Global Investment Strategy | Global Financial Services

The Scottish government has announced plans to investigate the potential raising of funds by a Scottish bond issue on international markets. Nicknamed "kilts" instead of gilts, while the details are sketchy at the moment, this would be a significant move for the SNP-dominated Scottish government. So, what more do we know about the potential issue of bonds?

Is this a new power?

While elements of the press suggest this is a relatively new power given to the Scottish government, this has been available to them since 2015. So far, no bonds have been issued, although there were rumours of a potential bond issue ahead of Glasgow hosted COP26 in 2021. This would have been the perfect time to issue "green kilts", but the subject never got past the discussion stage.

Current setup

Scottish government borrowing limits are currently capped at £450 million yearly or £3 billion. Until today, all funding has come through loans and, more predominantly, the UK government National Loans Fund (NLF), with local governments across the UK benefiting from the strength of the UK as a whole.

The current system came into place after the 2014 independence referendum to encourage voters to remain part of the Union. In August this year, a further agreement was reached, which would see inflation-linked increases to the £450 million per annum and cumulative £3 billion debt ceiling.

Is a Scottish bond issue feasible?

In theory, nothing is stopping the Scottish government from issuing bonds to international investors to raise funds. When it comes to the cost of such debt, while ultimately likely to be backed by the UK government, it will be more expensive than UK government gilts.

As discussions regarding potential independence continue to dominate Scottish politics, there are other issues to consider, such as:-

· A potential switch to the euro, or another currency, if Scotland separated from the UK

· Removal of the Bank of England as the effective guarantor

While Scotland has a strong independence movement, financial markets don't deal with romance; they deal with cold, hard facts. It is feasible that the Scottish government could issue bonds, but there would be a hefty premium against the UK 10-year gilt yield.

What interest rate would a kilt bond attract?

It is essential to put this issue into context, looking at other areas of the UK and the cost of their debt. Over the last couple of years we have seen:-

· A £400 million 30-year sustainable bond issued by the Isle of Man at 70bp-75bp over the UK gilt equivalent.

· A £500 million bond issued by Jersey with a 30-year maturity and 100bp over the UK gilt equivalent.

While the Isle of Man is not formally a part of the UK, instead seen as a self-governing British Crown dependency, there are still strong ties. The ties with Scotland are even more robust, which may influence the cost of debt, although the political uncertainty in Scotland will offset this.

Will it happen?

The Scottish government is looking into the issue, which would almost certainly lead to increased debt funding costs. Compared to the NLF, effectively the UK government's overdraft, it will likely be much more expensive. However, it potentially creates a pathway to long-term independence and the start of Scotland's reputation in the bond market.

Summary

Many are sceptical about the potential issue of Scottish bonds, and even if there were an issue, it would still be relatively small. This would impact liquidity, inclusion in global indexes and ultimately, investor demand. When you also consider that interest rates have recently increased from 0.1% to 5.25%, is now the best time to pay a premium for your debt?

It will be interesting to see what happens with the Scottish kilts, although the likes of Wales and Northern Ireland are unlikely to follow suit. Is this part of a potentially costly move to independence or common sense?