As the name implies, there’s a “fence” that creates a protective ring around the separated assets or business unit. This can be a figurative border that is simply understood to exist; or it can involve a clear legal separation and definitive actions, such as creating separate bank accounts.
Alternate names: Ring-fence, ringfence, ringfencing, ring-fencing
For example, in the UK, regulations stemming from the aftermath of the financial crisis require large UK banks to ring fence their retail banking units from other parts of banks, which means legally separating these sides. Ring fencing lowers the chance that essential services could be put at risk by problems in another part of the business. For example, a bank’s checking and savings accounts would not be at risk of failure if there was a failure in its investment banking services. To comply with these rules, Barclays, for instance, set up a separate entity for personal banking services in the UK. This business unit is still part of the larger company, Barclays Group, but it operates separately from another entity that handles other services such as business banking. In addition to trying to protect consumers, ring fencing can also be used for purposes such as bankruptcy protection. Separating a subsidiary from a parent company, such as by holding assets for each unit separately, could help a subsidiary maintain its assets even if the parent company goes through bankruptcy.
How a Ring Fence Works
A ring fence works by separating assets or a business unit from other parts of an organization. The exact process for ring fencing can vary depending on what the organization is using it to achieve. For example, creating a ring fence for bankruptcy protection may involve a distinct separation of assets between a subsidiary and a parent company. This could be through the use of separate bank accounts and bookkeeping records, rather than having intertwined assets. Ring fencing could also involve the creation of a special purpose vehicle (SPV) to separate a business unit from its parent company. An SPV is its own legal entity that does not take on the financial history of the company it is separating from. This creates a level of financial protection. Ring fencing a business unit into an SPV can also potentially help with areas such as taxes, rather than having that subsidiary take on the tax liability of the whole parent company.
Types of Ring Fences
Different types of ring fences can exist. Some may be more informal ring fences, whereas others are clear legal structures. Legal ring fences are generally set up for specific purposes. This could be achieving a distinct financial benefit such as bankruptcy protection, or complying with regulations like the UK’s banking rules. Other types of ring fences might not necessarily be legal structures. Instead, they might involve an organization putting its own rules in place to separate assets or operational aspects. For example, a health care organization might ring fence some hospital beds to be used for specific types of procedures. Similarly, a ring fence could involve setting aside funds for a specific purpose. With charitable giving, for example, a donation or a certain level of funding might be ring fenced for one area of philanthropic support. In contrast, an organization without any ring fences might have one commingled asset pool. That may give the organization more flexibility to use the money as it sees fit. But it also means that some causes won’t have a guaranteed level of support.
