Scottish National Investment Bank: consultation paper

5. Operating model, classification and capitalisation

"The Bank should be a limited company, wholly owned by the SG. The Bank should be accountable to the Scottish Ministers for its performance, and through them to the Scottish Parliament. SG should have the ability to set and monitor the overall mission of the Bank."

5.1 The Bank will adopt the limited company model (incorporated under the Companies Act 2006 with a separate legal personality from the Scottish Government and Scottish Ministers) and Scottish Ministers should be the only shareholder. It is expected to be classified to the public sector (central government) by virtue of the degree of control which Ministers will have over the Bank's strategic direction and the appointment of the Chair and non-executive directors. The Bank will also be initially provided with capital up to the level of £2 billion over 10 years.

The limited company model

5.2 The Implementation Plan did not specify which limited company model should be used and there are several options with different implications for the Bank and for Ministers.

• Private company limited by shares – fewer options for raising capital, only requires one shareholder, who can also be the sole director, no minimum requirement in terms of share capital and no requirement for a qualified company director.
• Company limited by guarantee – Most guarantee companies are not-for-profit and do not distribute surpluses but either retain them within the company or use them for some other specified purpose. They have members, not shareholders, and can raise capital through borrowing but not from offering shares in the company.
• Public limited company – can raise capital by offering shares or securities to the public and can distribute profits to shareholders through payment of dividends; increased governance requirements compared with a private limited company with a minimum of 2 directors and qualified company secretary and other requirements related to annual meetings and accounts.
• Companies created by legislation – consistent with the way that many public bodies are created, and also called statutory companies or corporations. They are created through bespoke legislation.
• Community Interest Company ( CIC) – can also be a limited company and therefore can be similar to company limited by guarantee. Created for undertaking an activity or business with community benefit and with an "asset lock" which can limit the way in which surpluses are distributed and, like charities, the CIC's assets and profits must be permanently retained within the company or only transferred to another company with a similar "asset lock".

5.3 The Government is considering a public limited company model as the best way forward and the most appropriate match for the purposes and objectives for this Bank. It would be possible to set the Bank up as a private limited company, but if it were to raise finance from wider sources in the future (for example, a public bond or share issue) it would have to change to being a public limited company. A company limited by guarantee is not an ideal choice because it cannot issue dividends to Scottish Ministers which would enable surplus funds to be available for other national priorities. The community interest model introduces an additional layer of regulation as well as a lock on assets.

5.4 Adoption of the public limited company model can include additional protections within the Bank's Articles. For example, to ensure that share ownership remains with Scottish Ministers, and that the Bank's borrowing is zero (as this would impact on the Scottish Government's fiscal position), unless Ministers or the Scottish Parliament approve a different arrangement in the future.

Capitalisation

"The Bank should reinvest its financial returns, both capital and interest, to create a self-sustaining, lasting institution with increasing influence on the Scottish economy"

5.5 The Bank's initial capitalisation is to be £2 billion provided over 10 years by Scottish Ministers. This level of capitalisation is deemed to be both ambitious and achievable, as well as capable of making a material difference to the Scottish economy. An initial £490 million of capital is to come from a combination of investments to be made through the £150 million Building Scotland Fund and a further £340 million which was committed to in the 2018-19 Draft Budget. These and later capital provisions will involve the issue of shares by the Bank which will be purchased by Scottish Ministers. The exact timing of the balance of capital to be provided to 2028 will depend on a number of factors, including: demand for the Bank's products, the Scottish Government's wider capital programme, future budgets agreed with Parliament, the Bank's forward projections in terms of capital coming back from investments (for example, through the Building Scotland Fund), and the arrangement for year-end flexibility agreed with HM Treasury.

(1) A three year Fund, which will be invested prior/as the Bank is formally established, and transferred into the Bank.
(2) Committed in the 2018-19 draft budget. Anticipated investments prior to the Bank being established and will also transfer into it. Exact profile still to be determined
(3) The balance of capital to be provided between 2021-28, subject to future budgets and to agreement of required profile.

5.7 Any arrangements for the Bank's Board and Scottish Ministers to agree the issue and purchase of share capital, or other routes for capitalisation of the Bank, will be set out in the Bank's Articles. Arrangements will also be supplemented in a Strategic Framework for the Bank.

5.8 Once the Bank is fully established the aim is for financial returns from its investment portfolio to at least meet its current and projected operating costs. This is not unrealistic; a net financial return of 2.5% on a £1 billion investment portfolio will be sufficient to fully cover operating costs of £25 million per annum. Any part of the financial return on investment that is not required either for re-investment by the Bank, or to help meet its operating costs (especially in the early years of the Bank's operations), could be returned to Ministers in the form of a dividend. The precise arrangements for this will be included in the Bank's governance documents.

Classification

"Over the longer term the Bank should also look to leverage its initial capital base, further strengthening its investment capability".

5.9 Classification is a process to determine the treatment of expenditure in the economy and National Accounts and it is overseen by the Office of National Statistics. The level of control exercised by Ministers over a body will primarily determine the outcome of classification (ie private body, or central government). The outcome of classification also determines how the body's financial activity is scored against the Scottish Government's budgets. The Bank's initial governance and funding means that it is likely to be classified to central government with all of its activities scored against Scottish Government budgets. Over time, it could be advantageous for the Bank's classification status to change to a Self-Financing Public Corporation ^[4] , if it were to generate sufficient income from external sources and revised governance arrangements were put in place to ensure fully independent decision-making. In terms of the Bank's ability to operate efficiently, the benefits of that alternative classification would include the ability for the Bank to carry and deploy reserves whilst minimising the impact on the Scottish Government's budget. Whilst it is only for the Office of National Statistics to determine the classification status of bodies, any proposal for change in the Bank's governance and control arrangements would be subject to review and there would be an opportunity for the Scottish Parliament to consider the options.

Question 8: Is there a better option than the Public Limited Company model, and if so what is it and why?

Question 9: Do you have views at this stage on the proposals for capitalisation of the Bank?

Question 10: Do you have views on how the governance and classification of the Bank should evolve over time, and if so, what measures and protections should be included now to guide and inform a future change in governance and classification of the Bank?