Financing Scotland's recovery: analysis

Executive Summary

Background

The Cabinet Secretary for Economy, Fair Work and Culture wrote to me on 23 September, inviting me to convene a working group to advise Ministers on recapitalisation, equity investment and any other issues considered pertinent to financing economic recovery. This request was made in response to the recommendation of the Advisory Group on Economic Recovery (AGER) that the Scottish Government should use its convening power to coordinate policy approaches to economic recovery in close liaison with financial services institutions.

Ten recommendations are made across four areas of focus: Economic Overview, Financing Business Survival and Resilience, Financing Opportunity and Growth, and Business Support and Collaboration.

Part 1: Economic Overview – Key Findings

In this section I summarise the key economic evidence that best contextualises my analysis and recommendations. I identify six critical points:

1. UK Government loan schemes has vastly increased the debt carried by Scottish businesses.

2. Demand for finance has been, and remains, significant, but more than half of business borrowing remains unspent.

3. UK Government loan guarantees and the relaxed viability/affordability checks for access to schemes has increased the supply of debt finance.

4. The relaxed affordability checks presents future risk. Ability to repay is precarious, potentially leading to business distress at scale and limiting future access to additional finance for resilience and growth.

5. Beyond the emergency we face economic ‘long-COVID’: the economy will take time to ramp back up and heavily indebted businesses will struggle to access the capital necessary to drive growth and recovery. These effects are likely to have sectoral and regional dimensions.

6. EU Exit will compound these challenges and could extend them to sectors that may otherwise have coped relatively well with the pandemic.

Together, these findings present an extremely challenging economic context.

Part 2: Financing Business Survival and Resilience – Key Findings

In this section I define ‘recapitalisation’ as the measures necessary to help the economy recover from diminished revenues and significant new exposure to debt.

To succeed, any recapitalisation package must therefore achieve two objectives:

• managing debt exposure to prevent it from causing businesses to fail on a mass scale; and
• providing access to new capital to drive recovery, through investment in growth, sustainability and innovation.

The remainder of Part 2 is focused on meeting the first of these objectives: effective and fair debt management. In the first half of 2021, the economy faces a ‘cliff edge’ at which furlough and other support schemes end just as repayments on loans and deferred taxes begin to fall due. Due to the sheer scale of this problem, it is one best addressed through the fiscal and regulatory levers available to the UK Government. The imperative for Scottish Ministers is to influence this work, ensuring it is sufficiently ambitious and that it is responsive to the needs of the Scottish economy.

I therefore propose a range of positions on recapitalisation which, together, could act as a credible engagement agenda for Scottish Ministers to pursue with the UK Government. I identify six key objectives for that engagement:

1. Extend Forbearance i.e. seek to delay loan repayments and extend support schemes; allowing businesses time to re-establish revenues and save jobs.

2. Extend the Trade Credit Insurance Guarantee beyond 30 June 2021 – this is crucial support that protects supply chains and underpins business-to-business transactions.

3. Secure flexible repayment terms. Businesses, sectors and communities are not all created equally and it is important that lenders have discretion to work with businesses to find individual solutions that allow for restructure and refinancing.

4. We need an agreed framework to manage and recover coronavirus loan debt in a way that is clear and fair. Recovery processes should be transparent, sympathetic and consistent. Similarly, insolvency procedures should be streamlined with expertise made available to ensure ‘soft landings’ for distressed businesses.

5. We will require new finance schemes to bridge the gap between the pandemic and normal market conditions. These successor loan schemes must be ambitious, flexible and responsive to the needs of the Scottish economy.

6. Ensure small and medium-sized enterprises (SMEs) can seek meaningful redress for unfair treatment – this was a problem following the 2008 financial crisis and one that has yet to be fully resolved.

Part 3: Financing Opportunity and Growth – Key Findings

In Part 3 I look beyond the immediate crisis towards the longer-term challenge of providing access to new capital for the many businesses who are now heavily debt leveraged. Injecting capital is critical to ensure that businesses can drive recovery through investment in growth, innovation and sustainability.

To that end, I argue that there is scope to expand the use of patient equity investment across more traditional sectors of the economy normally considered unsuitable for this kind of investment. Making this work would require commitment and imagination. I therefore propose that the Scottish National Investment Bank (SNIB) and Scotland’s world-class asset management industry should collaborate to develop new approaches that stimulate the interest of both investors and a new class of potential investees. I also highlight similar discussions taking place at UK level and propose that Ministers ensure Scottish interests are represented.

In addition to providing access to new capital, an increase in patient equity investment provides opportunities for the Scottish financial services industry.

I also consider Scotland’s more established market for equity investment in high growth businesses. Here, I echo the findings of Mark Logan’s Scottish Technology Ecosystem Review; arguing that, despite the overall strength of the Scottish market, there is a concerning absence of venture capital activity and that we therefore need to increase the density and diversity of capital. I propose this could be achieved by pro-actively developing relationships with venture capital (VC) firms; putting energy and resource into showcasing Scotland’s best high growth prospects and considering state-backed capitalisation of privately-operated VC funds with a remit to investing in Scottish companies. I close Part 3 by highlighting the economic opportunities of establishing Scotland as a hub for green finance, investment and innovation.

Part 4: Business Support and Collaboration – Key Findings

In Part 4, I depart from my core remit of advising on financing recovery to offer brief commentary on the support that businesses will need, beyond the purely financial, to cope through a period of unprecedented challenge. The advice offered on these issues is not exhaustive and should be considered as a brief addendum to my main findings on financing recovery. I conclude that there has never been a greater need for the private and public sectors to work together to improve the quality, accessibility and intensity of advice and support for businesses. Scotland is a small country with a relatively small number of key economic institutions and networks. I suggest that it should be possible to leverage this to our advantage through more pro-active sharing of intelligence and networks to facilitate businesses’ access to new funding, partners and markets.

In the field of financial services, I propose a new model for industry engagement for further discussion between Scottish Financial Enterprise (SFE) and Ministers. I also introduce the first iteration of the SFE ‘Banking Barometer’ a monthly report which summarises aggregated real-time data from seven key Scottish banks. This is the first time that data of this kind has been made available to Ministers and has the potential to be a powerful new tool to inform policy development.

I finish the report with a reminder that Scotland faced economic challenges prior to the pandemic and that the effect of these ‘old’ problems is likely to be amplified. I propose that in planning longer-term economic strategy, attention should be paid to programmes which encourage investment in new technologies and innovation; improved leadership capability and mechanisms to diffuse best practice from highly productive firms to the wider economy.

Table of Summarised Recommendations ^[1]

Recommendation	Responsibility
	Scottish Government	Industry/ banks	Enterprise Agencies	SNIB	Business Organisations
1. Seek strategic route map to delay and intelligently schedule loan repayments.	Engage with UK Government (UKG).	Report through Banking Barometer.
2. Create a nationally agreed debt management framework.	Engage with UKG.	Report through Banking Barometer.
3. Influence design of successor loan schemes ensuring fair access to finance.	Engage with UKG.	Report through Banking Barometer.
4. Identify distressed businesses that play an important role in key supply chains and support financially and strategically.	Coordinate delivery of support to distressed businesses.	Help identify businesses & contribute to support. Report through Banking Barometer.	Help identify businesses and contribute to support.		Help identify businesses and contribute to support.
5. Explore expansion of patient equity instruments.	Initiate work from SNIB.	Collaborate with SNIB.		Collaborate with asset managers.
6. Diversify Scotland’s high growth investment market.	Attract VCs. Consider establishing new funds.	Advise on strengthening investment market.	Advise on strengthening investment market.
7. Use COP26 to showcase Scotland as a hub for green finance & investment.	Develop plan with SFE/SNIB.	Develop plan with SG/SNIB.		Develop plan with SG/SFE.
8. Public/private collaboration to improve quality, intensity & accessibility of business support.	Coordinate work. Develop policy.	Contribute to design & delivery of improved business support.	Contribute to design & delivery of improved business support.		Articulate needs of businesses & ensure design & delivery is of sufficient quality.
9. Harness shared networks to facilitate new contracts and access to markets.	Convene discussion.	Develop industry contribution.	Develop public sector contribution.		Articulate needs of businesses.
10. Take account of ‘old’ challenges in planning future economic challenges.	Lead policy development.