ABERDEEN, Scotland (Reuters) - A promise in a bond issued by Aberdeen city stipulating that investors can demand their money back early if the country leaves Britain is the starkest sign yet of investor nervousness over the prospect of Scottish secession.
In what lawyers said was a debt market first, the 370-million-pound bond issued late last year includes an "independence event" clause allowing early repayment if Scotland secedes before the end of the 37-year life of the debt.
Aberdeen council told Reuters on Thursday it may borrow a further 130 million pounds via the bond, the first by a Scottish municipality. Most of the debt raised so far will go towards a new conference center, a project at the heart of a plan to diversify an economy vulnerable to the slow decline of oil production in the North Sea.
Scottish leader Nicola Sturgeon wants to hold a second independence referendum -- a bid in 2014 failed -- now that Britain has voted to leave the European Union. She argues that Brexit is not in the interests of the Scottish people and points out that most Scots didn't vote for it.
With surveys showing record support for independence, investors appear to be taking extra steps to protect themselves against uncertainties over the country's future currency and creditworthiness.
The clause in the Aberdeen deal attracted little notice when the bond was issued in November. But it has gained attention ahead of the UK's local council elections next month, when the independence issue is expected to dominate debate in Scotland.
"There is a nervousness about Scotland becoming an independent country in the markets," Aberdeen's finance chief Willie Young, a staunch opponent of independence, said from an office overlooking Union Street, the city's main thoroughfare.
"Those that are lending us the money get the comfort from UK PLC, and they wanted that clause inserted," he told Reuters.
One concern about such a deal is who would pay investors early if Scotland did declare independence.
Young has previously said that local public services would have to be cut to pay the debt and that the citizens of Aberdeen, Scotland's third largest city, would suffer.
But the leader of the separatist Scottish National Party group of the council, Stephen Flynn, told Reuters such a suggestion was "fanciful".
"The reality is that if Scotland were to become independent then like any other nation, the Scottish government would be the bank of last resort like the UK government is at this moment in time," said Flynn, speaking in his cramped, dimly-lit office decorated with a large Scottish national flag.
In an emailed statement to Reuters, a spokesperson for the Scottish government said: "Risk is inherent in any bond issue, and any conditions attached to this issue have been taken forward by Aberdeen City Council."
Local authorities usually turn to the Public Works Loan Board, the UK government loan fund, to finance public projects.
In this case, Aberdeen said it found the terms of the privately-arranged bond cheaper and more advantageous because scheduled repayments do not start until mid-2019, by which time some of its projects should start generating revenues.
Aberdeen said by not going to the government for a loan, it will save 10 million pounds over the life of the bond.
The major risk outlined by investors in the Aberdeen deal was uncertainty about an independent Scotland's future currency and what it meant for servicing the sterling-denominated debt, a source close to the deal said.
If a country adopts a new currency that depreciates against its old one, borrowers will have to pay more to repay interest and principal on old debts.
Investors have voiced similar concerns about European debt markets, given that Marine Le Pen, a leading candidate in France's presidential election, and Italy's 5-Star Movement have pledged referendums on euro membership.
Before the 2014 Scottish referendum, completion of some financial transactions like loans, company mergers and property purchases were conditional on 'no' votes, but rarely included watertight contractual break clauses.
In the debt world, lawyers said, such clauses were unprecedented.
"We are not aware of any deals in the wider context where such a clause has been used to shift the risk of the relevant event to the issuer, rather than flagging the risk to investors who are then on notice when they purchase," said Matthew Hartley, a capital markets lawyer at Allen & Overy in London.
The source close to the deal said seven investors were involved including fund managers, insurers and a pension scheme. One investor alone bought half the deal.
Council leader Jenny Laing said other authorities had expressed interest in using the city's municipal bond model.
"Other authorities have been looking at what our model was and how we have gone about it because they can see it as a way of bringing that money in," said Laing.
"If we hadn't stepped forward this city would have really suffered because the business sector were unable to do the investment at this time so the public sector had to step in."
But Luke Hickmore, an Edinburgh-based investment manager for Aberdeen Asset Management, said any other Scottish municipality would have to include an independence clause and that early repayment risk may be something they are not willing to take.
"Once you have done it once it becomes standard template. It may well put other municipal issuers off."
Editing by Sonya Hepinstall