On Thursday, Scotland will take to the polls to determine whether it wants to break off from the United Kingdom. And while even a vote in favor would simply be the beginning of a long and extremely complex process, all of a sudden, markets are paying rapt attention to the potential outcome.
The upcoming Scotland vote has led investors to sell shares of Scottish companies, place bearish bets on the British pound—and worry about the widespread implications of the potential Scotland split-off.
“If you have investments in the U.K., you should be very much concerned,” said Oliver Harvey, macro strategist at Deutsche Bank. “A ‘yes’ vote has big implications for U.K. growth and big implications for investments. And if you have assets in Scotland, all of the sudden they’re not under the same tax or regulatory regime.”
While most expect Scotland to eventually vote against independence, the polls have certainly been close. Many U.S. investors only started to pay close attention when a YouGov poll last weekend showed a narrow lead for independence voters. More recent polls have shown a lead for those voting against the move. Still, the “yes” vote has been broadly gaining momentum, and many likely voters report that they are still undecided.
On Friday, online betting sites were offering a payout of about 3-to-1 for a “yes” vote bet versus 2-to-9 for a “no” bet, indicating that a pro-independence result is being viewed as an unlikely, but not outlandish, scenario.
Meanwhile the pound has fallen dramatically against the U.S. dollar over the past two weeks, reflecting fears about what Scottish independence would mean for the British economy and currency. Scotland is a major producer of crude oil, and it remains unclear how Scotland and the remaining U.K. would divide up its energy resources. And Scotland’s currency options remain hazy and extremely complicated.
In Scotland, many companies—including major banks Royal Bank of Scotland and Lloyds—have said they will move to England if Scotland votes for independence. Shares of the two banks have been under pressure recently, though they have staged a rebound over the past few sessions.
Harvey said that investors can be reassured by the fact that banks would move (at least technically) and that Bank of England Gov. Mark Carney is actively working to avoid a disaster scenario. It seems that in a “yes” vote situation, if RBS and Lloyd’s move to England, the BOE will remain their lender of last resort. That should prevent a massive capital flight, or a great degree of risk for those holding Scottish assets.
“It’s not a great outcome, but at least a very disruptive outcome will be avoided,” Harvey told CNBC.com. “Basically, what’s going to happen is that there will no longer be a Scottish banking sector.”
The ramifications of Thursday’s vote could stretch far beyond Scotland and England. Market participants have noticed a rise in Spanish government bond yields on the back of independence-friendly poll number. The connection here is the Spanish region of Catalonia, where a large degree of the population has always called for independence from Spain, and a massive demonstration in favor of an independence referendum was held on Thursday.
If Scotland votes for independence, or even if the Scottish “yes” vote fails by a thin margin, the Catalonia movement may gain ground in discussions with Spain.
Even if Catalonia never prevails in succeeding, any headway in that movement might hurt the financial position of Spain, according to a recent note from UBS.
“The market reaction might not ultimately be benign. One of the central issues behind the independence movement in Catalonia is that of fiscal independence, as Catalonia pays a large part of its tax income in fiscal transfers to the rest of the Spanish state. As a result, any compromise would likely mean more fiscal devolution which might imply fiscal challenges for the central government in Madrid,” wrote a team at UBS.
Of course, when it comes to the Scottish vote, there remains the possibility that markets (and perhaps the financial press) are doing what they do best—making a big deal out of a situation that ultimately won’t amount to very much.
“This is a very low probability event that the market’s very emotional about,” summed up Kathy Lien, managing director of FX strategy at BK Asset Management.
To capitalize on both the short-term fear and the likely outcome, Lien is recommending that clients short the pound through Tuesday evening or Wednesday morning, at which point she advises closing out the shorts and placing buy orders a bit above where the pound is trading.
This will allow them to capitalize on the pound’s upward momentum if the “no” vote wins, and avoid being exposed to any precipitous drop in the unlikely scenario of a win for the pro-independence crowd.