Investment Strategies

Citigroup Warns That Investors Are Underpricing Risk Of "Yes" Vote For Scottish Independence

Tom Burroughes, Group Editor, London, 29 August 2014

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As the date of the referendum on whether Scotland should become a fully independent nation draws near (18 September), economists and analysts at Citigroup argue that investors are under-pricing political risk of such an outcome.

As the date of the referendum on whether Scotland should become a fully independent nation draws near (18 September), economists and analysts at Citigroup argue that investors are under-pricing political risk of such an outcome.

In a note from Michael Saunders, Tina Fordham and Jamie Searle, they argue that Scotland has a relatively weak fiscal position at present; there are concerns about what sort of currency the country would adopt if Scottish voters chose to say “yes” to independence. The trio argue that the current pro-independence government in Edinburgh – in the devolved system – are seeking a policy of “sterlingisation” in which any independent Scotland would continue to use the pound. But even advocates of such an idea, Citigroup have noted, say this isn’t a long-term solution. It has been argued that while Scots could use sterling in financial dealings, Scotland would no longer have any say in who sits on the Monetary Policy Committee of the Bank of England.

Scotland traditionally has had a large banking industry. The parent of the private bank, Coutts, is Royal Bank of Scotland and as it name clearly spells out, a significant institution in that jurisdiction. Standard Life Wealth is part of Standard Life, which is headquartered in Scotland. The country is also home to a number of asset management and boutique wealth management organisations.

Citigroup argues that a “no” vote — which it thinks is by far the most likely outcome – will reduce some near-term uncertainties; such a vote is probably already fully discounted in government bond prices.

“A `no’ vote probably would be followed over time by further devolution for Scotland within the UK. Support for independence probably would not vanish and this year’s referendum would be replaced by a scenario of `neverendum’. Conversely, a ‘yes’ vote would be a huge surprise and create significant near-term uncertainty over both the economy and political risks. Concerns that the remaining UK will be hit by a ‘debt shock’ would likely prompt an initial reaction of bear-steepening and cheaper 30-year gilt-swap spreads,” the bank said.

"Even if the Scottish referendum does not pass, the UK political landscape is likely to remain in a state of flux. With the combination of a likely enduring Scottish independence movement, the rise of UKIP as a political force, the moderate-to-high probability of a change of government in 2015 elections, and the non-negligible risk of a referendum on UK exit from the EU in 2017, we believe that UK political risks are under-priced,” it concluded.

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