"The greater danger for most of us is not that our aim is too
high and we miss it, but that it is too low and we reach it."
It was an honour to be asked by the First Minister in the autumn of 2017 to lead an Advisory Group to make recommendations regarding the establishment of the Scottish National Investment Bank ("the Bank"). It has, moreover, been a privilege to work with the Advisory Group and the many who have supported the endeavour over the last few months. This report sets out my recommendations for consideration by Scottish Ministers.
We have engaged with an extensive and broad group of individuals and bodies in both the public and private sectors who have generously informed the development of the recommendations. Whilst specific views expressed have been, as one would expect, varied and in some cases opposed, there has been a strong consensus that there is an immediate and pressing need for the creation of the Bank. The development of similar institutions in many other countries around the world has been very effective in enabling economic progress.
Independent commentators view the immediate outlook for growth in the Scottish economy as languid at best, in part due to the material risks associated with the unfolding of Brexit and its consequences. It is paramount that we are bold in applying our resources with focus and ambition to underpin an inclusive, sustainable point of inflection for the economy. To do so with confidence we need the Bank to be ambitious – in terms of scale, scope and adaptability – as a necessary condition. But it will not be a sufficient one, since the unequivocal primary focus of the Bank will be the provision of debt and equity finance. In order to support the economic aspirations of the Scottish Government, the Bank must operate in close collaboration with other actors such as Scottish Enterprise to engender and support ambitious entrepreneurial behaviour in the Scottish economy. As we establish the Bank to provide additional financing coverage, we should recognise the success achieved in contiguous investment spheres. For example, recently published research underlines Scotland as home to the strongest regional angel network and Scottish Enterprise as the most active UK venture capital funder other than crowdfunders. Notwithstanding this success, the establishment of the Bank should be embraced as an opportunity to make access to finance and advisory support easier for SMEs in Scotland. In defining the purpose, vision and strategy for the Bank, it is vital to say what it is and what it is not. The Bank should be focused primarily on financing, albeit it will necessarily and appropriately offer support to its customers. It will not play a primary role in funding or application of grants, nor should the Bank compete with private financing such that there is a material risk of ‘crowding out' private finance.
We have undertaken rigorous analysis, leaning on previous studies where possible, to determine where the Bank could act to complement existing private and public contributions to the economic well-being of Scotland. In familiar economic parlance we have sought to identify ‘market failure' which undermines the potential for inclusive and socially beneficial economic growth. The expression ‘market failure' has negative connotations and can be unhelpfully divisive. It is perhaps more progressive to think in terms of ‘risk appetite'. That is, existing financing sources focus on specific appetites for risk in terms of the nature of the investment and of its likely tenor. By adopting a strategic focus and risk appetite that is different, the Bank can fuel the economy through direct debt and equity investment, and by acting as a catalyst for private investment. Furthermore, many large deals involve foreign investors and our participation by share of deals – both by number and by value of investment – is low in comparison with other regions of the UK. The Bank should be capable of amplifying the voice of Scotland in this important regard.
The Bank will invest in a broad range of activities where it can make a complementary contribution to economic development. It will do so with the twin objectives of making a return in excess of the cost of capital at portfolio level and by achieving inclusive and social economic benefits. The Bank must be constructed in a manner which enables it to evolve over the long run in response to the changing economic needs of the nation. Equally, at every stage of its development – and perhaps most importantly at the outset – there must be uncompromising prioritisation of resources. An unwillingness to do so would, ineluctably, create an Achilles heel.
The areas identified as opportunities for the Bank fall into three broad categories:
- Support for early stage SME investment
- Scaling up SME investment
- Mission-led, patient long-term investment.
It is critical that the Bank ensures that SMEs have access to micro loan finance through the continuation of the existing activities of the SME Holding Fund. But we must also extend the offering to SMEs by providing short to medium-term loan finance – both senior and mezzanine debt – in the range of £100k to £2m. We should consider specifically – as is being done in Ireland – the opportunity and potential to deploy debt funds to support SMEs likely to be adversely affected by Brexit. The existing Scottish Investment Bank co-investment model for early stage equity investment up to £2m should be maintained. A real gap in the market which the Bank must serve, however, is the availability of financing to enable SMEs to scale up their business and the level of finance involved here is typically in the range of £1m to £10m, sometimes more. The Bank must be focused too on the opportunity for the transformative change required under the Programme for Government. These projects will often be defined as ‘missions' and will enable key participants to coalesce around grand challenges such as the pursuit of decarbonisation or the adoption of artificial intelligence and machine learning, rather than being specific to traditional sector classifications. Through the provision of strategic, patient capital, the Bank will assume an enabling leadership role in industrial transformation, innovation and the shaping of markets.
We examined the merits of alternative ownership and governance structures. On ownership we concluded that Government ownership was clearly preferable to private ownership to ensure that the purpose of the Bank could be pursued consistently and with confidence in perpetuity. That conclusion was reached with an assumption that current constraints associated with such a structure would be relaxed to allow the Bank to deliver the desired impact in the medium and long-term. Needless to say, the level of capital and potential leverage will need to be commensurate with the intent of the Bank. Appropriate governance is essential to ensure that the institution operates effectively in a manner consistent with its purpose, strategy, and values. The approach set out in the recommendations would allow the Bank to operate independently under experienced, professional leadership, and within a framework agreed with the Scottish Government in relation to a strategic plan, a risk appetite and reserved matters. Scottish Ministers should also consider establishing an advisory group to advise Ministers in order to provide representation from a broad range of constituencies in the strategic reviews of the Bank. Further consideration should be given to the chair of this group having a place reserved on the Bank's Board.
There is an incontrovertible case for the establishment of a Scottish National Investment Bank. In order for it provide the required stimulus for the Scottish economy, it must have absolute clarity of purpose and values, it must have the right expertise and governance, and it must have the courage to prioritise rigorously. And it must do so with ambition.