Is Scottish independence a financial gamble?

Back in 1296, when William Wallace first took up the mantle for an independent Scotland, the nation had only been shackled by England's King Edward I for one year. This time around Scotland and England have been wedded together by one monarch since King James VI of Scotland and I of England came to the throne in 1603, and one parliament since October 1707.

Moreover, the call for independence from some quarters of Scottish politics is not nearly as simple as Wallace's one-word rally. Over more than 300 years the UK has woven a complicated fiscal and monetary web. So complex, in fact, that if Wallace had been successful in his call for 'freedom', that web may never have been woven.

The referendum on Scottish independence is set to take place on 18 September 2014 and, while only over-16s living in Scotland get to vote, the implications will be wide-ranging for the rest of the UK's residents too. And that is largely because of the size of the Scottish financial services sector.

An independent Scotland would have banking assets worth more than 12 times the size of its own economy, which could mean big risks in the face of another financial crisis. To put this into perspective, Scotland's position is proportionally far larger than banking assets relative to GDP in Cyprus (seven times), Iceland (more than eight times) and Ireland (almost nine times) prior to those countries' financial collapses. These assets are not all held by Scots either; figures from HM Treasury in the table below show just how many financial products investors and savers outside Scotland hold with Scottish institutions.

Meanwhile, Scottish government figures show Scottish businesses sell more to the rest of the UK than to the rest of the world combined, and 185,000 jobs depend on the financial sector in Scotland. Finding a way for the financial sector to continue working to such scale in an independent Scotland is a major task, and it is not altogether clear whether it will be an achievable one.

Better Together

The pro-union campaign Better Together is led by former chancellor Alistair Darling. It points out that the size of the UK market means the costs and risks of financial services are spread across the whole country, while in a smaller country those costs could be passed on to customers. As an example, if independence resulted in even a small rise in the cost of a mortgage, say 1 per cent, it could cost the average Scottish household with a 75 per cent mortgage on their home around £1,300 more in increased payments in the first year, Better Together claims.

One of the most pressing considerations, should Scotland become independent, will be which currency the country uses. If a decision is made to create a separate currency this could have a massive knock-on effect on savers and investors, because it would most likely mean following a distinct monetary policy, and therefore the country setting its own base rate.

There is still no agreed policy from the pro-independence movement on which currency Scotland would use. Some campaigners in favour of independence, such as Dennis Canavan, chair of the 'Yes Scotland' campaign and former Labour MP and independent MSP, have backed the creation of a separate Scottish currency. Meanwhile, the Scottish National Party's short-term position is to keep the pound, leaving the door open for changes further down the line.

If Scotland decides to opt for its own currency and monetary policy committee, terms for Scottish investments and financial products could be vastly different from those in England and Wales. This is because the base rate sets the interest rates of many products. So, in the case of inflation-linked products, such as floating mortgages, different policies would have to be designed for residents in and outside Scotland.

FSCS protection

Perhaps of even greater concern is whether or not the Financial Services Compensation Scheme (FSCS) would still provide financial protection for those living in Scotland, or for those living outside Scotland who hold savings and investments with Scottish companies.

A Scottish government spokesperson says: 'Following a vote for independence in 2014, Scotland will remain part of the UK while the terms of independence are negotiated. The FSCS is funded by the financial services industry and customers in both Scotland and the rest of the UK would remain protected.

'The Scottish government would ensure that arrangements for an effective compensation scheme are in place, mirroring the level of protection provided in the UK FSCS, and in line with European harmonised levels of consumer protection,' he concludes.

But Owen Kelly, chief executive of Scottish Financial Enterprise (SFE), which represents Scotland's financial services industry, is not convinced. 'As far as we know, little work has been done on whether or how the FSCS could continue to cover Scottish depositors or savers or, indeed, how or whether a Scottish scheme could cover non-Scottish depositors or savers,' he says.

Also, Kelly says the pro-independence argument that the Financial Conduct Authority and Prudential Regulation Authority could continue to cover Scotland even after independence is problematic. He points out that if Scotland wanted to remain an EU member state it would presumably have to fall in line with the rest of the members in having its own regulator. Additionally, he does not see any obvious benefit to the rest of the UK in bearing the risks and liabilities of regulating Scotland.

Kelly stresses the SFE is not politically motivated but needs to understand how independence could affect its members. Indeed, coming across as politically motivated is a fear held by a lot of financial professionals in Scotland.

One wealth manager, who does not wish to be named, says the company has to keep in mind that it has clients who are anti- and clients who are pro-independence and it does not want to alienate any of them.

White paper

A number of financial services firms are voicing frustration that there has not been more clarity and certainty around what the post-independence economic landscape would look like. However, the Scottish government, led by the SNP, is expected to issue a White Paper before the end of November with more information.

Kelly says there are five key questions surrounding independence that are most relevant for investors and savers, both within Scotland and outside: What currency could be used? Under what terms could Scotland be a member of the EU? What will be the effects of independence on the current single market for the financial services in the UK? How long would a transition to independence take and how would the process be managed? And, lastly, what would be the requirements for financial regulation?

The scariest part for those living south of the border is that they will have no say in whether Scotland splits from the UK or not, and no input into the answers to these questions, which could go to a referendum once the independence vote has been cast. In the meantime, savers and investors are held hostage. Maybe Wallace would have had a quicker answer?

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