Survey article

SURVEY THE MILLENNIUM BUG

Bare essentials

			The networks that keep an economy working

ALL industries are important; but some are more important than others. Businesses need power, water, communications, transport and finance. All these depend disproportionately on networks and therefore tend to emphasise reliability and continuity. Power generation, for instance, usually has a margin of built-in spare capacity so that if one generator shuts down, others can fill the gap. But, once the pressure on a network exceeds the safety margin, a collapse at one point may feed through progressively to others. Networks thus offer a way to share risks—but to spread them, too.

These key businesses also depend disproportionately on IT. How far they have got with their millennium preparations varies enormously from country to country, but broadly speaking finance seems to have made most progress; air transport, telecommunications and energy come next; and water and surface transport bring up the rear.

With power, the main concern, at least in the rich countries, is the distribution network rather than generators or nuclear plants. In the United States, Merrill Lynch frets that “the problem could be worse than currently known”: too little information is available to judge, and responsibility for the electricity-distribution network has been blurred by the advent of competition. In Europe, where countries trade electricity with each other, the European Commission fears that some countries may be basing their contingency plans on shutting off exports.

Water may be an even bigger problem. Companies easily forget that if the lavatories will not flush, the business usually cannot operate. Where water has been privatised, its new owners have often upgraded their IT, but in countries where water remains state-owned, operators may be further behind. As with power, embedded systems are a particular headache.

Because the millennium bug is not really a “bug” in the sense of a virus, there is no risk that communications networks will cross-infect each other. For the main telephone networks and the large telecommunications companies in rich countries, it is likely to be business as usual on the big day. But smaller and middle-sized companies, even in the United States, may not do so well. “There are some 1,400 of them, and some are probably in stellar shape, but some are doing nothing,” says Michael Powell, a commissioner at the Federal Communications Commission.

Unlike the networks that distribute power and water, the telecommunications network is global. That means carriers in the rich countries have a business interest in the readiness of their opposite numbers elsewhere. A survey of carriers in 113 countries by the American State Department in March found that fewer than half expected to be millennium-ready in time.

But will you fly?

Airlines also have an interest in what happens around the world. They, more than any other industry, are under pressure from their insurers. IATA plans to publish a “cartography of Year 2000” by mid-1999, highlighting potentially hazardous flying zones and airports. Established carriers will simply avoid them. That, coupled with the fact that aircraft on international flights are made by a relatively small number of well-organised companies, should ensure that international air travel will be one of the safer ways to get about in the early days of the new millennium.

It may, however, be slow and inconvenient for a while. At Sydney airport, Varina Nissen, head of corporate relations, points out that, if check-in for a flight has to be done manually, the average time required at rush hour rises from 20 to 45 minutes. That has knock-on effects on the number of people in the terminal building, on parking, baggage-handling and ultimately departure times. For rich-world airlines, the main worry may be air-traffic control in middle-income countries, together with a host of niggling details: will they be able to refuel the flight, or settle the bill for the crew’s accommodation? If not, they will not fly to that destination.

Financial institutions realised early on that they were exposed to three different sorts of risk. Their own systems might give trouble; the electronic links that transmit money, financial instruments and information might not work; and most important of all, their borrowers might get into a mess, creating a counterparty credit risk. That means banks, along with insurers, have a key role in coaxing other companies into taking action.

Banks have announced the biggest Year 2000 budgets outside the public sector to date (see chart 6). The rough rule of thumb is that they will spend $1m for every $1 billion of assets. Financial institutions are not only more dependent on information technology than any other industry, they are also more tightly regulated. Edward Kelley, a governor of the Federal Reserve Board, which has visited 13,000 financial institutions, says that “well over 90% are well along towards ensuring compliance, and the 4-6% not as yet where they should be are being watched intensively.”

Once big banks and financial institutions take the issue seriously, they begin to put pressure on others. Thus SWIFT, the global financial communications network, is imposing tests on its 6,000-or-so members around the world; Visa is pushing its 22,000 member banks not just to make their own systems compliant but also to look at the terminals, stocks and suppliers of the merchants they deal with. Bigger banks are plying their counterparties with questionnaires. The implicit threat that they might restrict credit is likely to spread the message more effectively than any government campaign.

Here, as in so many other areas, large American institutions seem to be ahead of the pack. “The IT culture is stronger among managers than in Europe, especially in banks,” explains Samuel Theodore of Moody’s Investor Services. “And the drive has come from regulators, who in particular tend to be more familiar with IT than regulators elsewhere.” This has also prompted large European banks with a presence in the American market to start work earlier than others in Europe.

In finance, the systemic risks that might arise from one big collapse have attracted the attention of the Bank for International Settlements, which has been prodding central banks to take action. They have a role not just as regulators, but also as managers of their economies. Both the Federal Reserve and the Bank of England, for instance, are deciding what to do if half a dozen banks were to find that they could not settle their accounts at the end of the day. They are also trying to estimate how much extra money a nervous economy is likely to want to have in circulation on the eve of the millennium: the Fed plans to add $50 billion to the government’s usual $150 billion stock of dollar bills.

Undoubtedly financial institutions will take cover as the millennium approaches. Tanya Beder of Capital Market Risk Advisers in New York, a specialist in risk management, expects big fund managers to stop their year-end trading by December 15th next year, or at least run it down. Others are already planning to rearrange their portfolios, moving cash flows on loans out of the period from mid-December to the end of the first quarter of 2000. The main economic threat from the bug will be its effect on financial confidence.