Can an institution legally "ring fence" cash it has to mitigate an exposure to a counterparty (using it as financial collateral)? The institution does not wish to notify the counterparty. The CRR is not clear on whether financial collateral used to mitigate an exposure must come from the counterparty or not.
An institution wishes to mitigate an exposure they have. They wish to do this without involving or notifying the counterparty. They are not permitted to receive guarantees from their parent or to have an asset exposure to their parent as part of their license condition.
Cash used to mitigate an exposure pursuant to Article 197(1)(a) of Regulation (EU) No 575/2013 (CRR) must constitute a 'funded credit protection' as defined in Article 4(58) of the CRR. As such, Article 4(57) of the CRR states that this 'credit risk mitigation [...][is] used by an institution to reduce the credit risk associated with an exposure'.
Given that the cash described in the question comes from the institution itself, it does not provide any credit risk reduction. Therefore, such cash is not a 'funded credit protection' and as a result, is not eligible under Article 194(3) of the CRR.
Regarding the specific case of cash, Article 197(1)(a) of the CRR that specifies the eligibility of collateral under all approaches and methods, refers to 'cash on deposit', making it clear that cash collateral should be received by the institution.
Update 26.03.2021: This Q&A has been reviewed in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR) and continues to be relevant.