On 18 September 2014, Scotland will vote on whether to leave the United Kingdom (UK) and move powers in areas such as taxation, welfare and the economy from Westminster to the Scottish Parliament. This is the first time Scottish people will be given the chance to withdraw from the Parliamentary Union of 1707 and, unsurprisingly, it has infrastructure investors worried.
Scotland’s triple-A rating could be lost amid uncertainty over its ability to stand on its own two feet. While London is a well-established, trusted financial centre with credible financial regulation and approved levels of taxation, will the same be said of Edinburgh if it is given the chance to go it alone? Certainly, investors are anxious about the implied guarantee of the UK Government being replaced with the much smaller, and potentially weaker, Scottish balance sheet.
Since the referendum announcement, established Scottish corporations have been increasingly vocal about moving their Scottish headquarters south of the border. The historic Dundee investment firm, Alliance Trust, has already set up two new subsidiary companies in England in response to concerns about instability from their customers. Standard Life, Royal Bank of Scotland and Barclays have also voiced concerns.
The ongoing currency union debate provides an additional hurdle in securing confidence in a stand-alone Scottish economy. First Minister of the Scottish National Party (SNP), Alex Salmond, has accused the three major UK parties of “bluff, bluster and bullying” in their rejection of a sterling currency union. However, Secretary of State for Energy and Climate Change, Ed Davey, has said the Scottish Government should “face up to the fact [that] independence means independence – not a continuation of business as usual”.
To date, co-ordination of taxation, spending, monetary policy and financial stability policy across the UK has resulted in a successful union. Risks are pooled, there is a common insurance against uncertainty and no one area or sector of the larger economy is too exposed. However, within a sterling currency union, an independent Scottish state could struggle more to adjust to the effects of economic challenges, such as a fall in the global oil price, than Scotland currently does as part of the UK.
As a result, the continuing UK would become unilaterally exposed to much greater fiscal and financial risks and UK taxpayers would be required to support the wider economy of another state, which would include providing assistance to any banks that should fail. With HM Treasury advising the UK Government against a sterling currency union, investors currently face the prospect of a shadow currency, increasing volatility and risk.
As well as an unstable market, financial backers also have to consider the future of Scotland’s position in the European Union (EU). European Commission President, Jose Manuel Barroso, warned it would be “extremely difficult, if not impossible” for an independent Scotland to join the EU.
As a result, Scotland would lose the benefit of EU finance initiatives, such as the Europe 2020 Project Bond, which has been designed to stimulate capital market financing by creating attractive conditions for additional private sector financing for infrastructure projects. It allows promoters (such as public-private partnerships) to achieve credit enhancement by effectively dividing their debt into two tranches: senior and subordinated. The provision of the subordinated tranche increases the credit quality of the senior tranche, offering peace of mind to investors.
The subordinated debt is given to the promoter at the outset of the project and can take the form of a loan from the bank or a contingent credit line which can be drawn upon if the revenues generated by the project are not sufficient to ensure senior debt service. The promoters issue the bonds and support is available to them during the lifetime of the project.
EC ‘clear on break-aways’
Major Scottish projects previously financed by capital investment include construction of the £1.6 billion Forth Replacement Crossing (€2.0 billion; $2.7 billion) and the New South Glasgow Hospitals (£842 million). With such initiatives no longer available, will Scotland struggle to compete? The SNP has dismissed arguments that Scotland's future position in the EU is in jeopardy, but the European Commission has been extremely clear in the approach that shall be taken to deal with break-away states.
In order to counteract these arguments, the SNP has highlighted the importance of the Scottish Futures Trust (SFT). Scotland has traditionally been an attractive place for infrastructure investment, with Salmond recognising infrastructure as one the six key priorities for a successful economy in an independent Scotland. The SFT works to improve the efficiency and effectiveness of infrastructure investment in Scotland with the aim of providing better value-for-money investments and ultimately improved public services.
Speaking at the 2nd Annual Financing Scottish Infrastructure Partnerships event, Barry White, chief executive of the SFT, predicted that capital spending will decline rapidly between now and 2021, signalling a “paradigm shift in how we look after our assets and invest in infrastructure in Scotland”. Nicola Sturgeon, Deputy First Minister, also emphasised the importance of the SFT as a platform to promote innovative finance methods, particularly as capital spending is unlikely to grow.
The innovative development of Scottish procurement models, such as the Non-Profit Distributing (NPD) form of private finance, which has superseded the traditional Private Finance Initiative (PFI) model in Scotland, have been hailed a success by contractors. In times of capital scarcity, the £2.58 billion revenue funded programme allows Scotland to secure vital improvements to essential public infrastructure, which would have otherwise been deferred for several years. The model aims to eliminate uncapped equity returns, and instead, limits returns to a reasonable market rate through competition.
The Aberdeen Western Peripheral Route has been procured through SFT’s NPD model and is expected to boost the economy, increase business and tourism opportunities, improve safety and expand opportunities for improvements in public transport facilities.
Scotland has also set out plans for closer economic ties between Scotland and the north of England after independence, with Salmond pledging to commission a feasibility study for work on high-speed rail beginning from the north and heading south if Scotland becomes independent. The announcement follows reports that the proposed third phase of the current High Speed Two (HS2) scheme from either Leeds or Manchester to Glasgow and Edinburgh would be ditched after a ‘yes’ [to independence] vote.
Undoubtedly, the repeated message is that certainty and consistency is critical. Scottish independence presents a significant economic risk, something that is far from attractive to investors. When making complex decisions over where, when, and how much to invest, financial backers need as much certainty as possible on what return they will receive and the level of risk associated with each option.
As things currently stand, there is very limited information on how the Scottish Government proposes to manage infrastructure investment and how this will be afforded if Scotland votes ‘yes’ in September.
Liz Jenkins is a London-based partner in the construction and infrastructure group at law firm Clyde & Co.