Insight & Analysis

Caledonian corporates contemplate independence issues

Published: May 2021

Companies across Scotland will be thinking about how the results of the recent Scottish parliamentary election could impact their treasury strategies over the lifetime of this parliament and beyond.

Scottish flag blowing in the wind

The Scottish National Party’s apparent willingness to wait until the coronavirus crisis has passed before ramping up its drive for a second independence referendum is a welcome development for the majority of the country’s companies, irrespective of their attitudes to the union.

It is hard to make the case that a global health disaster (which could yet have a few more twists in its tale) and the resulting economic uncertainty is the right environment in which to be focusing on whether Scotland would be better off within or without the United Kingdom.

This approach will also allow corporate debt levels to settle at a more ‘normal’ level. Ross Walker, chief UK economist at NatWest has estimated that UK firms will have taken on an extra £100bn of debt by the time the coronavirus crisis is over.

If another independence referendum were to take place, UK corporates in general and those in Scotland in particular could expect overseas investors to lose their appetite for corporate bonds in the months leading up to the vote as was the case in the period before the 2014 referendum.

Bond buyers – like most investors – abhor uncertainty and regardless of the circumstances, market volatility would be heightened before and after such a major event. The prospect of a fall in economic output (even in the short term) would raise fears of higher corporate default rates.

But the impact on the valuations of companies headquartered in Scotland might already have been priced in by the market if the experience of 2014 is anything to go by.

Research conducted by academics from the University of Strathclyde and University College Cork found that heightened political uncertainty was priced during the period surrounding the referendum – in other words, that uncertainty-averse investors succeeded in gaining compensation for holding the volatile stocks of Scottish headquartered companies.

An Oxford Economics report on Scotland’s economic prospects and challenges published on behalf of the Hunter Foundation in March suggested that the current tax system penalises equity financing by businesses while subsidising debt finance.

The report suggest that by allowing debt financing costs to be deducted from a company’s corporation tax liability but not allowing equity financing costs to be deducted, debt finance works out much cheaper and therefore companies are more likely to choose debt financing.

The reason why the report authors express concern about this is that equity finance has a number of advantages over debt finance, such as the ability to attract long-term investors who can bring new skills into the business, as well as connections from previous investments that could prove beneficial to the company’s development and therefore its financial success.

Then there is the currency question. A J.P. Morgan research note issued on 29th March suggests it is less likely that Scotland could adopt the euro - at least during a potentially lengthy transitional phase - as it would need to apply to rejoin the EU.

According to Tony Mackay, an advisor to the World Bank, the Asian Development Bank and the European Commission, a new Scottish currency could be worth less than 80% of the pound. He estimates that exports to England would fall by 15% following independence, with a similar drop in company profits.

These are just some of the issues that would affect business in an independent Scotland and don’t even take account of potential divergence in key areas such as corporation tax rates. Regardless of where they stand on the independence question, what businesses north of the border crave most of all is clarity – and given the status quo the onus to provide this clarity lies with the Scottish government.

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