Ringfencing is a process of separating out company’s assets, profits or business of a particular entity to form a subsidiary for legal, taxation or regulatory purposes. It’s a technique to isolate risks & losses associated with one entity from the rest of the business.
Though after ringfencing the company is legally & financially separated with respect to its assets and profits, it may not necessarily be operated separately. This legal barrier created by a company can be due to various reasons mentioned below.
Reasons for Ringfencing:
Asset Protection – A company can segregate its assets & liabilities (belonging to a common corporate group) into separate companies for asset protection through financial arrangements.
Regulatory Purpose – Ringfencing separates company’s regulated lines of business (LOBs) from the non-regulated ones so that regulated business can be kept protected from other business entities.
Taxation Purpose – A company may have its business spread over multiple Line of business and industries, all of them can have different tax rules. Hence these can be ring fenced for taxation purpose so that taxation of one line of business does not affect taxation of other business.
Liquidity Purpose – Ringfencing can also be used to mitigate liquidation risks and to improve corporate rating. Risky businesses can be separated from the parent entity to improve credit rating of the parent entity.
Ringfencing vs Complete Separation:
A complete separation of a company’s business divisions involves financial as well as legal separation of the operations of the two entities. On the other hand, ringfencing only separates the entities structurally.
Ringfencing is comparatively quick and has less legal obstacles compared to total separation
Unlike total separation, Ringfencing provides better use of capital and preserves diversification benefits for the organization
Economic cost involved is higher for total separation compared to ringfencing