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TUESDAY, JUNE 23, 1998
U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.

    The committee met, pursuant to notice, at 10:10 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.

    Present: Chairman Leach; Representatives Bereuter, Lucas, Metcalf, Snowbarger, Sessions, Fossella, LaFalce, Vento, C. Maloney of New York, J. Maloney of Connecticut, Sherman, and Lee.

    Chairman LEACH. The hearing will come to order.

    The committee today convenes for the fourth in a series of oversight hearings of the Year 2000 technology problem. The international banking and finance dimension of the issue is the subject of today's session.

    International Year 2000 readiness is critical in this era of global interdependence. While some have speculated that there may be a run to American banks located overseas if local institutions fail to make the Year 2000 conversion deadline, such competitive advantages may be fleeting in the long-run if there are broad systemic problems with international banking and finance in the days after the start of the year 2000. No matter how well prepared American banks and business are for the new millennium, it is difficult to imagine how our banking systems and domestic economy can escape the consequences of a weak link in the worldwide chain connecting banks and their customers, trading partners, suppliers, telecommunications networks, and other counterparties. Their risks, to a large extent, are also our risks.
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    The scale of the global economic interdependence is graphically illustrated in the following statistics. Over a trillion dollars in global financial exchange transactions occur daily, of which more than 80 percent involves the U.S. dollar. Worldwide investment figures from the United Nations Conference on Trade and Development show over 275,000 foreign-owned affiliates located in local economies around the world with over 18,000 of those in the United States. Global trade as measured by exports exceeds $5 trillion, of which U.S. exports are roughly 12 percent.

    It is because of these broad and complex interdependencies that the committee has invited a distinguished panel of witnesses here today to address four major areas of concern. First, what is the scope of the Year 2000 risk to international banking and finance? What are the risks to U.S. financial institutions and businesses from non-compliant foreign banks and trading partners? Are the risks being exaggerated or understated? Is there anything unique or extraordinary about Y2K-related risks or are they no different than the ordinary, everyday kinds of risks with which financial institutions, payment systems, and trading partners deal routinely?

    At least preliminarily, the evidence which has accumulated in recent months is not reassuring. For example, the International Basle Committee on Bank Supervision issued a statement last fall in which it called the Year 2000 issue, ''potentially the biggest challenge ever faced by the financial industry.'' It warned that failure to address it in a timely manner would cause banking institutions to experience operational problems or even bankruptcy and could cause destruction of financial markets.

    The Board of Governors of the Federal Reserve recently reported to this committee that there is concern that most foreign markets and financial institutions are lagging U.S. organizations by anywhere from 3 to 18 months. Richard Grasso of the New York Stock Exchange sounded similar warnings, calling the potential impact of the Y2K problem on domestic and international markets profound. The Computer Sciences Corporation Report, which came across my desk earlier this year, suggested that under certain scenarios, international Y2K-related settlement difficulties could cost anywhere from $495 million dollars a day to $5.2 billion over five days. And, in the most alarming and, we hope, extreme assessment, Edward Yardeni of Deutsche Bank suggests a 60 percent chance of a global recession precipitated by the Y2K problem.
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    The nature of these kinds of statements and assessments leads to a second line of questioning: What is the international community doing to address these risks? Are foreign bank supervisors, international financial institutions, and other responsible organizations doing enough to address the problem? Is the United States itself doing enough to assist in these efforts? What safeguards are already in place to address systemic risk in international financial transactions? How adequate are these safeguards in the context of the Year 2000 problem? And, what, if any, additional safeguards may be required?

    It is encouraging to note the increasing level of international attention that has been given to the problem. After a Global Year 2000 Roundtable session in April, the Basle Committee and three partners established a joint Year 2000 Council of International Banking, Payment System, Insurance, and Securities regulators. Similarly the Global 2000 Coordinating Group has been formed under private sector auspices to target the most important international financial markets for Year 2000 remediation.

    The increasing level of international activity in addressing the problem prompts a third area of questions: How can the United States and other affected parties accurately monitor the progress during the next 18 months? Thanks to the work of the FFIEC, these kinds of questions may be easier to answer at home than abroad. Finally, are there additional actions the United States, including the Congress, should take to support international efforts?

    We begin the hearing today with a lot of questions and very few answers. To help shed some light on these issues, the committee has invited a panel of five distinguished experts: Ernest Patrikis, First Vice President of the Federal Reserve Bank in New York and Chairman of the Joint Year 2000 Council; Tim Shepheard-Walwyn, Executive Director of the Swiss Bank Corporation representing the Year 2000 Coordinating Group; John Mohr, Executive Vice President of the New York Clearing House Association; John Towers, my former wrestling colleague, Executive Vice President for Global Operations of State Street Corporation; and Samuel Theodore, Managing Director of Moody's Investors Service in the London office.
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    Unfortunately, both the Department of State and the Department of the Treasury declined to send witnesses but have submitted written statements for the record.

    At this time, would anyone else like to make an opening statement?

    Mr. METCALF. Mr. Chairman.

    Chairman LEACH. Yes, Mr. Metcalf.

    Mr. METCALF. Thank you very much, Mr. Chairman. I'd just like to say that I'm encouraged by what I hear as significant positive steps by the financial industry regulators to ensure that our domestic banking system is Year 2000-compliant as soon as possible. Hardly a day goes by where my office is not contacted by a constituent who's concerned about our Nation being compliant for Y2K. The greatest concern people have is not for the fear of lights going out or planes dropping out of the sky, though these are still potential concerns, but consistently the issue they have is being able to access their money and financial investments. Their highest concern seems to be that computer records and statements could be lost in the Y2K fray.

    We as Congress and you as regulators still have a daunting task. Not only convincing this Nation that we are compliant, but demonstrating to the public in the coming years that access to funds will not be interrupted. Obviously, if you as regulators cannot show you have control over this, the public could react in a dramatic fashion. Already many groups are advising people to convert investments and accounts before the end of 1999 and that kind of hysteria must not be allowed to grow.
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    In this past week's National Journal Magazine, an article by Julie Kosterlitz significantly highlights the Year 2000 problem the financial industry faces in the next year. She tells of a small bank in Texas that held a contest for its employees. The contest was simple. Whoever comes up with the longest list of equipment and software that could be affected by Year 2000 would win $200. The president of the bank said the winning list was, quote, ''a lot longer than I thought it would be,'' unquote. The winner in this small bank had a list of well over 100 items. ''The costs are still very significant,'' the article continues, in saying that, ''a bank with around $120 million in assets could see Y2K costs around $80,000. And an international company like Chase or CitiGroup could see costs in the neighborhood of $300 million.''

    Clearly the costs are significant, but the cost of putting off action would likely be higher. The complex issue of banking and Y2K is, to say the least, troubling. We have a way to go and I'm encouraged by your work as regulators and look forward to your comments. Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Jack. Does anyone else wish to make an opening statement? If not, the Chair would ask unanimous consent that all Members be allowed to present opening statements for the record. Without objection, so ordered.

    Let me introduce our witnesses. Our first witness is Mr. Ernest Patrikis, who is First Vice President of the Federal Reserve Bank of New York. Mr. Patrikis is appearing today in his capacity as chairman of the newly elected Joint Year 2000 Council, consisting of financial supervisors and regulators from various nations.
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    Our second witness is Mr. Tim Shepheard-Walwyn, who is Executive Director of the Swiss Bank Corporation and Chairman of the Global 2000 Coordinating Group. Like the Joint Year 2000 Council, Global 2000 is a cross-cutting international organization, but it represents private sector institutions, rather than governments.

    Our third witness today is Mr. John Mohr, who's Executive Vice President of the New York Clearing House Association, which operates an electronic payments and settlement system—CHIPS—otherwise known as the Clearing House Interbank Payment System, the world's largest electronic system for handing international dollar payments.

    Our fourth witness is Mr. John Towers, who is Executive Vice President for Global Operations of State Street Corporation, one of the largest financial institutions in the world, and in press articles last week, reported to be one of the leaders in Year 2000 remediation.

    And our fifth and final witness is Mr. Samuel Theodore of the London office of Moody's Investors Service and an expert on European banks and the Year 2000.

    We'll begin with Mr. Patrikis.


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    Mr. PATRIKIS. Thank you, Mr. Chairman. Good morning. I'm pleased to appear before the committee today to discuss the implications of the Year 2000 computer problem for international banking and finance. 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.

    As you know, the Year 2000 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. And all countries of the world, therefore, need to address the Year 2000 problem and its potential effects on their domestic financial markets.

    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 organization. Only firms working together can ensure 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 Year 2000-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.
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    Recognizing the global nature of the Year 2000 problem, the four sponsoring organizations organized a Global Year 2000 Roundtable at the Bank for International Settlements in April, which was attended by senior executives from over 50 countries. The communique issued by those organizations at the close of the Roundtable announced the formation of a public sector group called the Joint Year 2000 Council, to work with the private sector and to maintain a high level of attention on the Year 2000 problem.

    The Joint Year 2000 Council consists of senior members of the four organizations. Every continent is represented by at least one member on the Council. The Bank for International Settlements provides the Secretariat. The Council's mission has four parts. First, to ensure a high level of attention on the Year 2000 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.

    The G–7 finance ministers have recently called on the 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 formed and met with an external 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 that we will play a positive role in three areas. First, raising awareness. Second, improving preparedness. And, third, contingency planning.
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    To help raise awareness of the Year 2000 efforts underway globally, the Council will maintain extensive Worldwide Web pages, including a page for each country in the world with Year 2000 contacts and activities for that country. The presence of these country pages may also exert pressure on those countries where more vigorous action is needed.

    The Joint Year 2000 Council will be undertaking a series of initiatives to improve preparedness. We plan to issue a statement in the near future providing support for the concept of a national level coordinating body for the Year 2000 problem. We intend to issue within the month a paper aimed at improving supervisors and regulators worldwide, for moving from a general level of awareness to a specific, concrete program of action for overseeing the Year 2000 preparation. We will build on this effort, then, to develop a Year 2000 self-assessment tool that can be used broadly by the financial industry in each country.

    While there is still not nearly enough concrete, comparable information on the preparations of individual institutions to be able to make confident statements about the state of global preparations in any detail, 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 where more urgent efforts are needed. In these instances, our first step will be to work through the relevant national financial supervisors and regulators and also to involve multilateral institutions, such as the World Bank, to increase the national attention on the issue.

    The Joint Year 2000 Council will also encourage all firms and institutions active in the financial market to engage in internal and external Year 2000 testing, which is universally regarded as the most crucial element of Year 2000 preparation. We will build on existing efforts to collect and publicize information on the testing programs of payment and settlement systems, to include all important pieces of financial market 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 Year 2000 Council will also develop a series of documents to help countries set up testing programs as rapidly as possible.
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    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 community. This paper will seek to address firm-level contingency, as well as issues of marketwide contingency.

    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 the impact of each possible disruption. The sooner such thinking occurs, the more opportunity we'll have to plan around the possible disruption. Much more work is needed on contingency planning for Year 2000, 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 the Year 2000 during 1999.

    In closing, I'd 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 make a difference in improving the state of the Year 2000 preparations in the international financial community. As a central banker and bank supervisor, my major 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 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'd like to end my remarks by commending the committee for organizing these hearings on the implications of the Year 2000 computer problem for international banking and finance. The mere fact that you're interested in our efforts is a powerful source of support for what we are doing. Thank you.
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    Chairman LEACH. Thank you, Mr. Patrikis.

    Mr. Shepheard-Walwyn.


    Mr. SHEPHEARD-WALWYN. Thank you, Mr. Chairman. Mr. Chairman, Members of the committee, it's a privilege for me to have the opportunity today to testify to you about the activities of the Global 2000 Coordinating Group of financial firms. The Coordinating Group was set up in April this year as a collective effort of a number of internationally active financial firms to identify and resource areas where collective action would help to ensure that international financial markets are as well prepared as possible to handle the transition of the date to the year 2000.

    The background to our initiative was the recognition on the part of a number of firms which are active in financial markets that their own internal systems for mediation programs or even collective efforts within certain domestic markets could not, on their own, provide sufficient assurance that the global markets in which they operate would be ready for the year 2000 date change. Moreover, it was clear to the firms which formed the Coordinating Group that Year 2000 compliance is not a competitive issue and that firms must work with each other, with industry groups, and with the official sector, because we all have a mutual interest in success. In particular, we realized that there was very substantial mutual advantage in sharing information about the testing and compliance plans in place in the different markets in which international firms have a presence and in helping to identify and disseminate ideas about how firms and markets could best tackle the challenges of year 2000.
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    From the outset, there was close cooperation between the coordinating group and the industry bodies that were already involved in addressing the Year 2000 issue in a number of countries. I would mention here in particular the Securities Industry Association here in the United States, the British Bankers' Association and the London Investment Banking Association in the U.K., and the Japanese Securities Dealers Association and the Federation of Bankers Associations of Japan, all of which were involved as founding members and are active participants in the world of the Coordinating Group.

    There has also been very close cooperation from the beginning between our initiative and the official sectors collaborative international efforts which Mr. Patrikis has spoken about. Indeed, the announcement of the formation of the Coordinating Group on the 8th of April was made at the same time as the announcement of the formation of the official Joint Council on the Year 2000 by the Basle Committee, the International Organization of Securities Commissions, the Committee on Payments and Settlement Systems of the G–10 Central Banks, and the International Association of Insurance Supervisors.

    I would now like to explain how the Coordinating Group is organized to conduct its work and to outline the efforts we have been undertaking over the past three months, since the group was established. The Coordinating Group seeks to operate as an inclusive organization. Participation is open to any firm that has an interest in the international financial markets. And we share information about our activities with any interested party. We have no membership fee and any firm is welcome to join the meetings of the Coordinating Group on the sole understanding that participants support our efforts and are prepared to resource our initiatives to the extent that they are able to do so.
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    The Coordinating Group is supported by a small full-time Secretariat, which is provided by Swiss Bank Corporation and Union Bank of Switzerland. The Coordinating Group is run by a steering committee which consists of the founding members, together with country representatives from major markets around the world. There are currently country representatives from 18 countries on the steering committee. These are: Australia, France, Germany, the Netherlands, Denmark, Spain, the United Kingdom, Switzerland, Japan, Singapore, Hong Kong, Hungary, South Korea, Canada, Brazil, Italy, Spain, and the United States. And we hope to include other countries in the near future.

    The role of the country representative on the steering committee is particularly important. Each country representative takes a leadership role in the Year 2000 initiative in their own country and assumes a liaison function by providing information about these activities to the group as a whole. Further, the country representatives are able to ensure that the experience of the members of the Coordinating Group is made available to assist in the local initiatives in their own market.

    The Coordinating Group has focused its work in the past three months on three principal work streams: issues related to the internal Year 2000 programs of financial firms; issues related to the plans of financial infrastructure providers, such as payments and settlement systems; and issues related to the plans of key suppliers and utilities. In relation to the readiness of financial firms, the coordinating group has been developing a self-assessment framework to assist firms in assessing the status of their own internal Year 2000 programs.

    The Coordinating Group is also working with the Joint Council to help develop guidance for regulators and supervisors in reviewing the effectiveness of firms' plans for addressing the Year 2000 problem, while recognizing that each firm will have its own unique requirements, dependent on its own technology position. With respect to the readiness of financial infrastructure providers, the Coordinating Group has developed a framework for developing and assessing test plans which we hope will help to ensure that markets are able to develop consistent test requirements for the key elements of their market infrastructure. Drawing on the experience of a number of market which are now well-advanced in defining their test plans, this parses out a common set of definitions in relation to testing and makes certain recommendations as to the scope and the timing of testing for the different elements of the market infrastructure.
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    With respect to vendor and third-party readiness, the Coordinating Group has identified a number of important dependencies which every financial sector Year 2000 program should address, including in particular dependencies on power, water, and telecommunications. The Group recommends that each national program should examine these issues as a matter of priority. In addition, the Coordinating Group has made available a framework for firms to use in managing their own third-party vendor readiness programs and is currently developing guidelines for a cooperative approach for addressing issues of vendor preparedness.

    Following a meeting with the official Joint Council in Rome on the 9th of April and a subsequent meeting of its own on the 17th of June in Tokyo, the Coordinating Group has agreed to work closely with the Joint Council in developing guidelines on the issues mentioned above, as well as on the collection and dissemination of information about the arrangements which exist in different countries in relation to their Year 2000 programs. As Mr. Patrikis has mentioned, this information will be made available in the near future and we will either do that through the Coordinating Group's own Web site or through the Web site of the Bank for International Settlements, as Mr. Patrikis mentioned. The Coordinating Group has agreed to defer the consideration for the important issue of contingency planning and is also looking at the information which could be made available about the progress of individual firms toward the completion of their own Year 2000 programs.

    In addition to developing strategies for Year 2000 issues under these different work streams for use by both firms and markets worldwide, the Coordinating Group is actively cooperating with the Joint Council to communicate its efforts and recommendations to as wide an audience as possible. As part of this effort, I, together with a number of members of the steering committee, conducted a seminar in Hong Kong just last Friday which was jointly hosted by the Hong Kong Securities and Futures Commission and the Hong Kong Monetary Authority and which was attended by representatives from 11 countries in the Asia-Pacific region.
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    At this seminar, we explained the work of the Coordinating Group and the Joint Council and provided an opportunity for those countries to discuss issues related to their own Year 2000 program. I believe that this was felt to be a valuable initiative and we are currently seeking to arrange similar briefing meetings within the next two months in both Latin America and Eastern Europe.

    In conclusion, I would like to say that, as the chairman of the Coordinating Group, I have been enormously impressed by the level of support that we have received from the firms which have volunteered to participate in this initiative. We all recognize that this is a process where the issues are new to everyone. Consequently, a free and open exchange of information and experience is of the utmost importance. In my experience, the willingness of the firms involved in this initiative to participate on this basis and to work in the common interest is without precedent. And it is this spirit of cooperation which gives me confidence that we can succeed in our objective of ensuring that the international financial community is ready for the Year 2000. Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Shepheard-Walwyn.

    Mr. Mohr.


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    Mr. MOHR. Chairman Leach, Members of the committee, thank you for the opportunity to discuss the Year 2000 problem and its impact on payment systems and on the banks that use them.

    The Clearing House recognized the significance of the Year 2000 problem earlier than most organizations. At the end of 1988, the Clearing House started a project to substantially overhaul the CHIPS transaction record formats. At that time, the decision was made to also make these record formats Year 2000-compliant. This system was placed into daily operation on August 17, of 1992.

    Then, in early 1997, the Clearing House conducted a thorough review of all other Clearing House automated processes to identify possible Year 2000 problem areas. In addition to Clearing House-written software, all supporting systems and software supplied by third parties were reviewed. The results of this review, as well as progress reports and their remediation and testing efforts are regularly reported to various Clearing House oversight committees, including our audit committee and our Clearing House committee, which is made up of the senior executives, the chairmen and CEOs of major U.S. banks. As of today, CHIPS and all of our mission-critical systems, including our automated clearing house and electronic check presentment systems have been repaired and tested for Year 2000 compliance.

    The U.S. banking regulators, through the Federal Financial Institution Examination Council, or FFIEC, has been in the forefront of Year 2000 preparation for the banking industry. Through their early efforts, bank regulators have helped focus attention on Year 2000 issues by issuing interagency statements and conducting banking industry forums on Year 2000-related issues. These statements and forums have advised financial institutions on matters related to Year 2000 planning, assessment, and communication with the institution's customers.
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    Leadership by banking regulators have been one major factor driving financial institutions to ensure their components that make up domestic and international banking will be ready for transition into the next millennium. The FFIEC statements have underscored the importance of the Year 2000 problem for banks. In many instances, the banks have used the power of these statements as an effective lever to encourage earlier compliance schedules by vendor companies that are beyond the bank's supervisors' oversight. This leverage has produced improved vendor delivery schedules and has effectively given banks more time to perform Year 2000 certification tests and resolve any issues arising from them.

    In the area of contingency planning, past experience provides us with insights on how banks might deal with disasters in the future. There have been a number of disasters that could have had devastating effects on financial markets. A week-long power failure in Lower Manhattan in 1990, a blizzard in January of 1995, the bombing of the World Trade Center, and flooding of the financial district in Manhattan are several examples of non-Year 2000-related failures that were successfully addressed by the financial community.

    Banks must be able to discharge their responsibilities to act on payment instructions of their customers. In the United States, CHIPS and Fedwire are payment systems that are complete and separate systems that allow major banks that belong to both systems an alternative in the event that one is not operating. By the year 2000, the euro will be in use in Europe and the central bank payment systems within Europe will allow alternate routing choices for banks making Euro-based payments. Banks that have isolated failures within their own systems can utilize correspondent relationships with other banks to send and receive payments.

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    For disaster contingencies, the Clearing House maintains its own back-up data centers located in different power grids with resilient environmental systems, including redundant electricity and cooling subsystems and physically diverse telecommunications connections. These contingency plans have served the Clearing House well for many years.

    In the area of industry testing efforts, the Clearing House first offered a Year 2000 CHIPS test system on October 7, 1997. Since the beginning of 1998, the system has been made available to participants on a full-time daily basis. In May of 1997, the Clearing House announced that it would conduct its first mandatory Year 2000 test for CHIPS participants on September 26, 1998. This test is designed to assess the ability of CHIPS participants to successfully inter-operate with CHIPS and other CHIPS participants. The test is an important step in Year 2000 compliance for the banks' funds transfers.

    Looking forward, the Clearing House has announced four Year 2000 mandatory tests in 1999 for its participants. For one of these tests, we are attempting to arrange a coordinated global test with a number of major central banks. We would like to bring together payment systems in the United States, in the U.K., in Germany, and Japan, in Hong Kong, and in Switzerland, to have a test all on a single day. We are tentatively scheduling this test for June 12 of 1999, after the introduction of the euro and early enough to assess and address the results of the test.

    All payment systems operate on public telecommunications networks. Unimpaired operation of these networks is one of the most critical factors to the ability of banks to process payments in the new millennium. It is also a factor that is largely beyond the direct control of the banks. In January, 1997, the Clearing House embarked on a project to assess the readiness of all domestic, local, and inter-exchange carriers. The Clearing House met with the Federal Communications Commission on several occasions to ask for help in obtaining the carriers' plans. In early 1998, the Clearing House and the Securities Industry Association joined together to identify and evaluate telecommunications carriers on a worldwide basis.
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    There are still a number of issues facing the banking community. While banks in the United States have been actively tackling Year 2000 issues for several years, efforts may not be as far along in other parts of the world. In some cases, this is due to other political and economic factors that require immediate attention of the affected parties, for example, European communities are in the midst of introducing the euro on January 1, 1999. The Japanese are currently pursuing banking deregulation. The current financial crisis in Asia may seriously hinder Year 2000 preparations. In other cases, we are concerned that some of the lesser-developed nations have been slow to appreciate the full impact of the Year 2000 on their systems and therefore may be slow to implement sufficient remediation programs.

    In conclusion, I'd like to thank the committee for the opportunity to present the Clearing House's assessment of the payment's system Year 2000 readiness. We believe our payment system participants are acting responsibly and addressing these issues in a timely and comprehensive manner. Furthermore it, based on our experience and observances, we believe that our Nation's payment system will continue to operate efficiently through the century date change.

    Chairman LEACH. Thank you, Mr. Mohr.

    John, please proceed.


    Mr. TOWERS. Mr. Chairman, Members of the committee, thank you for the opportunity to appear before you today. I'm John Towers, executive vice president for Global Operations at State Street Corporation in Boston where I oversee securities processing, cash, and computer operation. I'll be speaking to you for just a few minutes this morning, Mr. Chairman, but I will submit a longer written version of my testimony and I'd add that to be added to the record.
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    Chairman LEACH. Without objection, full statements of all the witnesses will be placed in the record.

    Mr. TOWERS. Thank you.

    Chairman LEACH. Thank you.

    Mr. TOWERS. I'll focus my remarks today on State Street's experience in preparing for Year 2000 and suggest elements of possible action you may consider to help the country prepare to meet the challenges posed by the Year 2000 issue.

    State Street Corporation and its principal subsidiary, State Street Bank, provide safekeeping and financial services for $4.5 trillion in assets held primarily by pension plans, mutual funds, and insurance companies around the world. Our custody systems process over 50,000 securities trades daily in over 80 markets for several thousand mutual funds and pension plans. And State Street is also a major global asset manager, investing some $458 billion on behalf of institutional investors worldwide.

    Additionally, we maintain individual records for 401(k) participants and investors in mutual funds and industrial corporations. Early in 1996, State Street developed a program we call Resolution 2000, which is a comprehensive program to identify and resolve our Year 2000 compliance issues. The demands, impact, and progress of Resolution 2000 are communicated throughout our organization from senior-level management to every level of our operations professionals and to our board of directors.
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    The program covers four areas of compliance and contingency preparations. First, information technology; then suppliers and vendors; counter-parties and business partners; and, finally, business area operations. Our Resolution 2000 compliance target for all internal systems and applications software is December 31, 1998, meeting the recommendations of the Federal Financial Institutions Examination Council and allowing for a full year of external testing in 1999. This involves ensuring that all three levels of our technical environment have been reviewed. This is the system software environment where our programs operate, the applications software itself, and the many macro programs that are run on the personal computers throughout our operating areas.

    Y2K compliance is a challenge, but technology challenge is nothing new. State Street and other global financial firms are accustomed to constantly upgrading and recoding software to accommodate changes in customer and/or market requirements.

    State Street has a working relationship with over 100 subcustodian banks in 83 markets, all of which much be Year 2000-compliant. We rely on these subcustodian relationships for the settlement, safekeeping, and servicing of assets for our customers in those non-U.S. markets. Our subcustodians also serve to provide us and our customers with a critical interface with other local securities market participants. Our team of global custody professionals is in the process of assessing our subcustodians compliance, planning, evaluating their testing efforts, and reviewing the progress of other local market participants, including securities depositories, central banks, and clearing houses. Our evaluations also address how these participants are preparing contingency plans for potential points of failure after the millennium.
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    Our preliminary responses with respect to general market planning revealed wide variation in readiness. Some markets have revealed very little information and some have highly developed programs. Others are more occupied with the introduction of the euro or addressing recent market downturns. And we have also found significant variation in regulatory oversight within the market. However, virtually all markets view attainment of compliance as a fundamental prerequisite for post-Year 2000 survival. Some even regard the non-compliance of their market peer group as a potential competitive advantage and thus are not overly aggressive at sharing information. However, while many institutions are undertaking compliance programs, we have less information on the development of contingency plans for post-Year 2000 failure.

    Our primary concern with regard to compliance efforts is the inconsistent regulatory approach and the general lack of information sharing globally. Many market participants are taking action. Ministries of finance, central banks, government regulatory agencies, central depositories, and particularly the banking association. But, as I say, the scope of their work varies.

    In our direct contact with the markets, there is some good news. Target dates are clearly being established and most of our subcustodians are targeting internal compliance by December 31 of this year. There also seems to be universal acceptance that companies without effective plans risk severe consequences.

    By and large, participants recognize that information sharing would empower Year 2000 efforts, but financial institutions face a dilemma. If they are too candid and specific in their disclosure, markets may overreact and investors may retreat. If they disclose too little, they may face litigation in the case of an unsuccessful Y2K conversion. Pension plan sponsors and mutual fund companies expect global custodians, like State Street, to assess Year 2000-related market risks around the world. We understand that their investment decisions may, in part, be based on this assessment.
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    Unfortunately, however closely we monitor compliance among our financial services partners, we cannot monitor every link in the fundamental infrastructure around the globe in which all participants in a given market operate, such as utilities, telecommunications, and the like. The amount of information we have received in these areas has not been as extensive as those we have received from the banks or subcustodian banks and other financial market participants. But I am encouraged by the actions mentioned today by a number of the other witnesses in trying to stimulate further communications from some of these infrastructure participants.

    One area where Congress can make a vital contribution would be in considering a legal framework that provides some protection for liability arising from explicit disclosures on our finding of Y2K readiness. Defining and limiting liability can promote information sharing and limit behavior that impedes communication. And also it can promote disclosure. Without such protection, market participants will continue to be wary in their disclosure and what we vitally need to ensure success in the next millennium is more disclosure and not less. Further, we should encourage a more consistent regulatory approach worldwide, particularly across the security markets. Thank you.

    Chairman LEACH. Thank you very much, John.

    Mr. Theodore.

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    Mr. THEODORE. Thank you, Mr. Chairman. I'm Sam Theodore. I a Managing Director for European banks in the London office of Moody's. Moody's is one of the leading rating agencies in the world. We currently have rating on more than 1,000 banks in 80 countries. So, although my comments will address primarily the European landscape, I will make broader comments on the world in general.

    As we assign ratings to individual banks, clearly our main concern should be individual credit risks of the banks. But, having said that, we clearly believe that no individual bank can safely survive a systemic crisis. And, in our approach to the Y2K issue, we start by looking at the overall systemic risk. Now, as far as we have noticed it, the good news is that, by and large, the large financial institutions in the world, primarily the U.S. and West European institutions in countries like Germany, the Netherlands, France, the U.K., Switzerland, and, to some extent, Spain, have focused on the Y2K issue, starting with the early to mid-1990's.

    By and large, these large institutions seem to be on track with the compliance process and, as a matter of fact, they are far ahead of their own regulators concerns, which is clearly a positive for these large banks and also for the possibility that systemic risk-related Y2K would probably be more remote because, after all, these large financial institutions, on aggregate, are a critical transmission belt for financial flows worldwide.

    Now the situation is less positive, in our judgment, when it comes to smaller banks, regional, local banks, in many countries of the world including in the developed part of the world such as Western Europe for various reasons. The major area of concern, which was emphasized earlier by other witnesses, is the fact that, as opposed to the efforts of the U.S. regulators—bank regulators—in most other banking systems, national regulators seem to be truly concerned, but less aggressively concerned about how to steer their banks into complying with the Y2K deadline.
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    If I may say so, a time deadline, which is the year 2000, tends to have different connotations according to the geography. In Western Europe, for example, Bank of England seems to be, according to our judgment, by far the most aggressively concerned regulator. Other regulators are less concerned, and, clearly, we see that not at the level of the large international groups in each country, but more at the level of the middle-sized regional banks, which, for some reason, expect a lot of guidance to come from their national regulators.

    The major area of concern in Europe, as was emphasized earlier, is the fact that, as of next year, 11 countries in Western Europe will start the Economic and Monetary Union. The process of complying with Y2K has to run in parallel with the process of complying with the Euro-conversion.

    For different reasons, most European banks that we talked to seemed to look at the conversion to the euro more as a competitive, as a business challenge, and they tend to look at the Y2K issue more as a, quote, unquote, ''necessary evil.'' In other words, to comply with the Year 2000 is not going to make the bank stronger; not to comply with the Year 2000, of course, is going to make it weaker.

    But, at the same time, if a bank is able to assure the euro conversion in time, it can offer products and services to its clients, to its corporate clients, perhaps of better quality than some of its competitors. And when it comes, then, to the IT challenges of assuring both conversions, perhaps some banks would be tempted to cut corners, and because of the business focus currently under Euro, corners could, unfortunately, be cut in the Y2K compliance.

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    This could be illustrated by the fact that when we ask banks to indicate to us what total budgets for Y2K and the euro conversion are, the Euro-related budgets seem to be several times higher than the budgets for Y2K.

    If we look at Asia, without getting into a detailed analysis, it seems to us that the overall Y2K-related budgets of some of the large Japanese banks are many times smaller than the similar budgets of large U.S. or West European institutions, although the challenge is clearly the same for a large national institution in Japan or in the Netherlands or in the U.S.

    Now when it comes to the smaller banks, which clearly are our main area of concern, we tend to look at the regional and local banks with a wide range of activities, not all of them well-correlated, as being in the highest-risk category. There are many such institutions in Europe, for example, which try to diversify their revenues and increase profitability, and at the same time the systems are not really following this growth in activities, and many of these banks are less internationally oriented, on the one hand, and, on the other hand, have not yet built an IT, a strong IT, culture. We would call them mini-universal banks, which are in this high-risk category.

    Another area, major area, of concern is emerging markets. Now, arguably, if a bank in one emerging market is going to have Y2K failures, this is not going to endanger the overall financial system, but at the same time some of these banks could be at high risk.

    Probably the better sheltered banks in emerging markets are those affiliates or subsidiaries of some large banks in the developed world, and one good example is a large number of banks in Latin America which are subsidiaries of U.S. or Spanish banks.
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    Another critical area of concern for us is the so-called counter-parties. A bank can be very well prepared IT-wise for the Year 2000, but at the same time, if it doesn't make sure that its clients, its counterparties, both business borrowers and corresponding banking relationships are similarly well-prepared, this bank will have a problem. As far as we have noticed, two major categories of potential risks in this respect are middle market businesses in many countries around the world, and also a large number of local and regional governments, public sector entities, where the Y2K efforts are not very strong.

    As for legal risk, in assessing the situation, it seems to us that legal risk is less of an issue in other jurisdictions. After all, there are significant societal differences. Most societies in Western Europe and the rest of the world are probably less litigious, but at the same time one major risk which is universal is reputation risk—the risk that if a bank is going to be perceived going forward as not being fully Y2K-compliant, major borrowers and depositors of that bank may choose to go elsewhere, which would create significant liquidity and franchise problems for that particular bank.

    Now this whole situation is totally new for everybody, and it's clearly new for us as bank analysts. What we are trying to do is to assess this new challenge for banks not on a formulaic basis, not by having a questionnaire-based approach, but rather by trying to understand the issue as it relates to each particular jurisdiction.

    We are in the process of having in-depth discussions with most large banks of the world and with the medium-sized banks, the smaller banks. We have total discussions with national regulators and with IT consultants, banking associations, and others.
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    We hope that by September of this year we would have had a clear understanding of what's going on each in each country, in each system, with each bank, so that we can segregate for the second stage of our assessment process that outliers, those banks with potential Y2K-related problems and to focus on those.

    To the extent that at some point in 1999 we will identify Y2K as being a real credit issue for some banks, we would clearly take rating actions. At the same time, we are publishing the research. We have research now published on Y2K for U.S. banks, for European banks, for banks in the rest of the world, and we plan to address this issue specifically for each bank in part.

    Thank you very much. A fuller version of this statement is available. Thank you.

    Chairman LEACH. Thank you, Mr. Theodore.

    Mr. LaFalce.

    Mr. LAFALCE. I thank you very much, Mr. Chairman. I want to express my appreciation for the work represented by the testimony of the participants. I also want to thank the chairman and his staff for the manner in which they've conducted our four hearings on the Y2K problem. I'm sorry that my schedule prevented me from getting here until the time that I did.

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    I do want to make just a few points. There is a low realization at the grassroots level, and not just amongst the technically informed, that the situation is not something that can be swept under the rug. However, I'm worried that it's just a growing slow realization. I'm worried that the dimensions of the threat to both the American and the global economies are still inadequately perceived.

    To a considerable degree, Congress has fallen into the trap of analyzing the problem in the context of economic sectors. That's understandable. We have a committee structure, and our committee looks at the banking sector; the Commerce Committee is looking at securities and telecommunications, and so forth. But, of course, the problem is not within or unique to any one of the various economic sectors; the problem is with the base technology, and a breakdown of the technology infrastructure could be fundamentally debilitating for any and all economic sectors and the broader economy.

    Within our banking sector, however, failure to correct the Y2K problem could result in the generation of considerable misinformation and errors that would be most labor-intensive, slow, and costly to identify and correct. Bad and corrupted data could be a nightmare for bankers and the regulators, undermining basic financial transactions. Weak links in payment chains could abruptly affect others if payments failed to move as expected. Complicating the problem for global banks is that they must also program their computer systems to deal, for example, with a brand-new currency, the Euro, in approximately the same timeframe.

    Our bank regulators are attempting to address these problems in both the domestic and international context. We're making progress. But I think the breadth of the risk we face domestically or internationally will not be appreciated until we have a much broader understanding of the problems.
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    Much of the discussion has limited its focus merely to the rollover of the calendar on millions of systems from December 1, 1999 to January 1, 2000. This is an accurate, but a limited focus. Because it's limited, it would be a major error in judgment if we only focused on that date and did not spread enough technical knowledge about other dates that are going to be causing significant problems.

    In reality, major domestic and international glitches can occur at many points from, according to what I have learned, April 9, 1999 to December 31, the year 2001.

    In short, the subject matter of most public discourse may be too limited in scope and may promote self-blindsighting. Let me review quickly a list of crucial dates and briefly mention something about each.

    I also commend to the attention of all the interagency statement of April 10, 1998 by the Federal Financial Institutions Examination Council concerning guidance for testing for Year 2000 readiness, which points out the problems I am about to discuss.

    First, April 9, 1999, according to the Council, translates into an internal computer message of ''9999'' on some programs since it is the 99th day of the year 1999. This system of numbering from the beginning of the year is known as the Julian or ordinal format, and is indirectly related to the Julian calendar; ''9999'' signals an end-of-input or end-of-data-file for some routines. This would halt any processing dependent on such a Julian format, which, despite its antiquity, remains in use in a program like DOS when a command called ''ordinal execute'' is given a computer.
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    Second, September 9, 1999 would generate the same kind of ''9999'' error for systems dependent on the Gregorian calendar, which increased in use after the papal decree in 1852. That decree, which I will refer to again, is what is responsible for the Year 2000 being a leap year, while most of the end-of-the-century years are not.

    Third, the transition from December 31, 1999 to January 1, 2000 is the most significant transition and the one that has received most attention. I'll not go into that.

    The fourth, January 3, 2000 will be crucial as to accurate readings, and must be tested in the coming 18 months, since it is the first business day of the new year, which, incidentally, is not technically the beginning of the new millennium; 2001 is.

    Fifth, January 10, 2000 is the first date to require a seven-digit date, 01/10/2000. A very large part of the remediation problem has been that the old computer systems, often called legacy systems, were written with limited space devoted to date fields, since the ''19'' and ''1900'' was assumed. Much of the rewriting effort has been devoted to expanding these millions of fields by hand, since in many, many instances they cannot be enlarged in any other.

    Sixth, February 2000 will contain a leap year day, which is not true in Februaries in most end-of-the-year centuries. Even though end-of-the-century years are evenly divisible by four, which is the qualification for most leap years, the papal decree I mentioned earlier states end-of-the-century years are never leap years—with one exception. If the end-of-the-century year is evenly divisible by 400, then it is a leap year. That being the case with 2000, programs must be checked for anomalous results. For instance, losing a day of interest might not bankrupt a given accounting system on a 365-day interest schedule, but a nearly worldwide error would, indeed, be very expensive.
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    To underscore the confusion related to the leap year issue, even advanced new versions of Microsoft's Windows NT main operating program have had to be patched after distribution to correct for dropping February 29, 2000. This glitch gives some idea of what can arise with older mainframe systems.

    Seventh, October 10, 2000 will be the first date to require an eight-digit date field, 10/10/2000. As with the first date to require a seven-digit date field, adequate space has to be made on millions of line of code to accommodate this situation.

    And eighth, the Council also notes that some failures will be possible on December 31, 2000 and January 1, 2001, since these are the wrapup dates for 2000, and many programs might be inadequately programmed to close out the year without special treatments and routines being inserted, even given corrections made for the 12 preceding months.

    And finally, I'd like to emphasize a little observed, but also important fact: Not all computers run on reprogrammable software. Many are extremely small, but contain a calendaring facility—for example, one's watch or parts of the circuit timing system of a power grid. These devices run not so much on programs, but on a set of instructions embedded in them during the manufacturing process, and we really have no idea where such items might fail during Year 2000 in the United States—on the satellites or somewhere else on the globe. Some items have been investigated, like pacemakers, and declared error-free. The domestic electrical utility companies assured a Senate committee last week that they have matters in hand regarding such mini-machines.

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    Yet, we do know there are many computer situations that are not going to be easily handled. What they are controlling, or helping to control, in international finance, domestic finance, and, indeed, throughout the computer world, will be critical to our success in getting through what will certainly at the very least be a very difficult time.

    I simply commend each of the witnesses who are trying to come to grips with this difficult task, and I wish you well and hope that we can work with you closely in that endeavor. A special hello to Mr. Patrikis of New York.

    Thank you.

    Mr. PATRIKIS. Thank you.

    Chairman LEACH. Thank you very much, John, for that thoughtful statement.

    Let me just begin with Mr. Towers—and good to see you again, John, after 25 years, or whatever.

    Recently, on a delegation trip to Japan, I spoke with one of your offices. Representatives in your institution had just received an unsolicited major business relationship, and the assumption was it was based upon a view that your bank was well ahead of some other banks in Year 2000 compliance. Do you view this as a competitive circumstance or simply a fact of life?

    And, second, your institution, like all others, is dependent to some degree on suppliers, some of whom, presumably, are foreign. One of the things we've gotten from smaller institutions is they've put out queries to their suppliers and there is a huge amount of absolutely no response. Part of it relates, I think, to the liability issue which you raised.
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    Is this an issue in this country only or is this likewise an issue abroad, both in terms of liability and supplier dependence?

    Mr. TOWERS. Well, let me answer your first question, Mr. Chairman. Certainly, I think our efforts and the degree to which—particularly the degree to which we communicate our program throughout our corporation and aggressively to our customer base on request is something that makes us comfortable. I don't know that I'd cite it as a competitive advantage, because I think particularly the other institutions here domestically are likewise focusing very heavily on this. We're certainly proud of where we are on our progress, but there's a lot of work still to be done.

    In the area of vendor response, I think we've been quite encouraged by the degree of response that we have gotten here domestically. I don't know that we're quite as far along on some of our efforts at soliciting response from our vendors at our various international sites, but I think we've also seen at least early in the programs that we've undertaken there that there has been an encouraging level of response. We do go into some depth at trying to go through a series of questionnaires and of verification with the vendors to reach a comfort level. But I think that we've had a reasonable amount of success at generating responses, certainly domestically, and I think the early signs are we're having similar successes around the globe.

    Chairman LEACH. Thank you.

    Let me ask Mr. Patrikis. Are there peculiar international legal issues at stake or are all of these nation-state issues?
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    Mr. PATRIKIS. Well, I think the disclosure issue, part of it's human nature. As firms started doing their work, preparing, they felt very nervous, and firms wouldn't want to say much about what was happening. As firms finished their preparations and moved into the testing stage, one saw them develop more confidence. We could see that amongst the utilities here—the telephone companies, the electric utilities coming forward.

    But I still think there is an issue of, what is disclosure supposed to do? And it's partially a legal issue; part of it, just a very realistic issue.

    The key to Year 2000 is testing, testing, testing. There's not one test and it's all over. Firms will be testing all the way up to December 31, 1999, and I assume on January 1, 2000.

    So what does it mean to say ''to disclose,'' if I'm going to be continually testing? Every time I tweak my system I'll test. So there's no assuredness that can be given through the disclosure, and I think that creates some nervousness of being able to give some disclosure to be helpful, but not enough, because I'm never really sure until the end that I'll have done all the testing, that everything will work.

    So I think part of it's legal, and part of it's just very realistic. I can only give a certain degree of comfort through disclosure.

    Chairman LEACH. Let me just say we're going to operate under the five-minute rule, and there will be a second round of questions. So let me just at this point—I guess technically yours is an opening statement, John. Would you like to go first?
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    Mr. LAFALCE. Thank you. I appreciate the great work that all of you are doing.

    Did we come to this issue late in the creation of these various councils? For example, the Joint Year 2000 Council, that's a recent creature, isn't it, Mr. Patrikis?

    Mr. PATRIKIS. Yes, it started in April.

    Mr. LAFALCE. That's not a—I don't criticize it because it just started in April. It would be better addressed——

    Mr. PATRIKIS. I think what we saw is that we had the different groups. For example, the Basle supervisors had been working on the Year 2000 issue well before the formation of the Joint Council.

    Mr. LAFALCE. Sure.

    Mr. PATRIKIS. I think the Joint Council's point was that we really share this across supervisory and regulatory institutions, and we can do a lot more worldwide and have more impact if we all don't do our separate things. For example, the bank supervisors will develop a paper helping supervisors deal with preparedness, how to judge firms' preparedness. We'll take that paper, and all the supervisors and regulators will look at it. Then we'll also take it and give it to Tim and his private sector Global 2000 group, and have a paper that we can share internationally.
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    So I think what we've learned was we could get the bigger bang for the buck in terms of our effort if we joined together, but we all were doing work separately.

    Mr. LAFALCE. And how long, Mr. Shepheard, has the Global 2000 Coordinating Group been working?

    Mr. SHEPHEARD-WALWYN. We were established contemporaneously with the Joint Council. It was the same timing and I think very much the same recognition.

    If I can put perspective on it from my own firm, it was a recognition that, if we tried to do everything individually, again, we would simply run out of time in trying to find the information.

    Mr. LAFALCE. OK.

    Mr. SHEPHEARD-WALWYN. And as Mr. Patrikis has said, the efficiency this has generated in terms of a single point of——

    Mr. LAFALCE. OK. The more I get into this issue—and I have difficulty appreciating it technically to the extent that I'd like—the more concerned I become. Let me give you a little thermometer poll, if I will.

    On this thermometer, do you think this is a minor little problem, a modest problem with some significance, a very significant problem, or a problem that could have quite profoundly serious consequences? Mr. Patrikis?
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    Mr. PATRIKIS. Well, the answer clearly is it has the potential to create very serious disruptions, and I think we're working away at it. I think, clearly, there are some nations that are leaders, like the United States, where the supervisors, I think, have done a good job and the industry has done a good job, and some other nations that are slower. But I think the effect is everyone will be really running very, very hard to deal with it. I think in 1999 that's all we're going to be talking about, is how well are we doing on the Year 2000, because it is that significant an issue.

    Mr. LAFALCE. All right, I'll just assume that everybody would give an answer somewhat like that.

    I tend to believe that, no matter how hard we work, we're still going to have a serious problem. We must work as hard as we can to minimize it, but there are still going to be huge gaps that are going to mess our systems up. What are your thoughts about that?

    Mr. PATRIKIS. Well, that's why we literally want a web page that will have, for our Joint Council, that will list every country in the world, every payment system in those countries, the utilities in those countries, and have them have their testing schedules up. That will allow us to see how good progress is going to be.

    Saying that, even if we're all perfect, we're still going to make some mistakes. On Fedwire, for book-entry securities, we had a brand-new software program we put into place. We should have no problems whatsoever. We're well aware of the Year 2000. Nonetheless, when we started to do our testing, we found a few bugs that we had to go through and sort out. So, no matter how perfectly we try to deal with this, there are still going to be little problems here and there, and the question is: How good are we going to be in testing to ferret it out? Again, I come back with testing is the absolute key, and in Fedwire we're starting that now at the end of the month, and we'll be going through the rest of this year and next year.
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    Mr. LAFALCE. Is there any case law that's established with respect to legal liability or inadequate efforts to come into compliance? I know some of you expressed concerns about legal liability. I'm just wondering if there is now a body of case law. I'm not aware of any, but there may well be.

    Mr. PATRIKIS. I'm not in the best position to respond to that. I'm sure that there clearly are legal ramifications to a disclosure on what one does, but I'm not the best expert.

    Mr. LAFALCE. Thank you.

    Chairman LEACH. Mr. Bereuter.

    Mr. BEREUTER. Thank you, Mr. Chairman. Thank you, gentlemen, for your testimony. I'm sorry I missed much of it.

    I'd like to address my questions—hopefully, you can answer briefly—to Mr. Shepheard-Walwyn, because you are the Chairman of the Global 2000 Coordinating Group. I looked at the list of countries in your accompanying document that are participating. It seems to be fairly comprehensive by the major financial center countries, but I would ask you: Do you think that the group, now that the chair enjoys participation of all the countries considered, is critical to the global financial community?

    Mr. SHEPHEARD-WALWYN. The way we've approached this, Congressman, is to try to identify, from the perspective of the firms themselves, the markets which are most critical to their activities, but we don't want this in any sense to be an exclusive effort. We are seeking to make the work of the group available to as many markets as possible, and that's why we're seeking to take the work of the group through these meetings that we're having with regional regulators in all the major emerging market regions as well.
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    Mr. BEREUTER. Which non-participating countries might be of concern to you?

    Mr. SHEPHEARD-WALWYN. Well, at this stage we're simply progressing through seeking to get participation by as many countries as possible. So it's not that we have positively not had participation; it is merely a sequencing of the order. We've only been going three months. It's merely a sequencing of the order in which we manage to find the right people and encourage them to participate.

    Mr. BEREUTER. Let me lump together three specific concerns I hear about participation on a global scene. One relates to Japanese banks. They seem to have low budgets, as I understand it, devoted to the problem, and the claim of these banks is that they have no substantial compliance problems because they rely on the Japanese Emperor's calendar.

    Second, you've had a meeting in Hong Kong—I think it was just recently, last Friday perhaps. Is it your sense that Asia in general has take the Year 2000 problem seriously or that it's distracted by its financial problems? And then switching to Europe, is the January 1999 date for implementing the euro proving to be a distraction from the Year 2000 remediation efforts in Europe? Can you try to give me a quick response to those three specific concerns that are heard?

    Mr. SHEPHEARD-WALWYN. In terms of the perspective from my position as Chairman of the Group, what we have sought to do at an early stage is to engage participation by all the key markets that you refer to. We were in Tokyo for a meeting on Wednesday and Thursday of last week, specifically because there was a desire to have a dialog with the Japanese firms and the Japanese regulators. There was a representative from Mr. Patrikis' group there; Mr. Tamagowa from the Ministry of Finance. We had the Bank of Japan there. We had the Ministry of International Trade.
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    They were presenting extensively on the efforts the Japanese market is making to deal with this problem. They have a program in place. It's been in place for some significant time. They clearly have a different way of approaching it than some other markets. It's not my role to comment, I can't comment specifically, on the preparedness of any market, but what we have there is engagement; there's no question about that, and there's clear commitment from the official side and the industry in Japan to deal with this issue. I don't think that that particular issue about the Emperor's birthdate as opposed to the Western calendar is seen as a separate or a distinct issue. They recognize it's a real problem.

    Talking about Asia, I think there is an issue that relates to all emerging markets which has to do with the resourcing that's available, and clearly, what we have to do, and seek to do, is to bring as much information to bear there and to seek the support of the larger markets in the region to support the smaller markets, and that's exactly what was happening in Hong Kong. I think it's encouraging that Asia was the first region where we had this meeting. It was very much supported by the Japanese authorities, by the Hong Kong authorities, and, indeed, by the authorities in Singapore.

    Turning to the European market, I think that all that one has to say, as a bank that is based in Europe, is that these are both mandatory deadlines. We have participation in our group by major banks, all of whom are facing the requirement of dealing with both those issues. They recognize that both have to be met.

    Mr. BEREUTER. Thank you.

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    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Doug.

    Bruce, I'll leave it up to you. Do you want to begin now and go for a couple of minutes?

    Mr. VENTO. I'd ask a question. I don't know if I'll get back. So I'll just do this now.

    Chairman LEACH. Sure, please.

    Mr. VENTO. I don't want to delay you, though.

    Chairman LEACH. Mr. Vento.

    Mr. VENTO. Mr. Patrikis, the question is, you know, you talked about testing, but what is the outcome of that testing? In other words, you have a program; the software company or consultant comes in; you rewrite it; you change the fixed small clocks, as my colleague pointed out. What has been the result of that testing?

    Mr. PATRIKIS. Well, for us in Fedwire the testing—we start formally testing the end of this month. We've been testing our testing, with just a few of the larger banks this month, and I think it's going fairly well.

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    I think what we would expect to see through testing scenarios, when we do this, that some people will have problems the first time they come on and they test, and they know they have to go back and tweak their systems and work on it. There will be things that will need to be done.

    So the issue really is to see how much I can make sure that my systems are ready. Then every time I make a change in my system between now and Year 2000 I have to go back and retest to make sure what I did is consistent.

    So we ourselves feel that Fedwire is prepared and ready, and we have tested it ourselves. Now we're doing a second set of testing, of testing with our customers, the depository institutions that we do business with.

    Mr. VENTO. And as this testing comes back, then you rewrite the program or the prescriptions in terms of what's going on? So that, obviously, this testing is key in terms of over and over doing it.

    Mr. PATRIKIS. Right.

    Mr. VENTO. Of course, the system is not standing still; it's dynamic, and so it creates its own problems. But the fundamental fix—I expect when we get this program up and ready, I mean, there are going to be some nations, some vendors, that did not pay attention to this as they should have; you will then have a program that they, then, can look to in order to remedy their problem at that point?

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    Mr. PATRIKIS. And then also in the testing we'll do changing dates. As Congressman LaFalce said, we'll test for January 3; we'll test for leap year day; we'll have different days. So that when our computers are set up for Fedwire, that we'll be testing for these different days, and banks will know that if it's Saturday or a specific Monday this year, that that's the day we'll be testing for leap year day.

    Mr. VENTO. It sort of sounds like trying to time an 8-cylinder engine when three or four of the cylinders are missing.

    Mr. PATRIKIS. It's enormous. Working with the New York Clearing House, the Securities Industry Association, SWIFT, which is the international telecommunications system for financial institutions, coordinating these efforts are major efforts—what people call ''streetwide'' testing.

    Mr. VENTO. We've got to go.

    Chairman LEACH. I apologize. We have a vote on the floor. What I'd like to do is recess pending the vote. The hearing is in recess.


    Chairman LEACH. The hearing will reconvene.

    Let me just ask this question, and I think principally to Mr. Shepheard-Walwyn, but I'm not sure that others might want to answer. After the April meeting in Basle, there was discussion of the need for market conventions, and perhaps dispute resolution mechanisms. Has there been anything developed in that context?
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    Mr. SHEPHEARD-WALWYN. Thank you, Mr. Chairman.

    At this stage the answer is, no, nothing concrete has happened yet. I think that's not because it's an unimportant issue, but because there is a question of sequencing where the effort is applied, and the immediate focus of our group has been on trying to get information out to markets about what they need to do to deal with the issue; whereas, the dispute resolution market conventions is about how you deal with situations where things do not happen effectively, and in a sense it's part of the contingency planning, which is a natural next-stage in the program.

    But the Group certainly recognizes that that's an important issue, and I know it's something that Mr. Patrikis and his group is looking at as well.

    Chairman LEACH. Yes, sir?

    Mr. PATRIKIS. Chairman Leach, if you see the membership of our consultative committee, it includes a number of—I call them, multinational trade associations—like the ISDA association. To me, in a way, Year 2000 will be like a major blackout, and there will be some transactions that were supposed to mature and occur that won't occur; that if I borrowed funds today and I was supposed to pay them back tomorrow, I won't be able to pay them back; I'll be able to pay them back the day after, after I cure my problem.

    Well, what will be the interest rate on the transaction for the day that I couldn't repay the funds? And what I think we'll try to encourage these associations to do is to come up with conventions for pricing what we call broken transactions or broken trades, so that we won't have the backrooms of financial institutions individually negotiating with thousands of counterparties different rates. If someone said, here, this is a fair way to establish the trade and to have the trade settled for the number of delays, and that can be done for the different financial products, we'll have made life easier for a lot of people for all these little blips that we think that are going to occur.
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    The dispute resolution—another participant on our consultative group is the International Chamber of Commerce, which is developing dispute resolution procedures that are specifically designed for Year 2000, and I think they'll be a very helpful force in terms of trying to have very expeditious procedures and inexpensive procedures for dealing with disputes that will arise.

    Chairman LEACH. Are you thinking in terms of disputes between banks or are you also including telecommunications companies, that sort of thing?

    Mr. PATRIKIS. The ICC effort I think is much broader. It may be between vendors and suppliers, and between market participants. It's much, much broader.

    Chairman LEACH. The issue has been raised of liability and disclosure. The liability issue has many different dimensions. Whenever you raise questions of liability, you get lots of sensitivities. Do any of you wish to comment on Mr. Towers' suggestion?

    Mr. PATRIKIS. I would only say that it bears looking into. I, myself, haven't followed it up on that track. I think it's an interesting proposal, and there are an awful lot of lawyers who have been dealing with Year 2000 issues. I think it's worth saying: Is the game worth the candle? Should there be a legislative solution?

    Chairman LEACH. Mr. Theodore, you mentioned mid-market businesses. You also mentioned mid-sized governments or maybe any size governments, for that matter. Actually, the majority of the American economy is mid-market businesses, and probably not quite the majority of American governance, but a lot of American governance is. How do you see all of this interrelating? I mean, my sense is that there isn't a lot of preparedness out there in that kind of setting. How significant is that going to prove to be?
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    Mr. THEODORE. It's probably quite significant. By and large, when banks talk about the Year 2000, they tend to focus on their own systems, and they will always says, well, at some point we'll need to make sure that our clients, the borrowers, our counterparties, are also Year 2000-compliant, and they know that this is not case with a large number of middle-market businesses.

    I think that our concern is mainly not with the small businesses which, after all, are not highly dependent on IT, but rather with the higher-end, middle-market businesses, those which don't have, like large corporations, internal IT staff, those which have to rely, like a small bank, on outside vendors. These businesses also don't have an IT culture. They tend to postpone the compliance problem until as late as they can.

    At the same time, when you look at local governments around the world, my sense is that there is a difference between central governments and local governments, at least in this part of the world, Western Europe and the U.S. Local governments, by and large, are quite unsophisticated financially and IT-wise, and there is a possibility that some disruptions, payment disruptions, may occur. On average, a bank would consider a public sector entity or a local government as a low-risk credit, and it would be a big surprise for that bank to see that this low-risk local government is not making payments on its borrowing, and this is a real risk. We don't really see banks addressing this issue in an appropriate manner elsewhere in the world.

    Chairman LEACH. One of the great abstract issues that seems to exist is that as people become aware of the problem, they might want to make a commitment to resolving the problem, but there aren't the people there to do the work. Do you see huge labor shortages in this kind of area?
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    Mr. THEODORE. Definitely, especially in the rest of the world. Even Western European economies are less-IT-centered as the U.S. economy. So there is a significant IT labor shortage.

    If we look at banks, for example, a lot of small banks will tell us that they rely primarily on outside consultants and vendors to set up their Year 2000-compliant systems, as opposed to the large organizations which rely on internal staff.

    Now to the extent that companies and banks postpone the compliance process as much as they can for financial reasons, the cost of IT labor is clearly increasing and the quality is declining, because the top tier, the top-quality IT consultants and laborers would be by then fully booked, and this will clearly be a major issue for middle-market businesses, for local governments, and for the smaller banks.

    Mr. PATRIKIS. If I could add——

    Chairman LEACH. Yes.

    Mr. PATRIKIS. One organization that I think is going to be very helpful here, and we learned it at our meeting in Rome, is the World Bank. The World Bank has received a 10-million-pound grant from the United Kingdom. Recognizing that there are these shortages of experts, the World Bank is going to be coming up with a toolbox that can be used for countries and financial institutions, and I think will be willing to fund the hiring of consultants. So that's the first real gleam of light I've seen on the question you ask, which is a very serious one that some members of our Council have pointed out.
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    Chairman LEACH. Well, I'm glad you mentioned that, because I think the British grant to the World Bank is significant in two respects. One, it relates to a particular problem. Two, it was a voluntary grant that I think is very impressive on the part of the British Government, and for which I think it's certainly to be commended.

    I would be remiss if I didn't ask a question of Mr. Mohr, for one very profound reason. He has used a statistic involving a frame of reference that has never, to my mind, been suggested to this committee, and perhaps to the United States Congress. It's a new world, but the statistic that he throws out is that there have been $3.4 quadrillion worth of payments processed by CHIPS.

    I would say to our stenographer, I'm not sure you've written ''quadrillion'' before. If you want, I'll spell it for you.


    This is a magnitude of stunning dimensions, as well as that you've yet to have a failure of a settlement nature, but think there is a risk for the first time with this Year 2000. How serious is the risk?

    Mr. MOHR. Well, first of all, $3.4 quadrillion, for the stenographer, is 3.4 times 10 to the 15th, if that makes it easier.

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    The risk of a settlement failure on CHIPS we believe is very small. It does not mean that there is not yet much work to be done between now and the Year 2000. There is a significant amount of focus being put on it in New York to accomplish what has to be accomplished.

    Having changed our system in 1992 was the only first step forward. Having our banks change their systems, make initial changes, in 1992 helped also. But as everybody has pointed out, we live in a fully integrated world, and what goes on within the bank's interface to CHIPS is only the tip of the iceberg. We're highly dependent upon other systems and other parts of the world to help drive the large value payment systems in the United States.

    We have taken steps in the recent past to further guarantee the settlement of our system. There is a report that was issued by the BIS called, ''The Lamfallussey Report,'' which put out standards for payment systems such as CHIPS, and it called for a system to be able to settle even if the largest player on the system failed at its absolute worst position. We recently took steps to make ourselves not just Lamfallussey-compliant, but Lamfallussey-plus-one-compliant. We can now successfully settle our system even if the two largest banks on this system should fail at their absolute worst position.

    Chairman LEACH. Can I just stop you for a second?

    Mr. MOHR. Sure.

    Chairman LEACH. You have another word that needs some defining: ''Lamfallussey?''
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    Mr. MOHR. Oh, I'm sorry, ''Lamfallussey.'' Alexander Lamfallussey headed up a committee at the BIS to study large value net settlement systems and issued a series of recommendations.

    Chairman LEACH. So this is a named individual?

    Mr. MOHR. Yes, sir.

    Chairman LEACH. It's not a noun?

    Mr. MOHR. No, sir.


    So we have a high level of confidence that our system and our bank systems will function properly. We are testing it vigorously. We have taken steps that, if there is a problem, that we put in procedures to ensure that we can go forward even in spite of the problem.

    Chairman LEACH. I assume in the telecommunications arena the problem is grave if you have natural disasters or terrorist attacks, whether or not there's a Y2K problem, and that is not something that's Y2K-specific. Is that valid?

    Mr. PATRIKIS. In that way, an awful lot of the work we're doing builds on the contingency work that we do every day. Do we have alternative power sources? Do we have alternative communications lines, different carriers? So these things are built into the system. What Year 2K is, it just pushes us way beyond those things we have in place. For us, contingency is a natural. We have weekends where we practice contingency, where we assume that our computers are down and we startup all over again. The issue is: How fast can we come back, not whether we can come back, but how fast can we come back to the market?
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    Chairman LEACH. I understand you have some experience with the unpracticed. You had a telephone call once from a President, and you said there's no contingency for this, is that correct, Mr. Patrikis?

    Mr. PATRIKIS. Well, I wasn't quite ready to go ahead when he was, and we had a little more negotiating to do in Algiers before we were ready to go ahead, but we worked that out eventually.

    Chairman LEACH. Well, let me just say this is an unprecedented problem, and all of us are dealing with issues we're not perfectly comfortable with. It's always difficult to know the role of Government and how it interplays with the private sector. Clearly, this is predominantly a private sector issue, but there are a lot of governmental institutions involved too. In a way, this is one of the new challenges of the new economies.

    Anyway, I want to thank you all for appearing. If any of you have precise suggestions of legislation or approaches to administration that are not on the table, we would appreciate looking at them. Mr. Towers has made one today, but there may be others that you've thought through. This is a time period in which we're open to all kinds of suggestions.

    Thank you all very much.

    [Whereupon, at 12:08 p.m., the hearing adjourned subject to the call of the Chair.]