This would entail Scotland issuing vast amounts - billions of pounds worth - of 'sub-sovereign' bonds directly to the market. Potentially a good idea? Maybe, but ironically it's likely a non-stater because of SNP policies. Here's why (thread). 1/ https://twitter.com/tomfrench85/status/1280827810630774786

Sub-sovereign bonds are debt instruments 'issued' - sold - by sub-national governments & are not uncommon, especially in federations. The Free State of Bavaria for example issued €3 billion of bonds in March to help finance lockdown. 2/

The @scotgov argues it wants to take advantage of current ultra-low interest rates & become a big sub-sovereign borrower, but that assumes @scotgov will, like the Bank of England, be able to borrow at ultra-low rates. 3/

I would argue that, upon examination of the fundamentals that would determine the rate the Scottish government could borrow at, we find that Scottish government bonds in the current political climate would not achieve attractive borrowing rates - and that's thanks to the SNP 4/

In the absence of credit ratings agencies making a formal assessment of a hypothetical Scottish sub-sovereign bond market, we can look instead to the academic literature to gain a sense of how bond holders will view the risk of Scottish bonds. 5/

This paper for example provides useful insights. A key risk factor for sub-sovereign debt holders is the probability of a central (ie, UK) government bailout of bond holders if it were needed. 6/

https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1987.en.pdf

We can conclude that Scotland, as part of the UK, could issue sub-sovereign bonds at low interest rates as long as investors assess that there is a credible implicit expectation that the UK government is the ultimate backstop. But here's the thing. 7/

The current Holyrood administration's intent is separation from the UK as soon as possible. What's more, the SNP are currently surfing a wave of populist support, riding high in the polls, and recent polling has shown a small majority for separation. 8/

Now imagine you're an investor and are thinking about buying these new sub-sovereign Scottish bonds. You assess that the UK wouldn't let Scotland default currently, but you also know that there's a real risk that the UK backstop could disappear. 9/

In other words, there's a real risk that your bonds become - definitively - a pure Scottish liability, reliant on a newly sovereign government on its own meeting its payment obligations. What risk premium, above UK sovereign debt, would you demand for that risk? 10/

What's more, there's a very good chance that the new independent Scotland will default on its payments. More on that risk here: 11/ https://twitter.com/JohnFerry18/status/1271379726674919425?s=20

In conclusion then, with Scottish separation a real possibility, bond holders in Scottish sub-sovereign debt would demand a hefty risk premium (ie, the Scottish gov would have to pay much higher rates than equivalent UK Gilts) to hold the debt. 12/

Ironically, Scottish government bonds could be issued in large amounts at very low rates if we had a Holyrood government not intent on separation, and if polling demonstrated that separatism was a fringe activity. 13/

So if the SNP were federalists, for example, rather than nationalists, then a serious case could be made for the creation of a sub-sovereign Scottish debt market, but given their commitment to the extreme outcome of full separation, that makes it a non-starter. Pity. 14/

That said, if @scotgov are serious about this then the next step would be for them to commission leading rating agencies like Fitch to report on the establishment of a Scottish sub-sovereign debt market. This would include a formal review of fundamental credit risks. 15/15