Brewin Dolphin : Scottish Independence - potential impact for clients and markets

12/09/14

Comments from Brewin Dolphin CEO and analysts

Brewin Dolphin Chief Executive's comment
Sterling - Guy Foster - Head of Research
ISAs - Marc Wilkinson - Head of Brewin Dolphin Scotland
BT Group - Nik Stanojevic
Diageo and SSE - Elaine Coverley
Retail Sector: Sainsbury's, Tesco and Morrisons - Nicla di Palma
Lloyds and RBS - James Box
Aberdeen Asset Mgmt and Standard Life - Ruairidh Finlayson
Investment Trusts - John Newlands

David Nicol, Chief Executive of Brewin Dolphin said:

"Since our merger with Bell Lawrie and Stocktrade in 1993 we have expanded the business and grown our client base and funds under management both north and south of the border. We have shared the costs of business development and regulation with our wider firm throughout the UK and created economies of scale; this has helped us to reduce costs and keep our charges to savers and investors competitive. If the additional expense of local regulation and reporting for clients in another jurisdiction had to be borne solely by our Scottish offices - this could feed through to higher charges for customers. So the lack of certainty is still palpable for our clients and for us.
However, we would like to reassure all our clients that we are committed to our Scottish business. We confirm that all clients' Sterling cash is, and will continue to be, held in Banks authorised by the Prudential Regulation Authority (PRA) and for which the Bank of England is the lender of last resort. Brewin Dolphin Ltd and the nominee, in which clients' assets are held including all ISAs, are both English registered companies. We will do all we can to manage the impacts of whatever the future may hold for savers and investors in Scotland."

We estimate that a yes vote could see the pound fall 5-10% in total (including moves as the chances become more acute). The reasons are as follows:
Logically gilts should suffer a higher risk premium given that the some portion of the debt is set to be passed through from Scotland to the remaining UK with the remaining UK still guaranteeing the full debt. There has, however, been curiously little reaction in the CDS market, so far...
It is assumed that Scotland would use sterling as its currency. Westminster reiterates that this would not be formally permitted as a currency union, but of course that is all it can
prohibit and within 'sterlingisation' it is unlikely in the short term that monetary policy would be dramatically different either way.
An independent Scottish currency would be a desperate outcome as given the size of the trade links between the two countries the increase in transaction costs and potential volatility for businesses would create a substantial and unnecessary cost.

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Nevertheless the weakness of the pound, if it continues should be beneficial for UK equities more generally, which have suffered from the strength of sterling year to date and would be susceptible to a weaker euro if the ECB pursues more aggressive easing.

We expect Scottish savers in existing ISAs will be able to retain their ISA savings and any benefits they continue to accrue, for the foreseeable future in their current tax free wrapper. So do not sell ISAs.
The Scottish Government has not confirmed whether or not ISAs will be extended or what savings incentives they may develop in their place. If a Scottish savings scheme is introduced, it is probable that current ISAs held by Scots would be transferrable into the new
contract. All Brewin Dolphin and Stocktrade ISAs are held in our English registered nominee.

SSE is more exposed than peers to the risks surrounding a possible Scottish Yes vote, with around half the groups EV coming from Scottish operations, due to the investments made in renewable and regulated networks. The Government has highlighted the issue of stranded generation and network assets, saying it "will not continue to provide a support mechanism for new or existing renewables in Scotland post separation". The UK might continue to source renewable power from Scotland post-independence but at a price that would be determined via negotiation. Scottish renewables would need to compete against other sources of renewable power both internal and external to the UK. SSE has 931MW of wind capacity in operation in Scotland out of a total onshore wind portfolio of 1,477MW. We would expect the Scottish government to continue to support the renewable industry given its
importance for the economy, and we would expect the Scottish and UK Government to agree a regulatory support mechanism for an integrated electricity transmission network.

Diageo is the one of the largest producers of Scotch Whisky globally and 30% of its sales come from Scotch. The implications for Diageo are two fold, firstly currency disruption. Scotch whisky is invoiced in US$ irrespective of where it is sold. Therefore the only transactional FX exposure that the company faces is GBP/US$ which is typically hedged on a 12mth basis. Currency in an independent Scotland could be much more volatile and more difficult and expensive to hedge. Secondly, a standalone Scottish government would have significantly diminished negotiating powers over scotch import tariffs. At present scotch enjoys tariff free access to the EU's 28 member states (the EU accounts for around 20% of Diageo sales).

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Doing business in an independent Scotland would lead to a rethink of national pricing, in our view. This would mean higher prices for food and other items (clothing, etc). Clearly, there would be good reasons for doing so. Furthermore, currently the UK has 0%-VAT rate on a large majority of food products. This does not apply in the EU. An independent Scotland (within the EU) would have to impose VAT on its food products.
Potentially, these could lead to retailers abandoning national pricing altogether. We do not think it makes much sense to charge the same price in the wealthy South East as in the poorer parts of Northern England. Land costs, labour costs are higher in the South East and the prices charged should reflect that in our view.

Lloyds has been far from complacent on Scottish independence: the management team has mentioned on numerous occasions that it has a contingency plan in place - which means it is already a critical step ahead of the UK government. The precise terms of independence will determine the specifics of Lloyds' contingency plans, which could include moving the registered office to the UK and reconfiguring the legal structure to ring-fence Scottish assets and liabilities. Lloyds is a multi-branded group which could be helpful: for instance Bank of Scotland could become the "Scottish brand" while the Lloyds and Halifax brands remain south of the border.
If the Yes vote passes, the uncertainty around the precise terms of Scottish independence is likely to weigh on sentiment towards the stock. Independence will also undoubtedly result in one-off re-organisational costs relating to the contingency plan. Lloyds insists, however, that independence will not materially change its long-term strategy or its competitive strengths.

Nine out of ten customers are south of the border. It would therefore make more sense for Standard Life to move its registered company address and potentially its headquarters to London. It has already set up an English and Welsh shell company and there have been rumours that it is looking at suitable buildings in London for the transition. Will people move their pensions away from Standard Life as a result of independence? Unlikely, particularly if it is quick to move its registered address and given the sheer length of time it takes to transfer pension providers.

Aberdeen is not particularly exposed to the UK let alone Scotland. Client monies from Scotland represent a tiny fraction of assets under management (AUM) and the majority of AUM is denominated in currencies other than sterling. As a global fund manager, the money could be managed from Barbados, Fuji or East Timor. The Scottish brand is important and this is unlikely to change regardless of the result; therefore we suspect its headquarters will remain in Aberdeen with offices all over the world.

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John Newlands, Head of Investment Trust Research

Two useful reports, written by JPMorgan Cazenove and Oriel respectively, have been published recently on the impact of the Scottish Referendum. Both notes make particular reference to infrastructure and renewable energy trusts, a number of which invest in PFI, wind and solar projects in Scotland. In summary, both reports suggest that a Yes vote could lead to the UK government ceasing to underwrite or subsidise Scottish-based projects, leading to higher discount rates being applied. However, it is argued, the effect on overall net asset
value of such trusts would be modest - perhaps up 1.5% for PFI vehicles such as HICL, JPM Cazenove suggests, or up to 2.5% for pure renewables funds such as TRIG.

The financial brokerage firm Winterfloods has estimated that some 41 UK investment companies (still usually referred to, for historical reasons, as investment trusts) with gross assets of £21 billion, are incorporated in Scotland. These trusts represent a little over 20% of the total £102 billion sector. These Scottish-registered trusts are listed in the table below.

GA (£m)
GA (£m)
Alliance Trust 3076 F&C Private Equity Trust 225
Scottish Mortgage & Trust 2925 Schroder UK Mid Cap 188
Templeton Emerging Markets 1776 Pacific Assets 184
Edinburgh Investment Trust 1355 Value and Income 177
Murray International 1330 Securities Trust of Scotland 174
Aberforth Smaller Companies 1182 Independent Investment Trust 163
Scottish Investment Trust 807 Martin Currie Global Portfolio 162
Edinburgh Dragon 571 Troy Income & Growth 141
Personal Assets 556 Investors' Capital Trust 139
Murray Income 546 Henderson Value Trust 138
British Assets Trust 496 Martin Currie Pacific 134
BlackRock Smaller Companies 480 Baillie Gifford Shin Nippon 132
Finsbury Growth & Income 459 Dunedin Smaller Companies 117
Dunedin Income Growth 426 Dunedin Enterprise 115
Scottish American 404 EP Global Opportunities Trust 111
Standard Life European Private
Equity 386
Montanaro European Smaller
Companies 104
North American Income Trust 275 Mid Wynd International 76
Baillie Gifford Japan 266 F&C Managed Portfolio 65
Scottish Oriental Smaller Companies 265 Aberdeen Smaller Cos High Income 63
Standard Life UK Smaller
Companies 253 SVM UK Emerging Fund 4
Edinburgh Worldwide 241 £20.7bn

Source: Winterflood Securities.

Two slight oddities emerge from the table. The first is that a number of apparently "English" trusts, such as BlackRock Smaller Companies, Finsbury Growth & Income and Henderson Value Trust were originally formed in Scotland and remain registered there, even though they are run from London. The second and less immediately apparent anomaly is the opposite case. That is, a number of trusts currently managed from Scotland are registered elsewhere.

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Monks and Pacific Horizon, for instance, though both managed by Baillie Gifford from
Edinburgh, are registered in London. The table below lists these and other examples.

It should be noted that the above table excludes a whole raft of investment trusts - and other types of fund - registered outside Scotland and run by sizeable management companies such as Aberdeen Asset Management and Foreign & Colonial Management. These very large organisations have offices on both sides of the Scottish border and presumably retain the flexibility to locate their fund managers where they like. Again, in an extreme case these companies could decide to close their premises in Scotland entirely and relocate everything south.

All of the major investment trusts incorporated in Scotland have investigated the possibility and the costs of re-registering their companies in England. None (except Alliance; see below) has gone ahead with this process, mainly because of the cost, typically estimated at several hundred thousand pounds. The consensus feeling is that independence, if voted for, would become a reality only by 2016 at the earliest. As one trust's communication put it recently, "shareholders can be confident that in the event of a 'Yes' vote, the Board would act
impartially and do whatever seemed in shareholders' best interests as regards managing their tax affairs and maximising dividend receipts".
This situation is nevertheless under constant review and is likely to become more fluid over the coming months. For instance, in early 2014 it was announced that Alliance, the self- managed £2.5 billion investment trust that has been run from Dundee since the late nineteenth century, has begun relocating parts of its business south of the English border. To quote the relevant RNS announcement, "To remove any uncertainty, we have started work to establish additional companies which will be registered in England, in order to provide operational flexibility and to complement our existing business in Scotland. This gives all our customers, regardless of their location, full confidence that we will be able to provide continuity of service and protection for their investments and savings".
What Alliance has done is to register shell companies in England to expedite a transfer, should it be deemed necessary, of its two subsidiary businesses, Alliance Trust Savings and Alliance Trust Investments. No similar action has been taken for the investment trust itself.
I have canvassed most of the other major Scottish houses on an informal basis, all of whom so far seem content to await the outcome of the forthcoming referendum before taking action of any substantive kind. The move by Alliance, on the other hand, has clearly raised the profile of the whole issue could trigger more tangible actions by other companies and groups.

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The argument in favour of inertia looks better-reasoned, it has to be said, for wholly Scottish vehicles than it does for London-run companies such as Finsbury Growth & Income, which could take all cross-border risk out of the equation for once and for all by moving their registration south at modest cost in percentage terms.
A further point is that decisions of this type may not lie solely with the trust's respective
boards. While the boards remain committed to explore the best interests of their
shareholders it also remains appropriate for shareholders to consider their own best interests. These could be served, not just by the re-incorporation of trusts as rUK entities, but through consolidation within the sector during which Scottish trusts could be acquired or reversed into rUK-domiciled trusts - actions which have the scope to realise value in other ways too.
These possibilities suggest that, in the longer term, there could even be an advantage in being a holder of many of these trusts.

The above analysis suggests that investors resident in Scotland have less to worry about - in financial terms that is, as opposed to the worry of being severed from the United Kingdom - than their cross-border counterparts. It seems very unlikely that an independent Scotland would attempt to shoehorn several million people out of their tax-sheltered vehicles. This would be akin to alienating large chunks of the voting population. In addition, it does not look a logical move for such investors to exit from London or Channel Islands-registered holdings in favour of purely Scottish vehicles. This would introduce concentration risk coincident with the massive uncertainty of the financial status and credit-worthiness of an independent
Scotland. Such a strategy would make even less sense in the months before the referendum, just at a time when Scottish securities face uncertainties and possibly selling pressures of their own. As to the investment trusts themselves, it is worth noting that even should their managers, their Boards, their offices and their staff all be as Scottish as Robert Burns eating an Arbroath Smokie while wearing full Highland Dress, their investment portfolios tend to contain at best a small percentage of Scottish-registered holdings. While there may be an element of discount risk in the run up to the referendum, therefore, a trust's true worth, in the form of the net asset value of the invested portfolio, is likely to remain unchanged by these upcoming political events. At least until March 2016 and in Sterling terms, that is.

Returning to the main theme and the September 2014 reports about infrastructure trusts in particular, our overall conclusion remains that where investment trusts are concerned, there is no need for hasty action of any type. Investment trusts after all have portfolio holdings that
are largely made up of listed entities themselves and often trade at an overall discount to their net asset value. Very few of these holdings are based upon the fortunes of the Scottish economy, infrastructure vehicles, as highlighted above, being the most obvious possible exception. There is therefore an underlying worth there that short-term sentiment cannot destroy, even if there are nearer term price fluctuations. This view is incidentally shared by all the major Scottish investment trust houses, a number of which run both English and Scottish- domiciled trusts from north of the thus far non-existent border posts.

ENDS

No investment is suitable in all cases and if you have any doubts as to an investment's suitability then you should contact us.

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The value of investments can fall and you may get back less than you invested.

Past performance is not a guide to future performance.

The opinions expressed in this article are not necessarily the views held throughout Brewin Dolphin Ltd. No Director, representative or employee of Brewin Dolphin Ltd accepts liability for any direct or consequential loss arising from the use of this document or its contents.

Notes to Editors

The Brewin Dolphin Group manages over £28 billion of funds for over 100,000 private clients and of this £22.7 billion is on a discretionary basis. BD has 30 offices throughout the UK,

EIRE and the Channel Islands.

Brewin Dolphin Limited ("BD") is the principal operating company of Brewin Dolphin Holdings PLC. BD is authorised and regulated by the Financial Conduct Authority and is a member of the London Stock Exchange.

Established in 1762, Brewin Dolphin is one of the UK's largest independently-owned private client wealth managers. The Group provides a wide-ranging investment management and financial planning service for private investors, charities and pension funds. Stocktrade is the Group's Execution-Only telephone and online dealing division.

Please see the Media Centre section on our website: http://www.brewindolphinmedia.co.uk/media.aspxfor details and photos of all commentators and analysts throughout the BD Group.

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