Author: Charles Proctor
Fladgate has taken a close interest in the legal issues that will arise if Scotland becomes an independent nation. Our previous offerings on this subject include "Scotland and Independence – currency, banking and financial Issues" (April 2013) and "Scotland – a sterling nation?" (February 2014).
However, the referendum date – 18 September – is now under two weeks away. During August, two televised debates took place between Scotland’s First Minister, Alex Salmond, and Alistair Darling, Chairman of the "Better Together" campaign. During the course of these debates, it became abundantly clear that the currency is to be one of the key battlegrounds between the two sides in the run-up to the vote. Both sides have put forward their arguments on this subject in great depth and new issues are unlikely to arise at this late stage. This would therefore seem to be an appropriate time to reflect upon and summarise both the existing monetary arrangements and the legal options available to Scotland in the event of separation.
Whose currency is it?
As is well known, the Scottish Government wishes to use sterling within the context of a formal monetary union with the remainder of the United Kingdom, but the three main Westminster political parties have ruled out such an arrangement. Faced with this intransigence, the Scottish Government has maintained that it is effectively a "part-owner" of the sterling monetary system and thus has a legal right to continue to use it within a monetary union. For example, in "Scotland’s Future: Your Guide to an Independent Scotland", the Scottish Government stated that "…The pound is Scotland’s currency just as much as it is the rest of the UK’s…" and continued "…We will therefore retain the pound in an independent Scotland…". In similar vein, Mr Salmond wrote in the Sunday Herald that "… it’s our pound and we’re keeping it…".
This argument and the assertion of a legal right to use the currency in turn give rise to a highly abstract question, namely, who actually owns the sterling monetary system? There is very little legislative guidance on this subject. Article XVI of the Act of Union 1707, in its original form, stated "…That from and after the Union, the Coin shall be of the same standard and value throughout the United Kingdom as now in England and a Mint shall be continued in Scotland under the same rules as the Mint in England…". It is thus clear that, whilst the currency was to have the English "standard and value", it was henceforth to operate as a single currency system for the entirety of the United Kingdom. It may be argued that this provision offers some indirect support to the "shared ownership" stance adopted by the Scottish Government. This could remain the case even though the Act of Union would naturally be repealed as part of the independence process.
In truth, however, there is no real legal substance in the "ownership" approach. A monetary system operates under the auspices of a central bank which is a national institution. A single central bank can only serve as the central bank of two or more nations as a result of a treaty between the countries concerned (e.g. as in the case of the European Central Bank). By virtue of its independence, Scotland would cease to be part of the monetary zone served by the Bank of England and, as a necessary consequence, would have no claim to the use of sterling or its underpinnings (such as the Bank of England’s role as "lender of last resort"). Certainly, there is no basis for the Scottish Government to assert a legal entitlement to a formal monetary arrangement in the post-independence era. Whilst it is true that the dissolution of a State involves an equitable division of its assets and liabilities, this cannot apply to a monetary system, which is a means of exchange, as opposed to an asset.
Recent international practice has allowed for continued use of the "parent" currency by a seceding State, but only on the basis that the central bank of the parent State has exclusive control over the issue of the currency and monetary policy. This was the case with the "rouble zone" that subsisted for a short period in the aftermath of the disintegration of the Soviet Union. The shortcomings of the arrangement soon became apparent to all parties, and the former republics moved to establish their own currencies.
It is thus plain that a formal monetary union will be a matter for negotiation. Events in the Eurozone have demonstrated that a properly constructed union necessarily involves a significant degree of fiscal union, and a close approximation of the regulation of the financial markets. The terms of any such union would no doubt be agreed in the context of a wider package but, at least for the present, it must be assumed that no such arrangement will be on the table.
The Bank of England is not the exclusive issuer of banknotes in the United Kingdom. In Scotland, three institutions – The Royal Bank of Scotland, Bank of Scotland and Clydesdale Bank – are currently authorised to issue banknotes. There is no legislation that confers legal tender status on such notes, but they are of course universally accepted in Scotland as a matter of practice. Do these arrangements have any impact on the above analysis and Scotland’s right to use the pound?
If Scotland became independent and the Scottish note issuers remained domiciled in Scotland then their authority to issue sterling banknotes would lapse for a variety of reasons. In particular, under the Banking Act 2009, the authority to issue such notes only extends "…to the part of the United Kingdom in which [the issuing bank] was authorised to issue notes…". Since Scotland would cease to be a "…part of the United Kingdom…" this provision would necessarily fall away. It follows that ‒ at least in the absence of a negotiated monetary union ‒ the right of the authorised Scottish banks to issue sterling banknotes would effectively terminate at the point of independence.
An independent Scotland must thus establish a new monetary regime. The starting point for a new monetary system will always lie in the constitution of the new country.
Scotland – its constitution and its currency
As a newly-independent state, Scotland would have the right to determine its own currency arrangements. The case law of the International Court of Justice establishes that monetary sovereignty is a necessary concomitant of national sovereignty.
Hand-in-hand with monetary sovereignty is the right to regulate the use of the currency and to establish an exchange rate policy. The Articles of Agreement of the International Monetary Fund confirm that a variety of exchange rate arrangements are permissible, including "…(i) the maintenance by a member of a value for its currency in terms of the special drawing right or other denominator, other than gold, selected by the member, or (ii) cooperative arrangements by which members maintain the value of their currencies in relation to the value of the currency or currencies of other members, or (iii) other exchange arrangements of a member’s choice …". The third item is obviously very broadly based and provides the basis for the UK’s currently floating exchange rate policy.
Interesting as these international legal rules may be, they all presuppose that a country possesses, or wishes to create, its own national currency. The Scottish Government has shown no inclination to take that step, at least to date.
In terms of its own domestic law, the Scottish Government has published "The Scottish Independence Bill: A Consultation on a Interim Constitution for Scotland". This consultation includes a draft Scottish Independence Bill which would be intended to form the country’s constitution until a permanent version is established by a Constitutional Convention. It is noteworthy that the expressions "currency" and "money" are nowhere to be found in the draft bill. However, in the absence of any explicit provision in this area, laws creating or governing the monetary system could be made by the legislature. In that context, clause 10 of the draft bill provides that, subject to the constitution, "…legislative power to make and modify the law continues to be vested in the Scottish Parliament…".
It follows from the above analysis that the Scottish Parliament would thus have a free hand in implementing such domestic monetary arrangements as it deems appropriate.
The currency options
What, then, are the currency options that are realistically open to Scotland at the point of independence?
It is suggested that there are essentially five options – two involving sterling, two involving the euro and one involving a new currency. The Fiscal Commission for Scotland, in their report on an independent Scotland’s Macroeconomic Framework (February 2013), considered four of these options.
Sterling monetary union
A sterling monetary union was the preferred route of the Scottish Fiscal Commission, and that recommendation was adopted by the Scottish Government. However, HM Treasury’s "Assessment of a sterling currency union" (February 2013) counselled the UK government against this course. The three main Westminster political parties appear to have accepted that advice, and have ruled out the possibility of a monetary union with Scotland.
For the reasons given above, Scotland has no legal power to compel the remainder of the United Kingdom to agree to a formal monetary union. Whether that stance would change in the course of negotiations following a "yes" vote must be a matter for conjecture but, for the present, the option has been ruled out.
It is open to a country unilaterally to adopt the currency of another country as the local unit of account. Whatever may be the diplomatic courtesies or niceties of such a situation, it seems clear that the adopting country does not require the consent of the issuing country for these purposes. For example, it is understood that Ecuador did not seek the approval of the United States before it elected to dollarise its economy.
In the absence of a formal monetary union, this may be the best option available to Scotland. But this type of structure would have several drawbacks. The Bank of England would determine monetary policy for the remainder of the United Kingdom, and without reference to the interests of Scotland or its economy. This might not greatly matter if the economic cycles of the two countries remained broadly in harmony, but it could become problematic if those cycles diverged to any significant extent. In addition, Scotland would not have a central bank or monetary authority capable of providing liquidity support to the financial system. This could be a significant issue for major banks and other institutions that remain domiciled in Scotland.
Sterlingisation effectively requires that Scotland must "earn" its currency system by maintaining a trade surplus with the remainder of the United Kingdom.
Joining the euro
The Scottish Government has often stated that it will be an enthusiastic Member State within the European Union. As a result, it has at times been suggested that Scotland could adopt the euro. The following points may be noted in this regard:
(a) on the one hand, the accession treaties for all of the newer Member States have required the incoming countries to commit to Eurozone membership at an appropriate point of time. Although unstated, this no doubt flows from (i) the centrality of the euro project within the European Union and (ii) a certain distaste for the type of opt-out that was negotiated by the United Kingdom. Negotiations for the accession of Scotland to the EU as an independent Member State will almost certainly include this requirement; and
(b) on the other hand, the well-known "Maastricht Criteria" require a country to be a member of the exchange rate mechanism for a period as a precondition to euro membership. Scotland cannot meet this condition now, and will never be able to fulfil it until it has adopted its own currency.
It must thus be likely that the accession arrangements will require Scotland to commit to euro membership even though it may never be possible for it to meet the stated conditions to entry.
Leaving aside the curiosity of this position, it is plain that Scotland cannot meet the euro entry criteria by the date of its independence. Eurozone membership is thus not a serious option for Scotland in either the short or the medium term.
As noted earlier, Scotland could unilaterally adopt sterling without the consent of the remainder of the United Kingdom. By parity of reasoning, it could likewise adopt the euro as its domestic currency.
However, this would effectively require Scotland to run a trade surplus with the remainder of the EU in order to generate the necessary currency. In addition, unilateral adoption of the euro without meeting the Maastricht Criteria may not be consistent with a desire for constructive engagement within the EU.
There would be significant obstacles to, and problems with, this approach and it is perhaps unsurprising that the Scottish Fiscal Commission did not consider it.
A new currency
As a newly-sovereign nation, it would plainly be open to Scotland to adopt and issue its own, new currency.
To that end, Scotland would establish its own central bank and create its own currency unit. It would also provide a legal conversion rate, so that obligations formerly defined in sterling would be converted into the new Scottish currency at a defined substitution rate. This may create complexities in a contractual context – for example, which obligations are converted into the new Scottish currency, and which obligations remain outstanding in sterling? But these problems can be resolved and there is no legal obstacle to the introduction of a new Scottish currency.
The difficulties lie more at a practical level. The currency would have to be backed by assets. To some extent, these may consist of any share of foreign reserves that Scotland acquires from the remainder of the UK as part of the separation process. But the external value of such a currency would be uncertain – at least at the outset. However, exchange rate volatility is a risk that would have to be accepted as part of an independent monetary system.
For an extended period, the establishment of a new Scottish currency did not appear to find favour. However, in the second of the televised debates, Alex Salmond proposed three versions of a so-called "Plan B" to be implemented in the event that a monetary union is vetoed. He stated that "… we could have a Scottish currency. We could have a flexible currency like Sweden or Norway. We could have a fixed rate, Scottish pound attached to the pound sterling. That’s what Denmark does with the euro and Hong Kong does with the dollar…". In reality, this is one currency option, not three. Each proposal involves the creation of a new Scottish currency unit. The listed options merely refer to the management of that currency, or to exchange rate options. The "pegging" of a new Scottish pound to the pound sterling involves a form of currency board arrangement, which would again effectively deprive Scotland of control over its monetary policy.
It follows from the above discussion that an independent Scotland would have no legal right to continue to use sterling as part of a monetary union. Any such arrangement would have to be freshly negotiated as part of an overall independence package. Given the statements made in Westminster, this option has to be discounted, at least for the present.
Membership of the euro at the point of independence is not possible within the framework of the EU Treaties. Unilateral adoption of the euro would be subject to a number of practical impediments and may be seen as inconsistent with Scotland’s own application for EU membership.
This would appear to leave Scotland with only two alternatives, namely:
(a) the adoption of sterling on a unilateral basis, thus leaving Scotland without a central bank to support its banking sector; or
(b) the adoption of an entirely new, national currency. This may be legally feasible but inevitably involves something of a step into the unknown. It should however be said that all three versions of "Plan B" noted above would involve the creation of a new national currency unit.
Under the circumstances, "sterlingisation" seems to be the most likely option, even though this will not offer a perfect monetary solution to the Scottish banking sector.
The currency issues for Scotland are challenging at the political, economic and legal levels. Whether or not they will require further consideration will depend upon the outcome of the September referendum.
Charles Proctor, Partner, Fladgate LLP (firstname.lastname@example.org)