion).
Analyzing Y2K is like peeling an endless onion--each layer of
issues leads to another layer, often involving greater degrees of
interdependence between players in all three facets of the economy--
financial firms, non-financial firms and the public sector. As an
example, consider a bank. It is one thing to Y2K-proof the PC on each
employee's desk. It is quite another to determine how each credit in a
global loan portfolio, plus each counterparty credit in a multi-
trillion dollar derivatives market, will be impacted either directly by
Y2K or indirectly via exposures to others.
While a great deal remains to be done, my recent review of dozens
of key market players--including banks, broker-dealers, pension funds,
mutual funds, custodians and corporations in major capital markets
around the world--indicates an increase in the amounts of resources
devoted to Y2K technology issues as well as to business continuity
issues. For most large firms, the Y2K hot spots, both pre- and post-
millennium, are better defined than 1 year ago. Battle plans of
individual institutions have evolved along three primary dimensions:
--1. Y2K exposures under the firm's control
--2. Y2K exposures to others
--3. Contingency plans for Y2K exposures outside the firm's control
In general, large and medium-size financial firms in the United
States and Australia have analyzed and are on track to address Y2K
exposures under their control. Examples of exposures under a firm's
control include internal systems such as PC's and mainframes; embedded
system devices such as elevators and security systems; business
processes such as settlement/clearing activities or the issuance of
pension or annuity checks; and computer code.
Many large financial firms, both domestic and foreign, in the
United States and Australia are now conducting or are close to
conducting Y2K tests of their corrected internal systems. This is done
by rolling the clock forward to 15 or so key dates--including the
Millennium--at institutions' back up and recovery sites, or on-site
using parallel equipment. This leaves 12 months or so for large
institutions to address problems that arise.
As for Y2K exposures to others, large financial firms in the United
States and Australia also are reviewing in detail their exposures to
counterparties in financial transactions (including their loan and
investment portfolios) and to their supply chain. Firms typically
conduct the review of outside vendors via survey or questionnaire and
are aware of their reliance on the representations of others. According
to the GartnerGroup, typically only 25 percent of the surveys are
returned with response information, and fewer than 10 percent of those
returned are accurate.
This disappointing news from vendors has moved banks to consider
implementing financial transactions designed to reduce exposures--and
particularly cash flows--from the December 1999 through March 2000
period. Examples are contingency plans that envision completing year-
end portfolio trades by December 15th 1999; amending loans or entering
derivatives with customers and counterparties to move cash flows out of
the December to March period; and contingency planning for malfunctions
in the wire transfer, settlement, credit card, ATM, and other critical
systems.
Although preparations are well underway in the United States and
Australia, the story is quite different in other countries. Regulators
around the world continue to encourage and demand Y2K efforts by
financial firms, but there is wide agreement that financial firms in
Asia are far more concerned with whether they survive until 2000--an
issue we have named ``If 2K''--rather than Y2K systems issues. Moody's
recently reported that 49 major Japanese banks planned to spend $249
million as a group on Y2K compliance. This amount is only a fraction of
Citicorp's planned $600 million program, and only equal to Chase's
planned $250 million.
Financial firms in Europe are so absorbed by the systems challenges
posed by European Monetary Union that non-EMU projects, including Y2K
conversions, are commonly suspended or postponed. A parallel situation
exists in the United States, with some firms so absorbed by the systems
challenges of Y2K that they have placed moratoriums on non-Y2K
projects, such as dealing with a single currency in Europe. This will
have ramifications for our financial system in the future.
The Brazilian financial sector is slow--fewer than one-third of the
banks have started systems conversions. As in Asia, South America is
more concerned with economic health than Y2K. Russia and Eastern Europe
is a financial black hole, especially given the significant variation
in regulatory oversight.
There is, however, some good news to report. In the United States,
financial firms are using good old-fashioned prudence to manage their
risk. They continue to reduce their exposures to the financial firms in
Asia and Europe either through selling the assets they hold, or via
some combination of financial transaction amendments and derivatives.
In Europe, the happy news is that EMU conversion poses systems
challenges similar to Y2K conversion, hopefully shortening the time
that will be required to attain Y2K compliance.
conclusions
The dire situation in many Asian countries and implementation of
European Monetary Union will keep Y2K a low priority, as these markets
experience some of the largest wealth transfers of all time. U.S.
financial firms are focused on reducing not only their exposures to
Asia and Europe, but also to public sector and middle market entities
within the United States. The creation of contingency plans that remove
cash flows from the critical Millennium period are prudent measures
that are the basis of my fledgling optimism as to the risk of Y2K
exposure of U.S. financial firms.
In closing, I offer eight areas that keep Y2K chiefs up at night,
and merit focus by The Special Committee on the Year 2000 Technology
Problem:
--1. Telecommunications and Energy.--Most large financial firms
conduct 80 percent of their transactions electronically, and 25
percent or more of their transactions in the inter-bank market.
To summarize the remarks by many Y2K chiefs in this area, ``we
don't have a clue:'' this leads me to conclude that reliability
on telecommunications is a Y2K wildcard. More than 80 percent
of telecommunications managers in British firms polled in
February said they feared a ``large'' risk from the millennium
bug. The deregulation of industries such as communications and
utilities has diverted significant attention from operating
issues, making them slow to address millennium questions.
--2. Exposure to the middle market.--If a company cannot deliver its
product because key suppliers cannot deliver, or because key
customers cannot complete purchases, the financial consequences
are significant. Companies in the Fortune 500 plan to spend an
estimated $11 billion on Y2K fixes (including $3.5 billion by
the largest financial firms) and are focused seriously on
business continuity. The GartnerGroup Study of 6,000 companies
in 47 countries indicated that 30 percent of all companies and
governments have not started on Year 2000 compliance efforts,
but that 88 percent of the laggards were companies with fewer
than 2,000 employees. Small companies are more likely to be
able to operate manually and to be able to manage their full
supply chain in a crisis. But middle market companies are
likely too complex to operate manually, and probably have not
devoted sufficient resources to Y2K, and so are another
wildcard. Some analysts predict that up to 20 percent of middle
market companies will have problems with Y2K, leading to
significant increases in bankruptcies of currently healthy
firms. Of particular concern in the financial sector are
regional U.S. banks that control about 20 percent of U.S.
banking assets, and regional insurers who supply coverage for
30 percent of Americans.
--3. Information sharing.--Even though a great many Y2K problems have
been solved, information sharing among parties who stand to
benefit from others' knowledge is hampered by the fear of
litigation. During my review, several Y2K chiefs commented ``we
are happy to discuss Y2K, however under legal advice there will
be issues that we will not be able to discuss, at least not on
the record.'' Future litigation costs surrounding Y2K are
estimated to range between $1 trillion and $4 trillion--an
amount over and above the $1.6 trillion estimate I mentioned
earlier for technology fixes and direct business losses.
Perhaps a wartime-type profiteering limitation should be
considered for litigation costs, or maximum allowable damage
levels, in order to promote the sharing of information.
--4. Model risk.--Moratoriums on systems projects outside of Y2K or
EMU have caused some financial firms to postpone critical
reviews and updates of their other financial models. This
inadvertent neglect creates a potential time bombs for the
future. Examples of recent ``model losses'' are those reported
by Bank of Tokyo-Mitsubishi, NatWest, and Swiss Bank in their
derivatives books. Future model losses are also likely to be
driven by changes in credit spreads, correlations and
volatilities driven by changes in relationships among
currencies and interest rates and realities in the aftermath of
the Asian crisis, EMU and Y2K.
--5. Fraud.--An additional concern for many Y2K chiefs is the
potential for fraud. Some firms have corrected hundreds of
millions of lines of code, using automated software sniffers
versus manual intervention. Those who have relied on manual
code correction are more susceptible to fraudulent transfers or
other sabotage that may cause harm at future dates. Given the
pressure of completing the Y2K fixes, few firms have the luxury
of checking each manual change to their source code or other
software.
--6. Data issues in rolling the clock forward during Y2K testing.--
The question to pose is ``How robust are the tests?'' The
practice of rolling the clock forward to test key dates--
including the Millennium--requires far more than changing the
date in a computer. The asset, liability and transactions data
for the firm must be rolled forward as well, or the tests may
not fully test a future transaction and thus give a false sense
of security.
--7. Impact of mergers and acquisitions.--The continued global
consolidation of financial firms poses ongoing challenges to
established Y2K programs. In the United States alone, 72
percent of the banks have had their computing systems impacted
by a recent merger or acquisition. The challenge to managers
and regulators is significant--a good pre-merger report card
may be invalidated by disparities in systems in the combined
entity.
--8. Liquidity.--38 percent of IT professionals say they may withdraw
personal assets from banks and investment companies just prior
to the Millenium, to protect their personal finances from year
2000 failures. If financial institutions implement contingency
plans that prevent preclude use of electronic systems, and
consumers thus have to withdraw extra cash to avoid the risk of
credit card and ATM failures--for example, to cover their
holiday spending in December 1999--how much additional
liquidity will the banking system need?
Thank you. I welcome any questions you may have.
__________
Prepared Statement of Chairman Robert F. Bennett
Good morning and welcome to the second hearing of the Senate
Special Committee on the Year 2000 Technology Problem. I want to thank
Senator Moynihan for inviting us to hold this hearing in New York City,
the international financial center and a most appropriate venue for a
hearing in which we will examine the Year 2000 readiness of the
financial services industry from a global perspective.
In my role as Chairman of the Senate Banking Committee's
Subcommittee on Financial Services and Technology, I have examined the
Year 2000 preparedness of the financial services industry for more than
a year. Throughout this process, one message has come across clearly
and consistently. While representatives of the financial services
industry in the United States are cautiously optimistic about their own
remediation efforts, international Year 2000 preparedness presents a
significant wildcard. The United States financial services industry is
privy to little specific information about the Year 2000 preparedness
of foreign countries and has yet to fully consider and plan for the
possible consequences if there are widespread systems failures
overseas.
It should be clear to everyone in this country that our economy has
become a global economy. The concern over the current economic crisis
in Asia illustrates how U.S. companies can be vulnerable to economic
downturns overseas. The financial services industry is particularly
vulnerable in this environment. American financial institutions deal
with their international counterparts virtually every minute of the day
as they settle transactions, execute currency trades, and operate
offices throughout the world. Americans have invested significantly in
foreign stocks, primarily through investment funds, and the stocks of
American companies are traded at all hours of the day and night in
markets throughout the world.
Given this high level of interaction, it is not surprising to hear
witnesses testify, as they have before the banking committee, that any
significant computer systems failure abroad could have a devastating
impact in the United States. What we have not heard, however, is what
this country plans to do to manage those risks. We have called this
hearing to begin to assess the Year 2000 preparedness of foreign
countries and determine just where and how the United States may be
vulnerable. It is no longer sufficient to discuss the international
risk generally, we must identify the specific risks, do what we can to
solve the problems, and develop and implement contingency plans for the
inevitable failures.
__________
Prepared Statement of Richard R. Lindsey
I appreciate the opportunity to testify on behalf of the Securities
and Exchange Commission (Commission or SEC) to express its views on the
readiness of the securities industry and publicly held companies to
meet the information processing challenges presented by the Year 2000.
It has become clear to American business--and American regulators--
that most of the world's computer systems must be modified before the
new millennium. This poses an especially great challenge for the U.S.
securities industry for three reasons. First, the industry is enormous.
Currently, there are over 1,100 investment company complexes, 8,300
registered broker-dealers, 1,248 transfer agents, and 24 self-
regulatory organizations (SROs), including securities exchanges, the
National Association of Securities Dealers, Inc. (NASD), and clearing
agencies. Second, the industry relies heavily on computerized
information processing technology. Third, industry participants are
highly interconnected both within the United States and across
international borders.
These three factors combined underscore the need for the U.S.
securities industry to properly assess the extent of the Year 2000
problem, to correct (or remediate) systems that are not compliant, and
to engage in coordinated testing of those systems. A failure by the
industry to do these things could endanger the nation's capital
markets, as well as the safety of investor assets.
Last month, the Commission staff submitted its second report
requested by Congressman Dingell on the progress made by the securities
industry and public companies toward meeting the information processing
challenges of the Year 2000.\1\ This testimony outlines the Commission
staff's findings, which are described in further detail in the SEC
Staff Report. Based on the information we have received so far, the SEC
believes the securities industry is making substantial progress towards
addressing potential systemic risks to the U.S. financial services
system as a result of the Year 2000 technology challenge. We also
anticipate that upcoming industry testing will provide a clearer
picture.
---------------------------------------------------------------------------
\1\ See Second Report on the Readiness of the Securities Industry
and Public Companies to Meet the Information Processing Challenges of
the Year 2000, SEC Staff Report, June 1998.
---------------------------------------------------------------------------
i. industry progress toward meeting year 2000 goals
Like any business problem, addressing the problem of Year 2000
compliance in the U.S. securities industry involves several steps.
Industry participants must first become aware of the problem and assess
how best to address their compliance needs. The problem must then be
corrected, or remediated. Remediation, however, requires testing to
ensure that it is complete and will be effective. Finally, industry
participants must develop contingency plans in order to respond quickly
to unforeseen problems as they arise.
A. Awareness and assessment
Throughout 1996 and early 1997, the Commission focused on raising
awareness of the Year 2000 problem throughout the securities industry
and the need to address it. Through speeches, direct outreach to
regulated entities, inspections, and examinations, the Commission
encouraged the industry to develop Year 2000 plans and to adequately
budget for them. In October 1997, Chairman Levitt sent a letter to
every broker-dealer and non-bank transfer agent in the United States
urging them to take the Year 2000 problem seriously and to address it
on a timely basis. In November 1997, he sent a similar letter to every
registered investment adviser.
The Commission is confident that the securities industry is aware
of both the scope and nature of the Year 2000 problem. We have been
pushing hard to ensure that the entire industry appreciates the full
magnitude of the difficulties that will occur if all industry
participants do not take immediate steps to implement a Year 2000
compliance program. We have stressed how important it is to the
industry to be Year 2000 compliant on time and will have no tolerance
for laggards.
B. Remediation
During the past year, the Commission has shifted its focus from
educating members of the industry to monitoring their progress in
solving the problem. Progress is monitored through direct oversight and
examinations, as well as through collaboration with SROs and industry
groups. Most of the Commission's information to date has come from
self-reporting by industry participants. We believe, however, that we
have developed a meaningful picture of Year 2000 progress in the
securities industry.
C. Industry-wide testing
The Year 2000 remediation efforts for the securities industry are
complicated by the large number of participants and by the
extraordinary interdependence that exists among almost all of those
participants. Broker-dealers, exchanges, clearing organizations,
depositories, transfer agents, banks, and suppliers of market
information, among others, must all exchange, process, balance, confirm
and settle millions of transactions every trading day.
Each firm individually can prepare its own systems for the Year
2000, but no one can say with certainty how these systems will perform
when interconnected. Thus, integrated testing among participants in a
Year 2000 environment that simulates as many aspects of a normal
trading day as possible is the only meaningful way to reduce the risks
of failure to the lowest possible level. Recognizing this, the SIA has
taken a strong, proactive lead in organizing industry efforts.
In 1996, the securities industry, led by the SIA, established an
ambitious Year 2000 completion schedule. Under this schedule, all
exchanges and clearing agencies, member firms, and participants are
expected to have completed remediation, testing, and implementation of
their systems by December 1998. The SIA has formed a number of
committees to address key elements of the Year 2000 problem, such as
industry-wide testing, third-party software, data provider interfaces,
legal and regulatory issues, and exchange and utility testing strategy
and schedules.
During 1996 and 1997, the SIA developed working groups to develop
test scripts and plans for different product groups (e.g., equities,
mutual funds, mortgage-backed securities, etc.). This division is
essential since each product has its own unique trading characteristics
and processing cycle. The products that make up the SIA test program
include equities, listed options, municipal bonds, corporate bonds,
unit investment trusts, mutual funds, futures, asset-backed securities,
and U.S. government securities. For each product group, there is a
separate set of participants, test plans, test dates, and test scripts.
The SIA's program addresses four specific aspects of Year 2000
preparation and testing: (1) coordinating the testing of the exchanges,
clearing corporations, and depositories; (2) identifying vendor
compliance problems; (3) defining a test schedule for data feeds; and
(4) implementing the industry-wide test program.
Preliminary testing for equities is scheduled to begin this month.
When testing begins, over two dozen firms will initiate ``end-to-end''
testing for trading in equities, options, municipal bonds, corporate
bonds, unit investment trusts, and mutual funds. Tests for other
product groups will take place later this year and firms will also be
conducting bilateral tests with their counterparties. Participation in
industry-wide testing will be opened to the remainder of the industry
in March 1999. The primary focus of the industry-wide testing will be
on the industry's more than 300 clearing broker-dealers, since it is
those firms that must secure and assume financial responsibility for
every trade executed in the market. Testing will not only indicate how
well the industry is prepared for Year 2000, but also will help
identify potential trouble spots where contingency plans will be
needed.
Because the securities industry relies heavily on unregulated
third-party vendors, it is important that they also be included in
testing. Third-party vendors provide software, hardware, system
maintenance, information, and services that link markets, broker-
dealers, and customers together. Regulated entities using these vendors
do not control how vendors choose to address the Year 2000 problem, yet
are responsible for ensuring the integrity of their own operations
after January 1, 2000. The substantial use of third-party vendors by
regulated market participants further complicates the Year 2000 problem
and makes their inclusion in testing critical.
At this time, it is difficult to quantify how prepared third-party
vendors are for Year 2000. The SEC staff and the industry have been
working closely with these vendors, however, to minimize potential
problems. As part of the Commission's contingency planning process, the
Commission staff has also begun to compile a Contingency Contact List,
which will include the names, numbers, and areas of expertise of Year
2000 personnel at major vendors.
D. Contingency planning
No matter how much progress the industry makes in addressing the
Year 2000 challenge, it is virtually certain that some problems will
not be discovered or will not be remediated in time. It is, therefore,
imperative that the industry engage in contingency planning both to
minimize disruptions and to correct them quickly as they occur. To help
oversee this effort, the Commission is participating in various
government and industry contingency planning initiatives.
For example, the Commission staff participates in the Contingency
Planning Working Group, which is jointly sponsored by the Federal
Reserve Bank of New York, the SIA, and the New York Clearing House.
Other participants include SRO's, broker-dealers, banks, regulators,
vendors, and industry groups. The Contingency Planning Working Group
was formed to share information on the industry's Year 2000 compliance
efforts and to address potential system risk implications. While the
focus of this group is principally on the U.S. domestic market, it also
intends to identify cross-border issues and determine whether these
issues are being addressed.
The Commission is also working with other financial regulators to
establish contingency plans. Under the leadership of the SEC, the Year
2000 subgroup of the President's Working Group on Financial Markets is
focused on contingency planning issues. Each SRO is also working on
comprehensive Year 2000 contingency plans. In addition, the SEC is
developing its own contingency plans.
E. Progress of SEC-regulated entities
Today, a meaningful picture of Year 2000 progress in the securities
industry is beginning to emerge. The picture shows that progress is,
indeed, being made.
1. Self-regulatory organizations
SRO's include the nation's securities exchanges, its clearing
agencies, and the NASD. SRO's play a key role in both operating the
nation's securities markets and in overseeing the companies and
individuals who participate in those markets.
Since 1996, the Commission staff has conducted four surveys of the
SROs' Year 2000 efforts. The most recent survey requested: (1) a
narrative description of what each SRO was doing to ensure Year 2000
progress; (2) numerical data regarding those systems critical to
ongoing operations; (3) a description of any problems in meeting time
schedules; and (4) a discussion of their contingency planning
efforts.\2\
---------------------------------------------------------------------------
\2\ The staff requested that the SROs adopt the Office of
Management and Budget reporting format to report the progress made in
moving those systems through the various phases of achieving Year 2000
compliance.
---------------------------------------------------------------------------
The information gathered to date indicates that the SROs are on
schedule to be compliant on time. All SROs have completed the awareness
and assessment phases of the Year 2000 process, and are far enough
along in the remediation process to begin the first phase of industry
testing, which is scheduled to begin later this month. The progress of
the SROs is summarized in the following tables. The first table
addresses securities exchanges and the NASD; the second addresses
clearing agencies.
STATUS OF EXCHANGE AND NASD MISSION-CRITICAL SYSTEMS BEING REPAIRED
----------------------------------------------------------------------------------------------------------------
Assessment Remediation Testing Implementation
----------------------------------------------------------------------------------------------------------------
Milestone to be completed....... Mar. 1998........ Nov. 1998....... Nov. 1998....... Dec. 1998
Percent completed as of May 15.. 99.2 \1\......... 73.1............ 51.7............ 26.0
----------------------------------------------------------------------------------------------------------------
\1\ As of the date of this testimony, the assessment phase has been completed for 100 percent of exchange and
NASD mission-critical systems.
STATUS OF CLEARING AGENCY MISSION-CRITICAL SYSTEMS BEING REPAIRED
----------------------------------------------------------------------------------------------------------------
Assessment Remediation Testing Implementation
----------------------------------------------------------------------------------------------------------------
Milestone to be completed....... Jan. 1998........ Sept. 1998...... Dec. 1998....... Dec. 1998
Percent completed as of May 15.. 100.0............ 83.6............ 62.9............ 28.6
----------------------------------------------------------------------------------------------------------------
The staff believes that the SROs have made substantial progress,
and plans to continue monitoring their efforts closely. The staff will
also continue to monitor the SRO membership inspection and surveillance
programs to ensure that they continue to vigorously address the Year
2000 compliance of their members.
2. Broker-dealers
Broker-dealers are the primary intermediaries between investors and
the securities markets. They are at the heart of trading in our
markets. For that reason, we have made it very clear to broker-dealers
that Year 2000 failures will have severe consequences. For example, the
Commission staff has advised broker-dealers that any broker-dealer that
cannot maintain accurate books and records due to Year 2000 problems
could be in violation of the Commission's books and records rules.\3\
Similarly, any broker-dealer that is unable to determine its net
capital requirements or the amount of customer assets in its possession
due to Year 2000 problems could become subject to Commission action,
which could result in closure of the firm and the transfer of its
customer accounts to another broker-dealer.
---------------------------------------------------------------------------
\3\ Securities Exchange Act Rule 17a-3. See also Securities
Exchange Act Rel. No. 39724 (Mar. 5, 1998), 63 FR 12056 (Mar. 12,
1998).
---------------------------------------------------------------------------
Under the U.S. system of self-regulation, the primary oversight
responsibility for broker-dealers resides with the SROs. To monitor
broker-dealer compliance efforts, the SEC has been working closely with
both the NASD and the New York Stock Exchange (NYSE). Earlier this
year, the NASD mailed surveys to more than 5,500 member firms to
evaluate their level of preparedness for Year 2000. The NYSE also
surveyed its members regarding Year 2000 efforts.\4\ Results of the SRO
surveys confirmed the expected--significant but uneven progress in the
broker-dealer community.
---------------------------------------------------------------------------
\4\ Broker-dealer members who are members of both the NASD and NYSE
were permitted to respond to the NYSE survey only. Therefore, NASD
survey efforts target its 5,238 ``designated members.'' As of June 4,
1998, 5,080 member firms had responded to the NASD survey. A total of
306 responses representing 327 broker-dealers were received in response
to the NYSE survey.
---------------------------------------------------------------------------
The following tables reflect how broker-dealers estimated their
progress in achieving Year 2000 compliance.
FIRMS RESPONDING TO NYSE SURVEY \1\
----------------------------------------------------------------------------------------------------------------
Percent complete (as of 3/31/98) Assessment Remediation Testing Implementation
----------------------------------------------------------------------------------------------------------------
100 percent complete.............................. 89 48 34 32
51-99 percent completed........................... 4 21 13 16
1-50 percent completed............................ 2 21 24 20
0 percent completed............................... 0 3 13 14
No response....................................... 4 7 16 18
----------------------------------------------------------------------------------------------------------------
\1\ Due to rounding, some of these figures do not add up to 100 percent.
FIRMS RESPONDING TO NASD SURVEY
----------------------------------------------------------------------------------------------------------------
Firms Firms Firms
Firms reporting reporting reporting
reporting programs 1 programs 40 programs 70
Number of programs 0 percent percent percent
Type of firm firms percent through 39 through 69 through 100
reporting complete percent percent percent
(percent) complete complete complete
(percent) (percent) (percent)
----------------------------------------------------------------------------------------------------------------
Introducing firms.......................... 2,686 17 16 17 50
Clearing firms............................. 322 10 25 23 42
Other firms \1\............................ 1,339 16 15 17 52
--------------------------------------------------------------------
Total................................ \2\ 4,347 16 17 17 50
----------------------------------------------------------------------------------------------------------------
\1\ The NASD identified firms in its ``other'' category as insurance companies, investment companies, merger and
acquisition companies, limited partnerships, and other firms not specifically designated as introducing or
clearing firms.
\2\ 733 of the 5,080 firms that responded to the NASD's survey did not respond to this question.
It appears that many of the firms that reported the zero percent
completion are small firms relying on third-party vendors for their
information processing, and, therefore, have no direct remediation
programs. The Commission staff and NASD are in the process of following
up with broker-dealers to determine whether this response is
reasonable. In addition, the Commission will focus on those broker-
dealers who did not respond to the NASD survey, as well as those
members who provided incomplete responses. As industry testing begins
this summer and the Commission and the SROs obtain a more complete
picture of the progress broker-dealers are making in their Year 2000
programs, we will target firms that appear to be lagging behind.
While SRO surveys have provided much useful information about the
progress of broker-dealers, the Commission has determined that survey
data alone is not enough. In order to make broker-dealers directly
accountable to the Commission with respect to their Year 2000 efforts,
last week the SEC adopted a rule that requires broker-dealers to file
two reports with the SEC regarding their Year 2000 compliance. Broker-
dealers are required to file the first report by August 31, 1998. The
second report must be filed by April 30, 1999.
This new Year 2000 reporting requirement differentiates between
broker-dealers based on their size, type of business, and relative risk
they pose to customers and the market if they are not Year 2000
compliant. Smaller broker-dealers are only required to complete an
objective check-the-box style Year 2000 questionnaire. Larger broker-
dealers, in addition to completing the Year 2000 questionnaire, are
required to provide a narrative discussion of their efforts to prepare
for the Year 2000. For example, larger broker-dealers are required to
discuss (1) whether the firm has a written Year 2000 plan that
addresses all major computer systems for the firm worldwide; (2) the
firm's current progress on each stage of its Year 2000 project,
including the results of both its internal and external testing; and
(3) whether the firm has written contingency plans.
Unlike the proposed rule, the rule as adopted does not require an
independent public accountant to review several specific assertions
made by the broker-dealer's management. Based on comments received,
however, the Commission is soliciting additional comments on the
appropriate level of independent public accountant review.
The broker-dealer's Year 2000 reports will assist the Commission
staff and the SRO's in coordinating oversight efforts. The new
reporting requirements will also reinforce the need for broker-dealers
to aggressively prepare for the Year 2000.
3. Transfer agents
Transfer agents play an integral role in the national clearance and
settlement system by recording changes in securities ownership,
distributing dividends, and performing other related functions. This
role makes it very important that transfer agent systems be Year 2000
compliant.
The information the Commission staff has about non-bank transfer
agents' progress in addressing the Year 2000 issue is mixed. During
1996 and 1997, SEC examinations focused on raising the Year 2000
awareness of non-bank transfer agents.\5\ Ninety-eight percent of those
non-bank transfer agents examined \6\ indicated that action to correct
Year 2000 deficiencies had already been taken or was planned. In early
1998, SEC examinations of non-bank transfer agents shifted to a review
of specific programs and targets for implementation. A more recent
survey by the SEC staff, however, yielded less encouraging results.
---------------------------------------------------------------------------
\5\ Under Section 17A of the Securities Exchange Act of 1934, each
transfer agent must register with the Commission. The federal banking
agencies, however, are the appropriate regulatory agencies (ARAs) for
bank transfer agents. These bank transfer agents have either the Board
of Governors of the Federal Reserve System, the Office of the
Comptroller of the Currency, or the Federal Deposit Insurance
Corporation as their ARA. The Commission is the ARA for non-bank
transfer agents. There are approximately 1,248 transfer agents
registered with the Commission, and the Commission is the ARA for
approximately 695 of them.
\6\ The SEC examined 83 non-bank transfer agents.
---------------------------------------------------------------------------
In January 1998, the staff conducted a survey of non-bank transfer
agents asking whether the board of directors had approved and funded a
Year 2000 plan and what levels of management are responsible for
addressing Year 2000 problems. Of the transfer agents responding to the
survey, 76.4 percent reported that they had developed a Year 2000 plan,
and 10.1 percent reported that, although they had no Year 2000 plan,
their vendors did. 13.4 percent of those transfer agents that
responded, however, indicated that they had no Year 2000 plan at that
time.
The Commission has also adopted a rule, similar to that adopted for
broker-dealers, that requires non-bank transfer agents to file with the
Commission new Form TA-Y2K. Part I of Form TA-Y2K is a check-the-box
style Year 2000 report, which will provide the status of the transfer
agent's Year 2000 remediation efforts. Generally, non-bank transfer
agents (other than small transfer agents and issuer transfer agents)
must also complete Part II of Form TA-Y2K. Part II requires that non-
bank transfer agents provide a narrative discussion of their efforts to
address Year 2000 Problems.
Each non-bank transfer agent must file its first Form TA-Y2K with
the Commission by August 31, 1998. The second Form TA-Y2K must be filed
with the Commission by April 30, 1999. As with broker-dealers, the data
collected under this rule would assist the Commission in identifying
weaknesses in transfer agent compliance. The Commission's staff plans
to look carefully at those transfer agents that do not appear to be
making adequate progress.
4. Investment advisers and investment companies
Investment advisers assist both individuals and investment
companies in making investment decisions and, today, investment
companies (such as mutual funds) are one of the most popular means
through which individual investors participate in the securities
market. The Commission's approach to addressing Year 2000 compliance by
investment advisers and investment companies mirrors the approach taken
with SROs, broker-dealers, and transfer agents. First, the Commission
has been working with an industry group, the Investment Company
Institute (ICI), to obtain information in order to monitor the progress
of investment advisers and investment companies in addressing the Year
2000 problem. Second, through inspections and examinations, the
Commission staff is obtaining additional, independent information on
their progress. Third, last month, the Commission proposed a rule
similar to those proposed for broker-dealers and transfer agents that
would require registered investment advisers to report their progress,
as well as the progress of any investment companies they advise, in
making systems Year 2000 compliant.
The proposed rule would require reports from most investment
advisers registered with the Commission (an adviser that has at least
$25 million of assets under management or is an adviser to a registered
investment company).\7\ Advisers would report twice--once 30 days after
the effective date of the rule and again eight months later.\8\
---------------------------------------------------------------------------
\7\ As provided in Section 203A of the Investment Advisers of 1940,
small investment advisers satisfying specified criteria are not
required to register with the Commission.
\8\ Investment Advisers Act Rel. No. 1728 (June 30, 1998).
---------------------------------------------------------------------------
Current information indicates that while funds are making progress
toward resolving their Year 2000 problems, more needs to be done. A
majority of funds responding to a recent ICI survey indicate that they
plan to complete their Year 2000 programs by December 1998.
PROGRAM COMPLETION DATES FOR MUTUAL FUNDS \1\
----------------------------------------------------------------------------------------------------------------
1998 2nd Q 1999 post
or earlier 1998 3rd Q 1998 4th Q 1999 1st Q 1999 2nd Q 2nd Q
----------------------------------------------------------------------------------------------------------------
Percent of funds............ 3 5 72 8 11 1
----------------------------------------------------------------------------------------------------------------
\1\ Information reflects responses to the ICI's questionnaire dated March 16, 1998. Responses were received from
77 investment company complexes between March 16 and June 3, 1998, and represent 66.0 percent of industry
assets. Two of these firms did not provide a response to the question on completion date.
The ICI has also urged its members to participate in the SIA's
industry-wide testing program, and several major investment company
complexes will participate in the initial round of testing that begins
this month.
ii. international year 2000 efforts
The global nature of securities trading presents one of the most
difficult Year 2000 challenges. Considerable work on Year 2000
compliance remains to be done in countries throughout the world.
The Commission is actively encouraging financial regulators in
other countries to address the Year 2000 problem. In October 1997,
Chairman Levitt spoke to the International Federation of Securities
Exchanges to encourage it to take an active role in promoting
remediation and contingency planning by its member exchanges.
In addition, the Commission works within the International
Organization of Securities Commissions (IOSCO) to raise international
awareness of Year 2000 issues. In 1997, IOSCO issued two communiques
urging its members and market participants to take appropriate action
to address Year 2000 issues. Soon after, in early 1998, IOSCO conducted
a survey of its members regarding Year 2000 compliance, and is
currently conducting a second survey, focusing on testing and
contingency planning. The Commission expects IOSCO to publish the
survey results at its meeting this September.\9\
---------------------------------------------------------------------------
\9\ IOSCO continues to update the special Year 2000 section on its
web site at . This section includes information
on the testing and readiness of the securities industry and markets
worldwide.
---------------------------------------------------------------------------
Other international groups are also working to address the Year
2000 problem. In September 1997, the Basle Committee on Banking
Supervision \10\ issued a technical paper for banks that sets forth a
strategic approach for the development, testing, and implementation of
Year 2000 solutions. It also discusses the role that central banks and
bank supervisors need to play in promoting awareness of the issue and
enforcing action. In April 1998, the Basle Committee, IOSCO, the G-10
Committee on Payment and Settlement Systems (CPSS),\11\ and the
International Association of Insurance Supervisors (IAIS) \12\ jointly
sponsored a Roundtable on the Year 2000. Discussions at the Roundtable
emphasized that private and public sector bodies should coordinate on a
number of important issues and approaches, including: (1) strengthening
and widening external testing programs; (2) improving information
sharing among market participants and their vendors and service
providers; (3) fostering increased disclosure by corporations of their
Year 2000 testing and readiness results; and (4) reinforcing the role
of oversight bodies such as supervisors and auditors.
---------------------------------------------------------------------------
\10\ The Basle Committee was established by the central bank
Governors of the Group of Ten countries in 1975. It consists of senior
representatives of banking supervisory authorities and central banks
from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the
Netherlands, Sweden, Switzerland, the United Kingdom, and the United
States.
\11\ The CPSS maintains a special section on the Bank for
International Settlement's web site at that
provides information on the testing plans and readiness status of
payment and settlement systems worldwide.
\12\ The IAIS is working with its members to urge insurance
companies to implement detailed action plans to resolve the Year 2000
problems associated with their business activities.
---------------------------------------------------------------------------
The Roundtable sponsors also established the Joint Year 2000
Council, chaired by the Federal Reserve Bank of New York. The Joint
Council's objectives include, among other things, serving as an
information clearinghouse on Year 2000 issues, serving as a locus for
international coordination of Year 2000 testing programs, and
coordinating international contingency efforts. The Council will meet
regularly and has agreed on a wide range of initiatives to draw
attention to the Year 2000 problem.
The private sector is also undertaking initiatives to promote
international Year 2000 compliance. The SIA, in conjunction with its
International Operations Association, sent an ``international
scorecard'' to over 700 foreign regulators, exchanges, banks, clearing
organizations, and broker-dealers asking for information about their
Year 2000 efforts. While the SIA is still collecting and analyzing data
from the scorecard, one immediate result has been requests by foreign
entities to participate in the SIA's testing program. The London
Investment Bankers Association has agreed to take the lead in
coordinating test efforts with the United Kingdom, while the Swiss
Banking Corporation has agreed to act as coordinator in continental
Europe.
In addition, a number of banks and investment firms have formed the
Global Year 2000 Coordinating Group.\13\ The Coordinating Group plans
to gather and disseminate information on the Year 2000 readiness of
cash payment and settlement systems, securities clearance and custody
systems, exchanges, and foreign exchange and derivatives trading firms.
It is also planning a series of regional meetings with regulators and
industry participants in Asia, Latin America, and Europe. Membership in
the Coordinating Group is open to all interested financial services
providers.
---------------------------------------------------------------------------
\13\ The Coordinating Group is currently comprised of
representatives from 73 financial institutions in 19 countries:
Argentina, Australia, Brazil, Canada, China, Denmark, France, Germany,
Hong Kong, Italy, Japan, Mexico, the Netherlands, Singapore, South
Korea, Spain, Switzerland, the United Kingdom and the United States.
---------------------------------------------------------------------------
Despite these efforts, international Year 2000 compliance remains
an area of concern for the Commission. The Commission plans to continue
working actively with regulators in other countries and with
international working groups to address Year 2000 concerns. In
addition, it will continue to urge U.S. firms to press their
international counterparties for a more responsive approach abroad.
Nevertheless, risks from Year 2000 non-compliance abroad must be a
major focus of contingency planning for U.S. firms.
iii. issuer disclosure
The Commission staff has advised public companies and investment
companies that they must disclose any material effects that the Year
2000 problem or their own Year 2000 remediation efforts will have on
their businesses. To date, the staff has published a legal bulletin on
issuers' disclosure obligations, and has surveyed the quantity and
quality of the disclosure made by public issuers and investment
companies.\14\ Although the number of issuers discussing Year 2000 has
increased significantly, the staff is concerned that much of the
disclosure is not informative.
---------------------------------------------------------------------------
\14\ For detailed results of the survey of public issuers, see
Staff of the United States Securities and Exchange Commission, Year
2000 Disclosure Task Force Survey (June 1998). A copy of the survey is
available on the Commission's web site at .
---------------------------------------------------------------------------
A. Staff legal bulletin No. 5
The Commission's disclosure framework requires that public
companies and investment companies disclose material information about
themselves to the public. This enables investors to make informed
investment decisions. Although the Commission's disclosure framework
requires companies to provide specific categories of information, it is
flexible enough to enable companies to tailor disclosure to their
particular circumstances. Generally, the Commission relies on this
general framework and does not provide specific guidance on any
particular issue. However, the Commission staff felt the Year 2000
issue merited an exception and provided specific guidance as to what
public companies should consider when disclosing information about
their Year 2000 readiness.
On October 8, 1997, the Divisions of Corporation Finance and
Investment Management issued a joint Staff Legal Bulletin reminding
those entities with disclosure obligations that the Commission's rules
and regulations apply to Year 2000 issues, like any other significant
issue.\15\ On January 12, 1998, the Divisions revised the Staff Legal
Bulletin to provide more specific guidance under existing Commission
rules and regulations.\16\ The staff intended this guidance to
alleviate the uncertainty expressed by some members of the accounting
and legal professions regarding what a company should disclose about
its Year 2000 issues.\17\
---------------------------------------------------------------------------
\15\ A staff legal bulletin represents the staff's views only and
is not a rule, regulation, or statement of the Commission.
\16\ Revised Staff Legal Bulletin No. 5 supersedes the original
bulletin and is located on the SEC's web site at .
\17\ In addition, Senate Financial Services and Technology
Subcommittee Chairman Robert Bennett has introduced legislation, the
Year 2000 Computer Remediation and Shareholder Protection Act of 1997
(S. 1518), which would require public companies to disclose their Year
2000 issues.
---------------------------------------------------------------------------
For corporate issuers, the revised Staff Legal Bulletin explains
that public companies may have a Year 2000 disclosure obligation in
their Commission filings because an applicable form or report requires
the disclosure. The regulation most likely to trigger disclosure on a
Commission form or report is ``Management's Discussion and Analysis of
Financial Condition and Results of Operations,'' or ``MD&A.'' \18\ In
their MD&A, companies must discuss known trends, demands, commitments,
events, or uncertainties that are likely to have a material impact on
them.
---------------------------------------------------------------------------
\18\ See Item 303 of Regulations S-K and S-B.
---------------------------------------------------------------------------
In the revised Staff Legal Bulletin, the staff described three
circumstances under which a company should consider its Year 2000
issues to be material.\19\ The first is if the company has not yet
started to assess its Year 2000 issues. The second is if the company
has started to assess its Year 2000 issues, but has not yet determined
whether these issues are material. The third is if, after assessing its
Year 2000 issues, the company has determined that these issues could be
material to its business, operations, or financial condition,
irrespective of any remediation plans or insurance coverage. In other
words, the company must have determined the materiality of its Year
2000 issues on a ``gross'' basis.
---------------------------------------------------------------------------
\19\ This guidance is not exclusive. Compliance with the Staff
Legal Bulletin does not necessarily constitute compliance with the
disclosure requirements of the federal securities laws. Companies have
been advised that they need to consider these laws and the SEC's rules
and regulations in addition to the bulletin.
---------------------------------------------------------------------------
Once a company has determined that its Year 2000 issues are
material, the revised Staff Legal Bulletin provides specific guidance
on what type of information to disclose. The staff expects a company to
disclose, at a minimum, its plans to address the Year 2000 issues that
affect its business and operations, and its timetable for carrying out
these plans. When material, the staff also expects a company to
disclose (1) an estimate of its Year 2000 costs and any material impact
it expects these costs to have on its operations, liquidity, and
capital; (2) its historical Year 2000 costs; \20\ and (3) how the
company could be affected if its customers, suppliers, and other
constituents are not Year 2000 ready. Boilerplate disclosure is
discouraged.
---------------------------------------------------------------------------
\20\ Revised Staff Legal Bulletin No. 5 did not request this
disclosure. Rather, companies are required to make this type of
disclosure in the ``Results of Operations'' section of MD&A.
---------------------------------------------------------------------------
Investment companies are also obligated to assess whether Year 2000
disclosure is required, including whether such disclosure is needed in
registration statements. The Staff Legal Bulletin states that under the
Investment Advisers Act of 1940 and the Investment Company Act of 1940,
investment advisers and investment companies may be required to make
appropriate disclosure to clients and shareholders if operational or
financial obstacles are presented by the Year 2000. Further, Section
34(b) of the Investment Company Act prohibits investment companies from
omitting any fact that is necessary to prevent the statements made in
public filings from being materially misleading. Specifically,
investment companies are required by Item 5 ``Management's Discussion
of Fund Performance'' of Form N-1A to describe in their registration
statements the experience of their investment advisers and the services
that the advisers provide. In response to this Item, investment
companies may need to disclose the effect that the Year 2000 issue
would have on their advisers' ability to provide services described in
their registration statements.
B. Public company disclosure
After the Staff Legal Bulletin was revised, the Division of
Corporation Finance created a Year 2000 Task Force to determine how
many public companies are addressing the Year 2000 issue and to assess
whether the disclosure being provided is meaningful. As part of this
review, the Task Force attempted to determine if companies were
following the guidance in the revised bulletin. As described below, the
review revealed that many companies are not.
First, the Task Force searched the Commission's electronic filing
system, EDGAR, to compare how many public companies have been providing
Year 2000 disclosure at different points in time. These searches
indicated that only 10 percent of the annual reports filed by public
companies during the first four months of 1997 contained the phrase
``Year 2000.'' For the quarterly reports filed after the staff
published Staff Legal Bulletin No. 5, this percentage increased to 25
percent. After the staff published revised Staff Legal Bulletin No. 5
in January 1998, 70 percent of the annual reports contained the phrase
``Year 2000.''
While the number of companies disclosing Year 2000 issues had
increased dramatically, the Task Force's survey showed that many
companies were not following the specific guidance provided in revised
Staff Legal Bulletin No. 5. The Task Force read the Year 2000
disclosure in the filings of 1,023 public companies to determine
whether the specific guidance provided in revised Staff Legal Bulletin
No. 5 was being followed. To compile the 1,023 annual reports, the Task
Force randomly selected companies from 12 industry groups, including 66
small business filers. The aim was to compile a sampling of filings
that would fairly represent a cross-section of public companies. The
Task Force also surveyed the most recent annual or quarterly reports
filed by the Fortune 100 companies that are publicly held.\21\ Based on
the specific guidance provided in revised Staff Legal Bulletin No. 5,
the Task Force looked for information regarding the following seven
categories:
---------------------------------------------------------------------------
\21\ Seven of the Fortune 100 companies are not publicly held.
(1) The status of the company's assessment of its Year 2000 issues;
(2) The level of detail in the disclosure relating to the company's
remediation plan;
(3) The estimated timetable for completing the company's assessment
and/or its plan;
(4) Whether the company intends to evaluate, or is evaluating, its
Year 2000 issues with entities with whom it has material relationships;
(5) Whether the company discloses how much has been spent on Year
2000 issues to date;
(6) Whether the company discloses an estimate of the amount to be
spent on Year 2000 issues; and
(7) Whether the company addresses, and the level of materiality of,
its Year 2000 issues.
Based on this survey, the Task Force found the following:
Assessment.--the extent to which the company has assessed the
seriousness of its Year 2000 technology problems if no corrective
action is taken.
Assessment: Percentage
About to be started............................................ 9
Still in progress.............................................. 56
Completed...................................................... 27
No disclosure regarding assessment............................. 8
Plan.--the extent to which the company described its plan to remedy
its Year 2000 technology problems.
Plan: Percentage
General description............................................ 44
Detailed description........................................... 9
Plan is fully implemented...................................... 4
No disclosure regarding plan................................... 43
Timetable.--the time frame within which the company intends to
complete its assessment and/or its remediation plan. The Task Force
considered disclosure such as ``in time'' or ``by the year 2000'' as
``No disclosure.''
Timetable: Percentage
By the end of 1998............................................. 19
Other than the end of 1998..................................... 17
No disclosure regarding timetable.............................. 64
Relationships.--whether the company plans to evaluate, or is
evaluating, the Year 2000 technology problems of those entities with
which it has material relationships.
Relationships: Percentage
Disclosure regarding evaluation of material relationships...... 49
No disclosure regarding evaluation of material relationships... 51
Historical costs.--the amount of money the company has already
spent on Year 2000 issues to date.
Historical costs: Percentage
Disclosure regarding historical costs.......................... 8
No disclosure regarding historical costs....................... 92
Estimated costs.--the amount of money the company estimates it will
spend on Year 2000 issues.
Estimated costs: Percentage
Disclosure regarding estimated costs........................... 22
No disclosure regarding estimated costs........................ 78
Materiality.--whether the company disclosed that the Year 2000
issue is material to its business and, if so, the level of materiality.
Materiality: Percentage
Year 2000 issues could be material............................. 19
Year 2000 materiality is unknown at this time.................. 5
Year 2000 issues are not material as to remediation costs or 67
operations.
No disclosure regarding materiality of Year 2000 issues........ 19
The Commission and its staff continue their efforts to increase the
frequency and quality of Year 2000 disclosure made by public companies.
The efforts to date have made public companies more aware of this
issue, but have not fully succeeded in obtaining the quality of
disclosure that investors need. The Commission is concerned that while
a larger number of companies mention Year 2000 in their annual reports,
much of the disclosure is not meaningful.
The Commission therefore has begun to take several steps to improve
the quality of issuer disclosure. First, in the near future, Chairman
Arthur Levitt plans to write to chief executive officers of public
companies to remind them of the significance of the Year 2000 issue and
the Commission's guidance regarding companies' Year 2000 disclosure
obligations.
Second, as noted by Commissioner Unger in her testimony of June 10,
1998 before the Senate Subcommittee on Financial Services and
Technology, the Commission is planning to issue an interpretive release
in the near future setting forth its views regarding the application of
its disclosure requirements to the Year 2000 issue. The interpretive
release would formalize current staff guidance and, among other things,
remedy the apparent misconception that Year 2000 issues must be
disclosed only if the costs of remediation are material. The
interpretive release will clarify that companies must, in addition to
considering costs, determine materiality based on the potential
consequences of inadequately resolving their Year 2000 issues. Further,
the Commission's interpretive release may form the basis of Commission
enforcement actions against companies that fail to disclose material
information regarding their Year 2000 issues.
iv. conclusion
The Commission has long recognized the importance of the Year 2000
problem. It affects nearly every aspect of the securities industry,
including our own operations. We are working hard to ensure Year 2000
compliance in the securities industry, as well as within our own
critical systems. We have pushed market participants--the SROs, broker-
dealers, transfer agents, investment companies, investment advisers,
and public companies--to address these important issues. In addition,
the industry--through the efforts of the SIA--has stepped forward and
constructed an aggressive program of education and testing for the
markets and market participants.
The Commission appreciates the opportunity to discuss the readiness
of the U.S. securities industry and public companies to meet the
information processing challenges of the Year 2000. The Commission and
its staff welcome any questions on these issues that the Committee may
have.
__________
Prepared Statement of Peter A. Miller
introduction
Mr. Chairman and members of the committee, thank you for the
opportunity to address this important issue. My name is Peter Miller. I
am the chief information officer of J.P. Morgan and have been involved
with the Year 2000 problem since 1995. My remarks today will focus on
the nature of the Year 2000 problem, a risk-management approach to
solving it, and the need for industry-to-industry collaboration, as
well as international cooperation.
i: the problem
Let me begin by saying that the Year 2000 problem, or the
``millennium bug'' as it is sometimes referred to, is an issue that we
at J.P. Morgan consider of paramount importance to our firm, the
financial services industry, and the United States and world economies.
No other event in history will so thoroughly expose the vulnerability
of our living and working in a world so interconnected by computers and
telecommunications.
The problem as we see it, is not really a technological one,
although technology lies at the root of both the problem and solution.
Correcting the two-digit dating systems, which in their present form
can not tell one century from the next, is easy. Rewriting code, as a
technological matter, is relatively straightforward. The real problem
and the real danger can be summed up in two words: logistics and
dependency.
The logistical problem is that millions of computers are involved.
A huge undertaking in and of itself. Making the task even more daunting
are the intricate, complex, and pervasive interdependencies among the
computers and computer networks that populate the world today. It is
not enough that every computer, software application, and embedded chip
affected by the Year 2000 problem be fixed. They must be fixed in ways
so that they remain compatible with all the other devices with which
they interoperate.
The financial industry offers a perfect illustration of the
enormous size, scope, and complexity of the problem. Finance today is a
global business, where almost unimaginable sums of money are in a
constant state of electronic flux, and interdependency is particularly
acute given the networked nature of market participants. We have
already seen harbingers of what may be in store. The New York
Mercantile Exchange and the Brussels Stock Exchange have both
experienced date-related operating failures. Although these problems
were relatively small in scope, the scale of the issue becomes
magnified when you consider that all of the world's financial
institutions will find themselves tested on the same day. At the
extreme, the price of failure could be systemic breakdown.
Yet it is not enough for the world's banks, stock exchanges, and
clearing houses to have their respective houses in order. It won't do
them any good if their transaction processing systems are ready, but
they cannot relay information to clients, creditors, regulators, and
payment and settlement systems because of breakdowns in
telecommunications networks. And imagine if all the banks and
telecommunications companies are set to perform on January 3, 2000, but
their employees can't get to their desks because the elevators don't
work. Simply put, our networked world is only as good as its weakest
connection.
Typically, the barriers to Year 2000 compliance come down to four
things:
--Time--this is a problem with an immovable deadline
--Money--for some, compliance may not be economically possible
--Skills--even if you have the money, you still need to find people
who can fix the problem
--Competing priorities--if focus is on other issues, the likelihood
increases that Year 2000 problems simply won't get fixed. Major
corporate events like mergers, acquisitions, and privatizations
are the kinds of things that can keep managers from devoting
the time necessary to address Year 2000 issues within their
companies.
ii: j.p. morgan's risk-management approach
So how does one combat such an enormous and insidious problem? At
J.P. Morgan we have applied a comprehensive, risk-management approach.
In our measured opinion, things will go wrong. Statistical probability
tells us that the logistics and dependencies involved almost certainly
dictate some level of failure. So the question is not if things will go
wrong, but how many things will go wrong. Therefore, we believe that
the best course of action, and probably the only workable one given
time, cost, and skill constraints, is to identify the most critical
situations, fix them first, and then move down the chain of priorities.
Firms that will do the best will be the ones that:
--put their own house in order,
--coordinate their activities with their trading partners, and
--prepare contingency plans in the event that unexpected failures
occur.
At J.P. Morgan, we began discussing the Year 2000 problem at senior
executive levels in 1995. Early the following year, with the full
commitment of Sandy Warner, our chairman and CEO, we launched a
firmwide initiative. The commitment of senior management was crucial,
for without it, we would never have been able to muster all the
resources necessary to attack the problem. With 600 people working on
the initiative at its peak, we have estimated that the total cost of
making the firm Year 2000 compliant is $250 million.
Paula Larkin, a senior manager at Morgan, is charged with
overseeing and coordinating all of the firm's Year 2000 efforts. To
date, these efforts have included:
--raising awareness throughout the firm,
--conducting a comprehensive analysis of the problem and its many
impacts,
--putting in place a complete end-to-end methodology and
certification process, and
--applying the lessons learned broadly across the firm so as to
reduce costs and risks while accelerating progress.
By year's end, we expect to have all of our critical applications
and products tested and certified as Year 2000 compliant.
The importance of testing cannot be overstated. Our remediation
efforts have shown the problem to be pervasive and not always obvious.
For example, our testing of one product, which the manufacturer said
was Year 2000 compliant, found that while the product could handle the
changeover on January 1, it had not been programmed for the fact that
2000 is a leap year. The lesson here is that nothing can be taken on
face value.
iii: financial services industry activities
With our internal testing and renovation well under way, much of
our effort is currently focused on addressing external dependencies,
both inside and outside the financial services industry. This has
involved identifying and assessing our Year 2000 exposures as posed by
clients, counterparties, exchanges, depositories, clearinghouses, and
correspondent banks, as well as by power, telecommunications, and other
utilities.
Key to this effort has been coordination and collaboration with
others in the industry, namely competitors, exchanges, the Federal
Reserve, and trade associations. For example, J.P. Morgan has been
working with the Securities Industry Association, the New York
Clearinghouse, and others for the past 2 years on the Year 2000 issue.
Through various committees, the SIA has been promoting awareness,
developing testing guidelines, and coordinating industry-wide testing
efforts. J.P. Morgan and 28 other securities firms are currently
engaged in piloting the tests that will be used early next year to
check industry-wide dependencies and compliance.
The work of SIA and other organizations like it have helped place
the U.S. financial services industry into a leadership position in
terms of Year 2000 readiness. The U.S. financial services industry is
ahead of its peers abroad and also appears to be ahead of all other
industries. To the best of my knowledge, financial services is the only
industry conducting integrated testing to demonstrate readiness and
identify issues ahead of time.
But for financial services companies, the need for vigilance must
extend beyond their own industry. The ripple effect from a large
disruption in another industry, such as telecommunications,
transportation, or power, could have severe consequences for the
financial sector. As a result, J.P. Morgan, on its own and in
conjunction with industry efforts, is actively trying to understand the
risks faced by its service providers and the programs they have put in
place to mitigate the risks.
To mitigate these risks, the free-flow of timely and accurate
information is essential. This means the Year 2000 cannot be treated as
a competitive issue. Traditional barriers must make way for the sharing
of best practices. Through collaborative efforts, firms can leverage
resources and minimize costs. The government can play a key role here,
through influence and legislation, to promote cooperation and
information sharing across industries.
We also strongly support two parallel government efforts. Year 2000
disclosure requirements put in place by the Securities and Exchange
Commission and the decision by the Federal Financial Institutions
Examination Council to ask companies to prioritize their clients in
terms of Year 2000 risks. For its part, J.P. Morgan already views Year
2000 readiness as a factor in conducting due diligence reviews of
clients.
iv: international coordination
This cooperation and collaboration also needs to extend beyond the
borders of the United States. For J.P. Morgan, with operations in more
than 30 countries, the need for global attention to the Year 2000
problem is clear. Currently, we are working actively with our
counterparts and regulators outside the United States to increase
awareness and action. The ultimate goal is to demonstrate industry
readiness through integrated testing with all major market participants
in all major market locations. Progress is being made, but much more
work remains to be done.
Dependencies with potential cross-border implications are of
particular concern in the international arena. Disruption in a key
market could prevent the settlement of trades or movement of cash and
securities, which in turn could squeeze credit and liquidity. Were a
major international investment bank, for example, to find itself in a
position where it could not deliver or receive cash or securities, the
consequences could have a ripple effect on the world economy. Through
our scenario planning activities, we are attempting to estimate the
likelihood of these failures and identify appropriate remedies.
Our assessment of global readiness places the United States ahead
of all other countries. Preparedness in Europe varies country by
country. Thanks in large part to the work of the British Bankers
Association, the United Kingdom ranks in the top spot. Trade
associations are active across the continent, but the entire Year 2000
effort has been hurt by the time, energy, and attention being devoted
to the implementation of European Monetary Union.
Asia ranks behind Europe. Here the biggest threat is posed by the
downturn in the regional economy. Strong progress, however, has been
made in Japan over the last six months, due in large measure to the
efforts of the Japan Securities Dealers Association working with the
Ministry of Finance. Regulators are now actively reviewing firms'
programs, and coordinated industry testing is planned.
Action has generally been lagging in Latin America, however,
variations exist within the region. Mexico is proving to be a leader.
Currently, the SIA is making use of work done in the United States to
provide best practices to other locations. The SIA recently visited the
major market locations in Latin America to meet with regulators and
major market participants in an effort to leverage the financial
services industries program here.
In all these regions, as is the case in the United States, the
challenge extends beyond the financial services industry to all of the
external dependencies. Although awareness has increased abroad, not all
industries have demonstrated a recognition of the full scope and
ramifications of the issue. This includes infrastructure providers,
such as electric utilities and telecommunications companies, which are
vital for the conduct of international trade.
On a global front, a recent positive development has been the birth
of the Global Year 2000 Coordinating Group. The group raises awareness,
identifies resources, and coordinates initiatives on an international
basis. Currently, 20 countries are represented--a number that is
expected to rise. Members of the group are responsible for taking
leadership roles on Year 2000 initiatives within their respective
countries, and the dialogue among members provides first-hand status
reports on each country's problems, progress, and prognosis. One
initiative undertaken by the group is to develop tools to aid
international testing by providing a standard set of definitions and
recommendations on scope and timing. To date, three meetings have been
held with attendance covering most major financial markets. In
addition, the Basle Committee and other international regulatory groups
have created the Joint Year 2000 Council to focus the supervisory
community on the issue.
v: conclusion
To close, I would like to reiterate a couple of key messages. The
problem is serious. Things will go wrong. And, the companies,
industries, governments, countries, and regions that will be most
successful in addressing the problem will be the ones that:
--get a firm handle on internal issues that are particular to them,
--address the critical external dependencies that affect them,
--work collaboratively with others to share information and maximize
resources, and
--put in place contingency plans that guard, as much as possible,
against unforeseen events.
Addressing this problem will take hard work, and for the most part,
it's a thankless task. Success will be defined not by some great
discovery, but by minimal disruption. The financial services industry
has made considerable progress to date and is well positioned. However,
the test in all this lies in the strength of the weakest link, wherever
it may be.
I thank the Committee for the opportunity to share my thoughts and
look forward to working with it and others to bring this issue to the
most uneventful conclusion possible.
__________
Prepared Statement of Ernest T. Patrikis
I am pleased to appear before the Committee today to discuss the
progress of foreign financial markets in addressing the Year 2000
computer problem. I am appearing in my capacity as chairman of the
Joint Year 2000 Council, which is sponsored jointly by the Basle
Committee on Banking Supervision, the G-10 central bank governors'
Committee on Payment and Settlement Systems, the International
Association of Insurance Supervisors, and the International
Organization of Securities Commissions (collectively referred to as the
``Sponsoring Organizations'').
The international financial community has much work to do to
prepare itself for the challenges posed by the Year 2000 (``Y2K'')
problem. While much good work is being done and progress in many areas
is evident, more needs doing. The Sponsoring Organizations believe that
mutual cooperation and information sharing can play a key role in
helping individual market participants carry out these preparations and
limit the scope of Y2K-related disruptions. Our major concern, of
course, will be the possible impact of the Y2K problem on the
functioning of the international financial system as a whole.
Federal Reserve Governor Edward W. Kelley, Jr. has recently
elaborated on the activities of the Federal Reserve System in
connection with the Y2K problem, as well on possible macroeconomic
implications.\1\ I will not attempt to cover those topics again here.
Instead, this morning I will begin with some background on the possible
implications of the Y2K problem for international banking and finance.
Second, I will describe how various supervisory initiatives led to the
formation of the Joint Year 2000 Council a little more than two months
ago. Third, I will discuss the actions being taken by the Joint Year
2000 Council, particularly in the areas of raising awareness, improving
preparedness, and contingency planning.
---------------------------------------------------------------------------
\1\ See testimony of Governor Edward W. Kelley, Jr. before the
Committee on Commerce, Science, and Transportation, U.S. Senate, April
28, 1998.
---------------------------------------------------------------------------
background on the international implications of the y2k problem
The Y2K bug potentially affects all organizations that are
dependent on computer software applications or on embedded computer
chips. In other words, nearly all financial organizations worldwide are
potentially at risk. Even those whose own operations remain strictly
paper-based are likely to be dependent on power, water, and
telecommunications utilities which must themselves address possible Y2K
problems. Also, many non-financial customers have dependencies on
technology.
All countries of the world, therefore, need to address the Y2K
problem and its potential effects on their domestic financial markets.
In some cases, it is said that computer systems in particular countries
are not much affected because their national calendars are not based on
the conventional Gregorian calendar used in the United States and many
other countries. I do not derive much comfort from these statements
because in most cases operating systems and the software applications
running on them count internally with a conventional date system that
may not be Y2K-compliant. These systems typically also need to connect
and interact with other systems that use conventional dates, so these
interfaces must be tested for Y2K-compliance. More broadly, mere
assertions that computer applications are unaffected cannot be seen as
a substitute for the rigorous assessment, remediation, and testing
efforts that should be undertaken by financial market participants
worldwide.
The increasing extent of cross-border, financial-market activity
has been much remarked on in recent years. Perhaps less well known is
the fact that this activity is dependent on a large, geographically
diverse, and highly computer-intensive global infrastructure for each
of the key phases of this activity--from trade execution through to
payment and settlement.
As an example, consider the daily financial market activities of a
hypothetical U.S.-based mutual fund holding stocks and bonds in a
number of foreign jurisdictions. Such a mutual fund would likely
execute trades via relationships with a set of securities dealers, who
themselves might make use of other securities brokers and dealers,
including some outside the United States. The operational integrity of
the major securities dealers in each national securities market is
critical to the smooth functioning of those markets. In addition,
securities trading in most countries is reliant on the proper
functioning of the respective exchanges, brokerage networks, or
electronic trading systems and the national telecommunications
infrastructure on which these all depend. Financial markets today are
also highly dependent on the availability of real-time price and trade
quotations provided by financial information services.
For record-keeping, administration, and trade settlement purposes,
our hypothetical mutual fund would also likely maintain a relationship
with one or more global custodians (banks or brokerage firms), who
themselves would typically maintain relationships with a network of
sub-custodians located in various domestic markets around the world.
Actual settlement of securities transactions typically occurs over the
books of a domestic securities depository, such as the Depository Trust
Company (``DTC'') or the Fedwire National Book-Entry System in the
United States, or at one of the two major international securities
depositories, Euroclear and Cedel. Additional clearing firms, such as
the National Securities Clearing Corporation (``NSCC'') and the
Government Securities Clearing Corporation (``GSCC'') in the United
States, may also occupy central roles in the trade clearance and
settlement process.
Payments and foreign exchange transactions on behalf of the mutual
fund would involve the use of correspondent banks, both for the U.S.
dollar and for other relevant currencies. These transactions would
typically settle over the books of domestic wholesale payment systems,
such as the Clearing House Interbank Payments System (``CHIPS'') or
Fedwire in the United States, and the new TARGET system for the euro.
Correspondent banks are also heavily dependent on the use of cross-
border payments messaging through the network maintained by the Society
for Worldwide Interbank Financial Telecommunications (``S.W.I.F.T.'')
to advise and confirm payments. To provide some sense of the magnitudes
involved here, consider that the Fedwire and CHIPS systems process a
combined $3 trillion in funds transfers on an average day (split
roughly evenly between the two systems). While S.W.I.F.T. itself does
not transfer funds, its messaging network carries over three million
messages per day relating to financial transactions worldwide.
The many interconnections of the global financial market
infrastructure imply that financial market participants in the United
States could be affected by Y2K-related disruptions in other financial
markets. In assessing the scope of any such potential problems, we
should be realistic in accepting that some disruptions are inevitable,
while also recognizing that not all countries confront Y2K problems of
similar magnitudes. The problem simply affects too many organizations
and too many systems to expect that 100 percent readiness will be
achieved throughout the world. Nor are the best efforts of supervisors
and regulators capable of completely eradicating the risk of
disruption. Ultimately, the work of fixing the Y2K problem rests with
firms themselves, and even some of the most determined and well-funded
Year 2000 efforts may miss something.
global year 2000 round table
Recognizing the global nature of the issues surrounding the Y2K
problem, each of the Sponsoring Organizations undertook initiatives in
1997 to raise awareness, enhance disclosure, and prompt appropriate
action within the financial industry. Their decision last fall to
organize a Global Year 2000 Round Table was motivated by a growing
sense of the seriousness of the Y2K challenges posed in many countries
and of the potentially severe consequences for financial markets that
fail to meet these challenges. The Global Year 2000 Round Table was
held at the Bank for International Settlements on April 8, 1998. It was
attended by more than 200 senior executives from 52 countries,
representing a variety of private and public organizations in the
financial, information technology, telecommunications, and business
communities around the world.\2\
---------------------------------------------------------------------------
\2\ A videotape containing highlights of the Global Year 2000 Round
Table is available free of charge from the Bank for International
Settlements. Please contact the Joint Year 2000 Council Secretariat at
the Bank for International Settlements, Centralbahnplatz 2, Ch-4002
Basle, Switzerland. (telephone: 41 61 2808432, fax: 41 61 280 9100,
email: jy2kcouncil.bis.org)
The Federal Financial Institutions Examinations Council (``FFIEC'')
has also placed the entirety of this video tape on its web site, where
it is available for downloading in whole or in part. Please see http://
www.bog.frb.fed.us/y2k/video--index.htm#19980408.
---------------------------------------------------------------------------
The discussions at the Round Table confirmed that the Y2K issue
must be a top priority for directors and senior management, and that
the public and private sectors should increase efforts to share
information. The importance of thorough testing, both internally and
with counterparties, was emphasized as the most effective way to ensure
that Y2K problems are minimized. Round Table participants identified
the need to continue the widening and strengthening of external testing
programs in many countries.
The communique issued by the four Sponsoring Organizations at the
close of the Round Table recommended that market participants from
regions that have not yet vigorously tackled the problem should
consider the need to invest significant resources in the short time
that remains. The Sponsoring Organizations further recommended that
external testing programs be developed and expanded and that all
financial market supervisors worldwide should implement programs that
enable them to assess the Y2K readiness of the firms and market
infrastructures that they supervise. The Sponsoring Organizations urged
telecommunications and electricity providers to share information on
the state of their own preparations and encouraged market participants
and supervisors and regulators to consider the need to develop
appropriate contingency procedures.
At the Round Table, a new private-sector initiative known as the
Global 2000 Coordinating Group was announced. The aims of the Global
2000 effort are to identify and support coordinated initiatives by the
global financial community to improve the Y2K readiness of financial
markets worldwide. For example, current Global 2000 projects include
the development of recommendations for financial infrastructure testing
and guidelines for addressing Y2K compliance issues related to vendors
and service providers. The Global 2000 Coordinating Group, which
includes representatives from over 75 financial institutions in 18
countries, represents an extremely valuable private-sector attempt at
cooperation on this important issue. At the same time, however, the
international financial supervisory community recognized that it would
be useful to establish a public-sector group, called the Joint Year
2000 Council, that would work with the private sector and also maintain
a high level of attention on the Y2K problem among financial market
supervisors and regulators worldwide.
joint year 2000 council
The formation of the Joint Year 2000 Council was announced at the
end of the Global Year 2000 Round Table on April 8, 1998. The Joint
Year 2000 Council consists of senior members of the four Sponsoring
Organizations. Every continent is represented by at least one member on
the Council. The Secretariat of the Council is provided by the Bank for
International Settlements. I am honored to serve as the chairman of the
Joint Year 2000 Council.
The mission of the Joint Year 2000 Council has four parts: First,
to ensure a high level of attention on the Y2K computer challenge
within the global financial supervisory community; second, to share
information on regulatory and supervisory strategies and approaches;
third, to discuss possible contingency measures; and fourth, to serve
as a point of contact with national and international private-sector
initiatives. After their meetings on May 8-9, 1998, the G-7 finance
ministers called on the Joint Year 2000 Council and its Sponsoring
Organizations to monitor the Y2K-related work in the financial industry
worldwide and to take all possible steps to encourage readiness.
The Council has met twice since being formed in early April and
plans to meet frequently, almost monthly, between now and January,
2000. At our first meeting, we organized our work projects and approved
our mission statement. At our second meeting, we met for the first time
with an External Consultative Committee consisting of international
public-sector and private-sector organizations. Meeting with this
External Consultative Committee is intended to enhance the degree of
information sharing and the raising of awareness on different aspects
of the Year 2000 problem by both public and private sectors within the
global financial markets.
The External Consultative Committee includes representatives from
international payment and settlement mechanisms (such as S.W.I.F.T.,
Euroclear, Cedel, and VISA), from international financial market
associations (such as the International Swaps and Derivatives
Association, the International Institute of Finance, and the Global
2000 Coordinating Group), from multilateral organizations (such as the
IMF, OECD, and World Bank), from the financial rating agencies (such as
Moody's and Standard & Poor's), and from a number of other
international organizations (such as the International
Telecommunications Union, Reuters, the International Federation of
Accountants, and the International Chamber of Commerce). This diversity
of perspectives led to an extremely valuable discussion with the Joint
Year 2000 Council and stimulated work on several projects to be taken
forward with input from both the public and private sectors, for
example, the initiatives on Y2K testing and self-assessment that I will
describe shortly. Further sessions with the External Consultative
Committee are planned on a quarterly basis.
It is important at the outset for me to be clear that the Joint
Year 2000 Council is not intended to become a global Y2K regulatory
authority, with sweeping powers to coordinate international action or
to take responsibility for ensuring Y2K readiness in every financial
market worldwide. Through our ability to serve as a clearinghouse for
Y2K information, however, I believe that the Joint Year 2000 Council
will play a positive role in three areas: (1) raising awareness, (2)
improving preparedness, and (3) contingency planning. In the next
portion of my remarks, I would like to address each of these roles in
turn.
efforts to promote awareness
The Joint Year 2000 Council is undertaking a series of initiatives
that may be described under the heading of promoting awareness. By this
term, I do not mean to include only those initiatives aimed at raising
general awareness, although that too is still needed in some cases. I
mean to include efforts to promote better awareness of the many efforts
currently under way to tackle the Y2K problem. I have found that, while
many organizations are working hard on various aspects of the Y2K
challenge, in many cases these efforts would be enhanced by a greater
degree of information sharing with others. For example, at the Federal
Reserve Bank of New York, we have been holding quarterly Y2K forums
with a diverse set of financial organizations in the area. Participants
have requested that we continue to hold these meetings--in fact, to
hold them even more frequently--because they believe that the contacts
and the exchange of views are broadly beneficial. We hope to use the
Joint Year 2000 Council to achieve similar goals.
Each of the members of the Joint Year 2000 Council has committed to
help play a leading role in promoting awareness of Y2K initiatives
within their region. Each of us will help in coordinating regional Y2K
forums or conferences and will publicly promote the goals of the Joint
Year 2000 Council in speeches and on conference programs.
The Joint Year 2000 Council will also maintain extensive world-
wide-web pages that can be accessed freely over the Internet.\3\ These
pages are being maintained through the support the Council has received
from the Bank for International Settlements, in particular from the
General Manager, Andrew Crockett. These web pages will maintain current
information on the activities of the Joint Year 2000 Council.
---------------------------------------------------------------------------
\3\ The web pages of the Joint Year 2000 Council can be reached at
the web site of the Bank for International Settlements (www.bis.org).
These pages will also be registered under the name jy2kcouncil.org in
the near future.
---------------------------------------------------------------------------
The most extensive aspect of the Council's web site will be a
series of country pages, one for each country in the world. For each
country, the page will contain contact information for government
entities (including national coordinators), financial industry
supervisors and regulators (including central banks, banking
supervisors, insurance supervisors, and securities regulators),
financial industry associations, payment, settlement and trading
systems, chambers of commerce, and major utility associations or
supervisors. For each of these organizations, a name, address, phone
number, fax number, electronic mail and web site address will be
provided. Other relevant information on an organization's Y2K
preparations may also be included, for example, whether it has a
dedicated Y2K contact or has taken specific action with respect to the
Y2K problem.
The motivation for developing these country pages is to increase
awareness of the work that is being done to address the Y2K problem and
to enable market participants to easily find out more information about
the state of preparations worldwide. Establishing these national
contacts will also help to develop the informal networks and
arrangements that may be needed in addressing other Y2K-related issues,
for example, in formulating contingency measures. Finally, of course,
the presence of the country pages may exert pressure on those countries
where more vigorous action is needed. A blank or uninformative country
listing would probably not be seen as a good sign by some financial
market participants.
In addition, the web pages of the Joint Year 2000 Council will also
provide summaries of the efforts being undertaken by its Sponsoring
Organizations as well as links to the relevant web sites. For example,
reports on Y2K surveys of supervisors and regulators being undertaken
by the Basle Committee on Banking Supervision and by the International
Organization of Securities Commissions are planned to be made available
on the Joint Year 2000 Council web site. Public papers produced by the
Joint Year 2000 Council will also be available on the web site. A
listing of international conferences and seminars related to Y2K will
be posted on the web site, together with links to other Y2K web sites
and documents.
At this stage, each member of the Joint Year 2000 Council is in the
process of finalizing the country page for its respective country. I
recently wrote to every contact provided by the four Sponsoring
Organizations (almost 600 contacts in over 170 countries), asking for
assistance in coordinating the development of their country page. This
also provided a further opportunity to raise the awareness of the Year
2000 problem at the most senior levels of financial market authorities
and supervisors in countries around the world. Through the effort to
develop this web site and other similar efforts by the Joint Year 2000
Council, I believe we can succeed at keeping the awareness of the issue
at a very high level within the global financial supervisory community.
efforts to improve preparedness
Of course, awareness of the Year 2000 problem is only the first
step in addressing it. Global efforts to prepare for Year 2000 vary
widely, and many countries believe that more coordinated national
action will be necessary to tackle the problem as effectively as
possible. At our second meeting of the Joint Year 2000 Council, a
strong consensus emerged that a national government body in each
country could play a helpful role in coordinating preparations for Y2K.
While the Council did not have a strong view on what particular form or
what specific authority such a body would require in each specific
country, the Council members felt strongly that involvement in some
fashion by the national government could be beneficial.
Accordingly, the Joint Year 2000 Council plans to issue a statement
in the near future providing general support for the concept of a
national-level coordinating body for the Y2K problem. In the United
States, of course, the White House has established the President's
Council on Year 2000 Conversion, headed by John Koskinen. This effort,
as well as those of this committee under the leadership of Chairman
Bennett, and of the other Congressional committees that have addressed
the Y2K problem, has shown that national government bodies have a very
important and useful role to play in encouraging progress in addressing
the Y2K problem.
Turning now to the question of how financial supervisors can
implement effective Y2K programs, the Joint Year 2000 Council intends
to promote the sharing of strategies and approaches. For example, the
Basle Committee on Banking Supervision has prepared a paper containing
``Supervisory Guidance on Independent Assessment of Bank Year 2000
Preparations''. This document is aimed at moving supervisors worldwide
from a level of general awareness to a specific, concrete program of
action for overseeing Y2K preparations, both on an individual bank
basis and on a system-wide basis.
The Joint Year 2000 Council intends to adapt this paper for use by
financial market regulators and supervisors more broadly and to issue
it as rapidly as possible with the endorsement of all four Sponsoring
Organizations. The goal will be to provide guidance in developing
specific Year 2000 action plans for all types of financial market
authorities. Supervisors in countries that have gotten a head start on
the issue can thereby provide the benefit of their experience to those
who are starting later. Those supervisors getting a late start have a
need for tools of this type.
The Joint Year 2000 Council will also be working with the members
of our External Consultative Committee, particularly the Global 2000
Coordinating Group, to build on this effort and develop a Y2K self-
assessment tool that could be used broadly by the financial industry in
countries around the world. We also intend to develop additional papers
on a variety of Y2K topics that might be of interest to the global
financial supervisory community.
At this point, I am sure that members of the Committee have
questions regarding the state of Y2K preparations in various parts of
the world. I think that it is fair to say that most believe a spectrum
exists, with the United States at one end of the spectrum, and emerging
market and undeveloped countries at the other end. There are likely
exceptions of course; some developed countries are probably less far
along than they should be. Some emerging market countries, on the other
hand, appear to be quite advanced in their preparations.
Overall, however, there is still not nearly enough concrete,
comparable information on the preparations of individual institutions
to be able to make any confident statements about the state of global
preparations in any detail. Over the time remaining until January 2000,
we hope to use the Joint Year 2000 Council as a means of gathering a
better picture of the state of global preparations, and to help direct
resources and attention to those regions that appear to be faltering in
their efforts. We will use the information provided for our web site
and the discussions with members of our External Consultative Committee
as our primary resources in seeking to identify ``hot spots'' where
more urgent efforts are needed.
If we identify regions where more needs to be done, our first step
will be to work through the relevant national financial supervisors and
regulators to increase the urgency of efforts in their jurisdiction. We
may also involve multilateral institutions, such as the World Bank, to
help increase national attention on the issue. I do not believe that
calling public attention to problems in specific countries would be a
constructive step for us to take at this stage as we are still trying
to build cooperation and our current information is incomplete. In this
context, I would also point out that the market itself will begin to
bring strong pressures to bear on specific firms and markets that
exhibit signs of being ill-prepared during the course of 1999.
In conjunction with preparations for Y2K, the recent discussion of
the Joint Year 2000 Council with the External Consultative Committee
raised several important issues. First, in every national market there
is the question of the dependence of the banking and financial sectors
on core infrastructure such as telecommunications, power, water, sewer,
and transportation. In all cases, it seems that it is not an everyday
occurrence for representatives of these differing sectors to get
together with financial sector representatives and discuss their mutual
concerns. Yet, this must be made a priority if financial firms and
their counterparties are to achieve comfort that their own efforts to
prepare for Year 2000 will not be compromised by the failures of
systems beyond their control.
A representative of the International Telecommunications Union is a
member of our External Consultative Committee. At our meeting earlier
this month, he provided useful factual information on the preparations
being undertaken by telecommunications firms and indicated that a
further global survey and report on this topic is due to be completed
soon. This is the type of information sharing that helps all parties
understand the scope of the problem, as well as the efforts that others
are undertaking. We intend to encourage further information sharing
between the financial sector and core infrastructure providers at
future meetings of the Joint Year 2000 Council and the External
Consultative Committee. I would also strongly encourage such mutual
cooperation on Y2K preparations within each national jurisdiction.
Another issue that some participants in our Joint Year 2000 Council
are concerned about in regard to preparations in their countries
relates to the availability of human resources. In some regions, the
supply of available information technology professionals may be hard-
pressed to meet the challenges posed by Y2K. For each organization
facing resource constraints, this situation clearly indicates the need
to develop action plans for Y2K that set clear priorities among systems
and projects.
More broadly, we must also recognize that the lack of available
programming resources will be a significant overall constraint on the
scale of Y2K remediation efforts globally. As a result, the cost of
hiring computer professionals capable of addressing the problem will
continue to rise. Wealthy countries are undoubtedly in a better
position to bear these increasing costs than are poor countries.
A number of participants from our External Consultative Committee
cited the recent grant of 10 million sterling by the
British Government to the World Bank as a positive development. Among
other projects, the World Bank intends to use this grant to fund a
variety of educational and awareness-raising events related to Y2K over
the next several months. Given the potential consequences of a failure
to prepare for Y2K, the World Bank indicated to the Joint Year 2000
Council that it intends to take on an aggressive role in promoting and
assisting Y2K efforts in countries around the world. The Joint Year
2000 Council intends to work closely with the World Bank to enhance our
mutual efforts on the Y2K problem.
The subject of appropriate Y2K disclosure was also discussed by
members of the External Consultative Committee. Many of those present
agreed that greater disclosures would be helpful. However, there was
skepticism that a standardized disclosure format would be effective in
eliciting meaningful information for a wide class of financial firms,
given the complexity and variety of Y2K issues facing these firms
worldwide. It was also noted that disclosure which relies primarily on
a firm's own subjective assessments of its Y2K problems inevitably will
suffer from an optimistic bias.
In addition, most Y2K efforts will not reach the serious testing
phase until 1999. The purpose of the testing will be to uncover areas
where additional work is required, so that the first round of tests can
be expected to encounter problems. In this environment, it may be
difficult for firms themselves to assess the true state of their Y2K
preparations. Also, firms who believe they are going to be ready will
be directed by legal counsel not to make too strong a statement to
avoid liability claims in case of unforeseen problems. On the other
hand, firms that do not believe they can get ready in time will seek to
avoid stating this clearly to protect their activities during 1999. For
all of these reasons, I am doubtful that specific, reliable information
on the state of Y2K preparations by individual firms worldwide will
become publicly available.
Finally, in the area of improving preparedness, I have saved the
most important topic for last--namely, testing. Testing programs,
particularly external testing programs, are universally regarded as the
most critical element of serious Y2K preparations in the financial
sector. The Joint Year 2000 Council encourages all firms and
institutions active in the financial markets to engage in internal and
external testing of their important applications and interfaces. To
this end, many major payment and settlement systems around the world
have developed extensive testing programs and procedures for their
participants. In the United States, for example, Fedwire, CHIPS, and
S.W.I.F.T. have coordinated shared testing days for the purpose of
testing the major international wholesale payments infrastructure for
the U.S. dollar. The Securities Industry Association (``SIA'') has been
at the forefront of an ambitious program to develop a coordinated
industry-wide test of all aspects of the trading and settlement
infrastructure for the U.S. stock market. The FFIEC's efforts have also
been extremely beneficial in stressing the importance of testing within
the banking sector generally.
Yet, external testing programs globally need to be dramatically
extended and expanded. To that end, the G-10 Committee on Payment and
Settlement Systems last year started to collect information on the
state of preparedness and testing of payment and settlement systems
worldwide. To date, over 150 systems in 47 countries have responded to
the framework and posted such plans.\4\ The Joint Year 2000 Council
intends to expand the coverage of this framework to exchanges and
trading systems, as well as major financial information services
providers, and hopes to expand the number of countries and systems that
are included. We will also collate and present the information
graphically to help highlight anomalies in testing schedules, and to
facilitate the efforts of systems to coordinate test scheduling where
feasible.
---------------------------------------------------------------------------
\4\ The relevant information can now be found on the pages of the
Joint Year 2000 Council.
---------------------------------------------------------------------------
Primarily, I see this as an exercise in peer pressure. If we list
every country in the world on our web site and the public can see that
some countries have scheduled mandatory external tests of their major
trading and settlement systems, while other countries do not provide
any information, that second country may come under greater pressure to
organize an external testing program. This is our stated goal. We will
simply have blanks for those countries that do not respond to our
requests for information.
Of course, if the Joint Year 2000 Council is going to encourage
testing to such an extent, then it is only appropriate that we also
help provide some tools for those countries trying to get a serious
testing effort underway in a short amount of time. This is another of
our high-priority projects. We will be working with members of the
External Consultative Committee--including representatives of the
Global 2000 Coordinating Group, S.W.I.F.T., and the World Bank--to
rapidly develop a series of documents that help countries set up
testing programs and overcome common obstacles. We intend to issue
these documents broadly by the end of the summer, and some parts well
before that.
In closing this section of my statement, I do not think it is
possible to over-emphasize the importance of testing to help improve
readiness. To illustrate this point, I would like to draw on our
experiences with Fedwire, the Federal Reserve's wholesale interbank
payments system. Much of the current Fedwire software application was
written in the last five years, with the Y2K problem in mind.
Nevertheless, some of the older software code that was carried over
into the new application was not Y2K-compliant. Without the rigorous
internal Y2K testing program that the Federal Reserve adopted, our Y2K
remediation efforts might, therefore, have been incomplete. I think of
this experience whenever I hear it said that some countries are immune
to Y2K because they have only recently introduced information
technology and that recent software programs are less affected by Y2K.
I ask whether those programs have truly been thoroughly tested for Y2K
compliance.
contingency planning efforts
The third major role of the Joint Year 2000 Council will relate to
contingency planning. In this context, I should note that contingency
planning is something that most financial market authorities,
particularly central banks, undertake regularly with regard to a wide
variety of potential market disruptions. Most private-sector financial
firms, as well, have well developed contingency and business continuity
plans in place for their operations.
Nevertheless, it is clear that contingency planning for Y2K
problems has a number of unique characteristics. First, of course, is
the fact that one cannot rely on a backup computer site for Y2K
contingency if that site also uses the same software that is the cause
of the Y2K problem at the main site. In some cases, it is impractical
to build a duplicate software system from scratch simply to provide for
Y2K contingency. In these cases, as a senior banker explained at one of
our New York Y2K forums, contingency planning amounts to, ``Testing,
testing, and more testing.''
Contingency planning can also be separated into components that are
firm-specific and those that are market-wide. Each individual firm will
need to develop its own contingency plans designed to maintain the
integrity of its operations during the changeover to the Year 2000. The
FFIEC has recently issued guidance to banks in the United States
regarding the core elements of their own contingency planning.\5\ The
Joint Year 2000 Council will also be developing a paper on contingency
planning for the benefit of the global financial supervisory community.
This paper will seek to address firm-level contingency as well as
issues of market-wide contingency.
---------------------------------------------------------------------------
\5\ See www.ffiec.gov/y2k/contplan.htm
---------------------------------------------------------------------------
Market-wide contingency refers to the planning by participants and
supervisors done to ensure that individual disruptions can be managed
in ways that will prevent them from causing disruptions to critical
market infrastructures. For instance, we at the Federal Reserve have
gone to great lengths to ensure that barriers are in place to prevent
Y2K problems with a Fedwire participant from causing problems on the
Fedwire system itself. We are also now actively researching additional
steps that the Federal Reserve could take to better prepare the
financial markets as a whole to function in spite of disruptions at
individual firms.
It is also important to realize that contingency planning for Y2K
is not solely an operational issue. Financial firms may seek to adopt a
defensive posture in the marketplace well ahead of Monday, January 3,
2000 (the first business day of the new year in the United States). For
example, market participants may seek to minimize the number of
transactions that would be scheduled for settlement on January 3 or
January 4, or that would require open positions to be maintained over
the century date change weekend.
Contingency planning involves a series of elements, many of which
must be put in place well before January 2000. For example, we must
consider many possible sources of disruption and determine what
approaches could be available to limit the impact of each possible
disruption. The sooner such thinking occurs, the more opportunity we
have to plan around the possible disruptions. In this context, members
of our External Consultative Committee noted that one of the key
obstacles to effective contingency planning is the inability to list
and consider all possible disruption scenarios. Several of these
participants noted that their firms were engaging consultants or other
procedures to expand the number of scenarios for inclusion in their Y2K
contingency planning.
In New York, we will be using our Y2K forum later this month to
discuss contingency planning with a diverse set of market participants.
These local market participants will provide helpful insights for the
Joint Year 2000 Council. Clearly, more work is needed on contingency
planning for Y2K, especially at the international level. Once we get
beyond the early fall of this year, I believe that these efforts will
begin to receive much greater focus and attention, and--together with
testing--will dominate our discussions of Y2K during 1999.
closing remarks
In closing, I would like to thank the Committee for the opportunity
to appear and submit a statement on this important issue. I hope that
the efforts of the Joint Year 2000 Council will help to make a
difference in improving the state of Y2K preparations in the
international financial community. Realistically, however, I believe
that it is important to understand the limits of what financial market
supervisors can accomplish, either individually or collectively. Only
firms themselves have the ability to address the Year 2000 problems
that exist within their own organizations. Only firms working together
can assure that local markets will function normally. Supervisors and
regulators cannot guarantee that disruptions will not occur.
Given the sheer number of organizations that are potentially at
risk, it is inevitable that Y2K-related disruptions will occur. Today
it would be impossible to predict the precise nature of these
disruptions. However, we do know that financial markets have in the
past survived many other serious disruptions, including blackouts, snow
storms, ice storms, and floods. We will also have a very interesting
case at the end of this year with the changeover to monetary union in
Europe. We will all be watching carefully to see whether the extent of
operational problems related to this event is greater or less than
expected.
I would also like to say at this point that my discussions with
other members of the Joint Year 2000 Council and with members of the
External Consultative Committee have convinced me that successful
efforts to address the Y2K problem will be dependent on the credibility
of those calling for action. Those of us--such as members of this
Committee as well as others in Congress--who are seriously engaged and
concerned need to be able to persuade others of the need to take
appropriate actions promptly. It would be unfortunate if general
perceptions of the Y2K problem are driven primarily by unofficial
commentators whose rhetoric is seen to exceed the facts on which it is
based, and therefore easily dismissed.
As a central banker and bank supervisor, my major concern must be
with the system as a whole. At this point, I believe that we are doing
everything possible to limit the possibility that Y2K disruptions will
have systemic consequences in our markets. However, we must all
continue to work hard--both individually and cooperatively--in the time
that remains to ensure that this threat does not become more concrete.
In that spirit, Mr. Chairman, I would like to end my remarks by
commending the Committee for organizing these hearings on the progress
of foreign financial markets in addressing the Year 2000 computer
problem.
list of attachments
1. Communique of the sponsors of the Global Year 2000 Round Table,
April 8, 1998.
2. Communique of the G-7 Finance Ministers, May 9, 1998.
3. Communique and fact sheet of the Joint Year 2000 Council, May
19, 1998.
Attachment 1.--Global Round Table on the Year 2000
On 8th April the Bank for International Settlements hosted a Round
Table on the Year 2000, jointly sponsored by the Basle Committee on
Banking Supervision (Basle Committee), the Committee on Payment and
Settlement Systems (CPSS), the International Association of Insurance
Supervisors (IAIS) and the International Organization of Securities
Commissions (IOSCO). The meeting was attended by more than 200 senior
executives (from 52 countries) representing a variety of public and
private sector organisations in the financial, information technology,
telecommunications and business communities around the world.
In 1997, the sponsoring organisations each took initiatives to
raise awareness of the issues surrounding the century date change,
enhance disclosure and prompt appropriate action within the financial
industry. The sponsors' decision to organise the Round Table was
motivated by their recognition of the seriousness of the challenges
posed by the century date change in IT applications and of the
potentially severe consequences in the financial markets associated
with a lack of Year 2000 readiness. The discussions at the conference
focused on the increasing challenges presented by the century date
change, with specific emphasis on the identification of initiatives
that need to be taken in order to ensure that financial market
participants and the interconnected infrastructures around the world
can continue to function without major disruptions during the
transition to the new millennium.
The discussions at the Round Table confirmed that the Year 2000
issue needs to remain a top priority of senior management and
emphasised that private and public sector bodies should coordinate
their focus on a number of important issues and approaches. These
include the continuing need to ensure strengthening and widening of
external testing programmes, improving information sharing among market
participants and their vendors and service providers, fostering
increased disclosure by financial and non-financial corporations of
their Year 2000 readiness and testing results, establishing market
conventions and procedures for dealing with potential contingencies,
and reinforcing the role of oversight bodies such as supervisors and
auditors. The importance of thorough testing, both internally and with
counterparties, was emphasised as the most effective way to ensure that
problems are minimised.
sponsors' recommendations
1. Awareness of the seriousness and scope of the problem is high
but varies considerably across markets and institutions worldwide. The
sponsors believe that it is imperative that all market participants,
and especially financial market supervisors, work to ensure that Year
2000 preparations receive the maximum senior management attention and
priority, including at the board of directors level. In particular,
market participants from regions that have not yet vigorously tackled
the problem should consider the need to invest significant resources in
the short time that remains.
2. Testing for Year 2000 readiness is the most critical and complex
issue facing the financial industry. Because widespread testing has not
yet begun, the extent of the problems and the amount of remediation
work that remains is unclear. The sponsoring organisations urge market
participants to explore ways to enhance the transparency of testing
results.
3. The sponsors consider it critical that financial market
supervisors around the world implement programmes that enable them to
assess the Year 2000 readiness of the organisations and market
infrastructures that they supervise. Further, it is important for
supervisors to ensure that the risks related to the century date change
are identified, properly communicated among market participants and
appropriately managed in their jurisdiction.
4. The sponsoring organisations agree that the highest possible
priority should be given to Year 2000 preparations by
telecommunications and electricity providers in each national
jurisdiction. Failure of these organisations to prepare adequately and
share information on their plans in order to promote effective testing
could lead to serious disruptions in the world's financial markets.
5. In order to achieve a greater degree of market transparency, the
sponsors believe that the sharing of critical information on Year 2000
readiness by all market participants is essential. The sponsors
encourage private sector efforts to develop standard questionnaires and
frameworks for Year 2000 disclosure as these have the potential to
provide clear means for measuring progress.
6. Financial industry conventions and dispute resolution procedures
should be developed to address the possibility of transaction failures.
Additionally, contingency measures should be considered for the
potential failure of key parts of the financial market infrastructure.
Further, it is recognised that national payment systems need to
coordinate testing schedules in order to provide opportunities for end-
to-end testing on a domestic and international basis. The Round Table
sponsors welcome and support the initiatives taken by various industry
groupings in this respect.
joint year 2000 council
While the sponsoring organisations can raise awareness of the Year
2000 issue, only the private sector can assure that applications are
ready and thoroughly tested internally and externally and on an
international basis. To this end, several private sector initiatives
fostering international coordination and cooperation were identified
during the forum. To maintain a high level of attention within the
supervisory community and to support and encourage these private sector
efforts, the sponsoring organisations are forming a Joint Year 2000
Council comprised of senior members of each committee.
Attached to this communique are further details on the discussions
and conclusions of the Round Table. The BIS Web site contains further
information on the Round Table and will be used to provide ongoing
information on the activities of the sponsoring organisations and of
the Joint Year 2000 Council.
Details on the Discussions and Conclusions of the Year 2000 Round Table
key issues raised at the round table
The presentations and discussions at the Round Table confirmed that
the complexity of the issues associated with the Year 2000 cannot be
overestimated. Moreover, every senior political and business executive
should have realised by now that the issues pose a critical management
challenge and have potentially severe consequences for the ability of
business entities to continue operating through the transition to the
new millennium. The many challenges include the need to address
resource constraints, the need to share information on readiness (not
withstanding legal issues), the coordination of testing schemes within
and across markets, the heightened disclosure of vital information, the
development of market conventions to deal with transaction failures and
contingency planning for infrastructure problems.
Discussions at the Round Table confirmed that the Year 2000
challenge continues to require the unwavering attention of senior
executives in institutions throughout the world. Organisations need to
ensure that appropriate programmes have been established to address all
the various readiness issues that can be expected to affect their
business. The resource constraints (financial, human and technological)
and the amount of time needed to remediate and test internal systems
are compounded by the need to evaluate readiness and arrange for
testing with counterparties and customers, payment, clearance and
settlement systems, and various trading and information systems.
It is obvious that no individual IT user, individual institution,
sector, market, or country is immune to the difficult issues presented
by the Year 2000 problem. Even if an institution has verified and
tested all its internally developed systems and applications, it will
be affected by: the state of readiness of its vendors and third-party
service providers; the public utilities upon which it relies,
particularly the telecommunications and electricity suppliers; the
infrastructures that it relies upon for its trading, payment and
external information needs; and the counterparties and customers upon
which its business viability rests. Moreover, the globalisation of
financial and economic activity and the widespread use of information
and telecommunications technology throughout the world has created
various international interconnections and global interdependencies
which add greatly to the complexity of the challenge.
particular areas requiring further attention
The discussions at the Round Table emphasised that while only the
private sector can solve Year 2000 problems, public sector coordination
is necessary to facilitate domestic and global activities. Such
coordination is particularly helpful in designing external testing
programmes, improving information sharing among market participants and
their vendors and service providers, fostering increased disclosure by
financial and non-financial corporations of their Year 2000 readiness
and testing results, establishing market conventions and procedures for
dealing with potential contingencies, and reinforcing the role of
oversight bodies such as supervisors and auditors.
Testing for Year 2000 readiness may be the most critical and
complex issue facing the financial industry in its effort to ensure
that the various interrelated systems continue to function through the
transition to 2000. Because widespread testing has not yet begun, the
degree of uncertainty regarding the scale of the problems that will
arise and the remediation work that remains to be accomplished is
considerable. Further, the four sponsors urge market participants to
explore avenues that will serve to enhance the transparency of testing
results for the benefit of the remediation efforts of the industry at
large.
Given the degree of interconnection between market participants and
the fact that internal remediation programmes and testing efforts will
require continuous reassessment and adaptation, organisations should
maintain an open dialogue with their customers, counterparties and
creditors in order that all interested market participants are able to
make informed business decisions. Furthermore, it is essential that
organisations consider the likely effects of the century date change on
their customers and counterparties when evaluating future business
transactions with these entities. In order to achieve a greater degree
of market transparency, the sponsoring organisations believe that all
possible efforts should be made to remove legal impediments to the
sharing of critical information on Year 2000 readiness.
The significant dependence of most organisations on external
product and service providers is another concern. The potential effects
of a failing of the telecommunications or electric power infrastructure
would have far-reaching consequences for global business. The
sponsoring organisations agree that the highest possible priority
should be given to Year 2000 preparations by telecommunications and
electricity providers in each national jurisdiction because the failure
of these organisations to prepare adequately and share information on
their plans in order to promote effective testing could lead to serious
disruptions in the world's financial markets.
With respect to the role of oversight bodies, the sponsoring
organisations consider it very important that financial market
supervisors worldwide implement a strategy that enables them to assess
the Year 2000 readiness of the organisations and market infrastructures
they supervise in order to make certain that the risks related to the
century date change are identified and appropriately managed in their
jurisdiction. When Year 2000 remediation and testing programmes of
individual financial organisations or infrastructure operators are
deemed inadequate, supervisors will need to take prompt, meaningful
action. Further, it is essential that internal and external auditors
understand how an organisation's programmes for remediation and testing
are likely to effect their going concern status. It is also necessary
for auditors to ensure that the information used to compile client
financial statements has not been compromised by system errors related
to the date change.
Another important issue is the extent to which market participants
and regulators can rely on certifications of Year 2000 readiness. The
sponsoring organisations believe that financial institutions must
understand that an issuance of a certification does not guarantee a
product will perform as expected. While vendors have an obligation to
let clients know when they have renovated and tested their products,
users need to test that product within their environment to ensure that
it performs properly as a component of their system. As such, attempts
to obtain legally binding certifications of compliance are likely to
needlessly complicate the important work that must be completed in the
period prior to 1st January 2000. Additionally, market participants
must not adopt a false sense of security but recognise the limits of
any statement on readiness and that they need to perform their own due
diligence.
follow-up to the round table
The private sector, both in a domestic context and internationally,
appears committed to move ahead on a variety of fronts, including the
further development of mechanisms to share information relating to Year
2000 issues, an effort to set minimum best practices for programmes
designed to achieve readiness, and the support of rigorous internal and
external testing. Although competitive pressures may arise from the
markets' assessment of the readiness of individual institutions, there
is likely to be scope for institutions, individually or through
industry associations, to cooperate to ensure that the time remaining
before the new millennium is used to the mutual benefit of all
organisations. In the financial industry, in particular, it would be
useful if conventions could be developed for the resolution of
transaction failures, and contingency measures are considered for the
potential failure of key parts of the financial market infrastructure.
Further, it is recognised that national payment systems need to
coordinate testing schedules in order to provide opportunities for end-
to-end testing on a domestic and international basis. The Round Table
sponsors welcome and support the initiatives taken by various industry
groupings in this respect.
The sponsoring organisations intend to remain pro-active and
continue to pay particular attention to Year 2000 issues and to the way
in which individual firms, market infrastructures and industry
associations in their respective areas of competence implement
programmes and testing schemes aimed at ensuring Year 2000 compliance.
In the case of the Basle Committee, it may be decided in the future to
publish, if needed, more guidance on specific issues, such as the
cross-border aspects of the Year 2000 problem and the management of
external dependencies. The CPSS will maintain and expand the special
section on the BIS Web site (www.bis.org) that provides information on
the testing plans and readiness status of payment and settlement
systems worldwide. Likewise, IOSCO will continue to update the special
Year 2000 section on IOSCO's Web site (www.iosco.org), including
information on the testing and readiness status of the securities
industry and markets worldwide. The IAIS will continue to work with its
members to urge insurance companies to implement detailed action plans
to resolve the Year 2000 problems associated with their business
activities.
Where appropriate, the four sponsors plan to take further joint
action to promote the Year 2000 readiness of the global financial
industry. They will cooperate with regional efforts to promote the
organisation of regional seminars on the Year 2000 topic in order to
enhance worldwide awareness of the seriousness of the situation and to
induce appropriate action with the aim of achieving Year 2000 readiness
and contingency planning.
In order to share information on regulatory and supervisory
strategies and approaches, discuss possible contingency measures, and
establish a point of contact with national and international private
sector initiatives, the sponsoring organisations have formed a Joint
Year 2000 Council, composed of senior members of each committee with
broad-based experience.
The BIS Web site contains further information on the Round Table
and will be used to provide ongoing information on the activities of
the sponsoring organisations and of the Joint Year 2000 Council. The
Web site also carries details on the Year 2000 readiness and testing
schedules of payment and settlement systems worldwide. A summary video
recording of the proceedings will also be available and can be obtained
(in the appropriate format for your region) from the BIS Publications
Service.
Attachment 2.--Conclusions of G-7 Finance Ministers
london, 8 may 1998
1. Finance Ministers of the G-7 and the representative of the
European Commission met in London on 8 May, as a part of the
preparations for the Birmingham Summit, 15-17 May. We reached
conclusions on a group of issues, set out below. We will also be
reporting our discussions to our Heads of State or Government, for
their Summit next week. Michel Camdessus, Managing Director of the IMF
and Jim Wolfensohn, President of the World Bank, joined us for our
discussions on the lessons of the Asian crisis, and steps to strengthen
the world's financial system.
world economy
2. We reviewed recent developments in the world economy. We
welcomed the historical decisions in Europe on Economic and Monetary
Union. We look forward to a successful EMU which contributes to the
stability of the international monetary system. We discussed and
welcomed the substantial policy measures announced by the Government of
Japan in April, aimed at achieving domestic demand-led growth. Japan
expressed its intention to implement them quickly and stressed the
importance of further strengthening the financial system. We also noted
that the United States economy required vigilance to stay on a
sustainable path.
strengthening the global financial system
3. Globalisation brings clear benefits to people throughout the
world but it also brings certain risks. Previous summits have agreed on
ways to reduce these risks and strengthen the global financial system.
However, the continuing process of globalisation and recent events in
Asia have revealed a number of weaknesses and vulnerabilities in
national and international financial systems, as well as in the lending
practices of private sector investors. We need to act to strengthen the
global financial system further, both to reduce the likelihood of such
crises occurring in future and to improve techniques for containing and
responding to crises when they do occur.
4. We have developed proposals where there is now an emerging
consensus for modifications to the architecture of the international
financial system. There are important aspects of the issues discussed
that require further work. Discussion within our countries, with
emerging market countries and with the private sector will continue
over the coming months. For now, having restated the importance of
sound economic policies, we have identified the need for action in five
key areas:
--enhanced transparency and data dissemination;
--helping countries prepare for integration into the global economy
and for free global capital flows;
--strengthening national financial systems;
--ensuring that the private sector takes responsibility for its
lending decisions;
--enhancing further the role of the International Financial
Institutions and cooperation amongst them and with the
international regulatory fora. We are considering ways, and ask
the relevant institutions to develop proposals on ways, in
which greater co-operation can be achieved including options
for institutional reform.
5. We have set out our proposals in a separate report to our Heads
of State or Government, which outlines how work is being taken forward
in each of these areas and signals a number of areas for further work.
financial stability: supervision of global financial institutions
6. Since the Lyon and Denver Summits, work has been underway to
strengthen the international financial system. Recent events in Asia,
combined with the rapid consolidation and globalisation in the
financial sector, have highlighted once again the need to improve
urgently co-operation between supervisors of internationally active
financial institutions. We welcome the work done by the international
regulatory bodies in this area and urge them to move quickly towards
implementation of the concepts they have devised. Today we have reached
important conclusions in a separate report. We commend the 10 Key
Principles on information exchange which we will be promoting
throughout the world as standards to which all countries should aspire.
The G-7 also looks forward to the continuing contribution of the
private sector to developing international standards that enhance the
supervision of global financial firms, while reducing regulatory
burdens. On the year 2000 issue, we call on the Basle Committee, the
International Organisation of Securities Commissions (IOSCO), the
International Association of Insurance Supervisors (IAIS) and the
Committee on Payment and Settlement Systems (CPSS), and their newly
formed joint Year 2000 Council to monitor the work that firms in the
financial area already have underway, and to do all that they can to
encourage compliance.
financial crime
7. The fight against financial crime is one of the major challenges
of our times. We emphasise that, as both financial services and crime
become increasingly globalised, this challenge can only be met if all
major financial centres work together. Effective co-operation between
financial regulators and law enforcement authorities at the
international level is an essential element of this. A G-7 expert group
was set up by the Denver Summit to consider how this cooperation can be
improved within our countries. We now agree to:
--review our laws and procedures concerning information exchange
between financial regulators and law enforcement agencies
against a common list of key elements for effective
cooperation;
--identify by October what modifications are desirable, consistent
with fundamental national and international legal principles,
to improve our systems and to implement such measures as
quickly as possible;
--take forward a number of practical steps to improve cooperation;
--disseminate a G-7 Reference Guide to Procedures and Contact Points
on Information Exchange to financial regulators and law
enforcement agencies in our countries and to expand this Guide
to cover all major financial centre countries.
8. We have instructed the G-7 expert group to provide a report on
progress on all these areas and any further recommendations in
preparation for the Koln Summit.
9. We also recognise that action must not be confined to G-7
members and we emphasise that all countries should provide effective
international administrative and judicial cooperation. In particular,
we are concerned at the number of countries and territories, including
some financial offshore centres, which continue to offer excessive
banking secrecy and allow screencompanies to be used for illegal
purposes. We recognise that the Financial Action Task Force (FATF) has
already taken significant steps in this area and endorse FATF's efforts
to support the Offshore Group of Banking Supervisors in its mutual
evaluation process. We therefore call on the FATF to review the present
position and make recommendations to Ministers by the Koln Summit on
what can be done to rectify these abuses.
financial action task force
10. We commend the work that the FATF has carried out since its
creation in 1989 to develop and promote action against money
laundering. Its Forty Recommendations remain the essential standard for
effective countermeasures. However, although considerable progress has
been made in the fight against money laundering, we agree with the FATF
that much still remains to be done. We therefore endorse the decision
of the FATF to continue its mandate for a further five years and the
new strategy it has adopted.
11. We agree that the major task during this period should be the
establishment of a world-wide anti-money laundering network
encompassing all continents and regions of the globe. We support FATF's
intention to expand its own membership to a limited number of countries
meeting the agreed criteria and to encourage the further development of
regional anti-money laundering bodies. We call on other international
organisations to work closely with the FATF in its mission. We also
consider it essential that the FATF continues to monitor money
laundering trends and techniques and to ensure that its Recommendations
keep pace with new developments.
12. We encourage FATF to implement its new strategy as quickly as
possible and urge all countries to join in the fight against money
laundering.
tax competition
13. We warmly welcome the OECD agreement on action to tackle
harmful tax competition. This provides a strong basis for co-ordinated
international action to curb harmful tax competition through
preferential tax regimes and tax havens. And we note the complementary
development of the EU Code of Conduct.
14. We strongly endorse the OECD recommendations, and we welcome
the establishment of the OECD Forum on harmful tax practices. We will
work through the Forum to secure effective implementation of the
recommendations, and will actively support the proposed dialogue with
non-OECD members to promote the agreed principles and recommendations
on a global basis.
15. We urge the OECD to give particular attention to the
development of a comprehensive programme to improve the availability of
information to tax authorities to curb international tax evasion and
avoidance through tax havens, and through preferential tax regimes.
This would involve developing further the proposals to improve exchange
of tax information between OECD countries to address the problems
caused by restricted access to banking information and to improve the
supply of information from tax havens by the negotiation of effective
information exchange arrangements.
16. In addition we encourage international action to enhance the
capacity of anti-money laundering systems to deal effectively with tax
related crimes. Action here would both strengthen anti-money laundering
systems and would also be an essential component of a coherent
programme to increase the effectiveness of tax information exchange
arrangements. Action could be based on furthering the following
objectives:
(a) Effective anti money laundering systems must ensure that
obligations to report transactions relating to suspected
criminal offences continue to apply even where such
transactions are thought to involve tax offences.
(b) Money laundering authorities should be permitted to the
greatest extent possible to pass information to their tax
authorities to support the investigation of tax related crimes,
and such information should be communicated to other
jurisdictions in ways which would allow its use by their tax
authorities. Such information should be used in a way which
does not undermine the effectiveness of anti-money laundering
systems.
17. We intend to pursue the development and implementation of these
objectives with our OECD partners and in other appropriate fora
including the FATF.
18. We in G-7 commit ourselves to giving a lead by working to
further the foregoing objectives in all territories and jurisdictions
for which we have international responsibilities or over which we have
influence. And we will follow closely the progress of further work on
harmful tax competition which the OECD intends to undertake and the
related work on tax related crimes.
customs procedures
19. In Lyon we initiated an effort to standardize and simplify
customs procedures. We welcome the further work undertaken since Denver
which has produced a harmonised and simplified data set for import and
export procedures, and urge our experts to reduce that data to a
minimum consistent with customs responsibilities by the end of this
year. We ask our experts to complete their work, including the
development of standardised electronic declarations and to encompass
the related import and export data requirements of other government
departments and agencies. Our countries will, drawing on each others'
experience, take all steps possible to establish customs prototypes or
other procedures involving all the G-7 countries, which will use an
agreed G-7 data set, by the Summit in the year 2000 if possible.
20. We also welcome the significant progress made on the Action/
Defis programme of the World Customs Organisation to strengthen co-
operation between enforcement agencies and associations of
international carriers. We encourage further development of this work.
ageing
21. We welcome the reports of the G10 and OECD on macroeconomic and
financial implications of ageing populations. We ask the OECD to
undertake further work looking at individual country ageing issues. We
ask for a report from the OECD by the Summit in the Year 2000.
Attachment 3.-- Joint Year 2000 Council Press Communique
19th may 1998
On the occasion of the Round Table on the Year 2000 held at the
Bank for International Settlements (BIS) on 8th April 1998, the
committees sponsoring the event agreed to establish a Joint Year 2000
Council. The Council is constituted by senior members of each
committee, that is the Basle Committee on Banking Supervision (Basle
Committee), the Committee on Payment and Settlement Systems (CPSS), the
International Association of Insurance Supervisors (IAIS), and the
International Organization of Securities Commissions (IOSCO). Mr.
Ernest Patrikis, First Vice President, Federal Reserve Bank of New
York, chairs the Council and its secretariat is provided by the BIS.
The Council intends to meet regularly and has agreed on a range of
initiatives to ensure a high level of attention on the Year 2000
computer challenge within the global financial supervisory community,
to share information on regulatory and supervisory strategies and
approaches, to discuss possible contingency measures, and to serve as a
point of contact with national and international private-sector
initiatives.
At their meeting in London in early May, the G-7 finance ministers
called on the Council and its sponsoring committees to monitor the Year
2000-related work in the financial industry worldwide and to take all
possible steps to encourage readiness.
A fact sheet presenting the Council's objectives and projects as
well as its membership is attached. Information regarding the Council's
ongoing activities will be posted on the BIS web site (www.bis.org).
joint year 2000 council fact sheet
The mission of the Joint Year 2000 Council is:
--to ensure a high level of attention on the Year 2000 computer
challenge within the global financial supervisory community,
--to share information on regulatory and supervisory strategies and
approaches,
--to discuss possible contingency measures, and
--to serve as a point of contact with national and international
private-sector initiatives.
The Joint Year 2000 Council is sponsored jointly by:
--the Basle Committee on Banking Supervision,
--the Committee on Payment and Settlement Systems (CPSS),
--the International Association of Insurance Supervisors (IAIS), and
--the International Organisation of Securities Commissions (IOSCO).
The Secretariat for the Joint Year 2000 Council is provided by the
Bank for International Settlements (BIS). Information from the Council
will be made available on the BIS Web site (www.bis.org).
The projects envisaged by the Joint Year 2000 Council include:
--providing a forum for the disclosure of the status of global
financial market preparations for the Year 2000,
--encouraging all payment and settlement systems, clearinghouses,
exchanges, and other parts of the global financial market
infrastructure to make publicly available information on their
preparatory efforts and testing programs,
--meeting regularly with an external consultative committee composed
of organizations or associations with an international
perspective on Year 2000 preparations,
--developing a global supervisory contact list for the Year 2000
challenge that includes a coordinating contact covering as many
countries as possible,
--supporting, co-sponsoring, and providing assistance in planning
further conferences and roundtables on the Year 2000 challenge
in different regions of the world,
--facilitating exchanges of information related to Year 2000 testing
programs within the international financial community,
--encouraging coordinated cross-border testing to the maximum extent
possible,
--developing a series of publicly-available working papers on
different aspects of the Year 2000 challenge,
--facilitating the sharing of information on Year 2000 preparations
by core infrastructure providers such as telecommunications,
electric power, and government utilities, as they relate to
preparations by financial market participants,
--sharing and developing ideas on contingency measures appropriate
for individual firms and domestic markets,
--serving as a point of contact for the coordination of international
contingency efforts, and
--encouraging the development of, and the global sharing of plans
for, market conventions and dispute resolution procedures
designed to mitigate the effect of Year 2000 transaction
failures.
Members of the Joint Year 2000 Council
Chairman: Mr. Ernest Patrikis, Federal Reserve Bank of New York
Representing the Basle Committee: Mr. Huw Evans, Bank of England (Mr.
Martin Owen); Mr. Marcel Maes (Mr. Jos Meuleman), Banking & Finance
Commission, Belgium; Mr. Jose Florencio Guzman, Instituciones
Financieras de Chile (Mr. Jorge Cayazzo)
Representing the CPSS: Mr. Carlo Tresoldi, Banca d'Italia; Mr. Jammaz
Al-Suhaimi, Saudi Arabian Monetary Agency (Mr. Taha Al-Kuwaiz and Mr.
Ibrahim Al Hurabi); Dr. J. Tromp, South African Reserve Bank
Representing the IAIS: Mr. Tarmo Pukkila, Ministry of Social Affairs &
Health, Finland; Mr. Bruno Bezard, Ministere de l'Economie et des
Finances, France; Mr. Richard Smith, Insurance and Superannuation
Commission, Australia
Representing IOSCO: Mr. Robert Colby, United States Securities and
Exchange Commission; Mr. Masayuki Tamagawa, Securities Bureau of the
Ministry of Finance, Japan; Dr. Munir-Majid, Malaysian Securities
Commission
Ex officio: Mr. William McDonough, Chairman, Basle Committee on Banking
Supervision, Chairman, Committee on Payment and Settlement Systems; Mr.
Anthony Neoh, Chairman, International Organization of Securities
Commission Technical Committee; Mr. John Thompson, Chairman,
International Association of Insurance Supervisors
Secretariat (BIS): Mr. Paul Van den Bergh, Head of Secretariat; Miss
Cheryl Gleason; Mr. Yves Carlier
Correspondents: Mrs. Daniele Nouy, Secretariat, Basle Committee on
Banking Supervision; Mr. Eudald Canadell, Secretariat, IOSCO (Mr. Brian
Z. Gelfand); Mr. Knut Hohlfeld, Secretariat, IAIS; Mr. Darryll
Hendricks, Federal Reserve Bank of New York
Please address inquiries to:
Joint Year 2000 Council
Secretariat
Paul Van den Bergh
Bank for International Settlements
CH-4002 Basle
SWITZERLAND
Telephone number: +41 61 280 8432
fax number: +41 61 280 9100
e-mail: [email protected]
__________
Prepared Statement of Howard A. Rubin
Thank you for the opportunity to testify before the Special
Committee on the Year 2000 Technology Problem. This is an issue that I
have focused on for years in my work tracking and interpreting global
technology trends and in my role as a consultant to some of the largest
companies in the United States and the world. Based on the guidance
provided in your invitation to me to testify today, I will confine my
comments to the specific areas currently of interest to the Committee--
namely, the progress of foreign financial companies in managing the
Year 2000 computer problem and the potential negative impact of
failures abroad on the U.S. economy and ways in which the government
and private sector can mitigate those risks.
My fundamental position on this matter is that, in the global
financial markets, no institution stands alone and is immune to the
effects of the disruption of business transactions as they flow around
the world. The source of such disruptions may be a result of Year 2000-
related problems in the financial sector itself or may also be caused
by failures in the infrastructure that supplies power, water,
communications, transportation, or any of the core social or business
services. Furthermore, the Year 2000 computer problem has both direct
and indirect economic consequences for society and business. The direct
consequences have to do with the ability of businesses to conduct
business itself as the millennium approaches and is eventually upon us,
subject to the disruption sources previously mentioned. The indirect
consequences are what might be considered ``second order'' effects--
these have to do with the impact on the business of the diversion of
resources to work on the Year 2000 problem itself, in this era in which
technology, business, and society are all tightly intertwined.
Therefore, whether or not an organization believes Year 2000-related
computer problems will impact it internally, it is imperative that, in
the context of its own safety and that of the global financial network,
it assess its Year 2000-related risks and act to abate any identified.
However, because this problem is unique in computing/business history,
organizations must be prepared to deal swiftly and decisively with
three risk categories: the ``known knowns''--those things they know
they must address about the problem; the ``known unknowns''--those
things they know they don't know about the problem, but are prepared to
face; and the ``unknown unknowns''--those issues that have not yet been
identified as issues, but must be responded to when they arise.
First, as a backdrop for discussing my view of the Year 2000
picture for foreign financial companies, I'd like to provide you with a
quick snapshot of some of the ``known knowns'' of the global Year 2000
situation and the current U.S. status based on my survey results for
1Q98 and 2Q98. I have been tracking Year 2000 trends on a quarterly
basis for more that 4 years through my extensive data collection
network.
The table that follows provides an overview of estimated Year 2000
repair cost impact, by country, across all industry groups, expressed
as a percent of 1996 GDP for the countries for which I have been able
to obtain data. (My friend and colleague Capers Jones, of Software
Productivity Research, supplied some of the base cost data for my
analysis.) This should provide the Committee with some insight into the
magnitude of the diversion of resources that are likely to be deployed
to deal with the problem--these same resources, under ``normal''
business conditions, would be focused on moving business and society
forward. Now they are consumed by what some consider to be ``survival''
issues.
----------------------------------------------------------------------------------------------------------------
Estimated Y2K
Estimated Y2K total repair Companies in Percent of systems Robbins/Rubin
Country total repair cost cost as percent survey ``work in Y2K schedule
of 1996 GDP progress'' indicator
----------------------------------------------------------------------------------------------------------------
United States.......... $187,921,430,000 2.5 108 .83 .87
Japan.................. 105,964,254,000 2.3 12 .78 .85
Korea.................. 22,614,322,500 4.7 30 .68 .78
Germany................ 60,544,165,000 2.5 4 .79 .84
UK..................... 42,931,317,000 3.7 8 .82 .85
France................. 42,379,656,000 2.8 7 .78 .84
Italy.................. 33,731,929,000 2.8 2 .77 .79
Spain.................. 17,328,201,000 3.0 3 .72 .77
Netherlands............ 10,199,431,000 2.6 4 .77 .83
Belgium................ 7,232,049,000 2.7 2 .78 .84
Portugal............... 4,899,455,000 4.9 1 .69 .79
Sweden................. 6,191,702,000 2.5 3 .78 .86
Canada................. 18,129,243,000 3.1 22 .81 .85
India.................. 4,037,957,000 1.2 5 .75 .84
Mexico................. 19,250,198,000 5.7 1 .62 .76
Australia.............. 9,894,632,000 2.5 5 .73 .81
Argentina.............. 8,292,548,000 2.8 2 .58 .79
China.................. 4,442,256,500 0.5 3 .55 .78
Brazil................. 35,832,775,000 4.8 3 .61 .78
Russia................. 32,246,348,750 7.3 5 .58 .83
----------------------------------------------------------------------------------------
Averages......... 33,703,193,508 3.3 .72 .82
----------------------------------------------------------------------------------------
Totals........... 674,063,87O,150 230
----------------------------------------------------------------------------------------------------------------
In terms of the direct GDP impact of Year 2000 problem risk, my
colleagues at Cap Gemini have recently published a ``Millennium Index''
for the United States and European markets, which shows those at
greatest risk to be Germany, Italy and the Netherlands, Finland,
Belgium and the UK, the United States, Sweden, Denmark and Spain,
Norway, and France. In addition, they have identified Germany, Finland,
the Netherlands, Belgium, and the UK and Italy as the countries having
the largest number of organizations that are running ``late.''
One interpretation of these analyses is that, based on the data
presented (progress measures and GDP diversion/impact), there is
clearly a significant level of global risk. However, in my opinion, the
presence of such risk does not automatically imply disaster, just a
need for decisive risk management.
The next two charts provide a similar snapshot of the U.S. industry
position relative to schedule slippage and likelihood of project
success, relying on a high-level Year 2000 risk assessment technique
that I recently published (``Evaluating Success of a Y2000 Project,''
by Rubin and Robbins, published by Information Economics Press). In the
context of this hearing, the single most important finding illustrated
is that the financial services sector in the United States is among the
top three groups in terms of schedule performance and controlling
project risk. However, these points are no basis for complacency.
[GRAPHIC] [TIFF OMITTED] T6JL98G.001
[GRAPHIC] [TIFF OMITTED] T6JL98G.002
Finally, 2Q98 U.S. survey data sampled from Fortune 500 companies
as of June 28, 1998, indicates:
--The trend to underestimate Year 2000 cost continues--87 percent of
those surveyed say their Year 2000 spending projections are too
low. Only 2 percent now say they are ``on target.'' A further
69 percent say they are unable to assess whether their 1999
projections will go up, go down, or stay the same.
--A full-fledged Year 2000 strategy has begun in 86 percent of those
companies surveyed--up from 60 percent in March 1998.
--The number of companies focusing on contingency planning has jumped
from 3 percent in March 1998 to 72 percent in June 1998--but
few real details of such plans have been worked out.
--Year 2000 compliance is becoming a factor in business-to-business
relationships--55 percent of those surveyed indicate it is very
likely or potentially likely that they will not do business
with noncompliant suppliers and partners.
--A small percentage of those surveyed, 3 percent, claim they may
sell off or reorganize parts of their business in response to
Year 2000 issues.
--Staff working on Year 2000 projects are increasingly rating the
work as extremely ``boring''--up from 32 percent in March 1998
to 48 percent as of June 1998.
--84 percent, up from 80 percent in March 1998, have had to change
their overall approach since starting their initiatives.
--84 percent now say they are slipping milestones in their plans.
This is an increase from the 78 percent that said so in March
1998.
--In terms of work activity, for the mainframe platform, the dominant
activities are conversion and initial testing, while the
desktop and distributed environments lag with a focus on
assessment and conversion.
--The percentage of organizations expecting to have more than 50
percent of their systems compliant by 1/1/1999 has dropped from
85 percent in March 1998 to 81 percent.
--40 percent of those surveyed claim to have had a Year 2000-related
failure. Primary impact areas are systems processing
disruption, financial miscalculation, supply chain/logistics
problems, and customer service.
Now, I'd like to move on to the issue of the progress of foreign
financial companies--this is an area of many ``known unknowns''.
First, from my own work with leading U.S. corporations, the
importance of effectively dealing with the Year 2000 problem on a
global basis is well understood. This is evident in the details of
their plans as they have moved toward international mobilization and
coordination of their Year 2000 programs. In addition, inter-
organization activity has greatly increased and accelerated in terms of
``buddy testing,'' ``street testing,'' and other self-initiated
articulation activities. However, one of the biggest issues that I see
arising between parties in this sector has to do with the ability of
organizations to candidly and honestly exchange information--more on
this later.
In addition, level of concern about the Year 2000 problem and
progress toward a solution vary around the world. The highest Year 2000
problem visibility, in my opinion, is evident in the United States, UK,
Canada, other European countries, and Australia. Eastern/Asian markets
now appear to be increasing their level of concern, albeit somewhat
late in the game as gauged against United States activity initiation.
On a more quantitative basis, my observations about Year 2000
projects in foreign financial companies are:
--project starts appear to be late lagging behind U.S. peers by 3 to
12 months or more
--spending estimates are typically lower than U.S. peer companies
--spending rates are lower than experienced in U.S. peer companies by
about 50 percent
--project priority is not quite as high as in U.S. peer companies
In addition to using my own data sources, I typically try to
compare my findings with other work published in the field. In this
regard, the eBANKER results published by the Financial Times, developed
from surveying the Year 2000 status of the top 1,000 banks in the
world, shed additional light on the field. Again, posturing and
positioning may somewhat taint the accuracy of their findings, but the
high-level story shows:
--496 respondents out of the 1,000 contacted claim they will be ready
for Year 2000
--87 percent claim their projects are on schedule
--The ``not on schedule category'' has a high number of institutions
in Japan and Germany
--6 out of the 10 largest banks claim their critical systems will be
compliant by December 1998
Again, as indicated by my own survey results, a significant level
of risk is apparent, as demonstrated by the low response rate, the
amount of slippage, and the concentration of those ``not on schedule''
in key market areas. A further contributor to the level of risk is the
real lack of accurate data about the complete global picture. But
again, risk does not automatically imply disaster--it does imply risk
management, which is an issue that all the world's major financial
institutions have significant experience with.
Keeping in mind both the global cross-industry and the financial
sector Year 2000 picture I just presented, I believe that successfully
dealing with the Year 2000 problem requires a comprehensive risk
management mindset. Reducing risk will decrease the probability of
business disruption, but accurate information and open communication
are the cornerstones of a successful risk management program. In
addition, the risk management process is dependent on both quantitative
and qualitative information--both of which are not generally available
today or may be reported using misleading and easily misinterpreted
measures.
From a qualitative viewpoint, key indicators of a high potential
for Year 2000 success that the Committee should be concerned about are:
--Program management.--Having a well-defined project/program with
clear accountability.
--Business impact management.--Having a clear business view of the
problem.
--Scope of program.--Having a well-defined plan that links technical
and business priorities.
--Control.--Having appropriate tracking and oversight in the context
of risk management.
--Resource allocation.--Having the right (and adequate) technical and
business resources assigned to the project.
--Program assurance.--Having the right testing procedures and
processes in place.
--Contingency planning/event management.--Having contingencies
identified and contingency plans ready to be put into action.
While many organizations are reporting ``progress measures,'' in
terms of ``percent systems converted'' or ``percent partners
contacted'' and the like, or are attempting to assess progress based on
a universal Year 2000 progress ``timeline,'' this class of quantitative
measures sheds little light on the probable success of a project. From
a quantitative viewpoint, to truly understand the progress of an
organization's Year 2000 efforts, the following two questions need to
be answered in a concise and simple way:
--Is the project proceeding, in all its dimensions--from technology,
to communication, to contingency planning--at the planned pace
in terms of work being performed to bring the organization
toward implementing a Year 2000 business environment?
--Is the Year 2000 business environment becoming operational within
the required time frame?
Please note that these are ``business'' and not solely
``technical'' issues. It is clear that the time has come to escalate
the management of the Year 2000 problem to the business side of the
equation in all companies and insist on business accountability.
I suggest this Committee adopt such a composite Year 2000 tracking
and risk management viewpoint and move to enable and encourage, both
nationally and globally, the following:
--Mechanisms and communication channels for organizations to obtain
accurate and timely information about the state of
counterparties and those in its business transaction chain.
--Mechanisms and communication channels for organizations to obtain
accurate and timely information about the state of its
environmental chain (utilities, telecommunications, public
safety, etc.).
--Scenario analysis, driven from a business viewpoint, that will help
organizations (and countries) develop contingency plans that
deal with both single points or failure and multiple concurrent
points of failure.
These suggestions point the way to new forms of information
clearinghouses and perhaps even a national risk register. Success, to
me, in dealing with the Year 2000 problem does not mean more rules and
regulation regarding the methods or timelines that organizations must
use in attacking the problem. Rather, success means enabling
organizations to develop their own solutions and strategies internally
while expanding the bandwidth and content of honest and open
articulation between companies and across governments to minimize
global risk.
Perhaps more importantly, my final observation is contrary to the
basic focus of this hearing--this is not a standalone company or
industry issue; it is a network issue. The most difficult and critical
of the Year 2000 risks are the ``unknown unknowns'' of cross-industry
failures. We most likely will not know what these are ahead of time, so
of utmost concern to this Committee should be seeing to it that
organizations in all industries are prepared for rapid event
management.
Therefore I view the Year 2000 problem as a problem of ``choice''.
The world's governments and companies have the ``choice'' to manage the
risks by deploying technical and business resources to deal with the
problem, they have the ``choice'' of focusing those resources on the
most critical business and social areas where the impact will be felt,
they have the ``choice'' to openly share information with each other
and the public, and they have the ``choice'' to prepare for event and
perhaps crisis management.
Again, thank you for the opportunity to share my ideas with the
Committee. I'll be glad to keep you informed as my global tracking and
analysis activities continue.
__________
Prepared Statement of John Westergaard
Good morning. My name is John Westergaard. I am founder, Editor and
Publisher of Westergaard Online Systems, Inc., a publisher of Internet
webzines which is cybertalk for magazines on the Internet. We also
conduct investment conferences and have so for 21 years.
We publish Westergaard Year 2000, a daily webzine providing
information and analysis of the Year 2000 Millennium Bug which I will
refer to here as simply ``Y2K''. Westergaard Year 2000 publishes
several dozen expert columnists who regularly contribute commentary
covering virtually all aspects of the Y2K problem.
Westergaard Year 2000 is published as a not-for-profit public
service under the editorship of Adam Kaplan and assistant editor John
Yellig. Its Internet address is www.y2ktimebomb.com. It receives
thousands of visitors daily from some 80 countries and is recommended
as a Y2K resource by the World Bank and the Federal Reserve among
others.
I understand of course that the focus of this hearing is to be the
international financial and economic aspects of the Y2K problem. I'll
get to that. But first allow me to state some views with respect to the
handling of Y2K compliance by the federal government from a perspective
of having observed the issue develop at close hand for the past 2\1/2\
years.
I do so because the main point I hope to impress upon this
Committee is the need for the President, the Department of Defense, our
United Nations representatives, and the Secretary of the Treasury, to
exert leadership in alerting the world to the Y2K problem and to
provide technological assistance in achieving date compliance.
I fear historians will not treat the Clinton Administration well
for its management of a crisis which promises to be the defining event
of its second term. Congress will fare better thanks in main to
Senators Bennett and Moynihan of this Special Committee who have played
early leadership roles in sponsoring Y2K awareness, and to
Congresspersons Steve Horn and Carolyn Maloney for the excellent
hearings of their Committee on Government Reform and Oversight.
On the executive side, the agencies testifying immediately
following me here today--the Federal Reserve and the SEC--have been
well ahead of the curve on this issue. The General Accounting Office
(GAO) has done outstanding work.
The Office of Management and Budget (OMB), on the other hand,
appears to have focused on papering the problem over and has hampered
Y2K remediation programs at the state level by projecting absurdly low
federal estimates of remediation costs. This has caused supplemental
budget requests of state officials to appear high in contrast, invoking
thus the skepticism of state legislators.
The most egregious Y2K compliance offender, considering the
strategic importance of its mission and the vast resources and planning
abilities available to it, has been the Department of Defense (DOD). As
recently as last week the GAO issued a report sharply critical of the
Navy's compliance status. The Army and Air Force are also in serious
trouble over Y2K.
As for the media, with exception of the Washington Post and the
Financial Times of London, the general press here and abroad has failed
miserably in addressing the crisis. As recently as November, for
example, The Los Angeles Times was calling Y2K basically a hoax--
ironically at the very time that their internal operations people were
struggling over allocating resources to meet compliance deadlines.
The Wall Street Journal's coverage has been abysmal. I was told
last year by a Journal reporter that his editors weren't interested in
the Y2K story because it had already been told. That's the equivalent
of reporting the attack on Pearl Harbor on Monday morning, December 8,
1941 and then advising readers the next day: ``Oh, that story? We told
you yesterday there's a war on.''
Y2K may not be war but neither is it a one day story. It is an
event that will encompass 6 years by my count from 1996 through 2002.
Think of it as a plague, an ``electronic bubonic'' if you will.
However extreme my comments may appear, let me assure the Committee
that my view of Y2K is not apocalyptic. There will be a worldwide Y2K
recession but there have been recessions in times past. The world has
survived them and often been the better for the experience. I am in
fact a congenital optimist and have great confidence as to the ability
of the United States government, the business community, and the
financial community to eventually work their way through Y2K.
I foresee a period encompassing the first six month of 2000 as
being equivalent to the first half of 1942--Pearl Harbor to the Battle
of Midway--during which the U.S. mobilized for war. Enormous positive
energy and creativity was unleashed then and I expect the same to
happen this time.
I come here today not as a computer expert by any means, but as an
investment strategist who has a history of spotting financial and
economic trends early. That's not because I'm smart. It's because I
have published investment research on emerging small companies for 40
years run by entrepreneurs typically engaged in promoting new business
opportunities. I have thus tended to have an early look at new trends.
It was just such an entrepreneur seeking research sponsorship and
capital--Bob Gruder of Alydaar Corporation--who introduced me to Y2K in
December 1995. I immediately took the matter to my friend of 40 years,
Senator Pat Moynihan, who was incredulous as was everyone then (and as
many still are). But in keeping with his academic discipline, the
Senator requested that a study be prepared by the Congressional
Research Service.
CRS reported back within a few months substantiating in full the
issues I had raised. As an aside, is it not curious that the two
legislators who were first to recognize and take action on Y2K are
former college professors: Senator Moynihan and Congressman Horn?
Perhaps we should be electing more college professors to public office.
Isn't it also curious that others in Washington who have quickly
grasped the Y2K issue have backgrounds in business, to wit Senator
Bennett and SEC Chairman Arthur Levitt? Perhaps we should be electing
more business people as well.
Senator Moynihan advised the President of Y2K by letter in July
1996 and recommended appointment of a ``Manhattan Project'' style Y2K
Czar to direct federal compliance. A perfunctory response was received
in November, not directly from the President but from Frank Raines at
OMB. The Senator then arranged a meeting with Secretary of the Treasury
Bob Rubin and Assistant Secretary Larry Summers on December 14, 1996 in
which I participated.
Rubin and Summers were generally aware of the problem. We learned
that Treasury was then budgeting circa $75 million for Y2K. According
to a recent report, the figure in just 15 months has blossomed to $800
million.
The first public acknowledgment of Y2K by the White House occurred
on August 15, 1997, a full year after the Moynihan letter, when the
President stated at a press conference that Americans need not worry
about the ``computer clock'' problem. The appointment of John Koskinen
as Federal ``Y2K Czar'' in February of this year was the first sign
that the White House is taking Y2K seriously.
Senator Moynihan and I met with Mr. Koskinen at the end of March
and I am pleased to say he left me, and I believe the Senator, with a
comforting sense that an adult has been placed in charge. I believe Mr.
Koskinen occupies the fourth most important position in America today
after the President, Fed Chairman Greenspan, and Treasury Secretary
Rubin.
So what should the Senate be looking at and thinking about in
respect to the Y2K problem as it relates to international economic and
financial considerations? I will make a few predictions employing
inferential analysis to create three ``what if'' scenarios. Given the
speculative nature of Westergaard scenarios, they are as often wrong as
they are right, but you can be sure they are never in doubt.
scenario 1.--does y2k reflect god's will?
At year 1000 Europe was engulfed with random violence and fear that
the world would end. Out of this chaos emerged a new social order as
Christianity spread through Northern Europe. Russia converted in 988
followed by Poland, Norway, Iceland and Greenland in 999-1000. By way
of background, I refer the Committee to James Reston, Jr.'s recently
published ``The Last Apocalypse: Europe at the Year 1000 A.D.''
Saddam Hussein will interpret Y2K as retribution from an almighty
aimed at punishing technological infidels. He will interpret it as a
call to attack Kuwait and Saudi Arabia. He will assume with good reason
that Y2K will leave the U.S. military incapable of mounting a large
scale military response.
The financial and economic impact of a move south by Saddam will be
chaos in the world petroleum market, sharply higher oil prices,
inflationary pressures and consequent strains on international banking
and industrial systems of unpredictable magnitude.
Recommendation.--The DOD should be directed to prioritize Y2K
compliance to mission critical systems needed to meet another Saddam
challenge. It will be prudent to move troops into the region in late
1999 to counter the risk that continuing Y2K complications following
the Millennium turn would render impossible a timely response to
Saddam.
scenario 2.--world recession 2000
To understand business cycles, consider traffic backing up 20 miles
on the New York State Thruway as drivers rubberneck even the most minor
accidents. That is analogous to what will happen to the world economy
in 2000. It will back up as transactions of every type--shipments of
goods, travel, communications, payments, you name it--will slow down
even if only fractionally. It is improbable that a worldwide recession
can be avoided under such circumstances. The question isn't, ``Will
there be a recession?'' It is, ``How bad will it be?''
Recommendation.--A slowdown in healthcare reimbursement systems
worldwide will leave hospitals and other care givers short of cash to
pay employees of which there are some 10 million in the United States
alone. Emergency funding will be required to provide systemic
liquidity. Appropriate legislation needs to be prepared now for
introduction in 1999 in the United States and worldwide.
The United States, with the world's most advanced and respected
health care system, should exercise leadership in alerting health care
officials worldwide to the risk of slow payments and to potential Y2K
related risks in the application of medical devices. Certain devices
will be non-functional due to non-compliant software and non-functional
chips.
Upcoming confirmation hearings of Richard Holbrooke to the post of
U.N. Ambassador will provide the Senate with a forum for recommending
that an active role be taken by the United States delegation in
alerting member states, the World Health Organization, and other U.N.
agencies to Y2K issues.
scenario 3.--brownouts and blackouts
There will be spot shortages worldwide of electrical power. Nuclear
generating plants will be shut down to allay public fears of meltdowns.
The French economy with its proportionately large 40 percent reliance
on nuclear power will be hard hit.
Recommendation.--Conventional power generating plants are less
computerized than one might suspect but there will be at a minimum
brownouts in the United States and worldwide in 2000. The nuclear issue
will be resolved by shutting down nuclear plants over Millennium
weekend and bringing them back on stream one by one to assure the
public that plants are safe. The Department of Energy needs to take a
leadership role promoting Y2K awareness of energy related Y2K issues
domestically and abroad.
These scenarios represent no more than a passing insight into the
Y2K problem. I have not touched on Japan, the second largest economy,
which remains in abject denial over Y2K, nor on China with the largest
population. China on the one hand benefits from a proportionately low
level of computer dependency but suffers from employing large amounts
of pirated software leaving it without access to vendor assistance for
remediating code.
I could go on for the rest of the morning. More than 1,000 pages of
information, research, analysis and commentary covering every aspect of
the Y2K Problem can be found at our webzine, Westergaard Year 2000
(www.Y2ktimebomb.com). I trust the Committee and its staff will employ
this resource, register there for our free daily email alert service,
and feel free to contact me and the editors via email or phone any
hour, any day, anywhere.
John Westergaard
212-947-3853
[email protected]
______
[October 21, 1997]
Good Show, Arthur, But What You Need to Do is Take it to
The White House
(By John Westerqaard)
As a Williams College freshman in the fall of 1949, two individuals
stood out for me in the sophomore class--George Steinbrenner and Arthur
Levitt.
Steinbrenner stood out because he was a big shot, a bully type, and
a wannabe jock. Levitt stood out because his father was or was about to
become Controller of New York State. (I can't quite recall which). In
any event, unlike Steinbrenner, Levitt seemed like a nice fellow.
I came to know Arthur when he joined Carter Berlind Weill and
(subsequently) Levitt, the hotshot brokerage firm that eventually took
over Hayden Stone. For a while the merged firm was called CBWL-Hayden
Stone which Wall Street wags immediately christened ``Com Beef With
Lox.'' Hmmm. Typically names become acronyms. This was an acronym that
became a name (of sorts, admittedly).
Arthur is a classy guy and congratulations to him for the work the
SEC, which he now heads, is doing re the Year 2000 problem. In July,
the SEC issued a report on the subject, and just last week, Arthur
addressed the urgency of the Year 2000 Problem for the financial and
investment community in a speech before a gathering of distinguished
representatives from the International Federation of Stock Exchanges.
He said that Y2K should be ``on the top of the list'' of all their
outstanding IT issues. Way to go Arthur!
There are two SEC documents readers should take a look at if you're
in finance or if you're in anything having to do with public companies
or mutual funds. The main document issued last summer is titled
``Readiness of the United States Securities Industry and Public
Companies to Meet the Information Processing Challenge of the Year
2000''. The second document, was issued this past October 8. It reminds
corporations and the mutual fund industry in no uncertain terms that
they'd better be disclosing the extent of their Y2K problems in their
10K's, 10Q's and via 8K's or they're going to find themselves in
trouble.
And meanwhile, Arthur, why don't you knock at the Oval Office and
tell ``you know who'' that the Y2K Millennium Meltdown is taking him on
a path to outdo Herbert Hoover as the worst President of the 20th
Century, maybe the worst ever, for failing to address the problem, his
August 15 ``don't worry about the computer clock problem'' statement
notwithstanding.
As for Steinbrenner, I ask of him: ``George, why don't you pull a
Ross Perot and get the Florida Marlin's star pitcher Livan Hemandez'
brother out of Cuba? Remember when Perot sent a private commando team
into Iran to rescue his employees. There's a model for you, George.
``The brother is supposed to be better than Livan. Get him into
your rotation next year. Now, that's box office, George, and probably a
pennant to boot. Imagine the opening game of the 1998 World Series with
the two brothers squaring off. Hmmm. Can't you just taste it?''
______
[November 11, 1997]
Why Mixing Lawyers With Government Is Dangerous To Our Heath
(By John Westergaard)
A pet game of mine is guessing whether politicians I'm hearing for
the first time on TV talk shows are lawyers or not by listening
carefully to their language. Lawyers use language that subtly in one
way or another hedges their positions. It goes with being a good
lawyer. They never speak from the shoulder. You can always spot them.
Lawyers also tend to look back better than they look forward.
That's because the nature of their profession is to be mostly concerned
about covering their and their clients' backsides.
Consider the Y2K problem as it is playing out in Washington. Note
that only one of the eight players down there who seems to comprehend
the dimensions of the problem is a lawyer by background. That's Senator
Al D'Amato of NY. The rest come either out of academia--Senator Pat
Moynihan (D-NY) and Representatives Steve Horn (R-CA) and Constance
Morella (R-MD)--or out of business and industry: Senator Bennett (R-UT)
(management consultant), Jim Leach, IA (propane gas), Arthur Levitt,
SEC (publishing/Wall Street), and Carolyn Maloney (NY) (domestic
engineer).
Now do we understand why it is that the lawyers populating the
White House and ubiquitous throughout the administration are not
emotionally and intellectually equipped to comprehend the Y2K problem?
Is it not obvious why the administration appointed Sally Katzen, a
middle ranking regulatory lawyer with zero management credentials, as
Y2K ``czar' responsible for the entire Federal Government's response to
the Y2K crisis?
Sally Katzen in charge of a crisis that will dwarf the S&L brouhaha
of the 1980's? Can't one imagine the scene in the oval office, August
1996, as Senator Moynihan's now famous letter arrived on the
President's desk:
Mr. ICKES: ``Mr. President, there's a letter from Moynihan. There
seems to be some cockapithy problem called the Y2K Millennium Bug.
Leave it to Moynihan to come up with something way out there I've never
heard about.''
Mr. PRESIDENT: ``A bug? Where? In the Lincoln bedroom? Call the
exterminators for chrissake. What? Oh, oh that--the computer clock
problem? Yeah, I heard about that. Better cover our ass. Be sure to put
a lawyer in charge. Hillary has a friend over in OMB who needs
visibility if she's going to get a serious job when we're out of here.
Give it to her.''
Hmmm.
P.S. Some of my best friends are lawyers!
______
The Washington Interpreter--Archive of Previous Interpretations
1998
WI 26--Infrastructure and Interdependencies
WI 25--An Increase in Federal Y2K Awareness
WI 24--Congress Discusses Y2K
WI 23--Y2K Activity Heats Up in Washinoton
WI 22--Senate Establishes ``Special Committee on the Year 2000
Technology Problem''
WI 21--Y2K Issues and Recent Developments in Congress
WI 20--A Seminal Event: The President Acknowledges Moynihan As First to
Bring Him Y2K Problem
1997
WI 19--Worried About Flying Millennium Weekend? Then Try This On For
Size: Any Idea How Close Americans Came to Not Being Able to
Fly Anywhere Over Thanksgiving?
WI 18--Congressman Horn's Quarterly Y2K Assessment Indicates that if
the Department of Transportation Has Its Way, Planes May Not Be
Flying Until 2010
WI 17--Note to the Fed Chairman: The Chips Don't Fit the Old
Motherboard and the Old Motherboard Doesn't Fit the Valves
WI 16--Dear Harold: How Can it Be That a Problem as Ubiquitous as the
Y2K Millennium Bug Doesn't Wend Its Way Into the Consciousness
of the Oval Office?
WI 15--Ultimate Irony: The President Is Advised To Tell Europeans What
To Do About the ``Millennium Timebomb?'' Hmmm * * *
WI 14--Can Any of Us Imagine the Vilification That Will Be Heaped Upon
This Administration and Congress If Social Security Is Unable
To Process Disability Payments Come Year 2000?
WI 13--Why Mixing Lawyers With Government Is Dangerous To Our Health
WI 12--Saddam Hussein Licks His Chops As Y2K Meltdown Draws Nigh
WI 11--Folly, Folly. That ``Filthy Haze Over Kuala Lumpur As Proxy For
The Millenium Meltdown
WI 10--Good Show Arthur, But What You Need to Do is Take it to The
White House
WI 9--In Which I Spend the Morning Downloading and Sorting Out REP #
TIRNO-98-R-00001
WI 8--Bring Back Gordon Macrae
WI 7--Y2K and the IRS: ``Could Be Catastrophic'' Says GAO
WI 6--Is McDonough Greenspan's Stalking Horse?
WI 5--Westergaard Year 2000 Fearlessly Presents and Explains Some
Provocative Predictions
WI 4--Moynihan Letter Highlights OMB/GAO Rift
WI 3--Worried About Y2K? It's O.K. Everybody--Big Daddy Says Don't
Worry!!!
WI 2--An Open Memorandum to FedEx CEO Frederick Smith
WI 1--The President Fiddles While Washington Smolders
ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD
______
Statement of Treasury Deputy Secretary Larry Summers
Mr. Chairman, and members of the Committee, the Department of the
Treasury wishes to thank you for conducting this important hearing and
supports your efforts to review the year 2000 problems and its
ramifications on international banking and finance. Unless fixed, year
2000 problems will pervade every aspect of our financial system,
including the settlement of financial trades, the processing of routine
financial transactions, and the dispensing of funds by ATM systems.
All financial firms are potentially at risk. Even those entities
which act responsibly to renovate their own systems can still be
harmed, because of the intertwined nature of the financial system--a
failure by a counterparty, supplier or vendor can have a negative
impact on an otherwise solvent firm. If the failures are widespread,
they can pose a threat to central markets such as an exchange or
clearinghouse.
Today's hearing on this issue comes at a propitious time. There has
been a flurry of international action on the year 2000 matter over the
past few months. Two weeks ago, the United Kingdom hosted a meeting of
experts from the Foreign Ministries of the G-8 countries to discuss the
year 2000 issue and trans-boundary issues. At that meeting, each
country provided a brief overview of its domestic efforts, along with
an analysis relating to progress in other countries. Other
international fora, including the World Bank, OECD and regional
organizations are also undertaking significant programs to help in the
coordinate international activities in this area.
u.s. supervisory actions
In the United States, financial regulators have taken steps to
encourage firms to properly address the year 2000 issue.
The U.S. Securities and Exchange Commission now requires public
companies to disclose year 2000 problems in their corporate filings,
which can help investors assess the impact of year 2000 on a firm's
market value. Among other things, the SEC now requires a public company
to disclose the fact that it has not made an assessment of its year
2000 issues. In addition, a public company must describe material year
2000 issues and disclose the nature and potential impact on the firm,
including its general plans to address them. This disclosure, which is
potentially a very powerful incentive-based approach, is designed to
induce market pressure on public companies to take appropriate
corrective measures.
Similarly, U.S. bank regulators now routinely review year 2000
issues when they conduct examinations of federally supervised banking
institutions. The examinations are designed to:
--determine whether the organization has an effective plan for
identifying, renovating, testing, and implementing a year 2000
solution;
--assess the effect of year 2000 efforts on the bank's strategic and
operating plans;
--determine whether the organization has effectively coordinated year
2000 processing capabilities with its customers, vendors, and
payment systems partners;
--assess the adequacy of internal controls for the year 2000 process;
and
--identify whether further corrective action may be necessary.
concerns outside the united states
In the United States and elsewhere, the financial services industry
appears to be ahead of other major industry sectors in addressing the
year 2000 problem. Financial firms are working hard to renovate
obsolete systems in such large financial centers of the United States
such as New York and Chicago, as well as in other major market
jurisdictions such as London and Frankfurt. Leading international
financial firms have already started internal testing, and industry-
wide testing programs are scheduled for next year.
However, it is very difficult to assess the effectiveness of the
renovations programs currently under way in each country. Each country
faces unique difficulties as it searches for an effective solution to
the problem. In Europe, for example many countries in the European
Union must handle conversion to the Euro currency simultaneously with
the year 2000 problem. Japan is undertaking major changes to its
financial system, which could also affect its year 2000 compliance
effort. Other Asian countries must deal with more immediate threats to
their economies.
Outside the major financial centers, the problems caused by year
2000 may be greater. In these countries, it may be more difficult to
finance the cost of hiring programmers to fix the problem, or even to
identify the systems which need renovation in the first place. On the
other hand, the fact that many underdeveloped countries have not
automated to the same extent as the United States means that there are
not as many systems which can fail. Moreover, the systems which are in
place in such poorer countries have often been purchased more
recently--and are therefore more likely to be year 2000 compliant--than
computer systems installed in many parts of the advanced industrial
nations.
suggested steps for other countries
Each country will have to implement its own solution to the year
2000 problem, based on the particular circumstances, resources and
problems relevant to it. However, there are some fundamental premises
which many experts believe each country should keep in mind as it
implements a year 2000 compliance effort. In particular, there are
three fundamental issues--inventory/assessment, renovation, and
testing.
First, authorities in the computer area believe it is helpful for
each country to assess its vulnerability to the year 2000 problem. This
should include an inventory of all applications that require
modification and an assessment of what renovation measures must be
implemented. In the United Slates, the goal was to ensure that all such
inventory and assessment review be completed by September, and
regulators are monitoring those financial institutions which failed to
meet this deadline.
Second, experts agree that each country should follow assessment
with a renovation phase, where individual software programs are
modified to ensure year 2000 compliance. It is critical that firms
prioritize their efforts so that the most critical applications receive
priority attention, followed later by software programs which would
have a more limited impact on the firm in the event of a year 2000
failure. Most United States firms currently are undertaking their
renovations programs, which should be largely completed by December
1998.
Third, and equally important in the eyes of virtually all
professionals, is the testing phase, which individual countries should
mandate for firms in their jurisdiction. The importance of such testing
programs cannot be overemphasized, since even skilled programmers can
overlook critical tasks. External testing should include tests with
both single counterparties and multiple counterparties. In the United
States, such testing is expected to begin no later than December 1998,
but external testing necessarily requires the cooperation of
governments and firms in other countries.
work in other international fora
Because of our concern with respect to the progress that other
nations are making in the year 2000 area, Treasury began a major effort
to raise the profile of the issue and act as a catalyst for action in
many countries. Treasury submitted a paper on the year 2000 issue in
March 1998 to the G-7, which called on the G-7 countries to implement
comprehensive year 2000 programs in each of their jurisdictions, and to
help other countries as well. We have since worked with other countries
to ensure that the year 2000 issue was placed on the Birmingham summit
agenda. The May 8 G-7 Finance Ministers' conclusions called on the
international regulatory bodies (i.e., the Basle Committee on Banking
Supervision, the International Organization of Securities Commissions,
the International Association of Insurance Supervisors, and the
Committee on Payment Systems and Settlement) to ``monitor'' private
sector efforts, and ``to do all that they can do to encourage
compliance.'' As discussed below, these entities are taking up the year
2000 challenge and are actively assessing and monitoring year 2000
compliance efforts by financial firms in their respective industries,
rather than merely ``raise awareness'' of the problem.
Subsequently, on May 17, the G-7 Heads of State and Government met
and called on countries to work together to solve the year 2000 issue,
and expressly asked international organizations, including the World
Bank and the Organization of Economic Cooperation and Development
(OECD) to help solve the problem.
Treasury also raised year 2000 in other international fora. In late
May, Finance Ministers at the Asia Pacific Economic Cooperation forum
(APEC) discussed with private sector representatives the importance of
resolving year 2000 problems in APEC economies in a timely manner. They
also urged the World Bank and the Asian Development Bank to help
countries to address this issue, and domestic supervisory and
regulatory authorities in the region work with the international
regulatory bodies to implement measures to resolve this problem. The
year 2000 issue was also included in the Joint Ministerial Statement of
the Summit of the Americas Finance Ministers' meeting in Chile last
December, and Treasury is continuing to encourage this regional
grouping of North and South American finance ministries to work with
its member countries in implementing effective solutions to the
problem.
work of the international regulatory bodies
The international regulatory bodies have established the Global
Year 2000 Council, and they are taking action to coordinate financial
aspects of the year 2000 issue. The Year 2000 Council's efforts were
kicked off in April, following a conference of world leaders on the
Year 2000 problem held in Baste, Switzerland. That conference was
helpful in further raising awareness of the year 2000 issue. We are in
the process of designating a Treasury liaison to the Year 2000 Council
to be kept informed of and promote their efforts to undertake an active
program of monitoring and assessing the situation, and to develop
appropriate remedial steps where it is apparent that a particular
country or group of countries has fallen behind in its year 2000
program.
Other organizations, particularly the OECD, take part in the task
of coordinating some of the most significant non-financial aspects of
the year 2000 problem, such as telecommunications and power grids,
where a disruption to communications or power grids could cause general
economic harm.
role of the ifi's and the mdb's
Treasury is paying increasing attention to the role which the World
Bank and the International Monetary Fund, as well as regional
multilateral development banks such as the Asian Development Bank,
Inter-American Development Bank, and the European Bank for
Reconstruction and Development, could play with respect to the year
2000 issue. In our discussions with these entities, we are generally
satisfied that they are taking reasonable measures to assess and
renovate their own internal systems and we applaud their foresight in
this regard. Among other things, it appears that all of these
institutions have taken steps to assess their mission critical systems,
and they are well under way with respect to renovating or replacing
obsolete systems which will not be compliant.
We are also actively encouraging the international financial
institutions (IFI's) to consider a full range of policies which they
could undertake in conjunction with their client countries. We hope to
ensure that all projects and programs which these organizations finance
are year 2000 compliant. On June 15, CIO's of all the IFI's met to
share views and experiences on potential year 2000 computer problems
and to explore ways to provide technical assistance to their member
countries.
conclusion
There is no easy cure for the year 2000 problem. Like many other
issues, the year 2000 issue will require a great deal of diligence,
planning, and plain hard work so that countries prevent critical
systems from failing. Treasury is working in a range of international
fora to help promote appropriate solutions.
But while various international institutions, and the Treasury, can
assist the year 2000 effort underway in various countries, at the end
of the day each country will have to put in place its own solution to
the problem and take responsibility for any failures. We must be
realistic about the fact that the year 2000 problem is a novel event,
and we cannot foresee all of the complications which might arise.
Therefore, we cannot entirely rule out the possibility of disruptions
to the financial system and other sectors of the economy, both in the
United States and elsewhere. The key is to manage the risks, by
prioritizing those systems which absolutely must be in working order
while devoting lesser resources to other areas, and putting in place
appropriate contingency arrangements to reduce the harm of any failures
that do occur.
We are well underway with this process in the United States, and we
are hopeful that other countries are making similar progress with
respect to renovating and testing their computer systems to take
account of the year 2000 problem. This hearing is very useful to that
process, as they can help raise awareness and ensure that all relevant
entities employ their best efforts to solve the problem