Stamping Out Y2K Bugs
Clearing firms have taken the bull by the horns and met Y2K challenges head-on. Years of preparation and software conversion in anticipation of the date change contributed to a successful test of simulated trading conditions for December 30, 1999 by 400 securities firms, markets and utilities. The mock trades duplicated actual trading and clearing conditions with market trade cancellations, price corrections and "as of" transactions. During the simulation, Y2K-related problems were rare and quickly remedied. A breakdown in some communications hardware set contingency plans into motion with messages and information flow successfully rerouted around the affected circuits. A subsequent test of market data flow from the exchanges/originators to vendors and to clients in May 1999 also proved successful with no Y2K-related problems surfacing. Overall, the tests prove that critical market data and trade information will flow smoothly into the next millennium.
The securities industry has invested wisely to ensure that in January of the year 2000 that there will not be a problem. "During the past two-and-one-half years, the Securities Industry Association has spent $10 million to orchestrate the testing project and the 400 participating firms have spent over $100 million to perform industry-wide testing. Overall, we estimate that the entire domestic securities industry will incur in excess of $5 billion in costs associated with preparation for Y2K," says John D. Panchery, vice president and director, Systems and Technology with the Securities Industry Association in New York City.
In addition, to testing, the industry has been busy assessing and preparing contingency plans to ensure that everything works smoothly. According to Donald D. Kittell, executive vice president of the Securities Industry Association, "We've tested the Street's systems thoroughly and have proven that they can successfully simulate trading in 2000. But, just as any driver starting a long car trip carries a spare tire, we're going into the transition prepared for any situation. Anticipating any possible glitches that could occur, and making sure they can be fixed before they turn into problems, is the goal of our contingency efforts."
That confidence is echoed by the individual industry firms. "The industry testing worked flawlessly as confirmed by the major independent accounting firm which confirmed results before, during and after the testing. We have reviewed all internal and external applications and are going through a vendor review checklist to make sure we are compliant. We are 100% confident things will work well," says Jay C. Nadel, managing director of Weiss, Peck & Greer in New York City. Nadel also pointed out that preparing for Y2K created other opportunities to increase service and expand their contingency planning process to include disaster recovery plans outside of the Y2K arena.
Penson Financial Services is another firm not leaving anything to chance. "Above and beyond the mandated industry testing, we have performed upstream and downstream testing of our suppliers and other organizations that interface with us. Our batch process service bureau has undergone extensive Y2K compliance testing and is totally ready. When the clock rolls, we are ready to go," explains Daniel P. Son, president of Penson Financial Services, a division of Service Asset Management Company in Dallas, Texas.
These companies have spent so much time covering the Y2K topic, they are getting a bit restless and may be ready to start looking further out on the horizon. "We are ready to button up the final weeks of testing and vendor testing and are convinced we are well prepared for Y2K conversion. We have kept our customers appraised of our progress on Y2K with periodic correspondence. Our preparation has cost $2 1/2 million over the past two years and, frankly, we are getting tired of Y2K," comments William P. Behrens, chief executive officer of InvestecErnst & Company in New York City.
Companies are now happy that the issue is taken care of and new concerns can be addressed. "Preparations for Y2K drained human and capital resources away from other projects. With Y2K winding down, we can turn our attention to new software development and implementation of information technology to better serve our clients," says Ted Baker, managing director of the Pershing Division of Donaldson, Lufkin & Jenrette Securities Corporation in Jersey City, New Jersey.
Baker noted that his firm enjoyed a record year for new business as many broker dealer firms are opting to outsource their clearing operations for a variety of reasons. However, the firm does not plan to take on any new business during the last four months of 1999 and the first month of 2000, focusing on making sure the business runs smoothly during Y2K conversion. Pershing also feels that it is important to keep staff ready to help out other industry firms if problems should occur. "We are in this together and we plan on being a good corporate citizen by lending a helping hand where needed," Baker summarizes.
Fidelity is sure not to be left behind when the date changes. "This is an exciting time in our industry and we view the changes taking place as positives. Firms who want to remain competitive must change and meet these challenges. The Y2K project has been met with an extraordinary amount of effort and attention to detail and planning. We have completed 100% testing of our mission critical items and are working on vendor testing," says Robert P. Mazzarella, president of Fidelity Brokerage Services.
The main thrust behind T+1 targets providing market stability and reducing the risk inherent in settling securities transactions to clearing firms, their customers and the investing public by reducing the number of unsettled trades in the clearance and settlement system at any given time. In addition to reducing market and settlement risk, the shorter time frame works to reduce the liquidity risk among derivative and cash markets and streamline clearing agency and broker dealer operations. As with T+3, the Security Industry Association is working closely with the SEC and the industry to assure that the move to T+1 goes as smoothly as the previous move to T+3.
While Y2K looms on the horizon, T+1 remains a more distant concern.
According to Thomas Monahan, director of operations for Securities Industry Association, "We have yet to define what will happen with T+1. The task of forming T+1 committees is just beginning."
Many in the clearing industry are confident that, with the industry's ability to be technologically innovative, clearing for T+1 will not present a problem. "We already deal with government securities which clear the next day and will be ready to handle T+1 when it arrives, however it is defined," says Son of Penson Financial Services.
Industry experts have experience in making a similar change already under their belt. "The industry made an extremely smooth transition from T+5 to T+3 back in 1995 and our familiarization with that experience will make the process easier this time around when T+1 becomes a reality. T+1 will further redefine how we interact with each other," says Fidelity's Mazzarella.
There will be a number of benefits from the move to T+1. Among these benefits, Mazzarella anticipates a move from check settlement to the electronic transfer medium, elimination of the stock certificate and more efficient processing of dividend payments and other operations.
Clearing firms are looking to be major players in the movement to speed up settlement. "We believe T+1 is coming soon and are taking a proactive not reactive approach, searching out the best thinking on how to make another smooth conversion. We are keeping our clients informed, reviewing our operational infrastructure and keeping on top of industry events and deadlines," says Nadel of Weiss, Peck & Greer.
"While there is not a timetable yet for T+1, we anticipate it reasonably soon, either late 2000 or early 2001, depending on how other industry issues such as decimalization (trading in dollars and cents instead of fractional increments of eighths and sixteenths of a dollar) turn out. It's not a big deal and will alleviate some of the systemic risk from the clearing and settlement system," says InvestecErnst's Behrens.
Likewise, Pershing's Baker sees decimalization, a reduction in currencies and dematerialization lumped together under the heading of straight-through-processing. "It's important to remember that it's not just a street-side concept. It will be beneficial to all parties all the way to the end customer," summarizes Baker.
Extended Trading Hours
Extended trading hour concepts are still in the exploration phase but a number of options are under consideration. Limiting extended trading hours to between 5:30 P.M. and 9:00 P.M. or 10:00 P.M. eastern standard time, with a clear break put in place between normal trading hours and the extended trading hours session is an option. Trading would be initially limited to Nasdaq-100 securities, transactions would be reported and displayed in real time, market makers would be required to maintain firm, two-sided quotes, customer protections such as Order Handling and Manning rules would be in force, last-sale prices and volume on trades reported to the Automated Confirmation Transaction Service (ACT) would be displayed at 8:00 A.M. eastern standard time in order to maintain market transparency and trades would be identified as next day trades when sent to clearing.
Some are pessimistic about the value of extending the hours. "It will happen and we will be ready to participate in extended trading hours but we don't know anybody that is clamoring for it. At this stage it is driven more by the press than reality and early trading should prove to be very diminutive," says Behrens of InvestecErnst.
The move toward extended hours trading heated up in late August when E-Trade Group announced it would offer individual investors access to after-hours trading through Instinet, a unit of Reuters PLC and the biggest market for buying and selling stock when traditional exchanges are closed. In contrast with other trading systems limited to Nasdaq stocks, Instinet provides E-Trade customers after-hours access to New York Stock Exchange issues.
"We are keeping our options open in regard to extended trading hours, monitoring what is happening in the marketplace. One major concern is the degree of liquidity that will be available in extended hours trading and educating our customers on the differences from regular trading hours. In the meantime we are reviewing the implications on our trading operations and systems," explains Fidelity's Mazzarella.
Fidelity Investments, Charles Schwab Corporation, Donaldson, Lufkin & Jenrette and Spear, Leeds & Kellogg announced an agreement in late July forming a joint venture to launch a new ECN. The group's strategy for establishing the ECN is to provide customers with high-quality executions and increase liquidity by pooling the large order flow of the four firms.
Remaining competitive in a global market may warrant around the clock trading. "We believe we will have to be ready for extended trading hours before the industry. The need to compete globally leads to extended hours. Risk management will eventually force the need for real-time trading," cautions Pershing's Baker.
Baker also sees an industry consolidation taking place as innovative, entrepreneurial companies lead the way, seeking partners to acquire needed capital to grow or attract acquirers seeking to buy into market niches and new technologies.
As the volume is anticipated to increase, firms must be prepared. "At this stage, we do not know what the impact on volume will be due to extended hours trading. We have not yet added new trading staff. We pride ourselves on being technologically advanced and offering a full array of financial products and services to our customers and will add staff to the trading desk as volume dictates," boasts Son of Penson Financial Services.
Laying out the exact approach to handle extended hours requires careful planning. "We're taking a three-pronged approach to extended trading hours. First of all, we are trying to understand industry events, new technologies and new companies with new products and services. Second, we focus on the needs of our clients to determine who is and who is not interested so we can respond appropriately. Third, we are making sure the proper technologies and operating mechanisms are in place to serve our customers. Our main focus here is on providing a high quality of service. Extended trading hours will happen and we will make changes as the need arises," concludes Weiss, Peck & Greer's Nadel.
To be sure, plenty of challenges remain as the securities industry enters the 21st century but clearing firms and their industry counterparts have been working hard to make the path a smooth one. Minor glitches will occur but the overall clearing and settlement process will move forward on track, providing clients and end-users with quality transaction service. The future looks bright for those armed with years of preparation.
