The New York Stock Exchange made the right call to close for two days in the face of the devastating fury of Hurricane Sandy.
Risk to the market was less of a concern than risk to personnel and participants involved with market activity.
The epic storm, however, exposed how underprepared the exchange is to deal with a natural disaster or other event of such magnitude.
Institutional investors should ask for details on the reasons the NYSE never activated its contingency plan, and backtracked from its initial intention to operate electronically.
The decision not to activate the contingency plan raises questions on how adequate the plan was to deal with the type of emergency created by the storm.
The severe storm shut the NYSE for two days, the first time trading was closed for more than a day due to weather since 1969, when it closed for a full day and part of the following day.
The storm raised questions across the broad universe of market participants about the effectiveness of contingency planning and how well the Securities and Exchange Commission evaluates the comprehensiveness of plans of investment management firms as well as the NYSE.
A marketplace needs immense coordination to function. The Financial Stability Oversight Council, created by the Dodd-Frank Wall Street Reform and Consumer Protection Act to identify systemic risk in the financial system and to intervene when necessary to stabilize the financial system, ought to play a role in overseeing the evaluation of contingency planning because the emergency and recovery threatened the stability of the financial markets.
Investment management firms can press the NYSE to re-evaluate its contingency plans, but there is no excuse for not strengthening their own backup.
For institutional investors in Sandy's wide path along the Eastern Seaboard, the storm served as a test of the adequacy of their own disaster backup preparations and should encourage investment management firms elsewhere to re-examine the thoroughness of their plans.
Had the U.S. markets remained open during the disaster, were backup systems of institutional investment managers adequate to allow trading, as well as communicating with clients, custodial banks and any others necessary to complete transactions?
The storm also revealed the risk of the proximity of recovery sites to money management offices, leaving them vulnerable to the same path of disaster.
Because demand by other money managers stressed the recovery sites, in one example, Jacobs Levy Equity Management was unable to have its full complement of workstations at its backup site with SunGard Availability Services, although the number made available would still enable the firm to operate.
At AJO LP, its executives learned water entered its SunGard backup facility, an infiltration SunGard confirmed, although the water did not affect the recovery capabilities. Neither Jacobs Levy nor AJO needed to activate their operational contingency sites.
Recovery sites and their providers should come under review as well for how adequately they are prepared.
One challenge of contingency planning is that many firms have never been tested in real-time emergency situations. They have no idea whether their plans are adequate. Among ways of giving clients confidence, Jacobs Levy has its auditor Ernst & Young conduct an audit-type of review for adequacy of contingency plans and backup. SunGard has other backup sites and mobile capability available to clients should primary recovery sites have failures. In addition, it has its facilities audited.
The NYSE, SEC and investment management firms should have strengthened their plans, especially after 9/11. Unlike the terrorist attacks, forecasts gave the NYSE and other market participants warning of Sandy's approach to prepare people and resources.
The SEC should examine whether the emergency was a desperate situation that revealed the limits of even the best contingency planning, the uncertainties of activating such plans, and the trade-off of how far-reaching contingency plans should go in consuming resources. In addition, it should assess the impact of the NYSE's closing on investors, the economy and the markets, including the vulnerability of trading disruption from flash crashes or other problems upon reopening. An examination should look at the problem of concentrating so much of the market infrastructure in one metropolitan area, when so many tools to promote alternative trading mechanisms exist through cloud computing and other Internet resources.
A thorough evaluation of the encounter with Hurricane Sandy might enable better plans to be put in place allowing the markets to remain open.
