George Osborne's plan to sell the government's 80 per cent stake in Royal Bank of Scotland, the expected highlight of this week's Mansion House speech, looks set to fall short of Treasury expectations as leading investors baulk at buying shares in the state-rescued bank.

Sources close to UKFI, the quango tasked with selling government bank stakes, have told the Sunday Herald that some of the UK's biggest investors - including Legal & General (L&G) and Universities Superannuation Scheme (USS) - have indicated they would steer clear of the RBS sell-off.

Wednesday's Mansion House speech has been flagged by a Treasury spokesman as "an obvious platform" for Osborne to spell out plans for the state-rescued Scottish bank, following his pre-election hints at an imminent sale. Over and above his disposal of more than half the government's stake in Lloyds, he said he wanted to commence a disposal programme for RBS this summer.

However L&G is understood to have told UKFI it will only consider buying shares in RBS once the legal dispute with the bank over its disastrous 2008 rights issue, in which L&G is the leading participant, is resolved. One City source said: "L&G has told UKFI they feel they were duped by the bank back in 2008 and, until that wrong has been 'corrected', they won't be buying any further RBS shares." An L&G spokesman declined to confirm or deny the position.

Pension giant USS is also believed to have told UKFI that the £48bn fund has no interest in buying further RBS shares. USS also declined to comment.

In April 2014, both entities teamed up with other large investors to sue RBS, alleging it misled them over its 2008 rights issue. The result of the litigation, which is costing the bank and its pursuers at least £94m in combined legal fees, is unlikely to be known until 2017 at the earliest.

In recent weeks UKFI's chairman James Leigh-Pemberton and its head of capital markets, Oliver Holbourn, have been informally sounding out institutional investors about bank share sales The state amassed the shares during the 2008-09 banking bailouts. UKI declined to comment

Hamish Buchan, the influential chairman of Edinburgh's Personal Assets Trust, said investors that are suing RBS may find the rights issue litigation "a serious obstacle" to buying further shares in the bank, saying "why would anyone take the risk of buying shares in RBS given that the liabilities are unknown?"

Alan McFarlane, founding partner of Dundas Global Advisers, told the Sunday Herald it would be unusual for investors to increase exposure to companies that they are actively suing - especially where the litigation concerns allegedly "misleading" information surrounding in the earlier share offering. A positive outcome to the court case would, he said, mean they end up "compensating themselves".

Another senior City source said most institutional investors still regard banks including RBS as "pretty uninvestable" due to the opacity of their balance sheets and likelihood that fines and litigation costs for misconduct will persist for years. But Daniel Godfrey, chief executive of the Investment Association, said "everything has its price", detecting no formal or corporate governance obstacle stopping investors who are suing the bank buying further shares.

Colin McLean, chief executive of SVM Asset Management said the rights issue litigation is "a problem, but not an absolute barrier" to Osborne's reprivatisation plan. He said whenever the government is hawking a privatisation or a reprivatisation, "institutional investors generally talk the stock down, while investment banks talk it up. Think Royal Mail."

Standard Life Investments, another litigant against RBS, declined to comment on whether it felt precluded from buying RBS shares because of the legal confrontation, but sources close to the Edinburgh based asset management firm said it did not see it as an impediment.

RBS shares fell as low as 337p last Tuesday but rose to close last week at 359p. This is well below the 502p break-even price at which the UK government bought its stake. It has been reported Osborne is willing to start the sell-off at a loss in the hope of driving up RBS's share price up and starting a process of rehabilitating the bank in investors' eyes.

However consumer group Move Your Money UK and thinktank New Economics Foundation have warned Osborne against an RBS firesale. They are urging the chancellor to look at other options including breaking the bank into a string of regional lenders. NEF head of finance Tony Greenham said: "The story of RBS is a touchstone for much that's wrong with the current set up of the UK financial system. But we believe it's also the touchstone for how things could be transformed."

Last October UKFI's Oliver Holbourn, told the Treasury committee: "Ross [McEwan] has made very good progress in terms of trying to make RBS a simpler, better bank, but there are still a number of issues on which we would like more clarity before we feel that we could deliver a good outcome for the taxpayer."