Posts this month
A blog on financial markets and their regulation
The Financial Services Authority of the United Kingdom has put out a
discussion paper on its Resilience Benchmarking Project. This study seeks “to
assess how the UK financial services sector would be able to cope in the event of
major operational disruption (e.g. terrorist attacks, natural disasters) and how
quickly it could recover afterwards”. It contains valuable guidance for those
involved in preparing business continuity and disaster recovery plans in the
financial sector anywhere in the world. For example:
“The data suggest that reasonable target ranges for the recovery of wholesale
payments, trade clearing and settlement would be 60-80% of normal values and
volumes within four hours, rising to 80-100% by the next working day. The
overall aim within these targets would be to complete material pending transactions
on the scheduled settlement date”. (emphasis in original)
My own sense is that these would be demanding targets for firms in most other
countries. However, I also believe that these are reasonable goals to work towards
even in emerging markets like India.
A broader question in this context is the relative importance of regulation
and competition in ensuring the resilience of financial systems. The example of the
London Stock Exchange during the Second World War is illuminating. Ranald Mischie
(The London Stock Exchange; A History, Oxford University Press, 1999) tells
us that the LSE closed on September 1, 1939 when the war broke out. But an outside
market developed immediately and within a week, the exchange was forced to reopen.
After that, during the rest of the war, the exchange was closed for only one day
(on September 14, 1940) after physical damage to the stock exchange building itself
in an air raid.
It is fascinating to read how the exchange coped with “the ever-present
threat of fire due to bombing, which could have destroyed the Stock Exchange
“As the enemy are now dropping incendiary bombs in the City it is more necessary
that a careful watch must be kept on the roof and top floors of the Building, otherwise
fires could start and gain hold before they were discovered. The only time when any
discretion can be given is when aircraft are immediately overhead and shrapnel is
falling, then cover should be taken in the Fireman’s shelter which had been specially
constructed for this purpose”. (London Stock Exchange: Trustees and Managers,
September 18, 1940 quoted by Machie, p 290).
It is also interesting to observe that during the war, the stock exchange which
normally believes in the indispensability of the trading floor and discourages
trading methods that bypass the floor actively encouraged members to use the
telephone to trade. Competition does indeed work wonders.
In this light, I do wonder whether regulators that are overly protective of their
regulatees during periods of market disruption are inadvertently making markets less
resilient. For example, after September 11, 2001, Instinet was in fact in a position
to provide a trading facility for US stocks in London. However, regulators did not
permit this. This allowed the New York Stock Exchange to be shut down for
a few days. I still find it odd that the US government securities market which
suffered the heaviest human casualties on September 11, 2001 reopened sooner than
the stock exchange where the human casualties were proportionately far lower. Once
the decisions regarding disaster recovery are moved from the markets to the
regulators, the decisions clearly become more political and the end result is a market
that is less resilient to operational disruption.
Perhaps therefore the best thing that the regulators could do is to leave things
to the market with a clear signal that when disaster strikes, no market participant
should look to the regulator for protection.