Ring Fencing

Ring fencing is a mechanism to disintegrate the regulated public utility subsidiary from its parent corporation, which also performs non-regulated business operations, to safeguard the former from the unlimited risk involved in the latter. Thus, the entity needs to isolate a certain amount of its profits and assets financially.

Such measures serve as a virtual barrier to protect public utility customers from the negative consequences of financial distress faced by these parent entities during economic crises or other such events. This is commonly seen in banks, which need to segregate their retail services from their investment banking business, which is highly risky.

Ring fencing is a method through which businesses, banks, and individuals shield their assets from unlimited risk exposure. It emphasizes segregating the regulated public utilities assets out of all the financial assets of a parent company (the one that also executes the non-regulatory activities). The purpose is to secure the interest of the public utility customers from not receiving basic amenities like water, electricity, telecommunications facilities, banking services, and other services when the providers face significant financial losses. Thus, it protects them from indirectly being exposed to the unlimited risk involved in the non-regulatory functions of the companies and banks.

Moreover, the ring fencing also ensures that the parent firms do not illegitimately use the personal information of these utility consumers for advertising or promoting their non-regulated services for profit-making. Further, the ring-fenced subsidiaries have more excellent creditworthiness and, therefore, are more preferred by investors and creditors. Also, they can avail of loans at a comparatively lower borrowing cost than non-fenced assets or firms. Notably, the need for ring-fencing in the banking sector has become significant after the havoc caused in the banking industry amidst the 2007-2008 financial crisis, especially in the UK.

Ring-fencing is a method of securing wealth from exhaustion in certain financial circumstances. Given below are some of the different kinds of ring fences:

1. Legal: It is a lawful method adopted by companies to restrict the movement of their respective financial assets outside or inside a country's geographical boundaries. It aims to preserve these assets for a specific purpose.
2. Informal: In this measure, the company establishes informal procedures, practices, and policies to prevent its employees from disclosing or leaking critical information outside the company.
3. Regulatory: As discussed earlier, in this type of ring-fencing, the banks are required to disintegrate their retail banking functions from their investment banking processes to safeguard the retail customers.
4. Tax: Governments usually impose ring-fencing rules to prevent companies from consuming their losses in certain operations to curtail their taxable income from other activities.