Economy, Energy and Fair Work Committee

Meeting date: Tuesday, September 15, 2020

Official Report 683KB pdf

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Scottish National Investment Bank

Welcome back. Agenda item 3 is the Scottish National Investment Bank. I am pleased to welcome two witnesses from the Scottish National Investment Bank. They are with us in the committee room. Eilidh Mactaggart is the chief executive officer designate and Willie Watt is the chair designate.

I will start by asking about the mission-oriented framework that was developed for the bank by Professor Mazzucato. Are you satisfied that the proposed missions meet the five criteria set out in the framework for the bank?

I will start on that, then Eilidh can come in. The short answer is yes. The three missions certainly are targeted and directional. We think that they meet the grand challenges that Scotland has—creating a low-carbon future, dealing with inequality and stimulating innovation—which, in turn, should help to deal with some of our demographic issues.

It is for the bank to make sure that the progress is measurable. There is sufficient evidence from other investment organisations around the world that it is possible to create data-based measurement of mission-based activity. We need to put that into practice and we are working on that at the moment.

It is reasonable that the missions should be time bound. There is no point in looking at them on a short-term basis, because if we do that we will not move the dial. The reason why they are grand challenges is that they are persistent issues that require attention. It is right that there is a long-term time horizon for them. The reason why 2045 was picked for the low-carbon mission is obviously so that it coincides with the Government target for net zero. A 20-year time horizon for the other two missions should allow real change to embed itself.

Professor Mazzucato’s recommendation that we should not be sector or discipline specific is right. The missions have implications across all parts of the country and all industrial sectors, so to pick out just one or two sectors or disciplines would be wrong. We very much agree with that. The missions give the bank the opportunity to build bottom-up solutions, as Professor Mazzucato has suggested. In short, they give us the parameters and directionality that we need to fulfil the bank’s aims.

What is the priority for the bank? You talked about—

In terms of the missions?

Sorry, perhaps I could clarify the question. You talked about innovation, but that was only the third thing that you mentioned. Is there a list of priorities for how to approach things? How are they ranked? Was it just coincidence that that was the third thing that you mentioned?

That is the way that the missions are always written: net zero, place making and innovation.

To answer your question, the First Minister has said that the first among equals or the number 1 mission is the low-carbon mission. We have taken that on board and we need to work out what that means in practice. Neither of the other two missions is less important than the other, but if the low-carbon mission is to be the number 1 mission, the other two, by definition, need to be subordinated to that. I would describe it as there being a number 1 mission, then two equal missions.

In terms of our activity, we think that quite a number of the investments that we will make will cover more than one mission. For example, innovation covers technology investment, but if that investment was in clean tech—technology that captures carbon or helps to manage low-carbon solutions—that would clearly meet two mission requirements. If that business happened to be in a place of high inequality, it could potentially hit three missions.

When we report on our activity, we will need to make sure that we report each investment that we make against the mission that it is resolving, so that we can make sure that we are reporting on all the activity for which we are responsible.

I was not suggesting that the three missions were mutually exclusive in any way.

When you talk about investment, most people think about putting money in and expecting a return, or at least that it will hold its value. Is that part of your approach?

Yes. We reject the idea that commercial returns and mission benefits are in conflict with each other. We expect to see a mix of commercial return and mission benefit in every investment that we make. We will not make commercial investments that have no mission benefits and we expect to have a commercial return from any mission benefit investment that we make.

I will pick up on that point about commercial return and there being no apparent trade-off. Certain investments in the environmental sphere are more bankable than others, for example, an energy-from-waste plant versus other forms of less commercially bankable returns. How do you square that in relation to your investment strategy?

Primarily, the bank will be looking to invest in commercial projects. If something is too early in its evolution and needs grant funding or sub-commercial funding, we might work with other agencies to encourage that technology development.

As a development bank, however, we will look at investing in the higher risk end of the spectrum. If the retail, high-street or corporate banks are able to do the investments, we will not need to. We will try to path lead into that as soon as we can make the technology commercially viable, but there is a little bit there where we will be working with other agencies as well.

Will that be reflected in both the rate of return that you expect and the payback time?

Absolutely. There are two key issues in relation to rate of return. We are patient capital and patient capital has patient returns, so we will not see an immediate return from many of our investments. We will also be looking for mission benefits and ensuring that the commercial return marries well with those. For me, there will be an evolution: first, we want to get the bank to financial self-sustainability and then we want to look at providing a positive return on the investment made to the people of Scotland, which is essentially where the money is coming from. That evolution will take time, but we firmly believe that, with time, we can provide a positive return on investments that we make.

On the overall investment strategy, one of the issues that we have faced previously is related to the size of investment. When we talk about the circular economy, we are often talking about small-scale investments. What is the bank’s appetite for those sorts of investments?

We will be looking to invest across the piece. There might be a point at which an investment is too small; initially we will consider projects and businesses looking for investment above a certain level. If we are looking at a project in a rural area or that has a specific niche that appears to be worth considering, such as a start-up, circular economy recycling initiative, we will not take a hard line and say that we will not consider it. However, we need to ensure that our impact is sufficient. We are an investment bank and we sit at a certain point in the structure, so a certain scale will be required. However, we will work closely with others to ensure that the financial ecosystem, as a whole, provides.

11:15  

We can also invest in funds that are able to deliver smaller chunks of capital. We see the bank impacting on the overall ecosystem of funding by direct-funding a certain size of project—we need to work out what the size will be—but also by investing in funds that will go deeper into the smaller scale companies. Our job is to ensure that the funds that we invest in are fit for purpose and professional, provide value for money and do exactly the job that we want them to do.

You may have seen the Logan report, which we are quite interested in, because one of the other challenges involves scale-up and the bank has quite a big role to play in that regard. At the moment, there is quite a lot of angel investment, which does a really good job, but it is difficult for angels to follow the money as businesses scale up, because they have limited resources. We can do that.

The Logan report also highlighted that the venture capital sector in Scotland is immature. One of the things that we can do by investing in funds for early-stage development is help to foster that sector, because we can provide cornerstone investment for those funds to help to get them off the ground, and that will create more of a private sector ecosystem that will support early-stage companies.

We now have questions from the deputy convener, Willie Coffey, who joins us remotely.

I want to ask about scaling-up potential. Yesterday, I spoke to Technology Scotland. The discussion focused on how Scotland is pretty good when it comes to innovation and the generation of new ideas, especially in digital science, bioscience and even photonics. Although we seem to be really good at establishing things, we do not seem to be very good at hanging on to them and enabling them to grow in Scotland. How do you see the bank performing in relation to scaling-up exercises so that, as we hope, bigger companies emerge and stay in Scotland?

The point is well made, and we agree with it. There are some good examples of scaling up—Skyscanner is the one that everyone talks about—but there are too few of them and they are in too few sectors.

What is behind that problem? One issue is that the investors with the deepest pockets are not Scotland-based—they tend to be based on the west coast of the US, around Boston, in London or Berlin. The bank can be a deep-pocketed long-term investor, and we also hope that we will crowd in other deep-pocketed long-term investors. Scottish Equity Partners, which is our pre-eminent private sector venture capital firm and was recently rated as one of the top 10 venture capital firms in the world, was instrumental in the scaling up of Skyscanner. We can play that role.

We can also give management teams confidence to go further on the journey with their company, rather than selling out at an early stage. Why does that happen more often in Scotland than it does in other parts of the world? Perhaps it is because companies feel less confident about the overall ecosystem. I keep using that word; perhaps I need to think about using something a bit more original. However, the point is that they might have concerns about the other tech companies that surround them.

The Logan report is quite good on the subject. If you look at the successes, you see that those companies have a host of other companies around them, and that all those companies give each other confidence—“They made it big, so we can make it big, too, and go all the way through to a listing on the stock market.”

It is partly about confidence, partly about long-term funding and partly about not selling the technology at the stage of spin-out from university. I was looking at The Sunday Times tech track 100. One of the leading companies in that list is in Oxford, but the technology came from the University of Dundee; the company is now based in and scaling up in Oxford. I do not know anything more about that example, but the question that I ask is why that is happening not in Scotland, but somewhere else.

As a bank, we need to ask ourselves that question. We need to ask whether it is to do with the infrastructure around scaling up, in terms of premises or skills. If that is the case, we need, as well as actually investing in scale-up companies, to look for investable opportunities in real estate and skills development that could foster scale-up. It is a real issue.

That was a really good answer. Is part ownership and control a factor? Do you see the bank taking part ownership and control of companies when it makes investments to assist the scale-up process, so that it can give confidence and assurance that it is with the company during the transition? Would it help to turn that around a bit more in our favour?

Yes and no. The answer is definitely yes to working with a company and being a shareholder in it. We are talking to representatives of companies in which we will potentially invest; we are trying to have a dialogue about the long term and helping management teams to equip themselves for that.

Because we are a Government institution, there are limits to how big a share we can hold and how much control we can have before the investment goes on to the Government’s balance sheet, which I think no one wants to happen. Therefore, we have to be careful that we do not overstep the mark into being too controlling, or into being controlling at all. However, we can be a challenging and supportive partner and we can use our collective knowledge to help companies to go through growth phases.

I apologise. I think that one of the witnesses had prepared a brief opening statement. That information was not fed through to me, so our missing it at the start of the meeting was unintentional. At the end of the meeting, I will give the opportunity for a brief summing up, in the light of that.

I am not sure whether you can see our remote members on the screen when they ask questions.

Yes, I can.

That is great.

I will start with a question for Eilidh Mactaggart. You mentioned that the bank will invest in patient capital. In general terms, what level of support would you provide to someone who comes to you with a genuine blue-sky idea that has a lot of potential but has had very little development work done on it, and for which, because it is so innovative, the proposer has found it difficult to get the advice and support that they need? Do you envisage the bank being able to provide support for such things?

The bank will be able to work with businesses and projects—“technology project” is a term that we use in banking for something that is slightly different to a “business”—to finance their propositions.

Scottish Enterprise does a lot of work on financial readiness with businesses, and we expect that to continue. If someone comes to us with a blue-sky idea, and we think that they need a little bit more help on the advisory side and on setting themselves up, we might refer them to Scottish Enterprise. It will depend on where they are on the blue-sky spectrum.

I always say to the team, and to Willie Watt, that all the investments that the bank will make are likely to be hard-work investments. If they were easy investments to make, the corporate bankers would make them. We will work hard with our counterparties to make sure that a business or project is set up properly—that it has the right controls, the right balance sheet and protections, and the right levels of debt and equity in the structure to realise growth ambitions.

If something is too early in the blue-sky phase when it comes to us, and really needs grant or sub-commercial funding, we will look to other funds. As Willie Watt mentioned, the British Business Bank does great start-up sub-commercial funding, and grant funding is available through various Scottish Government agencies. We will try to ensure that we are connected to the whole system, so that we can point to the right person and work closely with them. We do not want simply to say to someone who comes to us, “That doesn’t work for the bank”, then send them off. We will want to ensure that they are picked up in that ecosystem; so are therefore working closely with public sector partners.

We also work closely with private sector partners. I think that it will be rare that we provide 100 per cent of the financing. We will always look to lever in private capital alongside the public capital in order to maximise the impact of the public capital. We will be constantly networking and talking to the market as a whole to make sure that everyone gets the service that they need.

Thank you. That was useful, because it links a little bit to Willie Coffey’s question about losing innovation from Scotland, in that all agencies that are geared up to provide support must make sure that they do as much as possible to encourage and assist entrepreneurs.

Section 5 of the Scottish National Investment Bank Act 2020 says that the bank “must prepare and update” a balanced scorecard. Obviously, it will be some time before you do that, but have you undertaken any work on how to approach that task?

Yes, we have. We have the “Scottish Public Finance Manual” framework, the United Nations’ Principles for Responsible Investment Association framework and the UN sustainable development goals. We are pulling all those together in tracking our investments. We will look not only at financial returns; we will look also at the full suite of mission-impact returns, which, given the nature of our mission, encompasses sustainable development, responsible investment and ethical investment parameters.

Before I joined the bank, the team did a lot of work on that for the passage of the bill. We continue to work on that, and we will continue to perfect that investment by investment, as we learn. We, too, are a start-up, so we will work on a continuous-improvement basis. That is the terminology that I use with the team when we are talking about that aspect.

As Willie Watt has said, our reporting will not just be the usual bank reporting of numbers; it will be much wider than that, and the balanced scorecard will be embedded in it.

I think that I heard you say that you are a start-up. Is that correct?

We are a start-up bank looking to invest in start-up companies.

You are a start-up bank, but you are not the only publicly owned development bank. At the current stage in developing the bank, have you found any financial institutions around the world to be particularly helpful in learning lessons from them or drawing on their experience?

Yes. We have had fantastic interaction with the British Business Bank, the Development Bank of Wales, and Invest-NL in the Netherlands, which is one of the most recent development banks in Europe. We have also had contact with the EIB Group. In my former career, I did a lot of investments alongside EIB, the International Finance Corporation and the World Bank. We have been tapping into that well.

Do you want to add to that, Willie?

11:30  

As Eilidh said, quite a lot of framework work has been done on that. Under the UN Principles for Responsible Investment Association’s ratings, the company that I ran previously was rated triple A, and A+ for its sustainability reporting. We can bring such experience to bear. In putting the board together, I am taking cognisance of bringing on to it experience that can help us, in that the people will have been there before. We have not finalised the board, but two or three potential members have strong backgrounds in that space in the public and private sectors. They could add a lot to Eilidh Mactaggart and the team, in terms of helping with that.

I hope that our balanced scorecard will, when it sees the light of day, include the benchmarking against best practice that has been talked about. However, it will also need to be tailored to our situation in Scotland; it will include a mix of the two.

I will start with a straightforward question. How confident are you that state aid permission will be secured from the European Commission before the end of 2020?

I am fairly confident. We have had some really positive engagement in the past month or so, and I have another call with the Commission this afternoon. Our last engagement was at the end of July.

We submitted the pre-notification—in essence, that is the draft notification—at the beginning of June, on 3 June I think. We have had some back and forth on it. The engagement at the end of July was very positive; Commission officials were talking about drafting decisions, and we went back with some answers. We will have a call this afternoon.

We hope to get the permission in timely fashion. In our conversations, there has been talk of decisions coming, so there has been good and positive engagement, of late. I am really pleased about that. The permission is time-critical for the bank; the act does not allow us to be capitalised until the state aid consent comes in.

Clearly, time is short until the end of the year, and things are moving very quickly. If consent does not come through, what are the implications of Brexit, and for the bank’s launch date?

If we do not have the consent by the end of the year, we will sit down with ministers to discuss how we will deal with that. We are working closely with the Commission to ensure that we do not get to that point.

As Eilidh Mactaggart has said, the act is clear that, without state aid approval, the bank cannot launch. We would want to sit down with ministers and decide what to do, if we were to be in the very unfortunate picture that Colin Beattie painted for us. Ministers are leading on that issue, but the bank team clearly wants to launch as soon as possible.

We have not yet talked about the Covid crisis, but there is clearly a huge pressure on and impetus for the bank to launch. We would be very concerned if we did not get state aid approval.

I presume that you have a plan B; there is always a plan B. We cannot assume that the permission will come before the end of the year. No matter how confident you might be in your discussions, all sorts of political considerations could derail it.

Yes—of course things could derail the permission. The challenge about plan B is in knowing the state aid environment that we will be entering. Members will be familiar with the political announcements by the Westminster Government about state aid; it is talking about a state aid environment that is much more permissive than the current one.

Earlier in the year, there was talk that the Competition and Markets Authority would be responsible for the state aid regime. We have open discussions with the Competition and Markets Authority, and recently we have been told that it might not be responsible for state aid.

It is important that we have a plan B. However, to be candid, that plan B has a political element and the Holyrood and Westminster Governments would have to be significant parties to it. The bank cannot come up with a plan B in isolation from our owners in the Scottish Government.

Any delay in launching the bank is obviously a great concern. Would it be reasonable to assume that, if we did not get the permission from the European Union, we would be virtually starting the clock again with a new agency—whatever it might be?

I am not sure that I would assume that. There might be other ways in which that could be dealt with. To be honest, ministers need to give us guidance on that.

Another problem is that discussions on the HM Treasury dispensation now form part of the fiscal framework engagement. That means that the bank’s year-end financial position will need to be taken into account as part of the overall Scotland reserve, and it has implications for the degree of independence that the Government would like to put in place for the bank. How will that impact on the bank’s operation? Where are we on that?

You have summarised the situation absolutely correctly. That is part of a wider discussion that is above our pay grade; that is where it sits. Eilidh Mactaggart and I need to work out how we run a bank without that dispensation. We need to be very closely connected to the Scottish Government Treasury function, so that we can plan our access to capital and our capital requirements at the micro level. That will mean that there are as few surprises as possible in relation to how much capital we need in any given time horizon.

We think that that is manageable in the first year or two. The risk is not in the same category as the risk relating to state aid. It is a manageable risk that we can deal with through good faith and operational planning from the bank and the Scottish Government. Clearly, that derogation is important to the bank and would really help us. We would like the situation to be resolved as soon as possible.

To what extent are you involved in those discussions?

We are not particularly involved in the discussions. They are being led by the Scottish Government.

Would you expect to be involved?

We would be happy to be involved in the discussions if it was felt that that would be helpful. The issue is important to the bank. Wherever one sits politically, the missions that the bank is focused on are for the good of the Scottish people. I do not see the issue as political.

Most important, are you reassured that the bank’s launch will not be delayed simply because of that issue? It just makes it more complicated.

That is correct.

Richard Lyle, who is joining us remotely, will ask the next questions.

How has the Covid-19 pandemic affected plans for the bank, and what role will the bank play in the Covid recovery response?

Since April—just after I joined—the bank has been working with Scottish Enterprise to support the Government’s response to the Covid pandemic. We are still in the start-up phase and are not quite launched yet, but we have the ability to do some investment and we have been supporting our colleagues across Government by doing that.

There was some discussion earlier—Willie Watt might be able to give more background on that, as it relates to a time before I started—on whether the bank launch should continue, given the Covid crisis, and it was decided to continue.

The most important thing for me here is that the bank’s focus is long-term patient capital. The bank should not be involved in short-term working capital requirements for businesses; there are other means by which that need can be met. If we are going to deliver on the missions that we are being set, we need to keep that focus on patient capital.

Undoubtedly, however, a lot of the investments that we make will help with the response to Covid. In many instances, we can see an increased need for the missions and the issues that they address—inequality, green recovery and so on—as a result of Covid, so we believe that the bank was already aligned with what needs to be done to respond to Covid.

The advisory group on economic recovery has recommended that the bank leverages public capital by issuing bonds as a “pressing priority”. How will the bank respond to that recommendation? Can I also ask, as I previously worked for the Royal Bank of Scotland, if the bank issues bonds, will they be sold to the general public or just to financial institutions?

I will take those questions in order and come to the investors second.

There are many ways to leverage private capital alongside the public capital, which I touched on earlier. We can co-invest with private sector capital on an investment-by-investment basis. We can invest in funds, as Willie Watt has covered, and there will be private capital in those funds alongside the public sector capital that the bank has. We can also establish our own funds; Willie and I very much share that ambition. We come from banking and investment management backgrounds, so there is that combination of experience. We are aligned in our ambition to raise funds, whereby we can use our public capital to cornerstone investments in funds to attract private capital, which will enhance and increase the impact of our missions overall.

In addition, we can issue bonds. Debt capital market issuances can take many forms. They can be bank-level bonds, in which the bank leverages itself. In the past 10 years, green bonds have been issued—for example, utility companies can issue green bonds. Down south, Anglian Water issued a green bond to put solar panels next to a reservoir to power the reservoir; green bonds can be used for many things. Social impact bonds are becoming increasingly common, and a number of development banks in Europe have been issuing them. The funds that are raised by those bonds are directed toward a type of project that has a social benefit, and that would be hugely beneficial for the bank. Most recently, HSBC has launched a transition bond for oil and gas companies that are moving out of the sector.

All those things are potential tools. For me, it makes sense that the bank should start on an investment-by-investment basis and build up from there. When you raise money for a fund, you often attract pension capital. That capital tends to be the biggest player in the debt capital markets, in terms of buying bank debt, issue debt, social bonds or green bonds.

I prefer the fund management side, because you have a closer relationship with your capital. Typically, the debt capital market is anonymous—you give an update over the phone—whereas in fund management, you sit much closer to your investors. However, all those tools would be advantageous to the bank, and Willie Watt and I certainly have those ambitions for the bank.

11:45  

I add that we think that, in the first instance, our investors will be institutional investors. The regulatory framework around offering fund or bond investment to retail investors is such that it would take longer for the bank to be in a position to do that. In addition, we would want to be much more confident that any investment that was open to the general public was one that we absolutely understood. Therefore, it is likely to take us a little while to get to a situation in which we could issue bonds or create investment funds for the general public. We will do that for institutional investors as soon as we can.

That is fine—thank you.

The committee received a submission from the Scottish Council for Voluntary Organisations and Social Enterprise Scotland that expressed concern about how the bank is engaging with charities, voluntary organisations, social enterprises and co-operatives. How will the bank engage with those sectors and community organisations that are economic generators?

We are certainly committed to working with the third sector, as that will be important to the delivery of our missions. We have already had some engagement with Social Investment Scotland and Charity Bank, and we regularly speak to housing associations. We sometimes engage with the third sector and, as part of that, we have been working with the education sector.

Communicating and working with the third sector, the public sector and the private sector will be critical to the bank’s success. I would not want to rank any of those people in importance. We need to make sure that we talk to everybody because, if we do not, we might miss an opportunity to invest for our missions.

Eilidh Mactaggart and I had a meeting with the chief executive and the chairman of Social Investment Scotland in July, I think—

Yes, it was July.

We thought that that was a positive meeting and we were encouraged by what they told us. They might like us to engage with them more sooner, but we are under pressure to get the bank launched. That is not external pressure; it comes from ourselves, because we know how important it is to get the bank launched as soon as possible.

We have said to interlocutors that we could deal with, not just in the charity sector but in commercial sectors, that we really have to get the bank launched. Once it has been launched, that will be the right time for us to engage in deep discussions. It is a matter of prioritising launch above anything else. As chairman, I know how hard the executive team is working on that. We are committed to launching the bank as quickly as we can. However, it is absolutely not the case that we will forget about the third sector.

When the committee took evidence on the Scottish National Investment Bank Bill, it was told that the demand for finance in Scotland was very mixed and, since then, we have had the pandemic. Given that you are focused on the priority of getting the bank launched and are not talking to those who might use the bank, does that mean that the bank will have quite a slow start? Are you going to stimulate demand in the market only once the bank has been launched, or are you working with organisations other than those in the voluntary sector to stimulate demand now?

We are already working on some investments. We are balancing the need to launch with the need to start developing a pipeline of demand. The chatter about the setting up of the bank has been stimulating demand. We get a lot of contact, and we are working on a number of investments. Of course, as time progresses and the bank builds, people will see the types of investments that we will make, which will itself stimulate demand. I am in the process of hiring a team to stimulate such demand.

We will also be relying on others to send opportunities our way, as all good institutions do. For example, we expect that Scottish Enterprise will refer a number of potential investments to us. We expect to see other agencies doing the same, and working across both the public and the private sectors.

It is not that we have not yet started the stimulation of demand. Rather, we will not have enough time to be able to spend all our time on that until the bank is launched, and we are already dealing with some opportunities.

Further, development banks tend to be counter-cyclical. We are looking at a downturn at the moment. Post-Covid, I think that the demand for our services will be even greater than it might have been in a different cycle. Therefore although demand stimulation is required, it is not completely dormant at the moment.

The Scottish Government often cites the bank as being one of the routes out of Covid that will help our economy to bounce back. How long will it take from the bank’s coming into being for it to run at full tilt?

If by that you mean actually making investments, we have some in the pipeline, which we hope will come through in the coming months. Willie Watt and I are both bankers by trade, so we know that investments are incredibly fickle as regards the dates on which they are done. Covid has delayed a lot of the projects that we were considering, so there has been a slight dampening there.

I expect there to be a progressive build. We will also need to walk before we can run, as we build up our team. We will not be able to run at full speed on day 1, but I expect to see us making some investments in this financial year and then increasing that, year on year, in a gradual, measured way.

We must ensure that any investments that we make are considered and structured properly. As I touched on earlier, because the bank is a development bank, the investments that it makes will involve more hard work and require a lot of time to pull together. In the private sector banking world, a banker might have a packaged-up investment hit their desk and be able to invest within a couple of months. However, it might take us up to six months to take an investment from the stage of an idea to actual financial close. We will build gradually, and we already have some stuff in the pipeline.

One of the differences between a mission-based bank and a development bank that is perhaps all about demand stimulation is that, once we have our team in place, we will seek out the right kinds of investments to meet our missions. In our world, that is called origination.

By the middle of next year we would expect to have in place a fully functioning team of people who are capable of originating investments across the whole spectrum of our missions. They will go out into communities and talk to people. Eilidh Mactaggart has a good phrase on that. She wants to go and talk to banks not about the investments that they are making but about those that they are not, because it is in those that we will find the things that we need to do.

Apart from the factors that we have already discussed, one of the key milestones in the build process will be hiring our team and getting it in place. We have made a lot of progress on that since we last gave evidence to the committee in June or July. However, until the team is in place it will be hard to be as proactive as we would like to be on origination.

So it might be summer next year before you see that happen.

I would like to think that we will make some investments in this financial year.

Of course. However, I think that the question was about when we might be fully up and running. I hope that the committee will not hold me to the exact date of next summer—although that is not really a date, so perhaps we will be all right.

I will continue on Rhoda Grant’s line of questioning about demand stimulation. Mr Watt, you said earlier that you feel that, among management in Scotland, there is often a lack of confidence about growing a business beyond a certain level. I wonder how the two things tie together—demand stimulation and the lack of confidence. I presume that that means that there are some organisations out there that need your investment but are not aware of it yet.

Yes—that is quite possible. One of the things that we will need to do, once we have launched, is make sure that everyone is aware of what we are about and what we can do. We will expend a lot of our effort on increasing awareness.

On demand, certain other factors are at play that were not there before. Fundamentally strong companies are coming out of the coronavirus crisis with solid business plans but, potentially, a lack of financial support. We do not know exactly how much banks will have to rein back what they can lend because they have to make provisions against losses, which will have a direct impact on what they will be able to continue to lend. We also do not know what private equity and angel investors are going to be able to do. However, it is a reasonable working assumption that, if there was latent demand before, there is going to be more demand.

I think that it is right to stimulate demand. As the Logan report said, we do not have enough early-stage, technology-based companies, so demand stimulation is right and proper, but there is also increased demand because the supply of capital may have shrunk. We are going to be involved in both of those aspects.

I think that that was the experience the last time, in 2008, 2009 and 2010. Good businesses could not get finance because its availability had shrunk.

Yes.

I understand that the British Business Bank has a specific demand development unit. Is that the direction of your thinking? Ms Mactaggart said that demand would come from a range of places.

No good investment bank, whether it is in the public or the private sector, will be able to stimulate demand by itself. All investment banks are part of an ecosystem. As Willie Watt said, we will be hiring a team of people that I call originators, who will originate deals and investment opportunities.

We will work closely with industry, Government and businesses to ensure that everybody knows that we are here and understands what we can do and what sort of investments we are looking to make in demand stimulation. Others will, potentially, refer business to us for investment. I will always say to my origination team, “You can’t close the door on an idea—it might not be the right idea from the person this time, but the next time they might have a good idea.” It is important that we have a very open and approachable unit.

I would normally embed a demand stimulation team within the origination team, and that is certainly where we will start. We will always look to others to see whether they have better ideas on how to continually improve things, but the demand stimulation team will initially be in the origination team. We are also going to have a partnerships and engagement team that will focus on speaking to everybody that we need to speak to.

Scottish Enterprise has demand stimulation at the centre of its remit, and we need to work in partnership with it. It is a deeply resourced organisation that focuses on, if you like, bottom-up demand stimulation. It is important that we work closely with it so that there is a seamlessness around support for enterprise that starts with small grants at one end and has scale-up capital of many millions of pounds at the other end. It is important that there is that seamlessness and that we work well with Scottish Enterprise.

12:00  

If a small business was thinking of selling up, might Scottish Enterprise, Highlands and Islands Enterprise or South of Scotland Enterprise persuade it not to, but to come to you instead?

South of Scotland Enterprise is obviously in its own start-up mode, but Scottish Enterprise and HIE have networks of relationships and it would be a complete waste if those relationships were not linked together. Nonetheless, as Eilidh Mactaggart said, we also intend to create our own relationships over time. Of course, as we keep saying, we need to get up and running to do that.

If a technology business was thinking of selling up, we would ask, “Why are you doing that? What are your motivators? Is there another way that you could take this to the next stage? Could we help you to do that?” Those are the sort of questions that we would ask. We would ask whether a lack of finance was part of the equation or whether it was more about a lack of uniquely skilled people who are only available in Silicon Valley, Berlin or wherever. That is the kind of dialogue that we would want to be part of, if we could be. We are working on something at the moment that involves exactly that situation. We were introduced to a business by Scottish Enterprise—we are in quite an exciting dialogue with it—and the issue is a mixture of those things.

I will touch on one other subject. The rate of return was mentioned earlier, and you explained how the mission and the rate of return relate to each other. Is there a target rate of return, or will there be one?

Eilidh and I believe that the bank should have a target rate of return but that it should be calculated on a long-term basis. As she said, it may take a period of time for returns to manifest themselves, and we will be making riskier investments than the private sector—otherwise, why do we exist?

We need to think carefully about the target rate of return. It is important, because returns need to be related to the cost of capital. Our capital is provided by the Government, but it is still real money, so comparing returns on that money with a recognised cost of capital calculation is important. As Eilidh said, the bank needs to be self-sustaining. We need to create positive returns that we can then reinvest, but we cannot be self-sustaining unless we make positive returns. We need to take into account the time horizon and the risk-return profile before we set the target rate.

The Scottish National Investment Bank Act 2020 makes it clear that it is for ministers to set the target rate of return, but the bank’s board will have the technical expertise to make a clear judgment on such things. We will be in discussion with ministers about the target rate of return, but—yes—we believe that we should have one and that it should be measured on a long-term basis.

I am sure that we all agree that it should be set for the long term; we politicians are all very patient, as you know. The British Business Bank has a target rate of return of 2.5 per cent but it achieved 4 per cent in a recent year. I understand that the Development Bank of Wales does not have a target rate of return and that the Scottish Investment Bank achieved a 0.7 per cent return. Can you give us an indication of what range you would be thinking about?

The actual returns that an organisation that is setting a long-term rate of return makes will fluctuate around that rate. I am not surprised that the British Business Bank returns might be higher than its long-term average—

Yes, it has had a good year, but it might not have a good year every year.

We need to do some work on that, but we are certainly talking about a single-digit rate of return. I do not want to be specific, because we have not done that work, but it will be in the same ballpark as the rates of the other institutions that you mentioned. It has to be a positive rate of return, and it has to be achievable over the long term. It also needs to take into account the risk reward. We really need to do some work on that.

One of the issues that we have is that we have no track record of having made any investments. On the basis of our professional experience, we believe that we can find mission-based investments that will give us positive returns. We will be looking at equity investments over a five-year to 10-year time horizon and, potentially, at project finance investments over a 25-year to 35-year time horizon.

We will need to pull together all our knowledge and use the people we are bringing on to the board, who are also very experienced in the area, to come up with something that we think makes sense. As I have said, the guidance that I have given you is our gut feeling about where we think the rate should be.

That is helpful. What is the timescale for that? When do you think we will have a rate of return?

As I said, under the legislation, the rate of return is set at the behest of the Scottish ministers, but I do not see any reason why we could not set a long-term rate of return in the first year of the bank’s existence. We need to make sure that we have got it right, but it will be a long-term rate of return, which is a useful tool for us in managing the bank, because it makes sense to have a target rate of return. It needs to be set at the right level so that we do not mitigate what we are trying to do with the mission. The Scottish people deserve to know that the bank is serious about its mission.

Personally, I think that we would be able to recommend something to the ministers within the first year, and the ministers would then need to pick that up.

I want to pick up on that last point. How do the rate of return, investment and historically low interest rates fit together? Some might question what a return is in the current circumstances if they carry on or if we end up with negative interest rates.

The cost of capital is at an historic low, as you say, and it has a direct relationship with the long-term returns that can be generated. We would be looking to make returns over and above the cost of capital, but, because that is so low, it has informed the returns that your colleague John Mason mentioned coming from other development banks. They are in the ballpark that they are in partly because of where debt-based returns are.

Is that partly because of where they started from? You are starting at the current rate of returns, but some of those banks started years ago.

I guess that you would expect any institution to review its rate of return in the light of experience. I do not know the history of the British Business Bank, but I imagine that it sets a long-term rate of return and then reviews it either annually or every two to three years in the light of changing interest rates.

Interest rates have never been as low as they are now, but they have been significantly low for a long time, and deposit rates have been almost zero for a considerable length of time. It is not new that we are in a low-interest-rate environment; it is new that it is as low as it is post-Covid. However, you are right to say that the interest rate regime is relevant to the long-term rate that is achievable.

There are no further questions from the committee members, but, before I close the meeting, I want the witnesses to do a brief summing up, because I did not afford them that opportunity at the outset. You might feel that all the issues you wanted to cover have been covered; otherwise, the floor is yours.

Thank you, convener. I thank the committee for inviting us to give evidence today. We look forward to creating a relationship with the committee over time, and I am sure that we will be back to speak to you on a number of occasions in the future.

Since we last met, in July, we have made significant progress with the launch work that we are doing. As I said, the team is working incredibly hard towards the launch. The committee has raised the right issues. They are things that we think about ourselves during our day jobs, and we are working as hard as we can to get the development bank up and running.

We are focused on launching the bank in the final quarter of the year.

Thank you to both of you.

12:12 Meeting continued in private until 13:08.