Issue blows up after Royal Bank of Scotland releases statement saying it would be “necessary to re-domicile the bank’s holding company”
Tim Evershed
September 15, 2014: As the Scottish referendum on independence enters its final phase, the campaigns have heated up while the polls have narrowed, which has seen the country’s financial institutions climb off the fence to become embroiled in a political situation.
The referendum on September 18 will determine whether Scotland will become independent, ending a political union with England that can be traced to a treaty that was agreed in 1706.
A number of banks, insurers, life and investments firms have long said they will make contingency plans for the event of a ‘Yes’ vote. However, the subject has blown up in the final week of the campaign after the Royal Bank of Scotland released a statement saying it would be “necessary to re-domicile the bank’s holding company”.
Other firms that have confirmed that they will re-domicile at least part of their registrations, holding companies or operations to England if Scotland gains independence include Clydesdale Bank, Tesco Bank, TSB Lloyd’s Banking Group, which includes the Bank of Scotland and Scottish Widows. They have been joined by life insurers Standard Life and Aegon UK, which was formerly known as Scottish Equitable.
All of the banks insisted that the change would be “legal and technical” and would not involve many jobs shifting out of Scotland.
So, the question is why should these firms feel it necessary to move if Scotland votes to leave the UK?
The answer would seem to lie in the age-old adage that business hates uncertainty. For Scotland’s financial services sector, a move to independence would be riddled with uncertainty.
The major uncertainty would, of course, be the currency that a newly independent Scotland would use. That factor has been exacerbated by the refusal of the three main UK political parties to agree to the Scottish Nationalist proposal that an independent Scotland be allowed to use the British pound as its national currency.
Financial services companies would also face a number of material uncertainties arising from changes to the fiscal, legal and regulatory landscape.
Banks need to have a “lender of last resort” to fall back on, which is currently the Bank of England, which also acts as a regulator. In a crisis, an independent Scotland simply would not be big enough to offer support to its enormous banking sector, which currently has assets of around 10 times larger than the country’s GDP.
And none of this is made any the more certain by the fact that Scotland may face a hiatus before joining the EU.
In addition, uncertainty could cause credit ratings agencies to think it more likely that a bank would default on a debt, and to say that lending to that bank is more risky.
In a report into the insurance sector, ratings agency Standard & Poor’s (S&P) said it believes that Scottish independence has the potential to drive negative rating actions on insurers operating in Scotland.
It was particularly concerned with the tax implications for the life insurance sector – one of Scotland’s outstanding success stories.
The report said: “We see the taxation of life insurance policies as a key driver for their demand. Were Scotland to become fully independent, it’s likely that life and pension products sold by insurers based in Scotland would no longer qualify for favorable tax treatment for policyholders in the UK.
“This would be a significant challenge for Scotland-based life providers, as 70% of their premiums currently come from customers in the rest of the UK. UK firms selling to Scottish customers would face the same challenge but to a lesser degree, as only 9% of their sales are to Scotland-based customers.”
S&P suggests that life insurers could sidestep the issue if they set up separate branches or subsidiaries on each side of the border (regardless of where the parent companies reside).
It is thinking such as this that explains the “precautionary measures” made by Edinburgh-headquartered Standard Life to “transfer parts of our business if there was a need to do so”.
The firm’s CEO David Nish said the company would remain part of the UK tax structure, be overseen by UK regulators, and ensure that customers outside Scotland would continue to be paid in sterling. Standard Life would also maintain its listing on the London Stock Exchange and continue to pay dividends as it has been doing.
However, S&P also warned that operating through a branch would seemingly only be possible if an independent Scotland were to remain within the EU or the European Economic Area, something that is by no means certain.
Even if that was the case, S&P warned: “If such a strategy were adopted, insurers would face the expense and practical challenges of migrating customer accounts from one entity to another. The process could also increase lapse rates.
“If Scotland adopts a new currency and sets its own interest rates, this will magnify the costs of transition. Some observers have argued that a “border effect” could develop over time, by which customers become resistant to using financial providers from the other side of the fence.”
However, S&P also says it expects the dynamics of a Scottish insurance market to stay the same with the Scottish rate of investment in life products remaining similar to that for the broader UK.
S&P also says that non-life insurers currently operating in Scotland should not be deterred from staying despite being faced with a reduced market due to the “highly developed phone and Internet distribution channels in the UK non-life segment, which preclude the need for expensive distribution networks requiring economies of scale”.
Then there are some economic consequences from the relocation, but quantifying them is hard. One reassuring factor for Scottish employees of these companies is the fact that it is not a simple matter for large companies to up sticks without losing key staff they would like to retain.
In the event of a ‘Yes’ vote, we would likely see a number of different strategies deployed by banks and the wider financial services. Perhaps, if negotiations go smoothly in the run-up to actual independence in the spring of 2016, the impact will be limited. However, if there are problems over currency and EU membership or that date begins to slip then the uncertainty will almost certainly drive further migration south.