08 Sep 2014

Scottish Independence: Some thoughts for lenders

Scottish Independence: Some thoughts for lenders

From a politically neutral viewpoint, Rob Aberdein, Partner, considers some of the key issues a ‘Yes’ vote at Scotland’s Independence Referendum would raise.

From a politically neutral viewpoint, Rob Aberdein, Partner, considers some of the key issues a ‘Yes’ vote in Scotland’s Independence Referendum would raise for lenders.

With opinion polls on a knife edge, lenders who operate and lend in Scotland need to be aware of the consequences of a 'Yes' vote on September the 18th. These range from the currency in which borrowers will repay loans to potentially the location of corporate headquarters. In spite of the divergence of views on both sides of the independence debate, it is possible to cut through the politics and propaganda - by looking at law and precedent - to form some logical hypotheses.

The importance of the Finance Sector to Scotland

Scotland is internationally renowned for the strength of its financial services, underpinned by a highly talented and skilled workforce. Currently Scotland enjoys a large domestic market with no restrictions on lenders buying and selling financial products across the UK.

Approximately 8% of Scotland’s onshore economic activity is contributed by financial services. The sector directly employs 85,000 people in Scotland with about an extra 100,000 indirectly employed. Figures show that only 16% of mortgages advanced by lenders were to Scottish postcodes, with the remaining 84% made to the rest of the UK (‘rUK’).

The current fiscal and monetary union allows the operation of a single regulatory framework covering the whole of the UK. The regulatory framework is designed to create an environment for both financial firms and consumers to act with certainty and assurance. Regulators and Schemes, accountable to Westminster, have been established in UK law to carry out this work. These include:

  • The Financial Conduct Authority (‘FCA’) – The FCA financial firms to protect the integrity of the system. They are charged with proactively regulating the conduct of financial services to ensure that they are acting in the best interests of consumers.
  • The Financial Ombudsmen Service (‘FOS’) – The FOS carry out a dispute resolution function. It is the official independent regulator charged with settling complaints between consumers and financial firms.
  • The Financial Services Compensation Scheme (‘FSCS’) – This is the UK’s deposit credit scheme. It pays compensation up to £85,000 where a financial services firm is unable to meet claims against it.
  • The Prudential Regulatory Authority (‘PRA’) - The PRA is responsible for the prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms.
  • The Bank of England has overall responsibility for financial stability, with the ability to act as a lender of last resort to help protect against financial crises.

Financial Services in an Independent Scotland

Financial services pose a complex challenge for an independent Scotland, more so perhaps than any other major sector. Regulatory frameworks are critical for business strategy, and it is important for this purpose that financial firms are well informed as to how this would happen in an independent Scotland.

How will this work in practice?

The Scottish Government’s Proposals are contained in its White Paper. Chapter 3 of the White Paper sets out the Scottish Government’s proposals for financial services. It states that an independent Scottish Regulator will be established. It then proposes that financial stability will be conducted on a basis consisted with the rUK. The regulatory framework would be supervised by a single ‘Sterling Zone’ body or alternatively with the equivalent Scottish and rUK regulatory bodies co-operating. The Bank of England would act as a lender of last resort and be accountable to both Scotland and rUK.

These proposals are inseparable from the Scottish Government’s ‘Plan A’ to enter a formal currency union with rUK, whilst also seeking to ensure that financial regulation complies with EU law, acknowledging the Scottish Government’s express desire for Scotland to be a fully fledged EU member on independence day.

It is important therefore to consider the currency options available and whether Scotland would be a member of the European Union upon independence.

Scottish Currency

‘Plan A’ – Currency Union

The Scottish Government and the Independent Fiscal Working Group maintain that a currency union represents the best option with regard to governance, sustainability and stability, for both an independent Scotland (‘iScotland’) and the rUK. Creating a ‘Sterling Zone’ would require a formal monetary union between iScotland and rUK. This would entail iScotland controlling taxes, spending and borrowing, with the Bank of England continuing to set monetary policy.

The official line of the UK Government, in unison with the main Westminster parties, is that rUK will not enter into a currency union. HM Treasury highlighted to the Chancellor of the Exchequer that currency unions are fraught with difficulty and it strong advised against a currency union as advocated by the Scottish Government.

Much of the debate has centred on the continuing use of the Bank of England as a lender of last resort for iScotland. As the Bank of England is accountable to the UK Parliament, the rUK would have to agree to extend its lender of last resort facility to iScotland. The Eurozone crises have underlined the systemic risks of a monetary union in which some members have less disciplined fiscal policies than other members. If the rUK did agree to extend the Bank of England’s lender of last resort facility to iScotland this would likely involve the Scottish Government accepting strict limitations on borrowing.

The Euro

The Eurozone crises appear to have quashed any enthusiasm there may once have been for iScotland to join the Euro.

In any case it is unlikely that this option would have been available to iScotland as a requirement of joining the Euro is that that country has had its currency committed to the Exchange Rate Mechanism (‘ERM’) for two years.  As Scotland doesn’t have a currency to commit to the ERM, it would appear that it couldn’t adopt the Euro, unless special dispensation was given.

The Groat or the Bawbee

Scotland has a rich history of coinage. The above are just two examples of historical Scottish coinage. iScotland could choose to float its own currency. This would allow iScotland full, uninhibited control of its monetary policy.

This option would however impact on pre-existing loans:

  • Usually when a country floats a new currency, all contracts are redenominated into the new currency as the old currency has ceased to exist.
  • However, in this instance, sterling would continue to exist which raises the question of which currency do payments under the contract continue in?
  • Competing creditor/debtor interests could exasperate the problem. Some creditors may want loan obligations to remain in sterling to protect its value against exchange rate fluctuations whilst presumably most Scottish debtor would prefer to have the loan redenominated to the same currency as their income.

In addition to impacting on the currency in which loans are repaid, this option also impacts on the mechanism by which payments are made:

  • UK payments such as BACS and CHAPS are only operable in Sterling.
  • New clearing and settlement systems would have to be put in place.

EU Membership

The Scottish Government’s Position

The White Paper states that iScotland would continue to be a member of the European Union although it is accepted that some degree of negotiation on the terms of such membership is required. The Scottish Government has stated that iScotland will be able to negotiate its continued membership of the EU in the transitional period between the referendum and the day of independence.

The UK Government’s Position

Conversely the UK Government’s opinion is that iScotland would constitute an entirely new state and therefore would have to re-apply for membership of the EU in the same way, and subject to the same rules, as any other state.

Legal Opinion

Opinion is sharply divided as to which of the above stated positions is correct. Both sides have produced opinions from eminent legal figures in order to support their view. The European Commission stating their position can only definitively settle the argument. The EC have advised that they will not give their view unless a precise question is asked of them. The Scottish Government have called on the UK Government to prepare as submission to the EC however that has not yet been done. The EU has recently pursued an inclusive and expansionist policy with its current membership now totalling 29 States. The impact of Scottish Independence on the EU would on be balance be largely neutral as there would be no change in either population or economic . Scotland is currently home to 80,000 EU nationals and the consequence of Scotland losing its EU membership, even if only for a short period, would be that all those individuals would potentially lose their right of residence.

For the remainder of this article, we will assume that iScotland will, at least eventually, be admitted as a member of the EU.

Prudential Regulation

The importance of prudential regulation cannot be underestimated. Scotland’s financial sector is huge with many of the traditional heavyweights in the sector having their headquarters in Scotland as well as relatively new entrants in the market. The location of headquarters is key to determining where financial regulation responsibility lies.

As mentioned, the Scottish Government’s proposals include establishing an independent Financial Regulator. European Law obliges Member States to establish its own Independent Regulator and the proposal to do so appears to be an acknowledgement of this requirement by the Scottish Government.

The Scottish Government has put forward the view that systemically important financial institutions should be supervised on a common and consistent basis. A system of dual accountability appears to be proposed. It is uncertain how this would work in practice where financial firms are regulated across the Sterling Zone and also from Scotland. Andrew Bailey, Head of the UK’s Prudential Regulation Authority has stated that, although it would not be without its challenges, policing banks operating under two separate regulatory systems was possible.

Who would iScotland be responsible for regulating?

An interesting point is the impact of EU Law on location of financial firms. Council Directive 95/26/EC dictates financial firms must have their head offices in the same Member State as its registered office. The underlying purpose is to ensure that a financial firm cannot opt for the legal system of another member state from that in which the bulk of its activities is carried out, simply in order to avoid stricter regulation. Although there is no suggest that regulation in iScotland will be any less rigorous than in rUK that may not matter if the Directive is prescriptive in its application.  Those banks with a head office in London may have to re-register in England. Practically such a move would reduce the administrative burden on the proposed Scottish Regulator. It would also mean that rUK would be responsible for supporting these relocated ‘Scottish’ banks should they become distressed. This would appear to undermine the financial risks given by the Treasury in their advice to reject a formal monetary union with iScotland.

As with so many other ‘Referendum issues’, the set of circumstances are unique. It may be that a formal currency union, with an agreement to ensure that financial regulation is consistent across the Sterling Zone, would be enough to prevent the Council Directive operating. It is uncertain how the Council Directive will be interpreted as it has never been tested in the courts and therefore there is no case law on this. The other major consideration in respect of location is the opinion of a firm’s shareholders. It has been suggested that as the UK Government are key shareholders in several bank, if the UK Government wanted those banks to be relocated within their jurisdiction then it is likely that this would happen.

Consumer Protection

Scotland will also be responsible for ensuring consumers of financial services are protected. This would include providing Financial Ombudsmen services including compensation schemes. Again EU law is key in this area with the EU seeking to harmonise levels of consumer protection across member states.

The EU’s Deposit Guarantee Schemes Directive requires member states to protect bank deposits. The FSCS currently protect consumer deposits to the equivalent of €100,000. The Scottish Government has said that it would provide protection equivalent to that available in the UK. This is a rather large undertaking for iScotland because in addition to guaranteeing deposits by Scots in institutions based in iScotland, its deposit guarantee scheme would also have to cover deposits made with a subsidiary in another Member State. This would mean thousands of deposits made at English branches of Scottish institutions would have to be guaranteed by the Scottish Government.

Consumer Choice

Under the proposed framework, consumers can choose not only from providers of financial products and services in their home market, but also providers based elsewhere in Europe. Choice for consumers could be further enhanced in iScotland by creating more diversity in the financial services marketplace.


As ‘Referendum Day’ draws ever nearer, more and more media attention has focussed on how the transition to independence would take place in the event of a ’Yes’ vote. Negotiations with the rUK would take place in terms of The Edinburgh Agreement. Alex Salmond has stated that a cross-party ‘Team Scotland’ would be set up to negotiate the ‘independence settlement’ on iScotland’s behalf.

As stated above, the discussions would be held in accordance with the principles of The Edinburgh Agreement between the Scottish and UK Governments, in which it was agreed that negotiations must take place with respect and in the interests of everyone in both iScotland and rUK.

The Scottish Government’s proposal is for Independence Day to be in March 2016. This would allow 18 months for negotiations, this is in excess of the average of 15 months taken by other countries that have become independent following a referendum.

Rob Aberdein, Partner

Please correct the errors below before submitting your request:

Get in touch

Our dedicated client contact team prefer to receive enquiries through our contact form. We'll endeavour to get back to you within 24 hours or during the course of the next working day.

Source of enquiry