Scottish independence—the issues for banking and finance lawyers

What are the potential implications of Scottish independence for the banking and finance sector in Scotland? Rod MacLeod and Hamish Patrick of Tods Murray LLP consider the issues and say a Yes vote means banks and other financial institutions operating in Scotland would need to adjust to a new regulatory environment.

How could your practice area be affected by an independent Scotland?

As banking and finance lawyers we advise most of the major UK clearing banks and other financial institutions operating in Scotland. An independent Scotland would mean a separate banking system in Scotland and, due to EU rules, most likely a separate financial services regulator and regulatory regime. While the framework for the Scottish banking system is already in place—and one would expect a Scottish government to adopt wholesale UK financial services regulations and legislation at the outset of independence—independence would require structural and operational alterations to the banking system in Scotland, and internally within Scottish and rUK financial institutions, to adapt to the new regulatory and business environment.

Decisions on currency (see below) and EU membership would also have a fundamental impact on our practice.

What cross-border issues currently affect your practice area?

The majority of cross-border transactions we work on are subject to a combination of Scots and English law (depending on the jurisdiction of the entities involved) and the location of assets used as collateral for leveraged or structured finance transactions. While we would expect the type of Scots law that we advise in our practice area—Scottish security, trusts and finance contracts—to be largely unaffected by independence, thanks to the separate legal systems north and south of the border, we would expect increased ongoing work for Scottish law firms in relation to law that currently operates on a ‘UK’ basis (such as tax and certain regulatory laws), where UK-wide businesses may currently seek advice only in England.

What are your key concerns as the referendum draws near?

We have two key concerns:

  • No Plan B on currency has been put forward by the Scottish government. Regardless of whether you believe the UK government would or wouldn’t follow-through on its stated opposition to currency union between rUK and an independent Scotland, the absence of a credible back-up option means we cannot say to our clients how they should be planning their business operations in the event of a Yes vote as we do not know for certain what currency an independent Scotland would use.
  • The length of time it would take an independent Scotland to negotiate EU membership (whether as a continuing member state or by way of an accession process as a new member state). While we do not anticipate Scotland being denied EU membership following whichever process is negotiated, we have deep reservations on the timescales articulated by the Scottish government and cannot envisage ratification of Scotland’s membership by all current EU member states within the 18-month deadline for independence set by the Scottish government. It would remain to be seen whether that deadline would be extended by the Scottish government if ratification was not completed in that time.

Furthermore, the longer uncertainty over issues like currency and EU membership continues, the more damaging it will be to business in Scotland.

Are you taking any practical steps ahead of the referendum?

In addition to producing e-bulletins for clients and briefing papers on these and related issues, we have set-up an independence blog for clients to view materials, links to press articles and video interviews and seminars that we have presented on independence issues. We have also set-up a similar webpage for English law firm referral partners who regularly instruct us on the Scottish aspects of cross-border transactions.

We are also delivering seminars and presentations on the impact of independence on financial services for a number of the clearing banks and magic circle law firms in London in the run-up to the referendum in September.

Do you think there are any issues that haven’t received enough attention or consideration?

The impact of independence on defined benefit pension schemes—the EU Pensions Directive 2003/41/EC prohibits defined benefit pension schemes operating across two or more EU member states from operating in deficit. Given that the majority of defined benefit pension schemes operating in both Scotland and England are not fully funded, the burden on businesses with cross-border defined benefit pension schemes having to plug those pension fund deficits would be huge, not just in Scotland but also in rUK. While this issue has received some press attention during the ongoing referendum debate, the Scottish government has not articulated how it would plan to deal with this issue and we are concerned that some businesses based in England and Wales with a portion of their workforce located in Scotland are unaware that this will impact on their rUK operations as well as their Scottish operations in the event of independence.

What would a yes vote mean in practice for lawyers in your field?

We would expect there to be a significant increase of one-off work for Scottish law firms (and indeed those in the south) resulting from the transition to independence.

As with many other businesses, currency issues would also need to be considered if there was no currency union. This would likely affect Scottish law firms with a significant client base in the rest of the UK more than other firms. For example, billing currency could have to be addressed if clients based in the rest of the UK wish to be billed in sterling and the law firm operates in a new Scottish currency—and while we and other Scottish firms currently sometimes bill US based clients in US dollars or Eurozone based clients in euros, increased exchange risks might have to be addressed. Similarly, clients operating in sterling could want their client deposits to be kept in sterling rather than in a new Scottish currency—and while at present a Scottish law firm may keep client accounts in England, different regulatory issues on location of client deposits may arise following independence.

Of course, if a new Scottish currency drops relative to sterling or other currencies, this could provide opportunities to Scottish law firms to export their services at advantageous prices.

What would a yes vote mean in practice for clients in your field?

Banks and other financial institutions operating in Scotland would need to adjust to a new regulatory environment (although there might be little divergence between the new regime and the current UK regime at the outset) and some banks might need to restructure their operations if they have headquarters in Scotland but are registered in the south (or vice versa) in order to comply with the EU Banking Directive (otherwise known as the BCCI Directive).

Scottish banks could also be subject to higher borrowing costs if an independent Scotland has a lower credit rating than rUK and, conversely, lower borrowing costs if Scotland has a better credit rating than rUK.

As noted above, the choice of currency would be key—if there was no currency union and Scotland had to issue its own currency then banks (and businesses in general) would need to assess how any Scottish redenomination laws might affect existing bank and general finance documents that they are a party to, their exposure to sterling debt redenominated in to the new currency and their exposure to exchange rate risk. The banks would have to participate in an overhaul of IT systems and bank payment infrastructure in Scotland in order to accommodate the new currency and there would inevitably be higher transaction costs for cross-border deals in the short-term due to exchange rate risk, currency conversion costs and price comparability issues.

There are already moves afoot for a separate stamp duty land tax and potentially different rates of income tax in Scotland—do you think there will be more devolved power to the Scottish Parliament if there is a No vote, as advocated by the previous ‘devo-max’ campaign?

More devolved powers are inevitable as the opposition parties (Scottish Labour, Scottish Conservatives and the LibDems) have all made varying promises on more devolved powers if Scotland votes No in the referendum. Devolved powers will also be necessary in order to stave-off renewed calls from pro-independence supporters for further independence referendums over the next five to ten years in the event there is a close referendum result. However, it will be interesting to see whether further devolved powers leads to similar calls for more devolved power to Wales, Northern Ireland and conceivably, regions in England.

In banking deals, will the big issues be currency, interest rates and who the central bank would be in a Yes vote?

We would expect currency to be the main issue for the reasons given above, although much would depend on whether a currency union could be negotiated or, in the event that Scotland issued its own currency, whether the Scottish government chose to peg the exchange rate of the new currency to sterling rather than opting for a floating rate.

Is there anything else significant that you think we might see in documentation if there is a Yes vote, or are banking documents likely to remain fairly static considering the different legal system already in place in Scotland?

Given that independence will not happen immediately following a Yes vote on 18 September 2014 (and there will be a period of negotiation and (presumably) a period of transition to independence), we would expect to see an increased use of change of currency provisions or similar trigger clauses that allow for renegotiation of contracts in the event of certain outcomes related to currency or EU membership in contracts involving Scottish entities and Scottish collateral assets together with an increased use of English law over Scots law as the governing law for facility agreements offered to Scottish borrowers.

Is it still a waiting game—are lawyers sitting tight until the outcome of the referendum?

A lot of law firms are reluctant to engage in the debate for fear of comprising their neutrality. A law firm’s role is to advise each client independently and in the specific interests of that client. Clients’ businesses are different and independence will be positive or negative for different businesses and in different ways and individual businesses require greater or lesser degrees of adjustment to independence (as reflected in the comments by the likes of fund managers with relatively minor adjustments to make on the one hand and the likes of Standard Life on the other, facing a possible large currency mismatch from its significantly larger customer base in the rest of the UK). It doesn’t help law firms or their clients in giving advice and making decisions based in part on that advice for the law firm to be anything other than ‘professionally neutral’ on independence issues. This is backed up by Law Society of Scotland rules on professional conduct.

Neutrality is not the same as not participating in the debate, a position adopted by a number of Scottish law firms. Detailed information and debate is necessary so that our clients can make informed business decisions and we have been actively engaged in promoting and contributing to that debate. As mentioned above, this has involved producing a significant amount of independence materials for clients and contacts. We have also been engaged with senior politicians from both sides and with civil servants and we have an upcoming event lined up involving the Scottish Labour and Conservative leaders to follow up a previous event involving the SNP deputy leader.

Given our significant English client base, we have also sought to promote debate south of the border and have had significant interest in an event we are hosting in London on 1 July 2014—Impact of Scottish Independence on the City—which follows on from a similar event we hosted in May 2012 when the significance south of the border of Scottish independence had not really crossed the radar of many in the City.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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