3 Financial services
Scottish financial services as
part of the UK
64. Scotland has a strong and competitive
financial services industry with a distinct Scottish identity.
Scotland's reputation, and the skills of the workforce are often
cited as key reasons why businesses choose to locate in Scotland.[93]
The financial services industry is crucial to the wider
Scottish economy through its contribution to GDP and jobs, both
directly and indirectly.
65. Information from Scottish Financial
Enterprise (SFE)[94]
shows that the financial services industry in Scotland:
· Accounts
for 8 % of Scottish GDP;
· Generates
around £8 billion for the Scottish economy (more than 8 per
cent of Scottish onshore activity);
· Manages
over £800 billion of funds;
· Employs
almost 100,000 people directly;
· Employs
almost 100,00 people indirectly (both together accounting for
approximately 7% of Scottish employment); and,
· Accounts
for 24 % of all UK employment in life assurance, and 13% of all
UK banking employment.
66. Owen Kelly, Chief Executive
of Scottish Financial Enterprise, told us:
Scotland has been a successful international
financial services centre for about 300 years, so the pedigree,
or history, of the industry in Scotland is certainly an attractive
factor for a lot of international investors. In the modern world,
perhaps putting the history to one side, what we hear from our
members in terms of the attractiveness of Scotland as a place
to do business is that it is the skills, the legal and regulatory
frameworks-of course, these are UK frameworks-and equally being
in the same regulatory and legal frameworks as the largest financial
centre in the world, which is London. Clearly, that is a good
thing and a good situation to be in. Many international investors
and other businesses can operate from Scotland, and yet participate
fully in the jurisdiction that contains the largest financial
centre in the world.[95]
67. HM Treasury states that the
high level of integration across the UK benefits businesses and
consumers both in Scotland and in the rest of the UK. There is
a large domestic market in financial services with no restrictions
on buying and selling financial products across the UK.[96]
The size of the UK market means that firms can spread both funding
and risk across a population of 60 million people. More firms
and greater competition provide customers with a far greater choice
of financial products at a lower cost. SFE estimates that 90%
of its members' customers are located in the rest of the UK, and
the market is highly integrated for most financial products.[97]
68. Financial services is a highly
regulated industry, and although the regulatory framework is a
European one, there are separate national regulators. In principle
the EU Single Market allows financial services operators legally
established in one Member State to establish/provide their services
in the other Member States without further authorisation requirements.
This is known as "passporting".[98]
However, cross-border trade in financial services has not been
as successful as envisioned.[99]
Professor Ian MacNeil, Professor of Commercial Law, University
of Glasgow said:
The majority of the consumers would
be outside Scotland, predominantly in England. Some are in Europe,
but we have not had as much branching and passporting business
as was originally envisaged in the European model, so there is
a big focus on exporting into the English market.[100]
69. When asked about the impact
of different regulatory systems on companies based in Scotland
wishing to trade with the UK, Andrew Bailey told us:
Major international firms do not
like it, but one of the things they have to put up with is that
if they are based in many different jurisdictions-typically they
are-they are used to operating under different regulatory regimes.[101]
70. Scottish financial services
companies sell freely to consumers throughout the UK as there
is a single regulatory and tax framework. Separation would create
separate regulatory and tax regimes under two separate Governments.
These regimes would be likely to diverge over time, thereby creating
barriers to trade that do not currently exist. Experience shows
that international borders reduce flows of products, money and
people.[102]
71. Some Scottish companies have
identified risks from separation and are preparing to move aspects
of their business outside Scotland in the event of a vote for
separation. For example Standard Life, which employs 5,000 people
in Scotland, recently announced that it has started work to "establish
additional registered companies to operate outside Scotland, into
which we could transfer parts of our operations if it was necessary
to do so".[103]
Lloyds RBS and the Royal London have made similar statements.[104]
72. Reuters has reported:
Several banking industry sources
have told Reuters that RBS and its part-nationalised rival Lloyds
Banking Group, which owns Bank of Scotland and is registered in
Edinburgh since it took over HBOS in 2009, are already drawing
up contingency plans should the vote on September 18 be for independence.
The main concerns for these Scottish-registered
banks are whether they will still be able to count on the Bank
of England as a "lender of last resort" and whether
their cost of funding would go up if they were downgraded by credit
rating agencies because of Scotland's relatively small economy,
according to industry sources.[105]
Financial services in a separate
Scotland
73. Separation may therefore lead
to a markedly smaller financial services market in Scotland, an
advantage of which could be specialised firms providing products
and services that are tailored and more responsive to the Scottish
market.[106] However,
the Scottish banking sector would be exceptionally large compared
to the overall size of the Scottish economy, making it more vulnerable
to financial shocks than is currently the case as part of the
larger UK economy. Analysis by HM Treasury shows the assets of
the whole UK banking sector (including Scotland's banks) are around
492% of total UK GDP.[107]
This is itself large by international standards. Scottish banks
have assets totalling around 1,254% of an independent Scotland's
GDP.[108] Furthermore,
the banking sector in a separate Scotland would be dominated by
the two largest banks-HBOS and the Royal Bank of Scotland. As
a result, serious questions have been raised about a separate
Scotland's ability to stabilise its banking system in the event
of a future financial crisis.[109]
74. The Chancellor of the Exchequer
explained:
the Scottish economy—which
has been a great success over many decades and it is fantastic
that it is growing and creating jobs at the moment—has two
very large industries. One is financial services and the other
is oil. Sitting within a bigger country like the United Kingdom,
we can insulate against increases in the oil price or, more to
the point, reductions in the oil price. We can absorb banking
crises, even one as big as the near failure of the Royal Bank
of Scotland. Scotland alone, even in a currency union, would be
hugely exposed to one of those things going wrong in the future
and have had enough experience in recent years to know that these
things are not remote possibilities. They can happen.[110]
The exceptionally large and highly concentrated
financial sector of a separate Scotland is therefore likely to
increase the risks to financial services markets, firms and consumers
in an independent Scotland. As a result, in the event of separation,
there are two potential alternative consequences for the financial
services industry.
75. In the first scenario, if banks
were to make no changes to their group structure and keep their
existing headquarters, a separate Scotland would have an exceptionally
large financial services industry. In this situation, concerns
about financial stability could raise questions for the firms
themselves and for markets that finance those firms. There would
also be questions for an independent Scotland; it would have to
consider what resolution mechanisms-the methods used to sort out
financial institutions in crisis or near crisis-to put in place.[111]
Alternatively, where banks are faced with greater concentration
of risk, they may look to diversify or restructure themselves,
for example, so that they are no longer headquartered in Scotland.
76. Owen Kelly told us:
The idea that you can just unscrew
your brass plaque and move it is not quite correct. There are
regulatory requirements, certainly in the UK, and I am sure in
other jurisdictions. You would have to move a certain amount of
decision making and a certain amount of mind and management of
the company to show that you were in a position to be subject
to the regulation of the UK authorities.[112]
This was supported by evidence from
the Chief Secretary to the Treasury who said "the question
whether relocation can be achieved simply by moving a "nameplate"
without moving job, clearly that is not possible. For financial
regulatory purposes the locations of a firm's head office will
be determined by the location of the firm's central management
and control functions. For practical purposes this usually means
the location of a firm's senior management but also central administrative
functions such as internal audit and central compliance. So, as
a minimum, you would expect to see these high quality jobs transfer
with the transfer of a firm's head office".[113]
77. Mr Bailey told us to protect
the financial services industry:
They would need clear answers on
the cornerstones of economic policy-currency, fiscal policy, intergovernmental
relations and all the things the major financial institutions
would naturally look to.[114]
78. The creation
of an international border between Scotland and the continuing
UK would put the success of the financial services industry in
Scotland at significant risk. We have already seen evidence that
significant Scottish financial services companies are preparing
to relocate their headquarters, with the consequent effect on
Scottish jobs and the Scottish economy, in the event of separation.
It is clear from the evidence of contingency planning being undertaken
by major finance companies, that the referendum on separation
has created uncertainty in the financial services industry. This
uncertainty is now unavoidable. However, the more serious effects
which may follow in the event of separation can still be avoided.
It is important that voters are fully aware of these potential
consequences when making their decision.
Regulation of financial services
in a separate Scotland
79. One of the biggest issues in
relation to Scottish separation and financial services is regulation.
There is currently a single regulatory framework and a number
of bodies covering the whole of the UK that include:
· The
Prudential Regulation Authority (PRA) which is responsible for
the prudential regulation and supervision of banks, building societies,
credit unions, insurers and major investment firms;
· The
Financial Conduct Authority (FCA), a regulator which supervises
the behaviour of firms;
· The
Financial Services Compensation scheme (FSCS) which compensates
eligible depositors, investors and insurance policy holders if
a firm fails; and,
· Other
bodies including the Pension Protection Fund, The Financial Ombudsman
Services and the Money Advice Service.
80. The Scottish Government's analysis
in relation to regulation is based on the assumption that Scotland
will become a full member of the EU and will retain sterling.[115]
While the first assumption is by no means guaranteed, and is only
likely to take place after substantial negotiations which presently
have an undetermined outcome, the retention of sterling as part
of a currency union has been categorically ruled out by the three
largest political parties, as discussed in part one of this report.
Despite this, the Scottish Government maintains that:
Membership of the EU and the increasingly
integrated single market for financial services will be central
to Scotland's continuing success as a leading financial centre.
We will adopt EU initiatives, just as the UK does at present.
The only implication for the rest of Europe, or for multinational
companies, is that such rules, regulations and directives will
be implemented in 29 countries instead of 28.
Financial products and services
(including deposits, mortgages, and pensions) will remain denominated
in the same currency. Moreover, as part of the same single market,
firms will, in the main, continue to provide products and services
to consumers across Scotland and the UK no matter where they are
based.[116]
81. As a member of the EU, a separate
Scotland would have to have its own financial regulator. A separate
Scotland would also need a compensation scheme for depositors,
investors and insurance policy holders if a firm fails and it
would need to ensure that the compensation scheme is adequately
funded.[117] Professor
MacNeil told us:
I think you can analyse the European
influence in two aspects. One is what you might call the trade
flows in terms of business being done. It is true to say that
the cross-border trade flows have not been as great as was originally
envisaged when the single market was established. The second aspect
is: where do the rules come from? Predominantly, nowadays, the
rules come from Europe. That is why I think there is a slightly
different picture depending on how you look at Europe as between
flow of business and source of rules.[118]
82. The Scottish Government's Fiscal
Commission Working Group expressed "a preference for financial
stability to be coordinated across Scotland and the UK" and
recommended that "key elements of prudential regulation […]
be discharged on a consistent basis across the Sterling Zone".[119]
83. On prudential regulation, the
Scottish Government says:
The Fiscal Commission set out that
the Bank of England Financial Policy Committee will continue to
set macroprudential policy and identify systemic risks across
the whole of the Sterling Area. There could be a shared Sterling
Area prudential regulatory authority for deposit takers, insurance
companies and investment firms. Alternatively this could be undertaken
by the regulatory arm of a Scottish Monetary Institute working
alongside the equivalent UK authority on a consistent and harmonised
basis. The Bank of England, accountable to both countries, will
continue to provide lender of last resort facilities and retain
its role in dealing with financial institutions which posed a
systemic risk.[120]
84. The Scottish Government has
said the Bank of England will continue to be 'the lender of last
resort', saying that where financial resource was required to
secure financial stability, there will be shared contributions
from both the Scottish and Westminster Governments. This is based
on the principle that financial stability is of mutual benefit
to consumers in both countries, reflecting the fact that financial
institutions both in Scotland and the UK operate with customers
in Scotland, England, Wales and Northern Ireland and their stability
will benefit all concerned.[121]
85. For conduct regulation, the
Scottish Government proposes that this aspect of financial regulation
will be discharged by a Scottish regulator which will assume the
key responsibilities of the Financial Conduct Authority The Scottish
regulator will work on a closely harmonised basis with the UK
regulators, delivering an aligned conduct regulatory framework,
to retain a broadly integrated market across the Sterling Area.[122]
86. HM Treasury has analysed the
Scottish Government's proposals that prudential regulation would
be carried out "on a consistent basis across the sterling
zone" and conduct regulation would be discharged by a Scottish
regulator. It identified problems of accountability where the
UK regime is accountable to the UK Government but Scotland would
be a separate state. Additionally, it would be difficult to be
consistent across the UK and a separate Scotland, with two separate
fiscal policies and two sets of macroeconomic conditions. HM Treasury
argues that the lack of a consistent framework across the UK would
create additional operating burdens for firms and complexity for
customers.[123] It
further argues that Scottish prudential regulation would lack
credibility as it would not have a proven track record; that would
mean international counterparties are likely to be more cautious
when dealing with Scottish firms, which could potentially harm
those firms.[124]
87. When asked about the Scottish
Government's proposal that prudential regulation is carried out
jointly, Mr Bailey said:
It is not a system, I think, that
is used almost anywhere else in the world. The only possible examples
I could find were Greenland and the Faroe Islands, and they are
not obvious major financial centres.[125]
He went on to say that this does "not
mean to say it could not work".[126]
However, Mr Bailey warned that without a currency union, the implications
for the regulatory system would be quite considerable, "because
you have to regard the regulatory system, particularly the prudential
regulatory system, as a structure that is dependent on the choices
on currency".[127]
The Scottish Government's plans for a mixed system of regulation
appear to be an incomplete compromise and, like the proposed currency
union, to which they are linked, would work neither for Scotland
nor for the UK.
CONSUMER PROTECTION
88. A separate Scottish state would
need to establish its own financial consumer protection because
of EU requirements that Member States have their own schemes for
protecting customers' deposits. A Scottish Government spokesman
has been quoted in the Money Observer as saying:
The Scottish Government would ensure
that arrangements for an effective compensation scheme are in
place, mirroring the level of protection provided in the UK FSCS,
and in line with European harmonised levels of consumer protection.[128]
However, the article also quotes Owen
Kelly saying:
As far as we know, little work has
been done on whether or how the FSCS could continue to cover Scottish
depositors or savers or, indeed, how or whether a Scottish scheme
could cover non-Scottish depositors or savers. [129]
89. Owen Kelly told us:
[T]he nature of the debate is such
that none of the questions business would really like to know
the answers to can be answered until after a yes vote, if there
is one. If there is a yes vote, we then begin a period of time.
The duration is uncertain, although I respect the Scottish Government's
statement that it would all be done and dusted quite quickly,
or certainly within an 18-month period. There are other views
on that, but, even if you accept that 18-month period, it is a
period when questions such as what currency we will use and many
other things will still not be resolved, so, following a yes vote,
inevitably we seem to have to deal with a period of transition
and uncertainty.[130]
Professor MacNeil describe the transition
period as "the killer".[131]
He explained:
even if firms and customers can
envisage the steady state after the transitional period, the risks
associated with the transitional period are likely to cause them
to make decisions, say, to relocate or not to buy products from
that firm, for example in the case of English customers who may
be concerned about how the transition is going to work out.[132]
90. We recommend
that the Scottish Government responds to HM Treasury's analysis
on regulation of financial services in a separate Scotland and
outline how it proposes to address the issues identified, notably
how in the absence of a currency union a Scottish system of prudential
regulation would work. Otherwise, in the event of a vote for separation,
there could be very serious consequences as Scottish firms seek
the regulatory certainty they understandably want. We also recommend
the Scottish Government details how it would ensure a smooth transition
period so as to minimise the impact on business and consumers.
Impact on consumers
91. A separate Scotland would be
responsible for its own competition and consumer protection, including
money advice and financial ombudsman services. HM Treasury analysis
indicates that a separate Scotland would create new barriers to
business and claims that separation could have a direct impact
on individuals' personal finances.[133]
Independence would have an impact on customers based in the UK
given that 90% of Scotland's financial services industry customers
are currently based in the rest of the UK.
92. In the event of separation and
the emergence of separate financial jurisdictions, there would
be implications for the following financial products:
I. Bank accounts - financial transactions
that take place across an international border can create additional
costs on both sides, notably because the banks or the states operate
different polices.[134]
II. Pensions - 70% of all pension
products bought by Scottish consumers are from firms based in
the rest of the UK.[135]
Analysis by the Institute of Chartered Accountants Scotland shows
that if Scotland were to become a separate State, "the potential
impact on funding requirements for employers operating defined
benefit or hybrid schemes across the UK is likely to be substantial."[136]
III. Mortgages - it is rare for
mortgages to be sold across borders given the complications of
operating across the differing tax, regulatory and legal systems
of different states.
The Shadow Chancellor of the Exchequer
told us "Scotland would lose jobs, mortgage rates would be
higher, taxes would go up and public spending would be cut. That
does not sound very attractive in the short term, unless you believe
there is some other benefit."[137]
93. Owen Kelly identified five key
questions[138] surrounding
separation of relevance for investors and savers, both within
Scotland and outside:
· What
currency could be used?
· Under
what terms could Scotland be a member of the EU?
· What
will be the effects of independence on the current single market
for financial services in the UK?
· How
long would a transition to independence take and how would the
process be managed?
· What
would be the requirements for financial regulation?
While the Scottish Government has set
out its view on these issues in its White Paper, a comprehensive
and definitive set of response to these questions has yet to be
produced.
94. The Scottish
Government's existing proposals for financial services regulation,
and for safeguarding the customers of the financial services industry
are unsatisfactory. At present the United Kingdom has a single
financial services compensation scheme, which safeguards the savings
of Scottish people and those elsewhere in the United Kingdom.
This ultimately depends on the resources of the UK taxpayer, and
taxpayers' money was used to ensure that the UK Financial Services
Compensation Scheme was able to safeguard the savings of all consumers
in the recent financial crisis. Given the scale of the Scottish
banking sector in relation to the size of Scotland's economy,
it is inconceivable that a separate Scotland would be able to
offer this degree of security.
- The Scottish Government
should conduct a full impact assessment of the impact of separation
on the consumers of financial services in a separate Scotland
and the continuing UK, including a quantification of the costs
and benefits arising from separation.
93 "Scottish financial sector remains resilient",
Financial Times, 4 January 2012 Back
94
http://www.sfe.org.uk/facts.aspx Back
95
Q 4585 Back
96
HM Government, Scotland Analysis: Financial services and banking,
May 2013 Back
97
Speech by Owen Kelly, Chief Executive of Scottish Financial Enterprise,
at the Scotsman Conference, "A Question of Independence:
The Economics of Independence", June 2012 Back
98
http://ec.europa.eu/internal_market/bank/index_en.htm Back
99
Q 4587 Back
100
Q 4584 Back
101
Q 4785 Back
102
National Borders Matter: Canada-US Regional Trade Patterns, McCallum,
1995 Back
103
www.standardlife.com/utility/customer_statement.html Back
104
Reuters "Analysis - Scottish banks plan quietly as independence
debate gets louder", 7 February 2014 http://uk.reuters.com/article/2014/02/07/uk-scotland-independence-banks-analysis-idUKBREA161G020140207
Back
105
Ibid. Back
106
Q 4586 Back
107
HM Treasury analysis of FSA regulatory data available at www.gov.uk/scotlandanalysis Back
108
Ibid. Back
109
HM Government, Scotland Analysis: Financial services and banking,
May 2013 Back
110
Q 5695 Back
111
HM Government, Scotland Analysis: Financial services and banking,
May 2013 Back
112
Q 4606 Back
113
Letter from Chief Secretary to the Treasury to the Committee,
19 May 2014 Back
114
Q 4846 Back
115
Scottish Government, Scotland's Future - Your Guide to an Independent
Scotland, November 2013 Back
116
Ibid. Back
117
HM Government, Scotland Analysis: Financial services and banking,
May 2013 Back
118
Q 4587 Back
120 119 Scottish Government, Scotland's Future - Your Guide
to an Independent Scotland, November 2013 Back
Back
121
Ibid. Back
122
Ibid. Back
123
HM Government, Scotland Analysis: Financial services and banking,
May 2013 Back
124
Ibid. Back
125
Q 4788 Back
126
Ibid. Back
127
Q 4816 Back
128
Money Observer "Is Scottish independence a financial gamble?"
27 November 2013 Back
129
Ibid. Back
130
Q 4592 Back
131
Q 4666 Back
132
Q 4667 Back
133
HM Government, Scotland Analysis: Financial services and banking,
May 2013 Back
134
Ibid. Back
135
HM Treasury analysis of FSA product sales data for the financial
year ending March 2012, available at www.gov.uk/scotlandanalysi
Back
136
Scotland's Pensions Future: What Pensions Arrangements Would Scotland
Need? ICAS, April 2013 Back
137
Q 5762 Back
138
http://www.scotlandfutureforum.org/assets/library/files/application/Kelly.pdf
Back
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