Number crunchers head to head

SIR Henry Benson, a former senior partner of what was then the accounting firm of Coopers & Lybrand, became a special adviser to the Governor of the Bank of England in retirement and doubled this up with being founding chairman of the International Accounting Standards Board (IASB).

This, 29 years ago, was the first incarnation of the international body which today under Sir David Tweedie is drafting uniform accounting standards for all major businesses in the European Union.

Thus from the beginning the Bank of England has had an interest in the development of international accounting, which makes observations yesterday by Deputy Governor Sir Andrew Large significant.

At a banking conference in London, he made it clear he - and by implication the Bank - is not happy with the way some international accounting standards are evolving.

He wholly supports the principle of meaningful international standards because 'they help to ensure the safe and efficient functioning of the financial system'. But, he added, 'it is essential that they have a clear, economic rationale, promote comparability and secure adequate disclosure'in every instance.

The Bank's view seems to be that it would be better to have no standard at all than one that has been compromised, and nowhere is this more apparent than with IAS39 on accounting for financial instruments. This now exists in two versions - one fromthe IASB, the other from the European Commission.

Diplomacy stopped Sir Andrew pointing out that the reason the process has become so foxed is that French banks lobbied President Jacques Chirac to have him block some proposals that would require disclosures they might find embarrassing. Thus did international accounting standards come to be portrayed in some circles as part of the cunning Anglo-Saxon plot to dominate financial Europe.

The only other senior politician ever to show an interest in accounting - this 28 years ago - was then Labour Chancellor Denis, now Lord, Healey with inflation accounting. Coincidentally it was also Healey who coined the 'Law of Holes' which says when you are in one, the sensible thing to do is stop digging.

Sir Andrew's proposal is on the same lines. He suggests both sides should stop lobbying and go back a few paces until they find common ground. If they could agree on fundamentals - on who the accounts are for, on how to handle volatility and where between historic and fair value accounting an agreed balance could be struck - the detail of IAS39 should prove less contentious.

Sir Andrew is right, but there is a fear that both sides are now too deep in their holes to climb out.

Derivative danger

BRITAIN'S annual gross national product is about £1000bn. Figures from the City's marketing group International Financial Services London (IFSL) yesterday showed the worldwide average daily turnover in over-the-counter derivatives had doubled between April 2001 and April 2004 to $1508bn.

The pound is now worth a little more than the $1.50 of 2001 but it is close enough to make the point that the value of the deals done in the derivatives markets every day is almost equivalent to the wealth generated by the entire country in a year.

London's share of this business has risen from 36% to 43% in the same period, so over a week in this activity alone it turns over twice Britain's national income.

Two points arise from this. The comforting one is that the arrival of the euro has clearly disadvantaged Continental financial centres, for the euro-denominated interest rate contracts account for 45% of global business against 34% for the dollar, and London's share of the euro business is 58%.

Provided we keep regulation within reasonable bounds, the Chancellor resists the temptation to change the tax regime for foreign non-domiciled residents and we get improvements in infrastructure, it is hard to see London losing ground to any other European capital.

The other point is less comforting. We are regularly assured that investment banks monitor the risk of their derivatives contracts, know what they are doing and keep close tabs on what they are putting out there.

But given that every day some event in the real economy shows how easily things go wrong and how flawed our methods of financial and economic control are, how can we possibly believe the derivatives market is different and that its controls work?

It is vastly bigger, much faster moving, significantly more complex, highly inventive and dominated by salesmen. One suspects that it will one day prove it also has the ability to deliver very nasty shocks.