Governance dangers that come with ring-fencing provisions

14 June 2023 Consultancy.com.au 3 min. read
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In the aftermath of a number of scandals, leaders across government and private sector are reviewing their ring-fencing provisions in order ensure information is not misused within their organisation. Implementing ring-fencing however requires careful consideration. Charitee Davies, Associate Director at Grosvenor, outlines some of the main dangers of ring-fencing practices and how they can be mitigated.

Governance dangers of ring-fencing

Diluted strategic oversight
By segregating different parts of organisational operations, ring-fencing can lead to reduced strategic oversight and control. Separate entities or siloes created through ring-fencing can develop their own governance structures, potentially weakening the overall governance framework.

This fragmentation makes it challenging to coordinate and monitor the activities of various entities or siloes effectively.

Ring-fencing to balance risk and accountability

Weakened risk management
Ring-fencing might also inadvertently dilute the focus on risk management. When certain activities are separated from the core operations, there is a risk of diminished risk awareness and a lack of consolidated risk management strategies. This can compromise an organisation’s ability to identify and mitigate risks effectively.

Regulatory arbitrage
Ring-fencing can create opportunities for regulatory arbitrage, where an organisation might exploit regulatory loopholes by transferring activities between segments to achieve favourable outcomes. This practice can undermine the intended risk reduction goals of ring-fencing and lead to unintended consequences.

Inefficient allocation of resources
The separation of entities or creation of segmented siloes can result in the inefficient allocation of resources within an organisation. Duplication of functions and services between ring-fenced segments can increase costs, hinder operational efficiency, and create unnecessary complexities. This may ultimately affect the organisation's ability to provide competitive services to consumers.

Complexity and compliance challenges
Implementing and managing ring-fencing can introduce significant complexity and compliance challenges. Done properly, organisations must navigate complex legal and operational requirements to ensure compliance with ring-fencing regulations. The associated costs and administrative burden of appropriately controlled ring-fencing can be substantial, diverting resources and attention away from core business activities.

Addressing the dangers

While the governance dangers associated with ring-fencing are significant, they should not overshadow the potential benefits it can bring. It is essential to strike the right balance between risk reduction and maintaining accountability. To address the governance dangers, organisations should consider the following:

Robust governance frameworks
Implementing a strong and unified governance framework across ring-fenced segments can help mitigate the risks of fragmented oversight. This includes establishing clear reporting lines, effective risk management structures, and consolidated board-level oversight.

Integrated risk management
Organisations should ensure that risk management practices are integrated across all segments, even if they are ring-fenced. This requires a holistic approach to risk assessment, monitoring, and mitigation strategies that consider the entire organisation as a whole.

Enhanced regulatory oversight of ring-fencing arrangements
Regulators should remain vigilant and adapt regulations to close potential regulatory arbitrage opportunities. Continuous monitoring and assessment of the ring-fencing arrangements can help identify and address emerging risks promptly.

Streamlined operations
Organisations should strive to streamline operations and eliminate duplication of functions and services across ring-fenced segments. This can improve efficiency, reduce costs, and enhance the overall effectiveness of the organisation.

In summary, while ring-fencing serves as an important risk reduction measure, its implementation can introduce governance dangers that require careful consideration. Striking a balance between risk reduction and accountability is crucial.