UK: Currency Union Or A Separate Currency In An Independent Scotland And Some Possible Implications Of Both

Last Updated: 18 February 2014
Article by Philip Mackay

This bulletin focuses on the currency elements of the paper entitled 'Scotland's Future - Your Guide to an Independent Scotland1 ' (the 'White Paper') in the context of a speech given by Mark Carney, Governor of the Bank of England on 29th January 2014 and the possible implications of a currency union or a separate Scottish currency.

Currency Union

The White Paper proposes a sterling currency union between an independent Scotland and the rest of the United Kingdom ("RUK") with the Bank of England remaining the central bank and lender of last resort for both RUK and an independent Scotland.

The concept of a currency union is dependent upon RUK approval and negotiation, as well as the outcome of negotiations with the EU on the terms of any Scottish membership (including any possible future membership of the Eurozone). The Scottish Government believes that a Sterling currency union is in the interests of RUK.

Governor Carney offered initial talks on the currency union concept in the Autumn and was in Edinburgh on 29 January to commence these with the Scottish Government: Although they were not framed that way, his comments could be interpreted as the initial technical negotiation stance of the Bank of England in the event of a 'Yes' vote in September 2014.

Governor Carney – "a durable, successful currency union requires some ceding of national sovereignty"

Governor Carney emphasised the following high level comments in relation to any such currency union (the words in italics are direct quotes):

  • Any arrangement to retain sterling in an independent Scotland would need to be negotiated between the Westminster and Scottish Parliaments. Whilst constitutionally Governor Carney's comments are correct, it is likely that the Bank of England's views will influence the Westminster Government and the international financial markets.
  • The costs and benefits of sharing a currency include the elimination of the transactions costs in using different currencies but this needs to be balanced against the potentially large costs of giving up an independent monetary policy tailored to the needs of the specific country, including a flexible exchange rate that can help absorb shocks.
  • The success of a currency area hinges on whether its features mitigate the costs of losing the flexibility that comes from an independent monetary policy. In other words, the loss of flexibility should be mitigated if the relevant economies are closely aligned. The Scottish Government has emphasised that the Scottish and RUK economies are highly integrated but Governor Carney noted that there is a body of evidence that national borders can influence trade flows, even between otherwise highly integrated economies. The high degree of integration between Scotland and the rest of the UK may in part depend on their being part of the same sovereign nation.
  • The existing banking union between Scotland and the rest of the United Kingdom has proved durable and efficient. It involves common standards and protections such as a single deposit guarantee scheme backed by the central government and a common central bank, able to act as Lender of Last Resort across the union, as well as common supervisory standards. The euro area has shown the dangers of not having such arrangements, as well as the difficulties in agreeing the necessary pooling of sovereignty to build them. An independent Scotland would therefore need to consider carefully how to develop arrangements with the continuing United Kingdom that are both consistent with its sovereignty and sufficient to maintain financial stability.
  • The fiscal arrangements surrounding a currency union are particularly sensitive in the political debate given the importance of fiscal independence to the arguments of the 'Yes' camp. He emphasised that in a monetary union between an independent Scotland and the RUK the two Parliaments would have to agree on fiscal arrangements and he cited the example of the Eurozone which highlighted that fiscal risk sharing may be necessary to make a currency union work satisfactorily.
  • In summary Governor Carney emphasised that if a currency union between an independent Scotland and RUK ever were to happen, it would have to be built on strong common foundations in order to avoid the problems associated with the Eurozone. In short, a durable, successful currency union requires some ceding of national sovereignty. It is likely that similar institutional arrangements would be necessary to support a monetary union between an independent Scotland and the rest of the UK.

What are the other relevant implications of the proposals in the White Paper for the financial sector?

Payments

An advantage of currency union is that there would be no consequences for payment provisions in contracts as such payments would still be in Sterling.

Interest Rates

If there was a currency union with Bank of England remaining as the lender of last resort in Scotland, then the base rate would be set by the Bank of England and would be the same in Scotland and RUK.

Interest Rate Caps

The White Paper proposes a cap on certain interest rates in line with some other developed nations. Not much detail is provided but it does appear to be aimed at consumer credit, particularly payday lenders. The scope and level of the proposed cap needs to be clarified and, in particular, confirmation is required that it would not apply to commercial arrangements such as high-yield bonds and notes.

Capital Adequacy

It is proposed that the capital adequacy regime would be the same between Scotland and RUK and this would be relevant to the capital raising costs of Scottish financial institutions post-independence.

Banking Bill

The White Paper endorses the approach of the Vickers Report and UK Government proposals about the ringfencing of "less risky" bank activities.

Banking Act 2009

The White Paper does not mention the special resolution regime created by the 2009 Act. However, on the basis that the Bank of England would remain the central bank of a currency union and similar prudential conduct regimes would apply, it may be presumed that the special resolution regime would continue to apply in Scotland. However, it is not clear what would happen if there was a disagreement between the Scottish and RUK Governments (or the relevant national regulators) on how to deal with a distressed Scottish financial institution. From Governor Carney's speech, it is clear that he would view it as vital for a currency union that a common policy (with common resources) be put in place.

If a Plan B involved Scotland establishing its own currency – What might it look like?/H3>

Background

There is no Plan B in the White Paper and it is a matter of conjecture what the Scottish Government would do if no agreement on a currency union was reached. Just as the UK Government has declined to show its hand, the Scottish Government is not discussing what would happen if there was no deal on Sterling. Apart from the option of adopting the euro (which is not proposed by the Scottish Government and, in any event, would require the agreement of the members of the Eurozone) the remaining option would be for Scotland to establish its own currency.

This would be a difficult exercise but if a Scottish currency (which for these purposes, we call the Scottish Pound) were to be created, what would be the possible consequences for banks and businesses in Scotland and RUK?

Conversion

We have some idea of how new currencies are created in the light of, in particular, the creation of the Eurozone. As most domestic payment obligations (both consumer and business) are denominated in Sterling, it would be necessary for the Scottish Parliament to pass legislation converting Sterling at a specified rate. We would envisage that the rate would be fixed after consultation with banks and other interested parties, not only for the purposes of seeking to maintain business confidence but also to avoid any possible Human Rights challenges if the rate was viewed as being fixed unfairly. It would be open to the Scottish Government to seek to peg the Scottish Pound to Sterling but the viability of such an arrangement is dependent upon market sentiment and the willingness of the Scottish Government to use financial tools such as interest rates to support parity.

The Scottish Parliament, in conjunction with the Scottish Government, would also need to consider the scope of the conversion process. It is presumed that debts between persons and entities situated in Scotland where the obligations are governed by Scots law would almost certainly be covered by the conversion process whereby amounts payable would be denominated in Scottish Pounds but other scenarios are more complex. For instance, if there is a Scottish debtor and a non-Scottish lender, it is possible that such payments would not be covered by the conversion process as the debt is not payable in Scotland. Also, if English law is the governing law of the underlying contract then it is possible that the English Courts would view Sterling as the relevant currency.

Specific Conversion Issues

Practically, it would be in the interests of the Scottish Government to implement a conversion proposal that maintained business confidence and it is possible that the conversion process could be drafted in such a way as to maintain Sterling payments for commercial agreements during their remaining lifetime. In any event, however, there would be "difficult" cases to be resolved.

For instance:

  • Would payments by Scottish debtors to branches of RUK or foreign banks be viewed as being payable in Scotland? We suspect that if the relevant account is in Scotland, then it could be viewed as being a Scottish payment unless governed by English law. It would be difficult to see a reason why the Scottish Parliament would favour non-Scottish banks over Scottish banks but it is, of course, open to banks to transfer accounts to England although that move may not be popular with some customers.
  • Would public bodies such as local authorities be obliged to pay in Sterling or Scottish Pounds? In some ways, it would be logical for such debt obligations to be denominated in Scottish Pounds but it may be the case that the lender is not resident in Scotland and that the loan agreement is governed by English law (in which case, as mentioned above, there is potential conflict as the English Courts may view the debt obligations as being denominated in Sterling). We think that there is a strong case for saying that pragmatism will prevail on the basis that the public debt market is limited and any adverse consequences for lenders as a result of redenomination could lead to a drying-up of lending to such public bodies although there could still be a mismatch between the public bodies' revenues and their Sterling obligations; however, this is not without precedent and public bodies in other European states have denominated debt obligations in currencies other than their national currency.
  • Would consumer credit or mortgage obligations be redenominated? There could be serious political ramifications if mortgage or other retail payments were denominated in Sterling whilst the debtor was being paid in Scottish Pounds.

Interest Rates

If the Scottish Pound was created and a contract was redenominated, then the Bank of England base rate would not apply and interest rate benchmarks for Sterling would no longer be relevant. A new Scottish central bank would set the base rate for the Scottish Pound.

Asset Value and Financial Covenants

Another consequence of redenomination would be the impact of currency fluctuation upon asset valuation. This would be of importance for company and fund accounts which are stated in Sterling but where the company has substantial assets situated in Scotland (particularly real estate) which are valued in Scottish Pounds. From a banking perspective, even if there was no redenomination of payment obligations, cashflow and asset cover ratios could be impacted where a borrower draws most of its revenue from, or has most of its assets in, Scotland.

Trading consequences

If a Scottish Pound is adopted and there is an adverse fluctuation in the exchange rate, this could impact upon Scottish exporters not only to RUK but to other overseas markets. It is possible that some exporters, especially where their costs are primarily in Scottish Pounds, could benefit from such fluctuations but there would be an additional (although common) burden of managing Sterling hedging costs. Importantly the consequences are not limited to Scottish exporters as businesses in RUK would also be affected. One statistic that highlights this is that whilst the US is RUK's biggest export market, its second biggest market is Scotland and indeed RUK exports to Scotland are believed to be greater than combined exports to Japan, India, Russia, South Africa and China. If the Scottish Pound was adopted, RUK exporters would have to look at whether they hedge such costs or if they continue to seek payments in Sterling but the latter route would not be a viable option for RUK retailers operating in Scotland.

Documentary Changes

It is difficult to advise whether lenders should revise their documents to mitigate any consequences of the adoption of the Scottish Pound, partly because not only are neither the Scottish nor UK Governments advocating such a move but also because, even if it were to happen, the exact terms are very unclear.

Summary

There is a lack of clarity on what currency arrangements would be in place if Scotland votes Yes this year. However, we will continue to monitor developments and update you in the lead-up to the Referendum vote.

Footnote

1. Published by the current Scottish Government on 26th November 2013

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.