Ring-Fence: Definition in Finance Accounting and Legality

What Is a Ring-Fence?

A ring-fence is a virtual barrier that segregates a portion of an individual's or company's financial assets from the rest. This may be done to reserve money for a specific purpose, to reduce taxes on the individual or company, or to protect the assets from losses incurred by riskier operations.

Moving a portion of assets offshore to reduce an investor's net worth or lower the taxes due on income is one example of ring-fencing.

Understanding Ring-Fences

The term has its origins in the ring-fences that are built to keep farm animals in and predators out. In financial accounting, it is used to describe a number of strategies that are employed to protect a portion of assets from being mixed with the rest.

The ring-fence may involve transferring a portion of assets from one jurisdiction to another that has lower or no taxes or less onerous regulations. Alternately, it may be intended to keep the money in reserve for a specific purpose.

It also may be done to make the money unavailable for another purpose. That is the intent of a new British law, known as the ring-fencing law, which went into effect at the start of 2019.

The law requires financial institutions to ring-fence their consumer banking activities in order to protect customer bank deposits from potential investment banking losses. The institutions were forced to recreate their banking arms as separate entities, each with its own board.

The intent of the law is to forestall another bank bailout like the one that followed the 2008 financial crisis. The government bailout was forced by the perceived vulnerability of ordinary consumers and their savings to a collapse of the big banking institutions.

Offshore Ring-Fencing

In the U.S., the term is often used to describe the transfer of assets from one jurisdiction to another, usually offshore, in order to reduce an investor's verifiable income or reduce the investor's tax bill. It also may be used to shield some assets from seizure by debtors.

Ring-fencing assets to reduce taxation or avoid regulation may be legal as long as it stays within the limits set in the laws and regulations of the home country. The limit typically is a certain percentage of the annual net worth of the business or individual, meaning that the dollar amount will vary over time.

Ring-fencing can also describe earmarking assets for a particular purpose. For example, a savings account may be ring-fenced for retirement. A company may ring-fence its pension fund to protect it from being drained for other business expenditures.