Official Report 719KB pdf
Our next item of business is an evidence session with the Scottish National Investment Bank as part of our stage 1 scrutiny of the Circular Economy (Scotland) Bill.
I am pleased to welcome Al Denholm, who is the chief executive officer of the Scottish National Investment Bank, and Jimmy Williamson, who is the executive director of the investment team for the Scottish National Investment Bank. Thank you for joining us.
Before we move to questions, I believe that Al Denholm wishes to make a brief opening statement.
Yes, thank you. Good morning to you, convener, and to the committee. I am pleased to have the opportunity to engage with the committee. This is my first meeting with the committee and I look forward to working with you all in future.
In terms of my background, I have worked in the investment industry for more than 35 years, initially with a subsidiary of the Royal Bank of Scotland before managing investment portfolios and investment management business units for a number of leading asset managers. That experience included Aviva Investors, Prudential, BlackRock, ING Investment Management, Insight Investment and Scottish Widows. I have also led environmental, social and governance investment teams since 2000, and their development has been something of a theme throughout my career.
I took up the post as chief executive of the Scottish National Investment Bank in May of this year. I am joined by my colleague, Jimmy Williamson, who will introduce himself.
Good morning. I am an executive director on the investment team. My background is in more than 30 years of investment in corporate banking, private equity and venture capital, as well as supporting private equity management buyouts in multiple sectors and consulting in the industrial and energy markets.
My day-to-day job at the Scottish National Investment Bank is leading one of the investment origination teams, which means originating, finding, sourcing, executing and structuring the investments that we make. I am also partly involved in managing those on an on-going basis.
Thanks, Jimmy.
Since coming into the post, I have been pleased to see the progress that the bank has made since its launch in November 2020. We are coming up for our three-year anniversary very soon. I am hoping to work with the team to build on that progress. I see particular opportunities to further develop the bank’s reputation as an impact investor and in working with institutional investors to mobilise their capital to meet the key economic and societal challenges and opportunities that we have in Scotland.
The bank has now concluded 29 investments, committing almost £460 million directly, with £750 million crowded in from third-party investors as well. That takes us to more than £1.2 billion of economic impact into the Scottish economy in those first three years.
We are pleased to be here to discuss the circular economy. That is an area in which we see an important role for the bank, and it is one of our key strategic initiatives or priorities. We are supportive of initiatives to support the circular economy including the introduction of the bill. I appreciate that the committee has been hearing detailed feedback on some of the proposals in the bill. As an investor, though, our interest is mostly at a higher level—how the bill might support the development of the circular economy business models to support and scale up circular businesses.
We are happy to share our perspectives and to provide an investor’s point of view on the development of the circular economy and the various business models therein. We already have a number of investments in that area. A particularly strong example, which the committee may be aware of, is a natural fibre insulation manufacturer called IndiNature, which our £5 million investment has supported to open a manufacturing facility in Jedburgh. We are seeing other opportunities in the circular economy coming into our pipeline and we hope to conclude more investments in that area in due course.
I will conclude there. We look forward to our discussion.
Thank you. You have quite a few questions coming your way. The first questions come from Monica Lennon.
Good morning, panel. I did not catch all the details, but you gave an example just a second ago. My first question is to ask how the Scottish National Investment Bank is currently supporting the transition to a circular economy in Scotland and how that links to your mission and investment principles—for example, to seek to invest where the private market is failing and to be a patient and ethical investor.
I will give an overview of that, and then I will ask Jimmy Williamson to go into a bit more detail with some examples, if you do not mind.
When the bank was set up, one of the key objectives was to focus on the transition to net zero, and on the circular economy as a core part of that. Whether we use less or recycle, it all plays into that, and we think that it is a good and positive thing to do. We are aiming to do that strategically by setting a focus on the area as a key objective for the bank. Over time, we will publish our results and how we are doing in that area—for example, the amount of money that we invest in businesses; by how much waste has been reduced; and how those businesses contribute to the circular economy. It is a key initiative for us.
As I mentioned, we have been starting to make some investments in the area. We are clearly reliant to an extent on what I will call commercial opportunities coming our way. We are not a grant or project-financing body—we invest in and support businesses as they have a commercial opportunity to scale up. If a business is attractive, or if we can help it to look attractive from a commercial perspective, that offers a strong opportunity for third-party private capital to come in alongside us. Obviously, private capital has its own target returns and objectives; most of those private companies want to make a positive return on their capital, in the same way as we do as part of our mandate.
Jimmy Williamson can give some examples to bring that to life.
In 2023, for the first time, we added a new objective to the net zero mission aims in our impact report, which is to grow the circular economy by 2045. That raises the prominence of the circular economy in our core mandate, as part of our net zero mission investment objectives.
In practical terms, that means that we are bound by objectives, as well as at an institutional level, to report on the progress of the investments that we make in contributing to that end objective. We aggregate those key performance indicators that we establish for individual business investments.
In practical terms, that will involve the amount that is invested in circular economy businesses and the proportion of the bank’s investments that contribute towards the circular economy. It could also involve KPIs at business level, where we have targets on the re-use of materials—for example, the recycling of products that have gone off. Those will be aggregated at institutional level, and we will report on the themes that underpin the trend towards a circular economy in our annual impact report.
The message is that it will become part of our core reporting framework.
To build on that, can you say a little more about the key opportunities to integrate circular economy principles across your missions of net zero, improving places and harnessing innovation? Will you look at circular economy principles when you are investing in housing, energy projects or technology, for example?
The consistent theme is that circular economy principles are very broad based. Although we position them within our net zero mission, they apply across all our mission areas, including the place mission as well as the innovation mission.
I will paint some examples of the type of business models that we expect to see and where we think that the opportunities lie. With well-thought-out legislation, and the regulation that comes from that and actually creates business models, those businesses will need to comply with that. There is obviously a cost to doing so, but equally there is a consequence of not doing so.
What we find in other markets where regulation is imposed is that business models establish themselves to help businesses to comply in service provision. That is one example of where we would expect to see interesting business models for investment opportunities.
There are other features that we see. Scotland is instituting these bills, which puts us, relatively speaking, ahead of the curve in comparison with other countries. Some countries are arguably ahead of where we are, and we would take soundings from those countries to understand what best practice looks like. However, in our experience, such an approach creates business models. If we are ahead of the game internationally, it creates export market opportunities, so businesses that are developing circular economy models in Scotland can then start to export those models globally.
I have seen examples of that. In the chlorofluorocarbon and refrigeration-gas sector, for example, recycling and reuse of those harmful chemicals were contained within a smaller number of businesses that became experts in those fields. Those business models exported themselves around different international territories as regulation developed. We like supporting export-orientated business models, so we see opportunities there.
We also look carefully at areas in which Scotland has a particular competitive advantage or where we have industries in which we are strong. Whisky would be one good example; the wind sector would be another. Where we find circular models that play to those indigenous industries, they rank higher on the bank’s priority list of where to deploy investment.
That gives some context around the types of industries and our approach, but I think that you asked a question about housing. Could you remind me of it?
That was just an example. You mentioned wind, so do you want to expand on that? What do you think the opportunities might be there?
I would be happy to. Clearly, the market development being done by ScotWind is placing Scotland at the forefront of floating offshore wind.
We see circular economy opportunities in the wind sector in a couple of areas. There is a real issue in the wind industry with leading-edge erosion—I might get a bit technical—on the blades themselves. Historically, manufacturers and developers would just dispose of the blades and replace them with new ones. That is very expensive, and the new ones were not really costed. Business models are being developed that use different types of materials and techniques to predict the failure rate in those areas, so that performance can be improved. We also expect to see, over time, certain products being engineered to be able to be replaced; for example, inserts can be put into the blades. That is one example of where the business models are developing. Another example of that is in the area of turbines.
There are parallels in the aerospace and gas turbine industries, where very detailed and complex supply chains have been built up to address failure of parts in order to enhance the performance over time of the embedded infrastructure and equipment. The wind industry, because it is less mature, has not developed the same level of supply chain support. We see opportunities to help the embedded infrastructure that will go into Scotland to be less disposable, with a supply chain that helps to prolong the life of turbines, for example. Those are a couple of examples of where we see opportunities.
That is helpful. I have a final question, and I will stick with you, Jimmy. You mentioned KPIs. What metrics and KPIs do you use in assessing investments to support the transition to a circular economy? You just talked about supply chains. Do you look systematically across the supply chain of a project? Does that include looking at things such as the ethical extraction of virgin resources, embodied carbon, biodiversity impact and the circularity of resources? Are you confident that your investment criteria are robust enough to avoid any harm in those areas?
In terms of KPIs, you are correct. For every investment that we make, as well as developing objectives on the financial performance of that investment, we develop a suite of KPIs on the impact outcomes that we expect from those investments.
We very recently developed a broad and detailed set of KPIs that are pre-engineered and pre-loaded for individual sectors. We have our own pre-agreed set of circular economy KPIs. We have looked at the circular economy industry sector to see what good looks like and we have developed a range of KPIs that we will apply in that sector; we will then need to be proportionate and choose the right KPIs for individual businesses.
That work enables us, when we see a circular model that we consider investing in, to draw from a universe of pre-existing outputs and measures for those outputs that are appropriate and should deliver the desired end results.
We are in the early stages of developing that more systematic approach to KPIs. We expect to see the outputs of that in due course and will report on that in our annual impact report.
11:15
I am interested in how you come up with the investment. With the current bank rate, some investors might look at a straightforward investment with a fairly moderate rate of return of about 8 to 10 per cent. With a riskier opportunity, that might go up to 17 per cent; it might go up even higher, depending on what investors are looking at for a rate of return.
You obviously will not be looking at that, which means that you could be investing in more risky businesses. You are not going to give me the standard rate of return that you would expect for your investment, but can you talk more about that so that I can understand how you are a facilitator to allow that without taking all the risk in the most risky projects?
I will tackle that question from a strategic holistic perspective. A key point is that we were set up as a development bank to take some risks that the private sector might not take. We were also set up with a clear set of guidelines that include the fact that we cannot crowd out the private sector. Therefore, we cannot offer investment terms that are well below commercial rates, because that would impinge on state subsidy control rules, so we are very cognisant of the market rate.
Convener, you mentioned some numbers, which are the sorts of numbers that we might look at on individual deals, based on the risk profiles. However, it very much comes down to the credit risk that we are taking and the commensurate interest rate that is charged on the debt or the equity valuation that we place on something.
We have that mandate to operate commercially but, with some investments, you will sometimes find that the private sector does not want to come in, even at higher commercial rates, because of the risk profile. That is the role of the development bank. In practice, that might mean that we take a longer-term view. For example, we might go in to create an opportunity and therefore crowd in other lenders or investors when the opportunity has developed a bit further and perhaps been de-risked a bit, because that then allows them to come in and get it through their credit committees, for example. That is how it works in practice. However, we absolutely do not intend, and nor are we allowed, to price below commercial rates.
However, longer-term investments mean that you tie up your capital, which means that you cannot replicate the investment as and when it is needed. What I guess I am trying to ask you, in a very clumsy way, is whether you would ever be below what the bank base rate is plus about 4 per cent?
It depends very much on the opportunity. We do not price on that basis; we price on a risk basis, based on the commercial rate at that point in time. As you know, interest rates have gone up recently, and, therefore, the prices that we would lend at have gone up commensurately.
But you will never be below the bank base rate, will you?
I just cannot imagine that, no. We could do something today and the bank base rate could change, so something that was written a few years ago—
I understand that. Some people who came in two years ago when the rate was 1 per cent or thereby will have got a very good deal, especially if they went for a 30-year transaction. In hindsight, that probably does not look that good in today’s market in order for the bank to have the capital to invest in other projects. How do you balance those aspects?
Jimmy Williamson can talk about what we are seeing happening today but, on your point about recycling, one of the things that we are focused on is ensuring that we invest with a view to removing our capital at some point in future, whether that is an equity investment or debt investment, so that the capital is not tied up for ever, as you are indicating, because that is absolutely not our objective. Our objective is to provide some development capital to support the business in its growth stage. Over time, a third party will come in, and the need for our capital will be removed. At that point, we can take that capital, either through income return, equity return or debt principal return and recycle it into other investments. That is the general model that we are talking about, so we are totally aligned with not tying up capital for ever.
I understand. What is the average time that you would aim to invest in a project for?
The period depends; it is determined by the project and the market. In our mandate, we have been given flexibility to lend money to businesses on a fixed basis, but we can also lend on a floating-rate basis. As we are investing over a relatively longer period, we have to be responsible, as any commercial investor would be, and understand the counterparty risk.
If you are investing on a fixed basis—for example, by lending—locking in the rate will look quite expensive at the moment. We have the flexibility to offer floating-rate lending at this point in the cycle, which would be expected. The projects and businesses that we are looking at, which are considering a lending-type investment rather than an equity-type investment, are more likely to take a floating-rate exposure, because the assumption is that rates will come down over time.
That plays into the point that we have flexibility to adapt to what the client is looking for. Ultimately, the client is the decision maker; we do not impose a structure on it.
My question is about the role of small and medium-sized enterprises, social enterprises and community businesses in the circular economy and whether they can be supported through financing. Over the years, that is where some great innovation has taken place in relation to the circular economy. Can you find mechanisms to support such business models?
I touched on the point that we see circular models across a wide range of business situations. We might look at pure-play projects where some form of off-product from another industry is being treated. By definition, that is a project, so it might involve a business that is just setting up or something that exists not as a business but as a special purpose vehicle.
We understand your point about SMEs. One of our more general concerns is about new regulation in industries. In general, larger enterprises are better placed to comply and have the financial and physical resources and the people to deal with that. Sometimes, SMEs are more challenged by that.
Regardless of whether there is a circular play, our approach is that we are set up to invest in SMEs—arguably more so than in larger enterprises. Subsidy control rules encourage us to support SMEs; dealing with larger enterprises is more problematic and involves navigating more hurdles. In that context, our ability to help to finance SMEs is built around their investment thesis rather than addressing a cost issue.
We see a couple of facets to our role. When a business is ready for investment and is ready to scale, as a development bank, we can help it to do that. That applies to a business that has a path to profitability—perhaps it has visible sales—and can scale. That is the here and now of what Jimmy Williamson and his origination team look at.
We also have a number of people in our team who focus on the market creation element that Mark Ruskell just referred to—that is how I am thinking of the question.
Yes—the question was about commercialisation benefits.
Those people are convening and sharing insights with key stakeholders and players in industry, whether that be in housing, the circular economy or natural capital. We engage in conversations, hold workshops or conferences and share insights about how such activities could, at some point in the future, attract commercial capital. That is how we see ourselves operating.
To give an example, yesterday, in a call with an agency, we talked about how we could work together to see whether it could bring capital into its space. We understand what commercial investors are looking for. As a development bank, we are the conduit; we are in the middle, so we can see whether, over time, we can join the dots. That will not happen overnight, but we are actively focused on that market creation—that is what we call it internally.
That is useful to know.
You mentioned the restrictions for the bank on funding public bodies. Do you see that situation changing over time? I see it as an area of frustration. I was talking just yesterday to Fife College, which is going through a massive redevelopment of its campus, and there is a frustration that it is not able to invest in electric vehicle charging facilities or renewable energy in the way that it might do if it were set up as a different body.
There seems to be a lot of frustration in the public sector that there are investment opportunities right now, as infrastructure that is needed to tackle the climate emergency is being built, but the finance is not always there.
We have many incoming inquiries, and one of our key criteria is that the project has to be ready for the commercialisation phase. We are talking to a number of major entities—housing, universities or whatever—with which we could perhaps come in on projects as part of an overall business plan. As Jimmy Williamson said, however, one of the problems with a project is that it is a sunk cost and you can never release your capital back out of it. We can be a catalyst but, from our perspective, we would ultimately like to get a return.
We would, therefore, seek to talk to those entities and ask how we can help them to achieve their goals through our market insights, rather than having us necessarily invest directly, because I do not believe that it is in our mandate to do so.
Finally, I turn to the opportunities around offshore wind, which you mentioned. There is potential with onshore wind too, and with a linkage between the onshore and offshore sectors. Given that we will be going through quite a dramatic phase of repowering onshore wind farms, do you see a circular economy opportunity to develop a supply chain and links to the offshore industries?
We are supporting both onshore and offshore—we do not have a mindset of focusing specifically on one or the other. In response to your supply chain questions, we are also actively seeking to develop the supply chain in Scotland. We have found that the supply chain tends to be quite limited in Scotland; a number of studies have suggested that a lot of components are imported. It would be great if they could be manufactured here, and ScotWind provides an amazing opportunity for us to do exactly that.
For the consents that have been given, there was a requirement for people who bought the licences to commit to supply-chain spending in Scotland. We are actively trying to develop those supply chains—it is a priority. If we can do that, it will be a massive opportunity for Scotland.
To go back to Jimmy Williamson’s point, once we create that expertise, we can then export it: the oil and gas sector created globally leading expertise and you can now go anywhere around the world and hear a Scottish voice on those kinds of projects. It would be nice if we could get there with wind as well.
Is there something in particular about the way in which the ScotWind process has evolved that has helped in that regard? For example, the supply chain statements have been up front in the bids for ScotWind leases. Has that revealed or provided a bit more certainty about where the opportunities are? Has it helped to stimulate things?
Jimmy Williamson is the day-to-day lead on that, so it is a very appropriate question for him.
From an investment perspective, it creates something that is deemed to be highly unusual, in the sense that there is a very significant long-term structural growth opportunity in offshore wind in Scotland. It has political support, broader community support and economic support. The projects take a number of years to develop and put in place, so that momentum creates a very stable environment—relatively speaking—in which to make investment decisions.
An important point concerns the frameworks that have been created around how ScotWind projects are developed. ScotWind is predominantly underpinned by floating wind technology, because the turbines and the locations are further offshore. That in itself is a new technology, and there is more technical risk.
11:30There is a very interesting transition finance play around taking skill sets from the offshore oil and gas industry, in particular around the north-east—the engineering requirements for floating platforms are quite similar to what was used in the offshore oil and gas industry, so that helps.
To go back to Al Denholm’s point, the UK’s offshore wind capacity and capability—of which Scotland is an important part—is, outside China, number 1 in the world. It is the leader in the sector not only in deployed offshore wind infrastructure, but in terms of commitments to more capacity going in.
We have got to that position on an import-led model, with the original equipment manufacturers, the supply chain and so on. Interestingly, we are exporting our people—if we look at recruitment businesses for specialist skill sets in that sector, we see that those skills are being exported globally, because they are very flexible resources.
Just now, we are seeing what are turning out to be well-crafted, thoughtful policies and systems that are put in place to encourage an investment regime by which we can create in Scotland some of what would have been imported. That includes sustainable original equipment manufacturers as well as better, longer-lasting port infrastructure.
Ultimately, we want to get to a place where that infrastructure and those businesses that we create here are not in the UK and Scotland just for the growth phase—we hope that, in due course, they will start to serve export markets. In our view, that creates a much more sustainable investment-in-business community.
The Circular Economy (Scotland) Bill includes powers to set legal circular economy targets. Can you explain what you think that the impact will be on the investment environment as a result of having those targets in place? Do those targets drive investment?
I will answer that broadly, rather than specifically in relation to the bill. One of the key points is that businesses—globally, not just Scottish businesses—like to have some certainty in a couple of areas. One is the direction of travel for every policy or for new industry targets, whatever those targets are—I am not here to suggest what they could be. As a general comment, however, I think that it is fair to say that businesses that are hoping to make commercial investments like to have some degree of certainty as to what the environment will be like when they make those investments. The circular economy is no different from any other industry—that is just a general statement—so I think that that will be helpful.
To add to the point that I made earlier about business models, if not complying with regulation has a consequence, that creates business models that will help businesses to comply in that way. That can involve separate businesses that are set up specifically for that purpose, or existing service providers that do something similar and then move into that space. There are business opportunities to help businesses to navigate the new legal framework.
Do you think that the SNIB has the mandate to pursue circular investment opportunities in and around the areas of reprocessing or reuse, which are geared more towards reducing consumption emissions and may not actually reduce our territorial emissions?
I am trying to work through that question—I am sorry; it got quite complicated at the end. Would you mind repeating it?
Do you think that the bank has the mandate to pursue circular investment opportunities in and around the areas of reprocessing or reuse, which I feel is geared more towards reducing consumption emissions rather than our territorial emissions?
In general terms, anything that we can do on reuse is positive. If that means having some form of processing to make that happen, it would seem to be, at first blush, something that we might look at. However, as I said earlier, it has to be something that fits with our overall mission and with both our KPIs and our commercial KPIs.
If I understood your question, an example is that investing in developing a port might lead to some carbon or to some concrete being poured, but it also creates the opportunity for offshore wind to be developed. We have taken the view that it is better to do the former in order to achieve the latter, in that example.
Have you come across any tensions between reducing our carbon footprint and our domestic net zero targets?
Are you aware of any, Jimmy?
There is societal endorsement that it is a good thing.
Most of the circular opportunities that we see now and that we are likely to see in future are industrial and commercial in their nature, rather than at the retail level, but there are retail and consumer opportunities. We were talking beforehand about a business called Bike Club. Kids grow up quickly and they do not use their bikes, so they become resources that are left behind, and it is expensive for the families concerned. Bike Club created a subscription model: families subscribe so that their kids have access to new and second-hand bikes and the total cost of the subscription over time is less than buying bikes would be. It could be argued that that may or may not result in more bicycle sales for manufacturers of bicycles. However, on a societal level and a business level, it is endorsed as a good thing.
The feedback that we get from businesses about circular models is generally not pushback. Businesses are not saying that circular models are bad or are going to reduce output or growth opportunities. We would struggle to think of any businesses where that is the case. Most accept this as progression.
They see that there are different opportunities.
In your 2022 report, you mentioned “enablers”—people who will increase investment. Who or what are the enablers? Can you give us a bit more information on them?
I am sorry, but I took up my role only a few months ago, so I do not remember the 2022 report. Could you give me some context?
The report highlights the importance of “enablers” in facilitating the growth of impact investment. Who or what are those enablers?
We have already touched on a couple of the themes. A couple of the enablers are policy certainty and working with agencies. We talked about creating clarity between the private sector and the public sector, which can enable us to do some market making. As a development bank, we can sometimes go in earlier than a commercial bank would, so I consider that as an enabler in helping to create a circular economy.
We have already touched on a number of examples of what I imagine that word means. I am sorry—I do not know the specific context that you are referring to—but that is what I imagine was meant by the word. We are also crowding in—
Yes, I understand that. I am trying to work out whether other people are following your lead. Private investment banks are getting involved in forestry, for example, and I am trying to find out whether there are other such enablers.
That is a really good question. One thing that I have noticed is that, over time, a number of large asset owners—we count ourselves as an asset owner, with the £2 billion commitment—have become very interested in committing to impact investments in a way that they were not 20 or 30 years ago, or even 10 years ago. Such investments were not on the radar of many chief executives or chief investment officers of large institutions, although, obviously, some of the impact funds and environmental, social and governance funds were market leading.
I have noticed that, in recent years, among large insurance companies, large pension schemes and other entities such as ourselves, the UK Investment Bank and the British Business Bank, there has been a massive shift—a change in mindset—to focusing on enabling investments in the areas that we are talking about. We all have similar impact theses in our mandates, although some are not as direct as ours. That part of our mandate is front and centre. Other organisations’ mandates might have commercial considerations as the first objective, with impact as a secondary objective, whereas we clearly consider impact and commercial issues equally.
There is a lot of interest in providing capital to support such projects over time. That is why, as we said earlier, providing certainty and clarity is important, as it will help with money being committed. If you sit on an investment committee, as I have done, at XYZ insurance company—I mentioned earlier that I have worked on investment committees for five or six companies, and I have been the chief investment officer of a number of them—you have boxes to tick and risk and governance processes to go through. All those companies are looking for clarity that their investment will be safe and will achieve good at the same time.
Okay, I understand that. There are companies and banks out there that want to join you.
Yes.
You have clear principles and standards of practice in relation to how you invest. Who will ensure that everyone else follows those standards and principles, and how will they do that? You would not want to be tied to an organisation that had fewer principles and lower standards of practice, would you?
One of the key things is to bring the market along with you. If you are a leader, the key is to convince others to come along and share those views. I have been down in London for the past two weeks speaking to some large institutions—I do not want to name names—which are all on journeys and are developing. I have worked for a number of such institutions throughout my career, so I can see the journey that they have been on. It is a moving feast.
I think that the Scottish National Investment Bank is slightly further ahead on that journey. What we are doing by, for example, publishing our impact report is market leading. We are about to publish our carbon management plan, which we also think is market leading. By putting that out there, we will set standards that, we hope, others will aspire to in time.
It is a journey. Not everyone will copy us; organisations will all have their own views. However, if we seek to go on that journey and to learn at all points—we are a young organisation that is seeking to learn—we will seek to improve on all those elements. We are not brilliant and do not profess to being so, but we are seeking to become a market leader in all those areas.
I am gently pushing you to see whether you are going to codify the principles and standards of practice, because, as an investor of money from the people of Scotland, you surely do not want to be involved in something that does not epitomise everything that you want to do as a bank. Will there be a code? Will you lay those things out, or will someone else lay them out for you to follow?
In our impact reporting, we clearly set out the impact that we are making across all the missions and sectors, and the information is getting more and more granular over time. Compared with the position three years ago, there has been an evolution in that regard.
The bank’s board has just signed off a set of targets for the impacts. We do not think that many private sector investors are publishing targets. A lot of them do backward-looking reporting, which is fine. It is good for that information to be in the public domain, but the setting of targets and mission levels is something that will set us apart. We continue to do that, but we are doing it in the context of our grand challenges and what we are seeking to achieve, so we are making sure that the targets are relevant to what we are seeking to achieve and that we are not taking a scatter-gun approach across all areas.
Have those targets been published yet?
Not yet. They have just been signed off by the board. They will be published in due course.
Okay. From the committee’s point of view, we would like to see those targets as soon as possible so that we can understand how they fit into the evidence that we have heard today.
Sure—of course.
That would be extremely useful.
Douglas Lumsden has some questions.
Will you update the committee on the £9 million investment that the bank made in Circularity Scotland? Do we expect any of that money to come back?
11:45
As you mentioned, a few years ago, we invested in Circularity Scotland with a £9 million debt facility. In our latest annual report, we show that, at that time, we expected a write-off of £4.5 million. We also said in the annual report that we expect to recover about £1 million, but that will be very much dependent on the administrator process. Since that point, we have had no further insight into what the specific number will be, but we are aware that the administrator is going through a due process. From what we are hearing, that seems to be a reasonable estimate of recovery.
What happens to the other £3.5 million, if you expect—
At the time of writing the annual report, which was in March, that was our view. As you know, things have developed since then, which have crystallised what was at the time an unrealised loss into a highly likely loss of a much higher magnitude, which is where we are now.
From that £9 million, you expect £8 million to be lost?
Yes—it is around that number.
Okay. What lessons have been learned from that process of lending to Circularity Scotland? Was the internal market act not previously seen as a risk, and is it seen as a risk now? Has anything changed in the bank when you look at potential investments?
I went through the due diligence process for CSL after I joined. Clearly, that process was happening just as I joined, so I wanted to get myself up to speed and, therefore, the answer that I give will be based on that. At the time, I think that the investment involved the relevant due diligence, in terms of opportunity and risk analysis, that you would expect of any asset manager that I have looked at. The elements of risk were properly discussed.
One element that we saw at the time as being what we call a risk mitigant was that deposit return schemes were being used in a number of countries globally. The UK Government and various political parties in the UK, as well as the Scottish Government and the Welsh Government, had all shown their support for such a scheme. Our view at the time was that that was a positive backdrop for the Circularity Scotland business case.
As it turned out, there were nuances in the internal market act, which was new legislation that had been developed and was, I think, introduced in 2020. In some ways, it had not been tested—clearly, it was tested with the deposit return scheme. My understanding is that the feedback at the time was that the various Governments that I referred to, including devolved Governments, were still in support of deposit return schemes. The key issue was around the timing of some of the elements.
When making investments in future, will you have a closer eye on the United Kingdom Internal Market Act 2020 and the potential that it could—
One would clearly take that into account as a lesson learned, if a similar analysis was required for a company that we were looking at. There is not that potential issue with all companies. As a learning organisation, we would do that. Having been an investor for 37 years, I know that there are always learning opportunities. A skilled investor will always learn lessons—the bank will not not learn from those lessons, if you see what I mean.
Do you think that the whole episode will put off investors from looking at certain areas of the circular economy?
As I said in answer to Ms Dunbar’s question, having clarity and consistency on regulation is absolutely important for any investment, particularly in a new area. In an established business area or part of the economy, that is less relevant but, when trying to create a new industry or service, it is very important to have that stability. If you are seeking to crowd in private sector investment, the more stability and transparency that can be produced, the better. That is part of what we are doing here in the committee.
You said that the bank has been going for three years. Scottish ministers were meant to set up an advisory board when the bank was created, but there is no sign of that yet. Do you have any more information about when that advisory board will be created and what its role and function will be?
You are right. When the bank was set up, there was provision for such an advisory board. We understand that it is not specifically our responsibility to do that; it is the responsibility of the Scottish Government to set up that board. I hope that, now that the issue has been raised, the Government will focus on setting that up.
In the meantime, the Scottish Government has oversight of the Scottish National Investment Bank in a number of ways. We have ministerial oversight and director-general economy oversight, as well as having a shareholder team that oversees us and responds on our behalf, and we appear at committee meetings. I stress that we are by no means unsupervised at this point, but that we are talking about an additional level of oversight that was written into the act.
The board is meant to provide
“advice on the Bank’s objects, conduct and performance”.
I am slightly concerned about who is carrying out that role, if the board is not in place. Will those people also fit into your risk management framework? I imagine that they would.
We agree philosophically that that board should be put in place, but the answer that I have just given is that there are a lot of people who assess us. In addition, we have an independent board that performs that role. Members of that board are very experienced and have a corporate governance skill set. They come from a number of sectors and from public as well as private sector backgrounds. Clearly, the element that you mention needs to be completed because that bit is missing just now, but day-to-day-governance is robust.
Thank you. I have more questions, but I think that we are out of time.
We are almost out of time. I have a question about something that Douglas Lumsden asked about. You say that you hope to get back £1 million, which is quite a high rate for an investment of £9 million, when there are liquidated assets. There are not many assets in that. Are you really comfortable that you will get back £1 million?
The feedback that we have had from the administrators is that that is a reasonable assumption at this point. However, the devil is in the detail, and we will find out in due course, once we have completed the process.
I respectfully suggest that administrators’ fees can be quite high. It will be interesting to see if you get your £1 million back.
I have a brief question. His Majesty’s Revenue and Customs always gets paid first, before anyone else. There is an argument behind that. Should the Scottish National Investment Bank, because it uses public money, be up there with the priority creditors, or do you think that there is no reason to call for that?
That is not a question that I am qualified to answer; other people have a better view on that. I hope that the administrators will take those factors into account.
HMRC always seems to get its money before anyone else.
Sarah Boyack has some questions.
I have two brief questions. The first follows up on the issue of renewables regeneration. Mark Ruskell talked about repowering onshore wind. There are massive opportunities for offshore wind, but we have had many of those opportunities for 20 years. How can we take a circular economy approach, reusing existing infrastructure and making it last longer? You talked about ScotWind. There are huge opportunities, but how do we actually deliver opportunities for green industry in Scotland? What are your thoughts about that actually happening, rather than being just a good opportunity?
We are short of time, so I will give a very quick overview. We are in active discussions with a number of projects that aim to deliver ScotWind in different formats. That includes speaking with field operators about offshore wind and with those involved in manufacturing the original equipment in Scotland.
Clearly, those are all commercial discussions, but there are a lot of those happening. As I am sure you know, the Scottish Government has also set up the strategic investment model structure to try and channel a number of those. We are liaising with people and expect to see a number of specific projects coming out of that process imminently. You are absolutely right: it is important that we deliver in this area and ensure that we fulfil the promise of ScotWind.
I see two elements of ScotWind as important. One is how the blades and the masts operate and deliver electricity; the other—which, for me, is just as important—is getting as much of that equipment as possible manufactured and serviced in Scotland, as that will ensure that we deliver the full economic benefit from the sector. We are focusing on both elements.
That sounds good. We will keep our eyes open for that second element happening, because it is not only the new construction that is important, but the reuse of existing equipment. That would be exciting.
Yes, and the reuse of existing skill sets is also important. Jimmy Williamson talked about all the people who have been working in the oil and gas sector for many years and have a lot of transferable skill sets. If we can help transition those skills into this renewable area, that would be a big positive.
I would make one final point on that. We have structured our investment origination team around offshore wind as a specific vertical. That creates responsibility and accountability in our investment team around resourcing and originating those transactions, which makes the process more refined and more targeted to individuals, so that we can be clear in the ecosystem that we operate within that we are close to where those opportunities are likely to come from.
In a broader sense, observationally, having worked in many investment institutions, I can say that the pipeline that we have is real, credible and significant, and it covers many disciplines—manufacturers, ports and infrastructure as well as, potentially, generation opportunities.
It includes support vessels, chains and so on.
Yes. As I say, our experience as commercial investors tells us that the pipeline looks and feels real and credible. The risks are around the fact that, as we have already discussed, interest rates and inflation are higher, which means that the situation is not easy for people who are looking to invest in capital projects just now. We are seeing things slipping to the right a bit, but that is similar across other construction sectors. However, as I said, the pipeline is real and credible—that is our view of what we are seeing on the ground.
My second question concerns the local authority targets in the bill, which will mean a huge amount of new investment in things ranging from vehicles to infrastructure to waste processing. The SNIB is not allowed to invest in public bodies, but to what extent does the bill present us with an opportunity in terms of infrastructure investment, so that we are able to see that acceleration of projects, particularly when some local authorities are doing a mix of public and private investment, with the local authority providing part of the investment and working closely with the private sector?
As you mentioned, we are not allowed to invest in that area but, as I said earlier, we are trying to work in the market creation role to bring commercial activity into some of those areas. That is a nascent activity for us—we are three years old, but we are seeking to do that and have people who are working and having conversations with relevant authorities. We have also invested in a couple of electric vehicle charging businesses, which are up and ready to go as soon as some issues are smoothed out—for example, planning can sometimes be a major issue in relation to installation. We are supportive of trying to roll out charging points to support the move to electric vehicles and so on.
That is useful feedback, because I have had feedback from the local authority side that there are worries about supply chains in terms of, for example, new vehicles that could be required. There is also an issue about accountability with regard to the benefit of having local authorities owning infrastructure as part of this process while also using private sector investment and expertise. It would be good for the committee to get feedback on what you think comes next on that, because it is a now issue.
As I said, we have two companies that we are actively invested in and seeking to roll out, so we could probably get some feedback on the challenges that they are experiencing and feed that back to you.
Thank you.
12:00
The convener mentioned the use of public money. Last year’s accounts showed a loss of almost £20 million, but you are still paying bonuses. Last year, the acting chief executive officer received a bonus of about £77,000. How can the use of public funds to pay bonuses be justified when there are such big losses?
We reported those losses last year. The vast majority of those were unrealised, which is the result of the mark-to-market accounting procedure. We talked about the movement of interest rates. If we have a fixed instrument and interest rates move, that creates a mark-to-market loss on our balance sheet. I stress that that does not necessarily mean that that is a bad credit risk and that we expect a loss. That is more of an accounting procedure.
The vast majority—from memory, it is £14 million-worth of those losses—were unrealised losses as a result of the mark-to-market accounting procedure. That is to be expected in what I would call a development bank. You will see that volatility early on, and we have seen it in a number of other entities when they were set up and in their early stages. You see that volatility before some realised profits come through.
In addition, I stress that the income that we are receiving on our investments is now significant. I think that we earned £10.7 million last year on income in our portfolio. If that figure is not 100 per cent correct, I will come back to the committee to correct it. That means that we are very close to being self-sustainable on a cost-income ratio.
What is the rate of return on the investment? That figure of £10 million could be good or bad figure, depending on—
Our portfolio is a blend of debt, equity and fund—
How much money have you put out to get £10 million?
The bank has £460 million out in investment. That is the in-year investment on that money, and we would expect that to grow over time as that investment is drawn down.
That is not a great rate of return, is it?
The figure of £460 million is the committed figure.
Sorry?
Our income on our investments so far is £10.7 million, on that calendar-year basis—that reporting-year basis.
I am sorry. I might have got this wrong. You said that you have lent the equivalent of £460 million.
We have committed it, yes.
You have committed £460 million, and you have got £10 million back. Is that right, or have I got that wrong?
No, we have not got it back. It is not a case of getting it back. That is the income on the debt.
That is the income. If I gave a bank £460 million with a base rate of 5 per cent, what would my return be? It would be more than £10 million, surely.
An important point to take into account is that we are deploying a mix of debt and equity. This is a development bank, so the expectation is that we will not achieve a return on equity investments in the early years as we take development risks, for example. The returns will come later, which is quite consistent with equity investors. For example, private equity and venture capital portfolios will not have significant returns in the early stages of the funds, but they will be expected to achieve returns when the companies are sold. Therefore, for the committee’s understanding, our portfolio is a mix of debt and equity.
I understand that, but I am just saying that it is not even a 5 per cent return; it is about a 2 per cent return on the money that is out there. Anyway, thank you for that. I understand that.
As there are no other questions, I thank the witnesses for attending this morning.
The committee’s stage 1 report on the Circular Economy (Scotland) Bill will be published in early 2024. I am not going to put an exact date on it.
That concludes the public part of our meeting and we will now go into private session.
12:04 Meeting continued in private until 12:36.