How were Wall Street's investment banks able to open for business so soon after last week's terrorist attacks destroyed much of their infrastructure? And how will investment banks deal with their next challenge: coping with markets characterised by extreme uncertainty and caution?
Morgan Stanley, which had 22 floors in the World Trade Centre, announced that its main business units were functioning the day after the attacks. It was not alone in being able to provide swift reassurance to clients that the many billions of dollars of financial assets for which it was responsible were safe.
Investment banks are remarkably fluid organisations, largely because their principal asset is people, as the tragic events of last week have all too clearly highlighted. To succeed in this industry a company needs to be able to make "human capital" flourish in any market environment, no matter how challenging. That means being able to provide alternative safe, secure and functioning offices at a moment's notice, as well as making second-by-second backups of all trades in secure places away from central operations.
Important security lessons were learnt after the IRA bombing of Bishopsgate in the City of London in 1993, and the bombing of the World Trade Centre in the same year. Investment banks have long been prepared for more mundane threats to their operations. Something as simple as a sprinkler system going off by accident can put an entire trading floor out of action, leaving thousands of stock or bond trades in limbo.
There is not just a financial incentive to have top-specification backup systems in place and ready to go. The 1987 Banking Act includes a high-level requirement that firms have "adequate systems and controls" in place to conduct banking business. The Financial Services Authority says this is widely interpreted to mean having backup systems to cope with a major incident. "There are no detailed rules, because we believe people know their own business best," says an FSA spokesman. "But it's something we talk to banks about regularly."
The detailed planning behind Morgan Stanley's successful evacuation of almost all its 3,700 staff in the WTC last week is mirrored in its contingency plans for creating a business-as-usual environment following the malfunction of key infrastructure.
Some 400 staff went to a back-up facility in lower Manhattan. The company has a similar setup for its operations in the City, with a secret backup centre in London that would take some employees, and others would work from home.
In deciding which employees are relocated and which are sent home, a bank will assess who is required for critical functions. It is simply not cost effective to have replica operations on standby all year round.
Banks are able to convert training centres into fully functional business units, but their principal fallback is dedicated backup trading floors, vacant but kept clean and functioning by a basic staff. These are typically much smaller than their day-to-day counterparts, and, given the exorbitant rents in financial districts, are often at a distance from main offices. Many Wall Street firms have backups in the neighbouring state of New Jersey.
Goldman Sachs has a variety of backup locations, including ones available through "disaster-recovery" firms, surrounding New York and London. These were tested five weeks ago when a steam pipe burst in a Wall Street unit, and the bank moved staff to neighbouring offices.
"Even before the Bishopsgate bomb, most investment banks had arrangements in place for many years in case of fire or water damage," says a Goldman spokesman. "It is hard to suddenly switch operations to another city. You need to have connectivity to the relevant exchange. In New York, you need to be able to talk to the specialists on the stock exchange floor." The company was even able to provide trading space to its rivals last week, as was rival UBS Warburg.
Backup trading floors are hugely expensive. Stephen Bean, marketing director of Guardian iT, the disaster recovery specialist, says a typical cost is £2,500 to lease a seat in a shared facility. Some of Guardian iT's clients lease floor space capable of housing 2,000 traders. The company can have most facilities ready in three hours, although the process may take longer. Clients may conduct three dress-rehearsal drills a year.
But banks must now contend with the equity market slowdown that was well underway before last week's attacks. If the climate in investment banking was harsh 10 days ago, it is doubly so now. The story in investment banking this year has been one of cost-cutting and job losses against a backdrop of second-guessing when the upturn may come. The Centre for Economics and Business research has forecast that some 20,000 jobs could be lost in the City this year. Even before last week's events, investment banking shares were on the slide amid expectations that a fresh round of cost-cutting was around the corner. Only yesterday, Commerzbank said it may have to cut about 10 per cent of its workforce.
One industry observer says: "There are two schools of thought. The environment looks worse, but banks may not wish to lay people off now, preferring instead to cut costs by trimming bonuses."
On every level, banks face enhanced challenges, in particular in their mergers and acquisitions business. The overriding problem is the uncertainty over how long and how severe the likely military retaliation by the US will be. In such a situation, the natural reaction among chief executives will be to do nothing as they become increasingly risk-averse. Plans for acquisitions and demergers, inevitably high risk ventures, will be deferred, with a knock-on effect for investment banks' corporate advisory departments.
Deals already announced risk being pulled. Hewlett-Packard's merger with rival computer-maker Compaq, announced two weeks ago, has suffered from a bad press in many quarters, and looks less likely to proceed. In the UK, WPP has reiterated its determination to acquire control of Tempus, the media buying agency, although many observers question whether it will wish to continue in its pursuit now that a consumer recession looks increasingly likely.
Aside from the dent to sentiment inside the boardroom, there are practical problems to investment banking activity, notably the heightened volatility of share prices. That will reduce the already weak appetite among investors for share placings, the capital markets staple form of fundraising. And even if markets stabilise, equities are likely to face an uphill struggle now that their greater investment risk has been fully exposed.
But some bankers are optimistic, claiming it is a widely-held misconception that corporate advisory fees dominate investment banks' revenue base. The present volatility and unusually high trading volumes could, in the short-term, offset weakness on the corporate advisory side.
A spokesman for Goldman Sachs says: "These will be tough times in investment banking. But it's not right to say there are no buyers out there. In times of uncertainty, it's the sellers who emerge first. We know that there are buyers who are keen to move."
Judah Kraushaar, an analyst at Merrill Lynch, is also cautiously confident. "We see little impairment of longer-term growth prospects for most companies," he says.Reuse content