Are financial markets prepared for the next disaster?

Can the U.S. financial markets handle another big terrorist attack? How about a worldwide pandemic such as avian flu?

The General Accountability Office (GAO) says the financial markets are better prepared than they were in 2004, but still have work to do. In a report released Monday the GAO said:

"As of January 2007, the seven critical exchanges, markets, clearing organizations, and payment processors GAO reviewed have the capability of performing their critical functions at sites that are geographically dispersed from their primary sites. These organizations were also preparing plans to reduce the likelihood that a disease pandemic will disrupt their critical operations, although not all had fully completed such efforts. They also improved their physical and information security measures, including by taking actions that GAO identified during this review."

These reports are important for one reason--the financial markets are typically the best prepared for disasters. If the financial markets have holes in their plans chances are very good that other sectors have humongous gaps (see all disaster recovery resources).

Among some of the disaster recover issues cited by the GAO:

• Key trading staff remains concentrated in one location or area. A big disaster in New York would still make it tough for financial players to resume trading. But the GAO noted the situation has improved as many firms have created backup trading centers away from headquarters. Others have trained international employees to trade U.S. stocks. The GAO noted that one firm completed a new data center 1,000 miles from its primary operating locations and can conduct all the processing needed to function.

Speaking about that firm that put its data center 1,000 away the GAO said:

"Because the distance between sites is too great to allow both the primary and the backup site to process identical data simultaneously, the organization has implemented a proprietary hardware based data replication technology that ensures that copies of all production data and processing results from the primary sites are stored and then transmitted to the remote site.5 Since installing this technology, the organization’s staff indicated that it has significantly reduced the time required to have the remote site take over operations to less than 2 hours with less than a minute of data loss if a disaster were to affect both primary processing sites."

• Telecommunications infrastructure is the weak link. "Various private and public sector groups continued to enhance the preparedness of the financial sector, although resolving vulnerabilities in the telecommunications infrastructure remains a challenge," wrote the GAO in a report.

Telecom networks will be critical if workers are forced to telecommute. A key passage from the report:

"Securities industry organizations have continued to conduct annual industrywide tests of financial market participants’ backup site operating capabilities, and key trading and clearing organizations are increasingly using communications networks that are less vulnerable to disruption to transmit information. After attempts to assist individual financial market participants to determine whether their own telecommunications lines were routed through single paths or switches proved difficult, regulators are assisting efforts to develop automated systems for identifying circuit paths. In response to concerns over whether the telecommunications infrastructure can absorb the increased demand likely to result from large numbers of organizations and individuals seeking to telecommute during a pandemic, financial regulators and market participants are assisting government efforts to model such events and develop potential solutions."

To remedy the telecom issue all of the groups examine by the GAO had signed up for circuits with the National Communications System’s Telecommunications Service Priority (TSP) program. The TSP gives priority to restore key circuits in the event of a disruption.

• Regulators need to set formal expectations for pandemic planning. Securities and banking regulators have been "actively addressing pandemic issues," but haven't outlined specifics and given market players time to test these plans. Without that regulatory kick in the rear only one in seven financial market players examined had a formal pandemic plan.

The big problem: No one truly knows how prepared they are until the next disaster hits.