The Scottish Referendum May Already Be A Black Swan

• A binary risk with a credible adverse scenario is a real risk today.
• There is a real risk today of a Scottish Black Swan.
• It could happen before the referendum on September 18th.

Last week I discussed the financial implications of a Scottish “Yes” vote in the referendum on September 18th. Today I would like to discuss the risk that exists today because of the referendum. There is no doubt in my mind that a Yes vote next week would constitute a Black Swan event for the UK capital market and possibly beyond. A Yes vote would materially raise the level of uncertainty associated with UK financial assets. I don’t think that is in doubt.

But what I want to say today is this: The risk today of a Scottish Yes vote may be enough to move markets in advance of the referendum. A rational investor needs to think now about positioning his portfolio for a possible Yes vote. Such anticipatory market activity could have a self-fulfilling impact. For example, if investors worry that a run on Scotland could result in a deposit moratorium, a run could occur before the 18th. Furthermore, a run on Scotland could prompt a run on UK financial assets. Already the pound has fallen by 6% over the past two months. I’m pretty sure that sterling will fall further next week in the absence of official intervention.

The Independent reports:

“Figures from investment bank Societe Generale showing an apparent flight of investors from the UK came as Japan’s biggest bank, Nomura, urged its clients to cut their financial exposure to the UK and warned of a possible collapse in the pound. [Nomura] described such an outcome as a ‘cataclysmic shock’...Investors have been pulling out for weeks and months, according to data on UK stock market funds cited by Societe Generale, which show a worsening exodus of global money from shares in British companies. From its best position this year of a little under $14bn (£8.6bn) flowing out from the UK earlier this year, the flight has accelerated to nearly $20bn (£12bn).”

This is still small potatoes, but the Yes risk is only now being analyzed in board rooms and investment committees around the world.

Thus, the risk today is not that Scotland ultimately redenominates, but rather that there can be no insurance against such a scenario, and that poses a risk right now. Two weeks from now, the risk could be gone, or it could be very real. Goldman: “Even if the Sterling monetary union does not break up in the event of a ‘Yes’ vote, the threat of a breakup would provide investors with a strong incentive to sell Scottish-based assets, and households with a strong incentive to withdraw deposits from Scottish-based banks.”

Moody’s: “The new Scottish government would, in all likelihood, need to issue its own currency, into which many if not all domestic private sector debts would be redenominated….One form of debt that would certainly face redenomination risk is bank deposits...It is inevitable that at least some types of deposits would come to be denominated in Scottish currency rather than pound sterling.”

I may be an alarmist from time to time, but I would not accuse Nomura, SoGen, Goldman or Moody’s of being alarmist. The next ten days could be very exciting, especially in London.