Scotland to sell £1.5bn of ‘kilts’ bonds after getting same credit rating as UK

Scotland to sell £1.5bn of ‘kilts’ bonds after getting same credit rating as UK

The Scottish government is planning its first major bond issuance since the late 17th century, aiming to sell £1.5 billion of securities, reportedly to be branded 'kilts' bonds. This development follows credit rating agencies S&P and Moody's awarding Scotland an investment-grade rating on par with that of the United Kingdom sovereign. The move marks a significant step in exercising the Scottish government's devolved fiscal powers and establishing a new source of market-based funding.

Context & What Changed

The announcement that the Scottish government intends to issue £1.5 billion in government bonds is a landmark event in UK public finance and the history of Scottish devolution. Historically, Scotland has not independently issued debt on public markets since the late 17th century, when it incurred significant liabilities to compensate investors in the failed Darien Scheme prior to the Act of Union in 1707 (source: ft.com). For over three centuries, Scottish public spending has been funded through a combination of a block grant from the UK Treasury, locally raised taxes, and limited borrowing from the UK government's National Loans Fund (NLF).

The legal and fiscal framework for this change was established through the process of devolution. The Scotland Act 2016 significantly expanded the Scottish Parliament's financial powers, including the authority to borrow on the open market to finance capital expenditure. These powers are governed by a Fiscal Framework agreed upon with the UK government, which sets an overall cap on the stock of capital borrowing at £3 billion, with an annual limit of £450 million (source: gov.scot). This framework was designed to provide fiscal flexibility while maintaining the overall stability of the UK's public finances.

What has changed is the Scottish government's decision to activate these market-borrowing powers at scale. The critical enabler for this move was securing independent credit ratings. Both S&P Global Ratings and Moody's Investors Service assigned Scotland ratings of AA- and Aa3 respectively, both with a stable outlook (source: ft.com). Crucially, these ratings are identical to their ratings for the UK sovereign. The agencies cited Scotland's strong and diverse economy, its robust institutional framework within the UK, and the implicit support from the UK government as key factors underpinning the high-grade rating. This external validation provides the necessary credibility for the Scottish government to access global capital markets at favorable rates, transforming a theoretical power into a practical financing tool.

Stakeholders

Scottish Government: As the issuer, the administration in Edinburgh has multiple objectives. Primarily, it seeks to diversify its funding sources beyond the UK Treasury's NLF, potentially securing more flexible or cost-effective financing for its long-term infrastructure plans. Secondly, establishing a successful presence in the bond market serves a major political purpose: demonstrating fiscal competence and advancing its agenda of greater autonomy. A successful 'kilts' bond market would become a tangible symbol of Scotland's distinct economic identity.

UK Government (HM Treasury & Debt Management Office): The UK government is a critical stakeholder. While the borrowing is for the Scottish government's account, the rating agencies' explicit linkage of Scotland's creditworthiness to the UK's institutional framework means HM Treasury has a vested interest in the issuance's success. It serves as a real-world test of the fiscal devolution framework. The UK Debt Management Office (DMO), which manages the market for UK government bonds (gilts), will monitor the issuance for any potential impact on the broader sterling-denominated sovereign debt market, though the initial size is too small to be disruptive.

Institutional Investors: This group, including pension funds, insurance companies, and global asset managers, is the target audience. Their decision to buy the bonds will depend on a cold calculation of risk and reward. They will assess the yield offered ('spread') over comparable UK gilts, the bonds' liquidity in the secondary market, and the perceived political risk associated with Scotland's constitutional future. The 'kilts' branding is a marketing tool, but investment decisions will be driven by financial metrics.

Credit Rating Agencies: S&P and Moody's have already played their key role by providing the foundational credit assessment. Their ongoing surveillance of Scotland's fiscal performance and political landscape will be crucial for maintaining market confidence. Any change to their rating or outlook would have immediate and significant pricing implications for the bonds.

Infrastructure & Industry Actors: The proceeds from the bond are expected to be earmarked for capital projects. This directly impacts construction, engineering, and technology companies that will bid for contracts to build new transport links, hospitals, schools, and green energy infrastructure. For them, the bond issuance represents a new, identifiable pipeline of publicly funded work.

Evidence & Data

Issuance Size: The planned inaugural issuance is for £1.5 billion (source: ft.com).

Credit Ratings: S&P assigned an 'AA-' rating with a stable outlook; Moody's assigned an 'Aa3' rating with a stable outlook (source: ft.com). These ratings are in the high-investment-grade category, signifying a very low risk of default.

Fiscal Context: Scotland's total budget for 2024-25 is approximately £59.7 billion (source: gov.scot). The £1.5 billion bond issuance represents about 2.5% of this annual budget, but its impact is magnified as it is dedicated to multi-year capital projects.

Borrowing Framework: The existing Fiscal Framework caps the total stock of capital borrowing at £3 billion and annual borrowing at £450 million (source: gov.scot). The £1.5 billion issuance will be structured over several years to comply with these limits, establishing a multi-year financing program rather than a single event.

Market Benchmark: The primary benchmark will be UK government gilts. The UK gilt market is one of the world's largest and most liquid, with over £2.6 trillion of debt outstanding (source: dmo.gov.uk). The new Scottish bonds will inevitably be less liquid, a factor that will demand a yield premium over gilts.

Scenarios (3) with probabilities

Scenario 1: Successful & Routinized Issuance (Probability: 70%)

In this scenario, the inaugural bond is well-received and oversubscribed by a diverse group of domestic and international investors. The pricing is tight, establishing a yield spread of 10-25 basis points over equivalent UK gilts, a level that investors deem fair compensation for lower liquidity. The Scottish government follows up with subsequent issuances, creating a predictable calendar and building out a ‘kilts’ yield curve. This success solidifies its reputation as a credible borrower, enhances its fiscal autonomy, and provides a stable funding channel for its National Infrastructure Mission. This outcome would be seen as a major political and financial success.

Scenario 2: Tepid Reception & Liquidity Concerns (Probability: 25%)

The bond is successfully sold, but demand is less robust than hoped, concentrated among a smaller group of investors. The pricing spread is wider, settling in the 30-50+ basis point range over gilts, reflecting higher-than-anticipated concerns about liquidity and long-term political risk. In the secondary market, trading is thin, making the bonds unattractive for investors who require high liquidity. While the government raises the required funds, the higher cost of borrowing and poor market depth make future issuances more challenging and less appealing than borrowing from the NLF. The program is not deemed a failure, but it falls short of its strategic objectives.

Scenario 3: Market Disruption or Failed Auction (Probability: 5%)

This low-probability, high-impact scenario sees the issuance derailed by external events. A sudden flare-up in the Scottish independence debate, a snap UK general election creating political uncertainty, or a severe global market shock (e.g., a credit crisis) could coincide with the launch. Investor appetite evaporates, leading to a failed auction where the government cannot sell the bonds at an acceptable price. This would be a significant blow to the Scottish government’s credibility, forcing a retreat to NLF funding and causing major political embarrassment. It would likely shelve any plans for market access for years to come.

Timelines

Immediate (0-3 Months): The Scottish government will appoint a syndicate of banks as lead managers. These banks will advise on timing and structure and will begin 'soft marketing' the issuance to gauge investor interest through a series of roadshows.

Short-term (3-12 Months): The inaugural bond will be launched, priced, and allocated. The performance in the immediate aftermarket will be closely watched to assess the stability of the pricing and the depth of secondary market liquidity.

Medium-term (1-5 Years): Assuming success, a regular issuance program will be established. The initial proceeds will be allocated to specific infrastructure projects, with public reporting on their progress. The spread between 'kilts' and gilts will become a key real-time indicator of investor confidence in Scotland's economic and political management.

Long-term (5+ Years): The Scottish bond market could become an established, albeit small, part of the sterling investment landscape. Its existence and performance will be a permanent feature in discussions about fiscal devolution and the economic case for or against Scottish independence.

Quantified Ranges

Issuance Volume: £1.5 billion for the initial program, likely tranched over several years to adhere to the £450 million annual cap.

Potential Yield Spread: The most critical variable. A highly successful launch could see spreads of +10-25 basis points (0.10%-0.25%) over UK gilts. A more challenging reception could result in spreads of +30-50 basis points or more. For a 10-year bond, this difference could amount to millions in additional annual interest costs.

Market Size: Even if the full £3 billion capital borrowing limit is financed via market issuance, the 'kilts' market would represent just over 0.1% of the size of the current UK gilt market, highlighting the potential liquidity challenge.

Risks & Mitigations

Political Risk: The unresolved constitutional question of Scottish independence is the most significant long-term risk. Any move towards a new referendum would introduce high volatility and widen spreads.

Mitigation: The Scottish government must provide clear, consistent messaging on its commitment to fiscal prudence irrespective of the constitutional debate. The stable outlook from rating agencies, based on the current UK framework, provides a crucial anchor of stability.

Liquidity Risk: As a new and small market, the bonds may trade infrequently, deterring large investors and increasing borrowing costs.

Mitigation: A clear and predictable issuance calendar helps build a critical mass of outstanding debt. Appointing a strong syndicate of banks as market makers who are committed to providing two-way pricing can help foster secondary market activity.

Execution Risk: A mismanaged launch (e.g., poor timing, misjudged pricing) could permanently damage the market's perception of the issuer.

Mitigation: Relying on the expertise of experienced sovereign, supranational, and agency (SSA) debt capital markets teams at the lead manager banks is essential. Phasing the issuance can also reduce the risk of a single large failure.

Fiscal Risk: The debt incurred must be serviced from the Scottish budget, creating a new, non-discretionary expenditure line. An economic downturn could strain the ability to pay.

Mitigation: The most effective mitigation is investing the bond proceeds in projects that enhance long-term economic productivity and expand the tax base. Adherence to a credible medium-term fiscal plan is essential for maintaining investor and rating agency confidence.

Sector/Region Impacts

Public Finance: This sets a powerful precedent for fiscal devolution in the UK. Other devolved administrations in Wales and Northern Ireland may seek similar powers, fundamentally altering the centralized nature of UK public borrowing. It introduces market discipline directly to a devolved government's capital planning.

Infrastructure: The Scottish construction, engineering, and renewable energy sectors are the most direct beneficiaries. The bond program provides a visible, long-term funding pipeline for major projects, improving planning and investment certainty.

Financial Services: The issuance creates new business for investment banks in underwriting and trading, and for asset managers who will analyze and invest in the new securities. It could modestly enhance Edinburgh's status as a financial center.

Scotland (Region): The primary impact is an enhancement of the Scottish government's fiscal toolkit and a tangible increase in its autonomy. The performance of its bonds will serve as a constant, market-driven verdict on the health and governance of the Scottish economy.

Recommendations & Outlook

For the Scottish Government: Transparency is paramount. We recommend publishing a detailed borrowing strategy and issuance calendar to build market trust. (scenario-based assumption: A predictable program supports the 'Successful Issuance' scenario by minimizing uncertainty and attracting long-term investors). Furthermore, proceeds must be transparently allocated to specific, high-return capital projects to demonstrate fiscal responsibility and bolster the economic case for the borrowing.

For Investors: The initial issuance will likely offer a concession (a slightly wider spread) to ensure a successful launch. (scenario-based assumption: This 'new issue premium' will present a tactical opportunity for investors). The core analysis must weigh this yield pickup against the long-term risks of liquidity and constitutional politics. Diversification within a sterling fixed-income portfolio is a key attraction.

For HM Treasury: This issuance should be treated as a crucial pilot for the future of fiscal federalism in the UK. We recommend establishing a joint forum with the devolved administrations to share lessons learned and develop a consistent framework for any future sub-sovereign borrowing to ensure it does not create systemic risk.

Outlook: The launch of Scottish government bonds is more than a financial transaction; it is a structural evolution of the United Kingdom's internal government. (scenario-based assumption: Barring a major political shock, the program is likely to succeed, establishing a new, albeit niche, asset class). This will provide Scotland with greater financial flexibility but also expose its budget to the direct scrutiny and discipline of global capital markets—a trade-off that will define the next chapter of its devolution story.