Scottish Independence - United or Untied Kingdom? Scottish Independence: United or Untied Kingdom?
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1 Scottish Independence: United or Untied Kingdom? Scottish Independence United or Untied Kingdom?
1 Scottish Independence: United or Untied Kingdom?
Contact: Overview
Duncan Lamont, CFA On 18 September 2014, voters in Scotland
Principal, Asset Allocation
will go to the polls to decide whether
+44 (0)20 7086 9168 Scotland should remain part of the UK or
duncan.lamont.2@aonhewitt.com
become an independent country. A highly
topical and emotive subject, the result will
have implications for individuals, businesses,
pension schemes and investors on both
sides of the border.
Aon Hewitt is politically neutral and does
not have an opinion on the merits or
otherwise of Scottish independence.
However, we understand that our clients
may face challenges and uncertainty as a
result of potential changes and we are ready
to support them. Aon Hewitt operates in 90
countries across the world and our Scottish
offices serve clients locally as well as in
Europe and further afield, giving us the
breadth of experience to help our clients
regardless of the referendum outcome.
In this discussion piece, we set out some
of the main economic considerations on
Scottish independence and look at how
markets may be impacted.
2 Scottish Independence: United or Untied Kingdom?
Other options exist:
What is proposed?
S cotland could continue to use sterling on an informal
The current vision for an independent Scotland is probably basis but without the approval of the rest of the UK,
not what the idealist in Alex Salmond, First Minister of such as happens with Panama using the US dollar or
Scotland and leader of the Scottish National Party, once Montenegro, the euro. However a key risk here is that
aspired to. Plans to maintain the links to the British pound interest rate policies would be taken by the Bank of
and monarchy are hardly policies which will ignite the England with no regard for the impact on Scotland,
most ardent nationalist hearts but Alex Salmond is a canny possibly resulting in inappropriate monetary policy for
politician and he will know that treading this middle Scotland. In addition, Scotland’s borrowings would
ground is more likely to appeal to moderates and may be in a currency it has no control over. This increases
yield greater chance of success at the polling booths. repayment risk and would likely result in the market
demanding Scotland pay higher interest rates on its
The independence which Scottish residents will decide
debt. It would also not benefit from the security of the
upon is independence from Westminster. An independent
Bank of England as lender of last resort to support its
Scotland, as set out in the Scottish Government’s white
large banking sector.
paper, would gain powers over matters such as taxation,
welfare and the economy as well as areas such as defence Scotland could adopt the euro. This would have more
and immigration. limited trade benefits given the dominance of the rest
of the UK as an export destination. It is also unclear
However, many important structural details remain
whether this would even be a viable option, at least
unresolved and there are disagreements over the long
in the near term, given comments from European
term economic prospects for an independent Scotland.
Commission president, José Manuel Barroso, that an
independent Scotland would not automatically be able
What currency would Scotland use? to join the EU, let alone use the euro.
Scotland could create its own currency. This would
The Scottish government’s preferred option would be for an
severely disrupt trade with the rest of the UK, lead to
independent Scotland to continue using sterling in a formal
increased transaction costs and also significant initial
currency union with the rest of the UK under the joint
costs and uncertainty as a new currency and central
governance structure of the Bank of England. This has clear
bank are set up. There is also a risk that investors would
benefits for Scotland as it would ensure continuity and ease
prefer the long established nature of sterling and
trade between Scotland and the rest of the UK, important
remove their assets from Scotland before they
given roughly 70% of Scottish exports go to the rest of the UK.
are redenominated in the fledgling currency, risking
However, the three main London political parties have capital flight. However, it would give Scotland
unusually been united in saying they would not support a greater control over its affairs. In times of difficulty a
formal currency union. Why? Because UK taxpayers would depreciation of the currency would act as an additional
have exposure to an independent Scotland and, in the release valve to improve competitiveness and support
event that Scotland ever ran into financial difficulties, it may economic stability.
need to be bailed out by the UK (and vice versa, it should
The question of currency is very much unresolved and this
be noted). To avoid this occurrence, the Bank of England
lack of clarity presents a challenge to voters.
would likely demand onerous control over Scotland’s
spending and borrowing, eliminating many of the benefits
of independence. Events in the Eurozone are a good
example of the risks that can emerge when countries share
a currency but are not integrated fiscally.
The “yes” campaign has countered that it is in the interests
of the rest of the UK to maintain a currency union. This
is a valid point as given the extent of trade between
Scotland and the rest of the UK, many non-Scottish
businesses would suffer if Scotland no longer used sterling.
Pertinent to the rest of the UK, the “yes” campaign has
also threatened that if the UK claimed ownership of the
currency, it would also be liable for Scotland’s share of
national debt. Both sides are accusing the other of bluster
but this impasse is unlikely to be crossed before the
referendum result is known.
3 Scottish Independence: United or Untied Kingdom?
Scottish budget deficits have been Concentration of risk — North Sea oil
lower than the UK on average
North Sea oil wealth is a valuable element to the case for
There are many successful small countries around the Scottish independence. On a geographic basis, Scotland
globe and there is no fundamental reason why a country could expect to take ownership of over 90% of North
the size of Scotland could not be successful. Sea oil reserves. This is much higher than a split based on
population size which would give Scotland only around
In addition, over recent years Scotland has been in a 8% of reserves. Assuming such a geographic split, North
relatively healthy fiscal position versus the rest of the UK, Sea oil and gas revenues would have represented an
if North Sea oil revenues are allocated according to average of around 15% of Scotland’s annual revenues
where they lie geographically. For most of the past five over the 2008-13 period. It is this which raises the Scottish
years, Scotland has run a smaller budget deficit than the tax take per head above the UK average. Without it, or
UK overall and Scottish taxpayers have contributed an assuming a population rather than geographic share, the
average of £1,200 per head more in tax than the UK Scottish budget deficit would have been consistently far
overall since 2008/09. worse than the rest of the UK over time.
Budget Deficit However, in addition to being a valuable revenue stream,
North Sea oil revenues are also exceptionally volatile.
2008–09 2009–10 2010–11 2011–12 2012–13
0% For example, 2012/13 revenues were around 40% below
2011/12 levels and the Office for Budget Responsibility
-2% (‘OBR’), the UK’s official independent fiscal watchdog,
estimates that a further decline of over 20% occurred
-4%
during 2013/14. Such volatility would present challenges
-6% for an independent Scotland in managing income and
expenditure, impacting public borrowing requirements.
-8% At present, Scotland contributes these volatile revenues
-10%
to Westminster in return for a stable income stream,
possible given the UK’s more diversified income base.
-12% An independent Scotland would cede this benefit. The
Scotland UK Scottish government intends to raise a sovereign wealth
fund to smooth these flows but this will take time to build
Source: Government Expenditure and Revenues Scotland (GERS) up. Therefore, income volatility is likely to be a difficulty
for an independent Scotland, at least initially.
However, an independent Scotland would have a number
of major challenges to overcome. On the income side, the A second and potentially greater challenge is that revenues
Scottish economy is currently dominated by two major from North Sea oil are projected to decline over time.
sectors: oil & gas and financial services. These are both North Sea production volumes peaked in 1999 and have
a boon and a hindrance to Scotland’s prospects. On the declined by almost 70% since then.
expenditure side, public spending per head is greater in North Sea oil and gas production
Scotland than the rest of the UK and this presents long
term budgeting challenges. 5
Million barrels of oil/gas
4
equivalent per day
3
2
1
0
1970 73 76 79 82 85 88 91 94 97 00 03 06 09 12
Source: Oil and Gas UK
4 Scottish Independence: United or Untied Kingdom?
Estimating future revenues from North Sea oil is challenging
Scottish public spending exceeds
given uncertainties regarding future oil prices and
production revenues. In this regard there is significant the UK average
disagreement between the Scottish government and the
OBR. Revenues over fiscal year 2012/13 came in below The other challenge facing Scotland is in terms of
even the Scottish government’s most pessimistic forecast expenditure. Despite contributing more total tax revenues
and 2013/14 is also estimated to similarly disappoint their per head than the rest of the UK, Scotland spends more
expectations. The Scottish government has not published too, partly due to the relative expense of delivering
any updated forecasts but asserts that the OBR’s forecasts essential services to rural Scotland. In 2012-13, Scotland
are overly pessimistic as they do not properly take account spent around £1,300 more per head than the UK overall.
of the investment businesses have made in the North Sea Similar to the rest of the UK, Scotland also has an ageing
which will benefit future production levels. Wildly different population which will place an increasing burden on the
projections for North Sea oil revenues lead to wildly different state over time. When coupled with the indisputable
projections for the size of the Scottish budget deficit. fact that North Sea oil and gas production will decline in
That is not to say that the Scottish government is wide the long run, this increases the risk of longer term fiscal
of the mark in its forecast of future revenues but it does problems unless there is additional austerity. Current plans
highlight the uncertainty around these forecasts and any by the Scottish government do not envisage major cuts in
dependence placed upon them. public spending but independent studies have suggested
that this would be a near inevitability in the long run to put
Scotland’s natural resources are not in question. However,
Scotland on a sound financial footing.
the income volatility and uncertainty surrounding them
does add risk for an independent Scotland and this would
likely be reflected in higher borrowing costs.
Concentration of risk – Banking
Scotland’s other major industry is its banking sector. This
is a major employer and income generator for Scotland
but also has the potential to cause serious problems in
the event of a downturn. Banking assets are over 400%
of UK GDP but would be 1,200% of Scottish GDP. This
qualifies the sector as being “too big to fail” and at the
very least, Scotland would be heavily exposed to the
fortunes of its banks. A full blown banking crisis would
risk far more serious consequences. Iceland, which fell
bankrupt under the weight of its banking sector, provides
a recent warning of the risks Scotland would face with
an outsized banking sector.
Indeed, it has been suggested that the Scottish banks
may relocate their headquarters south of the border
if Scotland votes for independence due to increased
risks and regulatory uncertainty and there is even some
possibility that they may be obliged to do so under EU
law. This would lead to negative headlines in the press
and a loss of prestige but the economic impact is likely
to be less savage. As a lower cost alternative to London
with experienced staff, Scotland would continue to offer
attractions and the banking sector would be unlikely
to abandon the country entirely. In addition, it could
ultimately benefit Scotland if it is able to establish a more
balanced economy.
5 Scottish Independence: United or Untied Kingdom?
What is the likely outcome? Impact on business
Independence is an emotive topic and this writer would Businesses prefer continuity and as few impediments to
not claim to be able to call how the electorate will vote trade as possible. As such, a number of large companies
on polling day. Opinion polls have shown a consistent have expressed concerns over independence. A recent
lead for the “no” campaign but the gap is narrowing and poll suggested that as many as 36% of Scottish firms would
the momentum is with the “yes” campaign as the chart consider relocating outside of Scotland in the event of a
below shows. The scale of this lead varies significantly by “yes” vote with almost half of those surveyed thinking it
pollster and across the ten polls which have been carried would be harmful to their business. Standard Life, Alliance
out since the start of March, the margin of lead for the Trust, BP and Shell have all made statements suggesting
“no” campaign has varied from as high as 15% to as low they would prefer Scotland to remain part of the UK. As
as only 3%. In addition with a material proportion of the mentioned earlier, questions have also been raised over
population yet to make their mind up, this referendum is whether European law would force the Royal Bank of
by no means decided. Scotland and Lloyds to move their registered offices or
legal homes to London.
Should Scotland be an independent country?
(average monthly opinion poll result) If such large numbers of Scottish businesses were to
relocate, then Scotland’s financial and economic health
60 would experience a dramatic downturn.
50 Others businesses such as Ineos, operator of the
Grangemouth oil refinery, and Aviva have remained
40 neutral whereas the airline industry has favoured
independence due to planned taxation changes which
30 would be beneficial to the industry.
20 It is worth noting that businesses have not voiced concerns
over Scotland’s ability to flourish as an independent nation.
10 Instead, their concerns are over potential disruption to
Feb-13
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their businesses. The path of least resistance would be for
Scotland to retain sterling with all other currency options
increasing risk and/or transaction costs. If this could take
Yes No Don’t know
place with minimal disruption, then this would minimise
Source: Angus Reid, ICM, Ipsos Mori, Lord Ashcroft Polls, Panelbase, Survation, the risk of major employers leaving Scotland.
TNS-BMRB, YouGov
A third way
Westminster parties have recently upped the ante to
win over undecided voters by suggesting that increased
powers and responsibility would be devolved to Scotland
if it remained within the UK. Firm proposals are unlikely
until after the referendum result is known but plans already
in place include:
From April 2016, the UK Treasury will deduct 10p from
standard and upper income tax rates in Scotland to
give the Scottish government the power to decide
how to raise cash. The Labour party have suggested
this could be increased to 15p.
The Scottish government has recently been granted
permission to issue up to £2.2 billion of its own debt,
which will not be backed by the rest of the UK.
In the event of a “no” vote, a possible third way
may therefore give Scotland some of the benefits of
independence but within the confines of the UK.6 Scottish Independence: United or Untied Kingdom?
Impact on markets However, before convincing ourselves that the referendum
could only result in gilt yields moving higher, we should
Gilts not forget that where the vote for Scottish independence
is concerned, the one certainty is uncertainty. This will be
In the event of a “yes” vote, a recently published Treasury true even once the referendum result is known. Markets
note confirmed that all obligations to repay existing UK have a deep rooted dislike of the unknown so it is entirely
debt will remain with the UK. The credit risk borne by gilt possible that yields could move lower if Scotland votes
investors will continue to be that of the UK rather than “yes”, despite the arguments made earlier. What seems
Scotland. The Scottish government would then have to most likely is that yields could enter a more volatile period
agree to reimburse the rest of the UK for any agreed share as the market digests the referendum result.
of the debt.
It is interesting to note that as of yet, there does not appear
The “yes” campaign’s threat to walk away from Scotland’s to have been any discernible reaction in the gilt market
share of the national debt if Westminster does not permit despite the narrowing in the polls. One possibility is that
a formal currency union is therefore not an empty one. gilt markets are blinkered to the possibility that a “yes”
A “yes” vote risks burdening the remaining UK with the vote could actually happen, meaning that any reaction
entirety of the national debt but without the revenues could yet still be felt. An alternative and potentially more
currently contributed by Scotland. The immediate impact plausible explanation is that bond markets continue to be
would be to raise the UK’s debt-to-GDP ratio and put an fixated on the future path for monetary policy in the US
increased strain on the UK’s public finances. This has led and UK and this has dominated proceedings. The prospect
the ratings agency Fitch to say that a “yes” vote would of an increased UK debt burden would be unwelcome
delay the prospect of the UK regaining its aspirational but, against a backdrop of strengthening UK economic
AAA status. growth, insufficient to galvanise the bond vigilantes when
In reality, the Scottish government would be unlikely to their minds are occupied elsewhere. That should not spell
take such an extreme course of action as it would severely complacency however. As the referendum draws nearer
hamper their ability to borrow money in international and the possible result draws closer, increased uncertainty
markets and raise the cost of borrowing for a newly and volatility look to lie ahead.
independent Scotland.
Equities
However, irrespective of any pre-referendum sabre
As covered earlier, businesses operating in Scotland are
rattling, an independent Scotland outside of a sterling
worried about the potential disruption or increased costs
zone would introduce an economic risk that Scotland
that Scottish independence could bring, especially if an
would, at some point, default on its obligations to the rest
independent Scotland were to no longer use sterling.
of the UK as these obligations would be in a non-domestic
currency. Should Scotland run into difficulties then it However, the UK equity market is highly diversified on
would likely experience a currency depreciation, making a global basis and, although some sectors will be more
sterling denominated debts more unaffordable and raising affected than others, in aggregate we would not expect a
the risk of default. major equity market reaction to the referendum result.
A “yes” vote is therefore the one that should concern gilt
investors the most. Watch this space
However, even in the event of a “no” vote, the gilt market
Given the high proportion of voters who remain
could also have cause for concern if the margin of victory
undecided, it could be a nervous few months for
were insufficient to dispel concerns that a referendum
businesses, individuals, investors and politicians on both
would be held again in future. This would maintain
sides of the border.
uncertainty over the future of the UK and raise the risk
that, at some point in future, the UK could be forced to
take on an increased debt burden.7 Scottish Independence: United or Untied Kingdom?
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