Ring-fencing to balance risk and accountability

26 June 2023 Consultancy.com.au 4 min. read
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In the wake of a number of scandals across Australia’s public and private sector, ring-fencing has become a much-debated topic in media and governance circles. Charitee Davies from Grosvenor, explains what ring-fencing exactly is and provides examples how different industries apply the provision to ensure information is not misused.

Ring-fencing is a regulatory practice that separates certain assets, information or activities within an organisation from its core operations, and is widely implemented as a safeguard against systemic risks.

While ring-fencing aims to protect consumers and mitigate risks, it also poses governance dangers that can have unintended consequences. The potential pitfalls associated with ring-fencing emphasise the importance of striking a balance between risk reduction and maintaining accountability.

Ring-fencing to balance risk and accountability

A relatable example of ring-fencing is where a bank separates its retail banking operations from its riskier investment banking activities. The objective is to insulate consumer deposits and essential banking services from potential losses incurred by the riskier parts of the institution. The intention behind ring-fencing in the banking sector is to prevent taxpayers from bearing the burden of bailing out failing banks in times of financial distress.

Ring-fencing is not exclusive to the banking sector and can be applied in various non-banking environments as well. In the field of research and development, organisations may employ ring-fencing to protect intellectual property and confidential information. By creating separate research divisions or labs, companies can compartmentalise R&D activities, ensuring that sensitive information is safeguarded and not compromised by other parts of the organisation.

In the insurance sector, many companies implement ring-fencing to separate different lines of business or specific risk portfolios. This practice is often seen in the reinsurance sector, where companies may set up separate entities to handle specific types of risks or to isolate and manage potential losses. Ring-fencing in the insurance industry aims to protect policyholders and ensure the solvency of different insurance portfolios.

In the energy sector, ring-fencing is implemented to separate different aspects of operations. For example, in the oil and gas sector, companies may choose to ring-fence their exploration and production activities from their refining and marketing divisions. This separation helps mitigate risks associated with price volatility, operational disruptions, and potential environmental liabilities.

Likewise, in utility companies, ring-fencing is often utilised to segregate different divisions or subsidiaries within a company. For instance, a utility company may establish separate entities for power generation, transmission, and distribution. This helps ensure that each division operates independently, maintains financial stability, and prevents cross-subsidisation among different business segments.

In project-based organisations such as building firms, ring-fencing can be employed to separate different projects or initiatives. Each project is treated as a separate entity with its own budget, resources, and decision-making authority. This approach ensures that project teams have autonomy and can manage risks and resources independently, minimizing dependencies and potential disruptions across projects.

Ring-fencing can also be employed in the public sector, particularly in government departments or agencies that have regulatory responsibility. For example, governments may establish specialized bodies or Commissions to handle specific areas of policy development, service delivery, and regulatory oversight such as national security, healthcare, or environmental regulation. These entities are ring-fenced to focus on their specific mandates while maintaining accountability and oversight.

It’s important to note the implementation of ring-fencing in non-banking environments will vary depending on the specific industry, regulatory requirements, and organisational structures. The primary goal remains to mitigate risks, protect stakeholders, maintain accountability, and ensure efficient operations within distinct segments of the organisation.

Don’t assume rind-fencing is in place

But, by no means is ring-fencing standard practice across all organisations that have the potential for an actual or perceived conflict internally. Recent lessons illustrate that as buyers of services, we must all be attuned to the risks that are posed to us as a result of the large, sensitive data holdings our service providers have about our organisations.

We should not assume appropriate ring-fencing practices are in place within all organisations, or that ring-fencing provisions alone will be sufficient to mitigate or control any risk of conflicts arising.