Scotland in the international bond markets? Give me a break…

'Scottish govvies? Jog on,' says Bill Blain, as runners compete in this year's Edinburgh marathon as it rounds the Scottish Parliament building

As the global economy stands on the precipice – about to step forward, Scotland announces its going to launch its debut bond issue. It is political theatre of the worst kind – there are so many reasons it’s such a bad idea – today. Tomorrow might be different.

In a world that feels increasingly fractious, as the lights are going out across the Middle East, thankfully we have some light comic relief in the form of Scotland announcing the intention to issue its first ever public bond issue.

I know what you are thinking:

• Surely, I should be writing a serious analysis of Tesla’s disappointing results last night (a massively overvalued, average car company sacrificing margin for market share, fighting off increasing competition, struggling to introduce a new model), or how Netflix’s better than expected numbers averted a tumble across Big Tech in last night’s aftermarket?

• Or should I comment on the signals and consequences the political incapacity of not-electing an unelectable Republican speaker of the House sends about the dollar, US debt and US hegemony, and what a shut-down will do?

• Maybe I could explain how the battle lines being drawn in the Holy Land spell a decade of energy turmoil for the global economy – who will be winners and losers?

• Or perhaps I should explain how the slowdown in deal making, higher yields, costs and competition spell a Reverse Big Bang for the City of London over the coming year, costing thousands of jobs and multiple negative consequences across the City ecosystem and economy?

These are all stories I need to come back to. Soon. Plenty of other folk will be writing about all these things this morning.

I am hoping this Morning’s Porridge will be useful for the many young fixed income bankers who will taking the high road to Edinburgh to bang on Humza Yousaf, Scotland’s First Minister and leader of the Scottish National Party, front door asking for the mandate for Scotland’s debut bond issue. (That’s the kind of job I had back in the 1990s!)

Yousaf announced the intention of launching a debut Scotland bond by 2026 to fund infrastructure, build roads, schools and housing, at the SNP’s recent conference. Hopefully they won’t be using the money to launch Ferries.. the life-blood of the Scottish Islands’ economy. Ferries have been something of an embarrassing failure for the SNP – costing over £500 mm to not launch 2 Clyde built ships due to political interference and dither.

Many times I have said I would like the job of running Scotland’s Debt Management Office. Such an organisation does not yet exist, so I wonder who is advising the Scottish Government on its bond deal? I would love that job. What a marvellous opportunity to sell my Nation’s skills, talents, and economic advantages to the World. I’ll do it free – all I ask is just 3 bottles (my choice) of whisky per annum, plus expenses.

As a Scot who loves his country, I feel it’s my patriotic duty to raise some of the many issues around a Scottish bond issue. As a Fixed Income specialist, I am unlikely to recommend the current proposed bond. It is little more than political theatre.

Over the past year, a number of Porridge readers have challenged me on my “failure” to write about the challenging time the SNP has been having since First Minister Nicola Sturgeon resigned early this year. I didn’t think any of my international readership would be particularly interested in trying to explain the global relevance of how the recent leader of my fairly small not-quite-a-nation was arrested for something dodgy involving an embarrassingly small amount of maybe-corrupted cash? I mean, its small change compared to what Hunter Biden apparently made daily. (I’d rather focus my energies on lambasting the ongoing Tory foolishness in England, even if my own countrymen run them a close second in the UK’s bad politics stakes.)

The SNP have been running Scotland since the Scottish electorate lost confidence in the Tartan Tories and Caledonian Labour Thistles back in 2007. Scotland found itself with a one-party state of SNP politicians with great enthusiasm and little else in terms of definable talent. Although the SNP like to think they run the country from the swanky Holyrood parliament (which is architecturally pointless), the reality is the Scottish Office up the hill and across the road from my old school, notionally does – when it can be bothered to do so.

As a result of schoolboy politics and London’s indifference, Scotland comes down well down any list of top countries in Yoorp. We are better at dying earlier than anyone else.

You will seldom mistake a Scotsman for a ray of sunshine. We are complex. We elected a government committed to independence, but declined the opportunity to actually become independent when 55% of Scots voted to remain in United Kingdom in 2014. The SNP’s overriding priority, to the exclusion of all else, is to hold a succession of referendums till they get the vote they want.

Watching the SNP is a bit like a generic prisoner of war TV series. Think Colditz in kilts. Each episode sees them dig another tunnel, forge another key, build a glider in the attic, or forge a bond issue to buy their way out, but their incompetence in regional government gives little hope they could ever competently run an independent nation or ever make a “home run”.

If Rishi Sunak was smart, he’d let the Scots vote now – if the SNP wins the Labour party has zero chance of winning the next UK election without a majority of Scottish seats, and if they lose, they lose.

Anyway, back to the bond issue.

The SNP think the bond will “help raise Scotland’s profile and engagement with international investors to attract investment.” Aye, because no one outside Scotland has ever heard of Scotland? Introduce me to a CIO, international banker or hedge funder who doesn’t play golf (ours), drink whisky (ours) drive a car (the tyres – ours), been cured by antibiotics (ours) or watched TV (ours). Yep. No one has heard of Scotland. Ever.

How should a Scotland bond be priced?

There are a couple of problems. At the moment I understand Scotland would borrow up to £3bn in debt, or give guarantees on debt, with the full faith and credit of His Majesty’s Government. No one questions the possibility the UK will ever default on its debt – if the manager of the Debt Management Office found his piggy bank was empty on redemption day, then he can simply ask the Treasury to fire up the Sterling money presses.

But an independent Scotland would not have its own currency. It will likely be using sterling. So if Scotland is broke when it comes time to repay the money... we will have to ask, very nicely (something Scotsman are genetically incapable of) the English to give us the money. Not going to happen. Scotland could adopt the Euro, but same thing – if asking the English (who at least will pretend not to gloat too much) was hard, the Germans will be beastly.

Because it is not a financially sovereign nation with its own currency, Scotland is a credit risk – without access to a money printing press, how will Scotland repay interest and principal on its debt? That’s a function of taxes, the competence of the government, the strength of the economy, currency and the perception its bonds are held in by the market.

There is the question of how much of the quantum of outstanding UK government debt should Scotland assume if the UK splits up. Based on population, Scotland should expect to be responsible for 8.2% of the UK’s outstanding debt of £2.44tr, meaning its debt burden would be £200bn, which is a 97.5% debt-to-GDP ratio – in line with the rest of the UK, plus of course, the £3bn the SNP will have issued by then, so call it 100% GDP. It won’t qualify to join the euro with that debt load.

Then of course is the question of what spread to Gilts would Scotland, as a sovereign credit (rather than a financially sovereign nation), issue debt? As a core nation within the UK, Scotland should maybe trade similar to a Canadian Province over Canada at a narrow spread to reflect the lower liquidity and Semi-Sov nature of the credit. Even differently minded francophone Quebec trades as a function of Canada.

But, it Scotland threatens, or looks likely, to break the Union in search of independence different rules apply. Investors will need to price that risk into the bond. Without a UK govt guarantee Scotland’s credit is clearly worse. The spread to the UK will widen – dramatically.

There is actually some evidence of what that spread might be. Soon after Scotland got permission to raise its own debt in 2015, the Scottish government, very quietly, provided a guarantee to payments made on hydro-electric power in a very convoluted private deal arranged by now disgraced financing firm Greensill. It involved the somewhat dubious Gupta steel making conglomerate. I looked at the deal and was amazed it had attracted a govt guarantee – (a story I shall be delighted to share..) It was dodgy as a dodgy can get. One of the funds that financed the deal became a forced seller. Bearing in mind it was guaranteed with a full faith and credit guarantee of the UK, but Scotland was still seeking independence, where do you think the price discussion was? How about 250bp-300bp over Gilts…

That was for an illiquid, private debt deal issued by an Indian/UK company, but guaranteed by Scotland. For a public Scottish deal, it would be safe to assume the independence premium, the amount investors would demand for the risk Scotland would give up the UK guarantee, would be over 200bp. Scotland would pay 2% more for debt than England.

Then there is the question of what kind of credit Scotland would be. A whiff of government corruption as Wee Nicola faces time sewing mail-bags in the women’s wing of the Bar-L is not an encouraging start. Nor is the handling of the Ferry contracts, Scotland’s failing education system, drugs deaths or a host of other SNP political misses. Political competency and sustainability counts.

Finally, there is the fact the global market place is unlikely to be particularly receptive to the Scottish government presenting themselves to the World to sell their debut sovereign bond issue – pretending to be an independent nation, when it’s still very much part of the UK. Investors want facts, numbers and dull, boring, predictability from the bond purchases. They don’t buy political fairy tales.

As I said, at some point Scotland will be a bond issuer — for all the right reasons.

Bill Blain is the author of The Morning Porridge, a strategist at Shard Capital and was the first ever news editor of EuroWeek, GlobalCapital's previous title.