What Is Ringfencing?

Ringfencing is when a regulated public utility business financially separates itself from a parent company that engages in non-regulated business. Ringfencing occurs when a portion of such a company's assets or profits are financially separated without necessarily being operated as a separate entity.

Ringfencing prevents customers of public utilities from credit risks or exposures of the parent company that may harm customers' access to essential services. Ringfencing should not be confused with setting up a ring-fence, which is a method of tax avoidance involving offshore assets.

Key Takeaways

  • Ringfencing is used to insulate the credit risk of a public utility from the risks of its parent entity.
  • This occurs when a larger corporation owns a regulated utility as a subsidiary, but the parent entity also owns and operates non-regulated businesses.
  • The goal is to keep utility customers free from disruption in case the parent company of such a utility experiences a negative credit event such as bankruptcy.
  • Ringfenced utilities may also enjoy greater credit quality for bonds or other securities issued by them.

Understanding Ringfencing

A ring-fence is a virtual barrier that segregates a portion of a subsidiary company's financial assets or operations from the rest of the corporation. 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 undertaken elsewhere in the corporate structure.

In the case of public utilities, this is done mainly to protect consumers of essential services such as power, water, and basic telecommunications from financial instability or bankruptcy in the parent company resulting from losses in their open market activities. Ringfencing also keeps customers' personal information within the public utility business private from the for-profit efforts of the parent company's other business.

The parent company can also benefit from ringfencing; bond investors prefer to see public utilities ringfenced because it implies greater safety in the bonds. Also, the parent company is usually freer to grow its non-regulated business segments once a ringfence is in place. Individual states are chiefly involved with ringfencing utilities within their borders, as no federal mandate is currently in place requiring that all public services be ringfenced.

Real-World Examples

A high-profile success story on ringfencing occurred during the Enron collapse of 2001-2002. Enron acquired Oregon-based Portland General Electric in 1997, but the power generator company was ringfenced by the state of Oregon prior to the acquisition being completed. This protected Portland General Electric's assets, and its consumers, when Enron declared bankruptcy amidst massive accounting scandals.

More recently, in reaction to the 2007-2008 financial crisis, to prevent future taxpayer-funded bailouts of "too big to fail" banks, U.K. officials issued a series of new measures. One step included ringfencing as a vital piece of post-crisis reform architecture. New provisions are aimed at splitting “core” retail services, such as deposit-taking, from riskier investment banking units. As the rule only applies to U.K. banks, and not U.S. or European banks operating in the U.K., critics argue that this could put U.K. banks at a disadvantage.