Sir David Tweedie heads a team setting down a global standard for accounting. However, its proposals on derivatives have met European objections, writes Dominic Coyle

It was standing room only when Sir David Tweedie came to town. Addressing packed halls is not something one associates with accountants, but Sir David is not just any accountant. The quiet-spoken Scot is the driving force behind what is probably the most radical reform of the profession.

As chairman of the International Accounting Standards Board (IASB), Sir David heads a team charged with developing a single set of transparent, understandable and enforceable global accounting standards.

When you consider that, in the European Union alone, every member-state - with the exceptions, for historical reasons, of Britain and Ireland - has differing rules, the scale of the challenge comes into focus.

The IASB was established in 2001. Its genesis, Sir David says, lay in concerns among multinational companies about the plethora of different rules governing the way their different subsidiaries had to compile accounts in different jurisdictions.

On its own, this would hardly have sparked such a fundamental review. However, the emergence of the Asian crisis put accounting issues firmly on the business agenda.

"You had companies out in the Far East that looked okay and suddenly went bust," says Sir David. "It scared the investors and they pulled their money out."

Restoring confidence became a serious problem, he says. "How would they fix it? Set their own standards? Who was going to trust them again?"

The answer was to adopt an existing set of trusted standards, and the choice was between the US model or an international one.

The existing international committee was essentially a part-time operation. "We felt we needed to set up a whole new body to find out what was the best standard and get everyone to follow it," says Sir David.

Initially, the big question was whether or not the United States would get involved.

Enron and the series of scandals that followed decided that.

"Who let the investors down in these situations? It was the executives, the non-executives, the audit committees, the auditors, but also the ratings agencies, the analysts, the US Securities and Exchange Commission (SEC) - there were one or two accounting rules that weren't good - and investment banks playing games," says Sir David.

"The whole system collapsed. It all just blew apart and that is when we got the Americans on board."

Apart from domestic problems, the US recognised the advantages a single set of rules would confer on US investment overseas.

The mantra since has been "convergence". The IASB got the SEC to set down the changes required to make international rules compatible with US standards.

A team from both sides then compared the standards in individual accounting areas, deciding which was the better - the US rule or the international one.

"Whichever one has the weaker provision is changing," says Sir David. "We have changed on business combinations, on goodwill impairment and on discontinued operations and, last December, the US put out proposals to change four of their standards, so we are both doing it."

Time was not on their side. Under a deadline set by the EU Commission for the introduction of new rules by the start of 2005, the IASB agreed to publish its standards in full by the end of March.

That meant a concentrated two-year drive to dissect existing standards, consult widely and formulate best practice across the range of arcane accounting rules.

Having met its deadline, the IASB now faces a challenge that will ultimately determine the success or failure of its project.

It centres on the proposed international accounting standard for derivatives (IAS39) that has met fierce criticism among Europe's financial services sector, particularly in France.

Essentially, they argue that putting derivatives on the balance sheet will create unnecessary volatility, undermining the strength of Europe's banking sector.

It is not an argument Sir David buys. The balance sheet value of derivatives last year, he says, was $8 trillion but there was no mention of them on balance sheets in Europe.

"That's why this standard is absolutely critical," he says. "We have to get them on balance sheets. I mean, Parmalat had derivatives all over the place and they are just not there. Similarly, Enron did not account well for its derivatives.

"You cannot see what is happening with a company if they are not on the balance sheet and that what it is really all about."

In any case, argues Sir David, the Americans will not accept a fudge on the issue.

"The real problem for Europe would be if you didn't take IAS39. Boy, that is the most massive reconciliation \ with the Americans. They will never accept accounts without that."

Sir David and the IASB have come under pressure from the EU Commission - and others - to compromise on the issue, but he is holding firm.

While he says the IASB is open to the idea that it can be wrong or that things can be done better, "what we cannot do is compromise on a principle, such as saying a derivative does not have to be shown on a balance sheet".

It has been argued that the failure of the IASB's US equivalent to stand firm against lobbying on the accounting treatment of stock options sowed the seeds of "Enronitis" and undermined the credibility of the system and its framers.

Sir David sees the issue of derivative accounting as similarly pivotal for the IASB. Succumbing to vested interests would see the US abandoning convergence and going its own way, probably with many of the 91 countries that have signed up to the IASB in its wake, Sir David argues.

Derivatives have not been the only bone of contention.

There have been similar rows over the introduction of volatility into company accounts as a result of new rules on accounting for pensions and stock options.

Sir David is resolute on both issues.

"When we first brought in the pensions standard in Britain, there was uproar," says the man who was previously the first chairman of the UK's Accounting Standards Board. "Now you get chief financial officers saying that, for the first time, they are discussing pensions in the boardroom because there is an accounting effect and it has to be managed."

The same goes for stock options, where the US recently followed the international lead.

A 2000 survey of the US's 500 largest companies showed that 75 per cent of all options went to the top five executives. "That's a massive number; it's hundreds of millions," according to Sir David.

Expensing stock options will knock 10 per cent off US corporate profits and about 3 per cent off European ones, he says.

His view has attracted heavyweight support in the form of Federal Reserve chairman Mr Alan Greenspan, who maintains that not expensing stock options distorts the picture of how well companies, especially in the high technology area, are doing.

"You still have this issue of volatility but then the world is volatile," says Sir David. "For investors, the new standards are still going to present a truer picture of company performance than before."

He stresses that the new rules will not be set in stone the true test will be how well they operate when they are applied. On derivatives, in particular, there will be a small committee set up to seek a better solution.

But the academic who railed against bad rules and practices in the 1980s only to find himself handed the job of putting them right is determined not to return to the days when "what we traditionally did was either ignore things (as with derivatives and stock options) or smooth it away (as with pensions, where you saw a number that bore no relation to what the actual position was)."

Come January, if the EU Commission endorses the new standards, Sir David hopes they will usher in a new era of "tell it as it is accounting".

First he must battle the French at his Waterloo.