Investing with Purpose: global capital investment plan

Executive Summary

Why Capital Investment is Important

As we move beyond the pandemic and face the future Scotland's economy faces significant challenges. The imperatives of the just transition to Net Zero are critical, and demographic shifts place greater demand on public resources while reducing the working age population. Challenges which are only made worse by the unnecessary disruption of EU Exit. We recognise that meeting these challenges requires an investment-led recovery. Our strengths in skills, academic excellence, research and innovation, advanced technologies and natural resources give us the tools to do the job. But to mobilise these assets, and build a wellbeing economy with fair work and inclusive growth at its heart requires significant increases in the levels of capital investment in our economy.

Guided by our Vision for Trade, the Global Capital Investment Plan is the final of our three pillars focused on internationalising the Scottish economy. Following on from our Inward Investment Plan and Export Growth Plan, it sets out how we will attract productive forms of private capital investment, in sufficient volumes, focused on creating the market conditions for an investment-led recovery; and doing so in a way that is consistent with our values of Net Zero, inclusive growth and fair work.

We are also clear about what this plan is not. We draw clear distinctions between those investments which seek private capital investment and those which are required to be undertaken solely by the public sector. This is not a plan to lever private investment into core public services but rather to increase the flow of private capital into supporting the wider economy. It seeks to align our efforts to attract private capital with the investment needs of our most competitive global sectors. This will ensure that start-up and scale-up businesses are well placed to benefit from investment to power their growth and create good, green jobs and with the needs set out specifically for private investment in the Infrastructure Investment Plan, the Climate Change Plan and Housing 2040. In doing so, the Plan draws on the recommendations and response to the Advisory Group on Economic Recovery report for an investment-led recovery which leverages public spend to increase private investment, and aligns with the actions in the Logan Review on building Scotland's tech sector and in the Financing the Recovery report on Scotland's business support needs.

Private Capital Investment in the Economy

This plan defines private capital investment as the deployment of an external source of internationally mobile finance into a project or business in Scotland. This differs from Inward Investment (or FDI) which seeks to attract foreign-owned companies to directly set-up or expand operations in Scotland. Private capital investment is a different market from FDI and as such requires a different investment strategy.

Capital investment can have a range of potential impacts on immediate economic outcomes, which then impact the Scottish economy in the longer term. The supply of private capital can help businesses realise their growth ambitions by removing key financial, and knowledge, barriers to expansion. This impacts on productivity through better quality infrastructure as well as through companies growing and having competition or demonstrator impacts on their sector. And there are further impacts from venture-backed company investment through supply chains and wider economic activity. Scotland, like the UK, has suffered from historic under-investment, which is seen as a key driver of slow productivity growth over past decades.

The Plan is broad, covering as it does investment into business growth, infrastructure and real estate. This, combined with the on-going economic uncertainty, makes it difficult to give an exact figure of the benefits to the economy of implementing the actions in it. However, internal modelling suggests that the longer term benefits to the economy can be both substantial and persistent. The direct impact of increasing private sector business investment to the overall level among OECD countries (as a percentage of GDP) and the potential indirect impacts of higher levels of productivity, could permanently increase the level of GDP by around 1.9% by 2030 (around £3.1 billion a year in 2019 prices). This could also increase average earnings in Scotland by 4.9%, around an additional £1,400 a year to the average Scottish employee in today's prices and is in addition to supporting our Net Zero and wellbeing economy ambitions.

Not all capital investment achieves these positive impacts. The choices set out in this plan explicitly seek to focus effort on attracting investment that generates wider spill-over benefits, and aligns with our values around good global citizenship, tackling climate change and increasing wellbeing.

Baseline performance

The plan begins by baselining our current performance. Scotland outperforms other regions in the UK in attracting inward investment. However, compared to other OECD countries, there is scope to improve our performance in attracting global capital investment into business growth, infrastructure and commercial property.

Business investment – Scotland's companies attract £34.8 billion in investment annually and this is gradually rising. Much of this is due to past success in creating a strong business angels network, but this is heavily focused on early stage investment. Investment around company growth and scaling is limited by a small market with few players, in which Scottish companies can be under-valued when they do attract equity, or have to leave Scotland entirely in order to gain investment. It is also limited by the number of companies seeking investment – we will need to work hard to increase ambition and financial awareness.

Infrastructure investment performance is more difficult to ascertain through data. However, much of Scotland's success here can be linked to investments in onshore and offshore wind, and in particular to the regulatory and pricing certainty offered by UK schemes such as Contract for Difference (CFD). Our investment needs to deliver Net Zero and our digital ambitions are very substantial. Whilst we need to vastly increase the scale and type of infrastructure investment to meet Net Zero obligations, we do not have the regulatory levers, nor clarity on the UK government's appetite for extending a CFD-style approach to sectors such as heat or hydrogen. We also need to address issues around the scale of projects in these sectors.

Scotland's performance in attracting commercial property investment has been flat, and below par at about 4% of UK levels. It has been tilted in favour of standing stock (existing assets changing hands) rather than development capital (which builds new assets). With COVID-19 and EU Exit, the first half of 2020 saw total commercial investment volumes decrease by 73% from the same period last year. We will need to encourage investment into re-purposing under-utilised assets in town and city centres and to expand industrial real estate capacity to support business growth, in particular around our clusters in our key target sectors.

Given tough market conditions, marshalling an investment-led recovery will require us to understand and engage with what makes a project, business, or location viable in the eyes of the market. Investment is constrained by uncertainty, and that uncertainty is currently being accentuated by COVID-19 and the UK's exit from the EU. Under these circumstances, we must be realistic about timescales, and prioritisation to engage with the right investment markets with the right solutions for particular economic needs.

The plan sets out three main pillars to address this challenge: these act as both filters to assess project suitability for private capital investment; and as levers to increase our chances of success for prospects we do take to market.

1. Increasing the effective supply of capital, by better understanding and targeting different sources of funding.

2. Presenting our best "market ready" opportunities, using the strongest internationalised areas in the economy to create demand for investment.

3. Bridging the gap – taking action to increase the viability and fit of what private capital markets want to invest in and the attractiveness of our investment propositions.

The supply of capital

The plan begins the work of mapping the global investor landscape, although recognising that this is an area in which Scotland needs to develop capability. There is a wide range of investor types, and within each type a wide offer of individual investors, each with their own risk and reward preferences, timescales, and investment mandates for individual funds. Our aim over time is to deepen our understanding of the needs of those different investors, in order to offer better tactical and strategic matches to individual projects. An overview of the spectrum of private investment capital is outlined in Figure 0.1.

Figure description:

Figure shows a simplified model setting out the different types of capital investor as defined by risk and reward profiles.

We also aim to build up better long-term partnerships with investors, as many initial investors in Scotland go on to be repeat-investors. As market and investor preferences evolve over time, this better intelligence and insight will also help us judge when we can nudge some investors towards greater risk appetite in Scotland and ultimately higher economic impact; and when for others we are more likely to gain a first investment by showing an investor a safer or lower risk route into Scotland.

Capital investors exist all over the world, but they do tend to concentrate in relatively few global centres. Again, a better understanding of the investors in each location will lead to better targeting of those partnerships we want to build by intelligent deployment of our global network, including Scottish Government overseas offices, Scottish Development International and our Trade Envoys and Global Scots.

Global investors frequently seek a local investor partner, which both gives assurance and helps overcome information asymmetries. We must not underestimate the emerging importance of the Scottish National Investment Bank in this space, or of making much stronger connections with the investment sector based in Scotland, which already manages £590 billion of assets.

Globally, there is a strong move towards responsible investing, variously called Impact Investment, Ethical Investment or Environmental, Social & Governance (ESG) investment. ESG criteria can play a decisive role in investment decisions: 91% of investors surveyed say that non-financial performance has played a pivotal role in their investment decision-making over the past 12 months either "frequently" or "occasionally".^[1] In 2020, ESG-focused funds broke through $1 trillion in assets under management. Despite still being a relatively small segment of the market, the direction of travel is clear, and has even seen acceleration during the COVID-19 pandemic. In the UK as a whole, more new money was invested in ESG funds in the second quarter of 2020 than in the previous five years combined, and global estimates show flows into ESG funds comprising between a third and half of all global fund sales over the past year.

Scotland is already in a strong position to pivot towards Impact/ESG investment. Research by the Ethical Finance Hub found that Scotland-based investment funds manage 11% of the UK's responsible investing market, compared to a 7% share of the conventional market; and that this had formed a significant part of the sector's strong growth in recent decades. The areas Scotland needs investment in are attractive to investors looking to increase their exposure in responsible investing. These include the Scottish growth sectors which offer strong ethics (data, digital and health), Net Zero and a business environment in Scotland focused on fair work and equalities.

Setting our Strategy: leading with Scotland's best opportunities

Our Inward Investment Plan has already identified the sectors in Scotland's economy which are globally competitive, crisis-resilient and likely to offer growth which benefits the broader economy and society as well as the business itself. New analysis for this Plan finds the strongest deal flows in the same sectors, underscoring them as the best opportunity we have to use the global economy to build our domestic strengths. The Plan summarises these sectoral opportunities into four sectoral themes: low carbon transition, health and life sciences, digital, and high value manufacturing.

These four sectors are the most likely drivers of future economic demand in the economy. They are broad, and that is deliberate. Whilst the focus has to be on those sectors which can drive growth and recovery precisely because they are already strong, this approach leaves space for different sub-sectors to develop and come to the fore, for particular regional clusters of expertise to be brought out, and for the broader macro-economic and regulatory frameworks to change (e.g. around nature-based technologies and solutions to climate change).

These sectors are located across Scotland and already tend to cluster, which in turn means that they are more attractive for development and investment capital in commercial property. Focusing on these sectors, and in particular focusing on the space and infrastructure they need to grow, will enable us to generate and originate a series of both place and sector oriented investment propositions which maximise their strategic attractiveness to investors by aligning infrastructure, business growth and real estate opportunities in a coherent fashion.

We have set out from the beginning to align with and help deliver the private capital element of the investment needs identified in the Infrastructure Investment Plan, Climate Change Plan and Housing to 2040. Leading with our strongest sectors, and their spill-over into the space and talent they need, in turn drives the viability of city and town centres near them, for housing and commercial property. In line with our Place Principle, we want this to include bringing investment into re-purposing under-utilised assets in town and city centres as part of the direct response to COVID-19. With an approach linking to the strengths and future demand in the economy, it will also be possible to seek investment in modernising construction techniques, including offsite construction, and alternative housing models to support independent living.

Finally, our commitment to Net Zero must underpin all that we do. We should simply no longer be putting public resource into originating, structuring and promoting investments in Scotland which are not aiming at Net Zero. By focusing on our priority sectors and employing a Net Zero and place focus, we will be able to start to build markets instead of individual investment opportunities. We should therefore build on and expand initiatives like the Green Investment Portfolio, and the cross-organisational work to define projects for carbon capture and storage, heating, hydrogen and natural capital, and seek to systematically turn these into opportunities which are both commercially sound, and structured as investments in a way which support a Just Transition. We are doing this at precisely the right time, as global investment markets shift towards ESG and investment in the transition to Net Zero.

Bridging the Gap: Taking Action to Meet Scotland's Investment Needs

Public sector efforts to support private capital investment attraction in the past have been relatively fragmented, with the relevant skills spread across a number of directorates, agencies and local authorities. That system itself is evolving with the launch of the Scottish National Investment Bank as both an investor and, over time, a centre of expertise for investment. We now have the opportunity to coordinate, reprioritise and focus the work across the public sector. Figure 0.2 shows the framework which guides the action plan that sets outs a series of actions that will help us deliver on our ambition.

Figure description:

Figure sets out the five priority areas for delivery that the plan’s actions are grouped under.

Actions

Leading with our Values: Net Zero and ESG

1 We will make Scotland's values a core part of our National Prospectus and our engagement with investors, making it clear that valuing our people, communities, and environment are core to our economic ambitions.

2 Investment opportunities that we promote to market will be benchmarked against ESG investment criteria. We will enable the companies and projects we support to report climate-related disclosures in a standardised and transparent way with flows of ESG monitored via a new metric which will cover environmental and social impacts.

3 We will use COP26 as a platform to showcase our investment opportunities such as our Green investment Portfolio.

4 We will build on existing ESG investment activity and work with Scotland's investment management industry, using events such as the Ethical Finance Summit to make Scotland a leading globally established hub for ESG investment.

5 We will proactively engage with ESG investors and with sources of capital new to Scotland, such as green bonds, to help us achieve our Net Zero and Wellbeing ambitions.

Building an Investment Ready Pipeline

6 We will identify and prioritise place-based opportunities or clusters e.g. low-carbon heating or hydrogen, and accelerate their investment-readiness for both company and infrastructure investment.

7 We will work with the private sector to identify and secure the private capital investment needed to develop internationally recognised clusters of excellence in our identified sectoral themes (Low Carbon, Digital, Health and Life Sciences, High Value Manufacturing) and build investment solutions for their business ecosystems.

8 We will build demand for private capital investment for the growth companies working in our key sectoral themes, for whom engagement with private capital markets is a viable and useful route to growth.

9 We will build capacity to structure major projects and programmes for financing focused on the Just Transition to Net Zero, building digital capacity to support data movement, and housing needs.

10 We will co-ordinate the wider public and private sector landscapes to aggregate opportunities of scale that will be of interest to institutional investors.

11 We will act as cornerstone investors in emerging sectors and technologies where Scotland has genuine potential to lead on the international stage.

12 We will establish a 'route-map' from project inception to promotion to ensure investment opportunities are investment ready and attractive to markets, and that the route to support is clear to candidates. The route-map will denote criteria for when a project is ready for development and will be considered 'market ready'.

13 We will take a Team Scotland approach to disseminate learning and best practice from across the public sector and private sector ecosystems. This will involve coordinating government and agencies with the private sector to accelerate the development of investment opportunities, using co-investment models for example.

14 We will benchmark how our investment propositions that we present to market compare with international standards to ensure our propositions are best-in-class.

Right Regulations, Right Incentives

15 We will establish relationships with UK financial services and pension regulators to influence and support the coordination of future regulations around reporting standards and our Net Zero aims.

16 We will align our suite of available incentives to help stimulate investment in our sectoral themes, places and Net Zero, whilst always seeking to understand and mitigate market distortions.

17 We will engage with the UK and international bodies to influence the design of market-creating financial and pricing solutions (e.g. Contract for Difference and carbon pricing), working constructively to remove barriers to investment.

Working in Partnership with the Markets

18 For each category of investor we will develop an investor relationship strategy to increase our level of understanding, engagement and partnership with the market.

19 To support business growth investment, and in line with the Logan Review recommendations, we will seek to fill the gaps in the Scottish equity market by:

• Developing a new Series A fund with a focus on the Scottish ecosystem
• Investing outside of Scotland to build a reciprocal relationship with funds that will in return, invest in Scotland
• Recapitalising and reorienting existing funds where this will support greater investment
• Ensuring that investment is fairly distributed through investment vehicles focused on female and minority founders
• Intensifying appropriate support for these companies, such as development, networking, contact building opportunities, leadership, peer to peer support and pitching masterclasses

20 We will increase connections with institutional investors who may not be familiar with what Scotland has to offer, starting with ESG investors and thematic funds.

21 We will build relationships with the most active developers and intermediaries in similar regions in the UK, linked to the sectors and opportunities we want more investment in.

22 We will work closely with local government pension funds to identify appropriate means of increasing investment in Scottish propositions.

23 We will use data and analysis to respond quickly to shifts in the market.

24 We will develop a service standard on investor experience, aligned with the Inward Investment Plan, to ensure we are providing investors with a rapid professional and comprehensive service to encourage them to commit to further investment in Scotland.

25 We will establish an investment panel to form a partnership with government, drawing on their expertise to provide industry insight on the structuring and financing of the large scale investments required for the transition to Net Zero.

26 We will put in place a process to track private capital investment into Scotland and to measure performance going forward.

Mobilising our Global Networks

27 Through our combined networks and relationships, we will continue to promote Scotland's broad and diverse capital investment offer to investors globally.

28 We will develop and deliver a programme of domestic and international events and activities to support the development and promotion of the pipeline of private capital investment opportunities, providing a platform to access new investor relationships.

29 We will increase our global capital investment resource in target international markets and make best use of use our international networks to provide insights, intelligence, introductions and advocacy focused on building investor relations and promoting investment opportunities in Scotland. Such networks include:

• SDI's network of overseas field offices
• Scottish Government's eight international offices based in private capital investment global capitals including London, Berlin and Paris
• Scottish Government Trade Envoys
• The GlobalScots Network
• The international footprint of our universities and colleges
• Private sector business networks that promote Scotland

30 We will further invest to develop the capital investment strand of 'Scotland Is Now' and utilise this as a key channel to communicate our messaging and propositions.