The Effects of Scotland’s Vote

Scotland Flag

On September 18th residents of Scotland will vote on whether to break away from the United Kingdom and become an independent country. Even if the Scots vote for independence (polls suggest the vote will be close), Scotland wouldn’t actually become its own country until early 2016. But for investors a “yes” vote on independence could have negative effects long before that for British stocks, particularly those of Scottish companies in industries such as banking.

In the event of a “yes” vote, it’s still not clear what currency Scotland would use (like the rest of the United Kingdom it currently uses the British pound). The leading advocates for independence argue that Scotland could simply continue to use the pound as part of a currency union with the rest of the U.K. But there are a few problems with this idea. Even if the rest of the U.K. agreed to the currency union, it would face the same problem that the euro zone has faced in recent years, where a currency shared by governments with different fiscal and regulatory policies led to economic calamity.

Furthermore the U.K. government has pledged not to join a currency union with an independent Scotland. Therefore if Scotland kept using the pound, its monetary policy would be managed by the Bank of England, which in theory wouldn’t be considering the state of the Scottish economy when making its decisions. These problems—and the general uncertainty surrounding the potential Scottish currency decision—could harm the Scottish economy and lead to additional costs for British companies.

There is further uncertainty for companies in highly regulated industries such as banking. Many Scottish banks think that their clients would prefer to have their bank regulated and backstopped by the government of the United Kingdom rather than the government of an independent Scotland (its banks are probably too large for Scotland to credibly backstop anyway). Many Scottish financial companies—including Royal Bank of Scotland and Lloyds Banking Group—have therefore declared that they will move to England in the event of a “yes” vote.

These uncertainties lead to higher costs (and therefore lower profits) for companies as they have to prepare for the various possible outcomes. If the independence referendum succeeds, these uncertainties and the associated costs will only increase further.