Computer Sciences Corp. has released a report that quantifies the potential ripple effect of year-2000 system glitches on foreign exchange markets.
The glitches would be created by programming bugs that throw computers into confusion when they must deal with references to dates after Dec. 31, 1999.
The report estimated that the financial services industry would lose up to $3.3 billion over five days if a big bank with 3% of the foreign exchange market were to have trouble settling its transactions.
Further, it predicted five-day losses of up to $5.2 billion if a private clearing house were to have settlement trouble and up to $2.2 billion if five smaller institutions with about 0.2% market share were to have similar problems.
The estimates take into account losses that would result from scaled- back trading, the time and money spent investigating problematic trades, and the nonreceipt of payments from counterparties whose systems were snarled by year-2000 glitches.
The report's conclusions are part of a new wave of thinking that focuses less on the cost of year-2000 compliance than on the cost of noncompliance.
Computer Sciences, the El Segundo, Calif., computer services giant whose profile in banking is rising, chose to focus on the foreign exchange sector because it accounts for $3 trillion, about half the daily dollar value traded in global markets.
Trading risk is high in foreign exchange markets because time zone differences mean national payment systems often are not open at the same time.
The CSC report stated: "There is the risk that after the first counterparty has delivered one side of the transaction, the other counterparty may go bankrupt and fail to deliver the offsetting currency. To the extent that this nonpaying bank has entered into a number of similar trades with other institutions, the failure is considered systemic."
Computer Sciences released the report, "Sustaining Stable Financial Markets Through the Millennium," at the Securities Industry Association's year-2000 conference and exhibit in New York last week. To compile estimates, it did interviews in October with 90 executives from large financial companies, regulatory bodies, and clearing houses.
By quantifying potential losses, Computer Sciences hopes to spur more action in year-2000 compliance and regulation.
The Gartner Group said that about 50% of U.S. banks are at least halfway through year-2000 compliance activities. However, only about 5% of large overseas banks have reached this point.
The Computer Sciences report made detailed predictions of industrywide effects from year-2000 glitches.
For instance, the $2.5 billion to $3.3 billion expense that could be incurred over five days as a result of a large bank's settlement troubles would be broken down this way:
Between $1.26 billion and $1.68 billion would be "cautious trading costs." Computer Sciences estimated that foreign exchange trading would be scaled back 15% to 20% as trading participants suspended trading altogether with high-risk counterparties.
Between $845 million and $1.25 billion would be "bottleneck costs." About 10% or 15% of trades would not get processed because counterparties would be too busy investigating potentially problematic trades.
About $370 million would be "noncompliant costs."
Even in a best-case scenario-one in which only a few small traders have year-2000 trouble-most trading operations would have back-office messes to clean up.
"It would likely take weeks to fix all the failed trades and balance the books," the Computer Sciences report stated. "This means any staff diverted from other areas would be taken away from their jobs for a significant period."
Computer Sciences recommended setting up a disaster recovery plan to deal with such a situation.
The company urged that regulators and central banks "work together to develop a coordinated contingency plan for providing liquidity in case of various year-2000 disruption scenarios."
