In 2014, the question of an independent Scotland was supposed to be put to rest for a generation. Those against edged out those in favour by 55.3% to 44.7% and the issue was deemed resolved: Scotland would remain a part of the UK, as it had been since 1707.
Except, just under two years later, the terms upon which this vote had been made drastically changed. When the Leave campaign voted to remove the UK from the European Union, the prospects for Scotland’s future outside of the bloc did too.
In the five years since, there has been a growing dissent within much of Scotland and that which ought to have been put to bed, the question of independence, has been a constant point of contention.
Despite failing to win an outright majority in the Scottish parliamentary elections earlier this year, the ruling Scottish National Party (SNP) claims that there is a growing mandate for a second referendum, which they refer to as ‘Indyref2’, and continues to push the UK parliament in Westminster to grant it.
However, in an attempt to maintain the integrity of the union and keep Scotland united with the rest of the nation, and to avoid being the leader to ‘lose Scotland’, UK prime minister Boris Johnson has publicly quashed the idea and outright rejected this request. Yet, with a significant majority of the ‘yes’ voting Scottish public falling into younger age categories it seems likely that a second referendum will arise at some point. It is a question of ‘when’ and not ‘if’, suggest experts.
So, with the much-heralded COP26 event in Glasgow nearly upon us, which will turn the world’s eyes momentarily onto Scotland, for this final edition of IFLR magazine we have decided to focus on the implications of Scottish independence for the financial markets, of course with a legal and regulatory twist, as we do best at IFLR.
Like Brexit before it, the financial implications of Scotland leaving the UK would be huge and would likely take years or even decades to iron out. Key debates would focus on how to break up the UK’s existing debt implications fairly; what currency an independent Scotland would adopt; whether the new country would be granted membership into the EU and how long that might take; establishing a central bank, and the not-so-tiny issue of what would happen to the established global asset management and banking institutions currently domiciled in Scotland but not confined to its borders in terms of activities.
This is by no means exhaustive and does not even consider some of the other – hugely difficult – concerns, such as establishing a border or how to handle trade with England (or the rest of the UK), currently Scotland’s biggest trading partner.
The 28th State
Among the most prominent debates is whether an independent Scotland would be able to join the EU following its divorce from the UK. It has been touted as an obvious solution by the SNP and those in favour of independence, but is certainly not a simple proposition.
It is by no means a secret that one of the biggest roadblocks hindering the Scottish independence movement is the objections of Spain, the fourth-largest economy in the EU. The Spanish region of Catalunya has been debating independence for decades but is yet to be granted so much as a legitimate referendum of its own, despite numerous unofficial victories for the separatist agenda and a significant backing from its population. The Spanish government will not entertain the idea of an independent Catalunya and fervently opposes Scottish independence to avoid precedence.
This is a major issue for Scotland and its separatist movement.
EU membership would solve a lot of the issues that an independent Scotland might face. It would allow the country to adopt the euro, remove the need to rewrite an entire rulebook of civil laws and regulations, and generally ease the financial burdens that a fledgling country might face.
Were it not for Spain, there would be little to stop this from happening. Except, perhaps, from within England.
“It would not be easy at all, it would be a very serious thing indeed, and I don't know how the UK would react – I suspect extremely strongly,” one well known anti-independent voice tells IFLR.
“The UK could easily go to Iceland, Ireland, Cyprus or Malta and say, ‘come and join us and we’ll protect you’, but if you’re starting to arbitrage states like that, if you’re having that sort of discussion it’s completely the opposite discussion of what it’s packaged up as being, which is Scottish independence.”
The only way of making independence viable, they continue, is to have Scotland rejoin the EU, which he suggests would be deemed constitutional arbitrage.
If Scotland were unable to negotiate terms of joining the EU prior to leaving the UK, it would put the country into a transitionary period during which it would have to establish its own financial system independent of both the UK and the EU.
This is not necessarily a roadblock.
“It's only when you are de jure independent that – formally speaking – you can apply to accede to the European Union,” says Andrew Wilson, former Member of the Scottish Parliament and shadow minister for finance and founding partner at Charlotte Street Partners. “Countries may be able to have informal talks in advance, and may be able to accelerate the process, but some academics say it could take up to five years.”
Scotland would need to establish a financial policy position, deciding what happens prior to independence and what happens the day after. The first step would be to set up a central bank and a debt management office that mirror existing fiscal rules and regulations in the UK so as to avoid legal divergence and a potential meltdown.
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Assuming the Scottish central bank would be the regulator of Scottish financial institutions, this would very quickly lead to significant balance sheet issues. “Most of the Scottish financial institutions that are off scale have already said that they will technically redomicile to London for the purposes of regulation for their overall business,” adds Wilson, who adds that this would not lead to job losses for Scotland.
“If you’re a banking group the size the former RBS group was or even NatWest now, the bulk of your assets (loans) and activities are outside Scotland and are best regulated where they are focused, in this case London. The Scottish central bank would focus on the domestic Scottish activities of banks in Scotland.”
It is hard to see how losing your biggest financial players would be good for a new country’s financial system, but in reality the prospects of a financially independent Scotland – comprising just over 5 million people – would be nowhere near that of the superpower that is London, and nor would it need to be.
Like the UK has in the years following Brexit, an independent Scotland would be able to build on the systems and regulations already in place. “There’s a recognition that there would need to be a central bank and a financial regulator, the assumption is that they would build upon what is already there in terms of expertise,” says Stephen Phillips, partner at CMS in Edinburgh. “For instance, the Financial Conduct Authority (FCA) actually has quite a big establishment in Edinburgh. In the early days, it would be very much the case of Scotland trying to mirror what the UK was doing and not trying to deviate too far away from that.
“That will spill out if there is much more divergence between the UK and the EU because of Brexit. It would be an issue for an independent Scotland because there would be more of a pull towards Europe,” he adds. “There would certainly be an attempt by Scotland to try to keep and keep as close as possible to the UK regulatory methods but at the same time it would probably to try to leverage off the fact that it would be seeking to join the EU, or at least have a closer relationship with Europe.”
Scotland could look for market access, and perhaps even “act as a bridge between the two”, he adds.
Banks planning to serve the Scottish market would also have to establish subsidiaries within the country to serve the Scottish market, but given that Scottish banks deposit ratios are healthy in terms of safety – which impacts regulation – excessive regulatory change would be unlikely.
“You wouldn’t see change in regulatory standards at all, it would be in everyone’s interest to keep things the same and to sort of grandfather the UK position into Scotland, providing stability for the financial sector through the transition period,” adds Wilson.
In 2014, the financial situation in Scotland looked very different to how it does today. While it is important to note that RBS has already confirmed intentions to leave the country in the case of independence, following the bank’s merger with NatWest it already moved a large part of its operations south of the border.
“The argument in 2014 was that the small Scottish economy could not withstand the burden of this financial instability, because the balance sheet was 15 times larger than the GDP of Scotland,” says professor Emilios Avgouleas, chair of international banking law and finance at the University of Edinburgh’s Law School. “Without this, financial stability is much, much less of a problem now than it was in 2014.”
Despite London’s dominance in the banking sector, the city of Edinburgh has an established financial services sector. The asset management sector, for instance, has seen some relocation of financial services activity, with large institutions such as Abrdn and Scottish Widows currently based there.
Sarah Hall, professor of economic geography at the University of Nottingham, suggests that there would be significant benefits for the asset management industry, but it would not be an easy ask.
“If independence meant Scotland became a member state, then obviously financial institutions in Edinburgh would be able to passport again, rather than relying on equivalents, which would be hugely beneficial to Edinburgh’s asset management cluster,” she says. “The issue is in the process of joining the EU, the evidence suggests that that is a very long process.”
While the end point of having single market access would be valuable to the industry, there would be a significant period of uncertainty while that was worked out.
Regarding the UK banking system, Nicholas Macpherson, Baron Macpherson of Earl’s Court, and former permanent secretary to the Treasury from 2005 to 2016, does not think “Scotland gives a damn any more about banks because they are all in London anyway,” but agrees that there are issues around the Edinburgh asset management industry and what happens to Standard Life, Abrdn, Baillie Gifford, etc. Most of their assets are not in Scotland, despite being headquartered there, but there would be issues.
“The big players might re-headquarter to London while having serious businesses in Scotland, just as Baillie Gifford have opened an office in Dublin to deal with aspects of leaving the EU – a lot of businesses would ride two horses,” he says. “In the process, Scotland would lose out more than London has lost out in leaving the EU.”
“At the moment, business regulation is effectively tied to EU regulation, and Scotland would be tied to that,” he adds. “Obviously, it would have to set up its own agency and depending on plans to join the EU it could actually tie its regulation to the UK’s, but for Britain, ‘taking back control’ means it is about to go out on its own and carve out its own approach to regulation.”
In the end, most regulatory issues will not be hugely problematic, as Scotland would either choose to follow the British approach or to follow the EU approach. The EU sets its own regulatory parameters, and it will be up to an independent Scotland to interpret them in a way which it sees fit.
Currently, that would not require any work at all. Whether that changes would very much depend on how long independence would take and how much divergence there has been in the meantime between the UK and the EU.
The issue of money
One of the fundamental questions surrounding independence concerns is currency; namely, what currency an independent Scotland would use. There are three potential options: keep pound sterling, adopt the euro, or come up with an alternative.
Economics aside, each of these options comes with its own set of legal issues and contractual conundrums that make the question hard to answer without some form of pushback. In 2018, the Sustainable Growth Commission – convened by SNP leader Nicola Sturgeon and chaired by Andrew Wilson – recommended that an independent Scotland kept the pound sterling as its currency for a “possibly extended transition period”.
“In the longer term, if it were in the rounded economic interests of Scotland to develop its currency arrangements Scotland would, of course, be able to introduce its own currency. The Commission recommends that such a future decision should be based on a formal governance process and criteria set out clearly in advance of voters making a decision on independence. Such an approach is an absolute necessity to maximise certainty and stability and to minimise risks,” reads the report.
From a legal perspective, taking into account contracts within Scotland that reference the pound for example, this option would be significantly more straightforward than any other.
Scottish economist and Oxford fellow John Kay agrees that the status quo would be the best course of action and would likely cause the least problems.
“The financial issues that worry me seem to be greatly exaggerated, the currency issue for one is straightforward,” he says. “The right thing to do is nothing.”
“It might be that in due course trading patterns look different, it depends on what Scotland’s relationship with the EU would be, but the idea that Scotland would simply rejoin the EU is naïve,” he adds.
However, given the political gains that the independence movement has made in the aftermath of Brexit, it seems unlikely that a referendum would be fought on any grounds other than rejoining the EU as quickly as possible. This would be no easy task and would require significant economic change, including joining the Economic and Monetary Union (EMU) and therefore adopting the euro.
“In the current world, an independent Scotland would make no sense whatsoever unless there is an arrangement with the EU that their membership would be fast tracked,” adds Edinburgh Law School’s Avgouleas. “Fast track membership for Scotland would mean that the country joins the euro.”
“This would resolve the issue of bank regulator – it would have to be the ECB [European Central Bank],” he adds.
The conditions for becoming an EU member state, referred to as the Copenhagen criteria, insist prospective countries have “the ability to take on and implement effectively the obligations of membership, including adherence to the aims of political, economic and monetary union”. While it would not be the case that Scotland would be forced to join the euro immediately, all members that have joined the bloc since the Maastricht Treaty in 1992 are legally obliged to adopt the euro once they meet certain criteria.
Sweden, which joined in 1995, is required to join at some stage.
“Technically, if you want to join the EU, you're supposed to sign up to joining the euro,” says Thomas Sampson, associate professor at the London School of Economics. “If the goal is to eventually rejoin the EU, then unless Scotland can negotiate a waiver – the EU does give waivers in certain circumstances – it would have to agree to work towards joining the euro.”
The euro has evolved over the years and has become a very stable, major currency, which would offer its advantages. The downside would be that Scotland would become a very small part of the bigger European markets.
“The other difficulty that would arise if Scotland were to join the euro, or to create his own currency, would be the technical and legal difficulties of taking contracts that were originally written in pounds, and converting them into a new currency,” adds Sampson. “This would be a huge undertaking. But it can be done.”
“The difficulties involved in creating a new currency mean it is probably the riskiest option for Scotland. Investors and holders would be worried that the currency would lose value in the initial days and weeks of independence, or that there would be a run on the currency and Scottish people earning money in the new currency would end up much poorer than they previously were,” he adds.
Some, however, do advocate for an independent Scotland to form its own currency. Lord Macpherson believes that despite the fact that Scotland spends more money relative to its tax base, the SNP could implement independence reasonably successfully, if it took tough decisions on tax and spending.
“The SNP would not say that ahead of independence, but I would try to encourage them to be fiscally careful so that Scotland doesn’t stand out,” he says. “It all relates to the currency issue and the fundamental lack of clarity around that.”
He adds that he struggles to see the benefit for the rest of the UK to enter into a monetary union with a country that is seeking to become more independent. “Scotland would have a choice, either try to peg the Scottish pound to sterling – which could leave you vulnerable to the speculative attacks – or to just make a virtue of necessity and float its own currency.”
“A Scottish pound would probably depreciate in the short run but in the longer term if Scotland can establish credibility there is actually no reason why it should be weaker than sterling; it is similar to when Ireland stopped pegging the punt to sterling,” he adds.
Made in Scotland
A further consideration would be how Scotland’s corporates would react to this uncertainty. It is fair to say that if a referendum were to result in a positive vote for independence then many would question the value of relocating to England to avoid the stresses of a potential Brexit 2.0.
Kay, however, would turn that argument the other way. “Historically, one of the things Scotland has suffered from has been the migration of large corporates out of the country,” he says. If you go back to the 1980s, he argues, there was a change to competition policies so that the planned takeover of RBS by HSBC was actually blocked on the correct grounds that it would damage the Scottish economy. After that, the UK competition policy was changed so that the regional issue was not grounds for blocking M&A. This allowed Irish giant Guinness to acquire the Distillers Company, arguably against Scottish interests.
“Independence might mean more of a chance in the future for homegrown Scottish corporates, but who knows, when Skyscanner left, for example, they didn't go to London, they went to Beijing,” says Kay.
The debate tends to focus on wider macroeconomic issues.
Of course, the impact would not just be felt by the larger corporates in the country, but also by SMEs. Ross Brown, professor at St Andrews, believes that independence would affect change that could alter Scotland’s economic growth in future years.
“Scotland would suddenly have quite a range of different policy levers to do things differently,” he says. “Rejoining the European Union would be one such distinctive policy angle which would be very attractive for all of the small businesses that are screaming at the moment, they now have non-tariff barriers with the biggest single market which amounts to about 10% cost increase for SMEs.”
A 10% increase could influence whether companies bother trading at all, or not, he argues. “Scotland could make a significant advance for the economy if it were to rejoin as a separate country, not just for companies in the country but for small companies in England which might consider relocation based on that decision,” he adds. “Small businesses are mobile these days, a lot of firms can move easily. It could prove very attractive, not just for indigenous Scottish firms but for English ones.”
UK debt share
One of the key economic implications of Scottish independence would revolve around the newly formed country’s proportion of the UK’s existing debt, and how that debt would be transferred – if at all – to the Scottish state.
At the end of 2020, the UK had general government gross debt of £1,876.8 billion, which an independent Scotland would be proportionality responsible for. A key question would be formulating exactly how much of this total was Scotland’s responsibility and how it would be serviced.
One solution to this problem would be for Scotland to pay an annual solidarity payment to the UK.
“This would be annual payment to service the agreed share of debt interest, so that that negotiation would need to weigh up both liabilities and assets which are currently on a report published by the UK government once a year, called ‘Whole of Government Accounts’,” says Andrew Wilson. The last published balance sheet shows £4.6 trillion of liabilities, but this number will have increased significantly due to Covid-19.
According to the report of the Sustainable Growth Commission, “an agreement should be sought for a mechanism for Scotland to pay a reasonable share of the servicing of the net balance of UK debt and assets”.
The Annual Solidarity Payment is modelled at around £5 billion including debt servicing contributions, 0.7% GNP contribution for foreign aid and a further £1 billion set aside for other shared services, continued the report.
“The calculation would tell us a legacy sum of money that Scotland would agree to service, which would be very important to begin with,” adds Wilson. “Over time, the legacy sum of that would be eroded and refinanced, and run down.”
An alternative to this would be for Scotland to transfer and take on a calculated proportion of the UK debt directly. This would bring a whole host of legal issues and concerns, not the least with the calculation of that number.
“The essential issue is that because the UK government has issued debt to finance budget deficit and spending – some of which it can reasonably argue has taken place in Scotland – a newly independent Scotland should assume its fair share of the debt,” says Neil Shearing, chief economist at Capital Economics. “The question is where to draw that line: is it a share of GDP, a share by population, or by government spending. Either way, it is going to be a mess really.”
“There are no provisions in bond issues for this sort of event, it is not like UK government bonds have clauses that say what is going to happen in the event of an independent Scotland,” he adds.
What an independent Scotland’s currency would look like is a key economic concern that has been richly debated in the years leading up to and following the 2014 referendum. The ultimate decision would also have a significant bearing on the outcome of the shared national debt.
If – as is widely suggested – the country were to use a pegged version of pound sterling, it would mean there was significantly less risk for the holders of the debt that was transferred to the Scottish sovereign.
“Of course, you would still have to take on the debt, but it would mean less exchange rate risk,” says LSE’s Sampson.
“It would be subject to negotiation, but if Scotland was still using the pound there would be no risk,” he adds. ”Suppose you use a new currency and set it up so that one Scottish pound is worth one British pound, if afterwards that is not what the market thinks it was and the Scottish pound were to depreciate, then things would look very suddenly in terms of the value of that debt.”
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This issue was also central in 2014, with the Scottish government suggesting that it would continue to use the pound as a pegged currency. At the time there was some suggestion that Scotland would renege on its share of the national debt if it was not given access to the pound sterling by Westminster.
“They’re still proposing that on some basis, at least until there is an introduction of a new currency,” says Owen Kelly, deputy director of the Edinburgh Futures Institute and one time CEO of the Scottish Financial Enterprise, the representative body for Scotland’s financial services industry.
“As part of that argument, there was a slightly silly suggestion that Scotland would refuse to pay its share of any legacy debt, unless the UK government allowed Scotland to use sterling on a dollarised basis,” he adds. “This could be a point of political contention, there might be an attempt to use it as a bargaining chip once you got into the business of negotiating the terms of the separation.”
Setting a precedent
Were Scotland to begin the process of preparing for independence, it would of course not be the first time that a country has seceded nor the first time that national debt be divided in such a manner.
Lee Buchheit, sovereign debt restructuring veteran and honorary professor at Edinburgh University, told IFLR that the public international law when a constituent of a state secedes or leaves to join another state – as happened in 1846, when Texas joined the United States – the rule is that debts incurred by the previously unified state have to be allocated between the two newly formed countries.
“There is no hard and fast formula for doing that,” he says. “The one thing that’s clear is that as your debt was incurred, let’s say to build a hydroelectric dam in the seceding province, then that debt stays with them, but the debt incurred for general governmental purposes has to be allocated between them.”
Buchheit says that when Yugoslavia broke up, this issue was not handled particularly well, and that the handful of emergent countries are still quarrelling.
“As it relates to UK guilds, the UK such as it might exist after Scotland left, would remain wholly responsible,” he adds. “The UK would negotiate with Scotland for what in legal terms is called a contribution, or they could say that something like 70% of the guild is now the responsibility of the UK and 30% is Scotland’s.”
The Sustainable Growth Commission and its Annual Solidarity Payment suggests the second approach.
“I would be astonished if they deviated from that if there is another referendum,” says Buchheit. “The history of these referenda around leaving is not particularly good in terms of debt.”
Of course, all of the aforementioned arguments amount to no more than speculation. The UK remains intact and Scotland remains a constituent member of that, regardless of what the pro-independence population think. The current UK government appears very unwilling to grant a second referendum, and the lack of the clear mandate in the national elections came as a blow to the SNP’s arguments.
That being said, many of the arguments used in 2014 to advocate for unity appear to have dispersed, and the population of voters who would now vote differently has, without doubt, grown. Empty supermarket shelves and growing despair at the way the incumbent government in Westminster is handling the transition away from the EU and the Covid-19 crisis, with the interweaving problems that brings, is politically and socially pushing Scotland away from its southern neighbours.
For now, the status quo remains intact, but in the years to come the pressure for change is only going to grow.
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