Pension funds and their sponsors in an independent Scotland would be faced with a number of key issues, with implications for the buyout industry and increased costs topping the list of considerations, said a Towers Watson paper.
Towers Watson said a number of challenges would need to be resolved in the event of a “yes” vote on Sept. 18 for Scottish independence.
Pension funds that are cross-border — with participants in both England and Scotland, for example — would have to be fully funded at all times, which could “drive some existing schemes to close or split,” said the paper, “The big questions: What Scottish independence could mean for pension plans, their sponsors and financial institutions.” The European Union requires cross-border pension plans to be fully funded at all times.
New taxation and regulatory regimes would be costly in terms of compliance, as would changes to pension buyout strategies. Towers Watson said buyouts would be impacted by the new relationship between a Scottish bond market and that of the rest of the U.K., while insurance and annuity pricing would be hit with different gilt structures, regulatory supervision and demographics.
When it comes to institutional investment, a tax agreement would be necessary between Scotland and the rest of the U.K. to ensure that the risk of pension funds with investments in either country having to pay tax in both countries is reduced or removed.
Hedging strategies will have to be examined because pension funds with liabilities denominated in Scottish currency — whatever that might be — or linked to Scottish inflation will be impacted. A market in Scottish inflation protection would need to be established to allow pension funds to hedge benefits linked to this inflation. Additionally, currency hedging might also be required.
Hedging would also be affected by perceived counterparty risk of a newly independent Scotland. “For hedging contracts, the strength of bank counterparties is dependent upon the relative size of the bank and the backing government's ability to cover a bailout,” the paper said. “A move to reliance on a Scottish government rather than the current U.K. government would imply a change in counterparty strength. The same would hold for reliance on a reduced U.K. economy, albeit to a lesser extent.”