MAF Proposed Changes to DIRA

NEW ZEALAND - Throughout 2011, the New Zealand Ministry of Agriculture (MAF) has led reviews of Fonterra’s farm gate milk price setting, the Raw Milk Regulations, and the appropriate regime to accompany Fonterra’s proposed capital restructure.

24 January 2012

5 minute read

Oceania

This week, MAF set out a consultation bringing together the various reviews in a bid to seek input prior to any legislation or other amendments being passed or made in 2012. TheCattleSite editor, Charlotte Johnston looks at what changes are proposed and why.

Raw Milk Regulations

Current raw milk regulations, through the Dairy Industry Restructuring Act (DIRA), mean that Fonterra must make available to independent processors up to five percent of the raw milk it collects from dairy farmers in New Zealand at either an agreed or regulated price. This is because Fonterra’s dominant position in the market could enable it to refuse to supply raw milk to other processors, or to supply it at monopoly prices.

MAF has recently undertaken a review of the Raw Milk Regulations to ensure the Regulations meet the overall objective of promoting the long term growth and dynamic efficiency of New Zealand’s dairy markets.

The objectives of the Raw Milk Regulations are to:

provide for an entrance pathway for independent processors into the farm gate milk market; and
support competition in the domestic dairy product markets.

Following the review, MAF proposes the following amendments:

for those independent processors who are in the business of sourcing milk directly from farmers, access to regulated milk would be limited to three seasons;
the total volume of milk available under the Raw Milk Regulations would be increased to five percent of Fonterra's total milk supply;
there would be a series of maximum quantity limits set, restricting how much milk an independent processor can take under the Raw Milk Regulations in different months of the season, to reflect the seasonal dairy supply curve;
the $0.10 margin would be removed from the regulated milk price, as processors taking significant quantities of regulated milk will no longer have the ability to flatten the supply curve;
the "October Rule" would be removed, as the quantity of regulated milk taken throughout the season will now be controlled by monthly maximum limits, rather than by comparison to the quantity taken in October; and
Goodman Fielder would continue to be able to access up to 250 million litres of regulated milk per season, on a flat supply basis.

MAF is asking for feedback on whether three seasons is sufficient for a new independent processor to establish its own supply of milk from farmers?

The recommendations include replacing the "October Rule" with a requirement that the quantity of milk that can be taken under the Raw Milk Regulations reflects New Zealand's seasonal dairy supply curve. Does the public have any views on this change? Are there any specific issues that this would create?

Fonterra’s Milk and Share Price Setting

During 2011, an interdepartmental review examined Fonterra’s farm gate milk price setting processes and methodology. The review concluded that Fonterra’s current pricing methodology aims to mimic efficient milk pricing outcomes.

However, up to September 2011 there has been a lack of transparency of how Fonterra sets its milk price (the DIRA does not require Fonterra to disclose how it sets its milk price), and it is difficult to assess whether Fonterra’s milk price in any given season is indeed consistent with the outcomes of a competitive market.

MAF has considered a range of options to strengthen confidence in and transparency of Fonterra’s milk price setting process, and consistency of its outcomes with those arising in a competitive market for farmers’ milk. MAF’s current preferred option involves the following:

embedding Fonterra’s current milk price governance arrangements in legislation;
requiring Fonterra to publicly disclose information in relation to its milk price setting; and
introducing a milk price monitoring/oversight regime, which would involve the Commerce Commission undertaking, and publishing the results of, an annual qualitative assessment of Fonterra’s milk price setting (including Fonterra’s underlying assumptions, inputs and processes) against the outcomes that would have arisen in a competitive market for farmers’ milk.

Regulatory Regime to accompany Fonterra Capital Restructuring

In 2009, Fonterra shareholders voted to change Fonterra’s capital structure to implement a system referred to as Trading Among Farmers (TAF). In February 2011, MAF consulted on regulatory options to ensure that Fonterra’s proposed move to TAF is designed and implemented in a way that allows New Zealand dairy farmers to enter and exit Fonterra in a timely manner and at efficient share prices.

Fonterra’s proposed TAF system, supported by the Shareholders Fund and registered volume providers, should result in an effective substitute to Fonterra issuing and redeeming its shares in a timely manner. This, in turn, should result in both farmers’ ability to freely enter and exit Fonterra, and Fonterra’s share price being, by and large, reflective of its efficient ‘fair value’.

However, if TAF’s design and/or implementation are deficient, there would be a significant negative impact on farmers’ ability to enter and exit Fonterra and on the contestability of farmers’ milk supply. In particular, effective functioning of the TAF system is heavily reliant on participation of external, primarily institutional, investors. If these investors do not invest, or do not trade actively, markets could become illiquid and farmers’ ability to buy and sell shares in a timely manner and at efficient prices would be impaired.

Furthermore, while Fonterra has commercial incentives to ensure a well functioning TAF system, it may also, at times, have countervailing incentives to lock farmers in or out of the cooperative. Left unregulated, Fonterra’s behaviour at any point in time will depend on the relative balance of these conflicting incentives.

MAF has considered a range of options to ensure that Fonterra’s proposed TAF system is designed and implemented in a way that allows dairy farmers to enter and exit Fonterra in a timely manner and at efficient share prices. MAF’s preferred options is for the introduction of the following package of legislative requirements:

a minimum Shareholders Fund size of $500 million as a pre-condition to the launch of TAF;
a further pre-condition that Fonterra shares and fund securities be listed on a registered exchange at all times;
locking-in key structural features of TAF to ensure that they are maintained post launch, such as the presence of market-makers;
explicitly prohibiting Fonterra from engaging in behaviour with the purpose of hindering liquidity and fungibility of the TAF share and fund markets; and
imposing obligations on Fonterra to ensure that fund investors have the ability to appoint/remove a fund manager, and the ability to wind up the fund.