Alex Stobart – 30th September 2021
Is the new Scottish National Investment Bank fit for purpose? Is it delivering on the purposes for which it was originally set up?
Eighteen months after its inception the answer looks like being a firm ‘No’. In fact, the way things are going, SNIB risks becoming the very opposite of what it was intended to be.
SNIB was conceived because traditional financial investors and their methods had failed Scotland. In their quest to maximise their profits, investors were refusing to back many enterprises that were financially and economically viable but which couldn’t (or didn’t want to) deliver returns high enough for the financiers’ liking.
Investment gaps were identified in three particular areas:
- Support for early stage SME investment
- Scaling up SME investment
- Mission-led, patient long-term equity and loan investment
SNIB was established to try and be different, and to fill these gaps; to make patient, mission-led, strategic investments to help address key economic and societal challenges. These missions were subsequently defined by Scottish Ministers in terms of Place, People and a Net-Zero Carbon economy.
But is SNIB actually doing any of this? Its first investment was in MSquared which, according to the company’s website, provides photonics systems to “a wide range of sectors, from frontier science to space, defence, oil and gas, healthcare and food and drink”. Its latest investment is in a private equity company, Gresham House Forestry, which is already worth £2 billion. In between, it invested in R3 IoT, which works in satellite communications and is seeking to expand into North American, European and Middle Eastern markets.
Meanwhile, a growing number of applicants who appear to fit SNIB’s original targets for investment are complaining that they have been turned down.
Confusion and cowardice
Two things have intervened to divert SNIB from its original purposes.
First, it has been staffed by traditional bankers with traditional banking mindsets. Willie Watt, the Bank’s chairman, spent 18 years at Martin Currie Limited, which was bought by asset management company Legg Mason with around $750bn of assets under its management. SNIB’s Chief Executive Eilidh Mactaggart hails from MetLife, America’s largest insurer, a company with a long list of fines from regulators for unethical practices. Ms Mactaggart was never implicated in any of these scandals, but their existence speaks to the corporate culture in which she was so recently immersed.
Second, Scottish Ministers have muddied the waters about the Bank’s real purpose via a mixture of intellectual confusion and political cowardice, particularly around the issue of ‘commercial’ returns.
The original Implementation Plan for the Bank made no mention of ‘commercial returns’. Instead, it set the Bank the twin objectives of “making a return in excess of the cost of capital at portfolio level” and “achieving inclusive and social economic benefits”.
By the time the Bill to establish the Bank was published however, the Bank’s prime object had been narrowed to “giving financial assistance to commercial activities”. Other original objects such as “creating and shaping markets through the provision of patient capital” and “contributing to the achievement of the Scottish Government’s economic policy objectives” were relegated to the status of ‘ancillary’.
Flip-flopping and hand-waving around this issue has continued ever since. In September 2020 SNIB chairman Willie Watt said in an interview in The Scotsman that “SNIB will not be just about commercial returns, and success will be measured against societal and environmental impacts.”
But two months later, in an answer to a Parliamentary question, the then Economic Secretary Fiona Hyslop said “It has been made clear that there will be commercial rates of return for the bank”.
Today, SNIB’s own website says “Any investment we make … must deliver both commercial returns and mission impact returns.”
Clarity of purpose
Can SNIB stay true to its original purpose and insist on ‘commercial returns’? The simple answer is No, for two reasons.
First, the notion of ‘commercial returns’ promotes the accountancy-driven delusion that the amount of profit accruing to investors is the only valid measure of a company’s economic performance. This is not the case. A commercial return to SNIB only measures the benefits it delivers to investors. It does not measure the benefits it delivers to any other stakeholders.
Take a simple ‘what if’ example. Say a £5m SNIB equity investment allowed a company to employ 100 people at an average wage of £35,000. With around 40% taxes on the total annual wage bill of £4.0 million, the Scottish government would reap annual tax payments from this company of around £1.4 million. If SNIB’s investment was patient, lasting over 10 years, the tax payment money ‘returned’ to the Scottish Government would be £14.0m.
Say this company developed a new technology that enabled a 0.1% reduction in the £46 billion costs of providing citizens with public services. That would generate an additional ‘return’ for Scottish Government of £46m.
Now say that, in order to deliver these benefits, the company broke even but wasn’t able to make any dividend returns to SNIB itself. From a ‘commercial returns’ perspective, a zero return would have been a disaster. But from a broader economic perspective the same investment would have been a triumph. Yet, by insisting on ‘commercial returns’, SNIB is ruling out the possibility of any such investment, apparently with the approval of Scottish Ministers.
Or take a different scenario where, say, an investment in a company developing green technologies produces a lower than ‘commercial’ return for SNIB of 7% rather than 15%. However, at the same time, this new technology delivers a public policy goal that would have had to be paid for anyway, but now at a much lower cost.
From SNIB’s yardstick of ‘commercial returns’, the difference between 7% and 15% is an uncommercial ‘subsidy’ it is ‘paying for’ because it could be getting the 8% difference elsewhere. But in terms of achieving public policy objectives at lower cost, the return is substantial, the difference between 7% and 15% being a ‘payment’ made to achieve a policy objective. Again, with SNIB insisting on commercial returns, such an investment would not be countenanced, even if the social and environmental returns it delivers were very high.
A mission parasite?
Now let’s return to what SNIB says on its website: “Any investment we make … must deliver both commercial returns and mission impact returns.”
‘Must’ deliver ‘both’. A bank that insists on both is not a bank that deploys public money in order to make social, environment and economic impacts possible. It is a bank that acts as a mission parasite – that prioritises maximising the money it can extract from these missions.
If SNIB continues down this road it renders itself pointless. If the investments in question could generate ‘commercial’ returns they wouldn’t need a SNIB in the first place. Other investors would be willing to invest in them.
Just to be clear. Saying SNIB should not demand ‘commercial’ returns is not the same as suggesting that SNIB should not earn any returns at all. The Bank should definitely not subsidise every Tom, Dick and Harriette with a hairbrained scheme to ‘do good’.
What’s needed is the exact opposite of such subsidies. What is needed is great rigour in the Bank’s decision-making, where the Bank digs deep into the credibility of the enterprise’s business model, the likely social and economic impacts any investment would deliver (including an analysis of the cost effectiveness of alternative ways of achieving the relevant policy objectives) plus the likelihood of achieving an acceptable return for itself. It requires more insight and discipline, not less.
The key point is that acceptable return is not necessarily the same as the maximum possible return. Insisting that the bank has to earn ‘commercial’ returns means it always has to look for the maximum possible return and that, in turn, rules out making investments that deliver social benefits and still earn a financial return but where this return falls short of the maximum possible.
Ruling out investments that make acceptable returns is crazy. Filling this gap – which is truly enormous – was what SNIB was set up to do. Now, thanks to a few knee jerk reactions by Ministers and the entrenched assumptions of the Bank’s executives, the opportunity to fill this gap is being squandered.
The time to act is now
To stop SNIB doing the opposite of what it was set up to do, Scottish Ministers need to act now. Confusion over the meaning of the word ‘commercial’ is not something that needs to wait for a statutory performance review in five years’ time.
The Scottish National Investment Bank Act 2020, by which SNIB was established, was drafted with an inbuilt contradiction. The Act requires the Bank to report on its performance in terms of ‘a Balanced Scorecard’ of environmental, social and economic impact. But it requires the Bank to make investment decisions according to a completely different set of criteria – only investing in ‘commercial activities’.
That is nonsense, a drafting error that can and should be rectified immediately. To succeed, SNIB needs clarity and consistency. If it is to report its performance in terms of a Balanced Scorecard of social, environmental and economic impacts, it should make its investment decisions on this basis as well. (Within this, it is quite acceptable for Scottish Ministers to require the Bank to “make a return in excess of the cost of capital at portfolio level”, as the Implementation Plan originally stated.)
In the run-up to the launch of SNIB, First Minister Nicola Sturgeon and Professor Mariana Mazzucato came together to launch a vision of the new bank. “The mission-oriented approach we have set out today will ensure that the bank does not support ‘business as usual’, but is instead focused on driving transformative change,” their statement said. Yet so far, all the evidence is pointing to the exact opposite: more business as usual, very little if any transformative change.
What sort of animal is SNIB going to be? A Mission Enabler or a Mission Parasite? This decision is now resting in Scottish Ministers’ hands.