Scotland Could Sell Debt for the First Time Ahead of Elections

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The Scottish government is exploring raising funds on capital markets for the first time, ahead of elections that could trigger a renewed standoff with the U.K. over independence.

The devolved administration in Edinburgh has had the ability to issue debt -- to be nicknamed “kilts” as a play on the U.K.’s “gilts” -- since 2015 under British rules to spread power. So far it’s refrained from doing so, with internal documents seen by Bloomberg showing officials concluded selling bonds didn’t make sense from a financial perspective.

Yet the idea is now being taken more seriously by the ruling Scottish National Party, as it eyes the potential for another referendum on leaving the U.K. if it can gain a pro-independence majority in May’s parliamentary elections. The nation will work closely with investors on a range of options including government-backed bonds to finance its net-zero emissions targets, according to a spokesperson.

“As this would be issued by a government with the stated goal of secession, the overall fiscal stance of a theoretical independent Scotland will be crucial in pricing this,” said Ross Hutchison, an investment director at Aberdeen Standard Investments in Edinburgh. “The green element is an interesting twist, and may of course attract a lot of investor interest.”

The push for Scotland to go green with its first bond may grow ahead of the next major United Nations climate change summit in November, which the country is hosting in Glasgow. That gathering has sped up plans for the U.K.’s first green gilt, with Britain already lagging peers such as Germany and France in joining a boom in sustainable finance.

While sub-national debt in Europe is less developed than the U.S. municipal market, others with nationalist movements such as the Basque and Catalan regions in Spain plus various German states have been among the sellers. They’re popular with investors given they typically offer a yield pick-up versus national debt for similar creditworthiness, based on the assumption the central state will not allow part of its country to go bust.

Scotland Could Sell Debt for the First Time Ahead of Elections

In the U.K.’s case, devolving fiscal authority away from Westminster has been slow. There’s a growing sense the political status quo isn’t working for those outside the capital -- a key factor behind the Brexit vote -- and that is kick-starting a nascent sub-national debt market.

The UK Municipal Bonds Agency, set up to help local councils access bond investors, made its debut last year. A new fiscal settlement to be negotiated between Edinburgh and London this year could grant Scotland more flexibility and change the administration’s view on debt raising, according to freedom of information documents seen by Bloomberg.

For now, discussions on debt issuance are at an early stage and probably won’t progress substantially until after the election on May 6. Opinion polls suggest First Minister Nicola Sturgeon’s SNP “has a 50-50 chance” of securing only its second-ever majority in May’s elections, according to John Curtice, the U.K.’s most prominent psephologist.

Scotland’s previous independence referendum, in 2014, was only agreed to by then Prime Minister David Cameron after the SNP won a majority at Holyrood in 2011. Voters rejected leaving the U.K. by 55% to 45% after promises of more autonomy, including finance and borrowing power.

One debt-raising option now on the table is to involve the government-backed Scottish National Investment Bank, created late last year. Scotland has an advantage in having greater tax and revenue powers than local councils, plus a developed asset management industry in Edinburgh, with firms such as Standard Life Aberdeen Plc and Baillie Gifford & Co.

Still, Scottish debt would be a thorny proposition for politicians and financiers alike. Opponents of independence could use any spike in borrowing costs as the market warning against the economic case for secession. Investors, meanwhile, will be conscious of what would happen to the debt if Scotland were to break away from the 300-year-old union, and might demand a premium for the risk.

“I think they would only issue them if they can do so at a very small spread over gilts,” said Mark Dowding, chief investment officer at London-based BlueBay Asset Management. “The issue is that if Scotland left the U.K. then you would assume that this debt would re-denominate into the country’s new payment currency.”

Short Kilts

Sturgeon’s government in Edinburgh has yet to confirm which currency an independent Scotland would use, particularly given its stated ambition of rejoining the European Union following secession. At the 2014 referendum, arguments about whether Scotland would be able to continue using the pound helped to undermine the nationalist cause.

A renewed push for independence in Catalonia didn’t stop BlueBay’s Dowding hanging onto its debt, believing increased autonomy rather than secession from Spain was the likely end game. He’s less sure of Scotland’s constitutional future and so would consider shorting any new bonds on this uncertainty, looking for them to trade with a hefty 100-basis-point spread over gilts.

“Mind you, ‘short kilts’ doesn’t conjure a mental image I would want to stare at for too long.”

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