Dairy Industry Restructuring Act proposals to accommodate Trading Among Farmers

Regulatory regime to accompany Fonterra's capital restructuring: Submissions

The Ministry of Agriculture and Forestry consulted dairy industry stakeholders on possible amendments to the Dairy Industry Restructuring Act 2001 that would enable Fonterra to implement its proposed new capital structure known as Trading Among Farmers.

The consultation document outlined the objective of the Dairy Industry Restructuring Act 2001 (DIRA) to promote the efficient operation of New Zealand dairy markets through the freedom of farmers to choose to enter or exit Fonterra.

The consultation document proposed a range of possible options for amending the DIRA in the context of Fonterrra’s proposed Trading Among Farmers’ system. MAF invited discussion with dairy industry stakeholders on these possible DIRA amendments.

If you have any questions, check out our FAQs below or email MAF.

1. What is the DIRA?

The Dairy Industry Restructuring Act (DIRA) 2001 is a special piece of legislation that allowed for the formation of Fonterra by permitting the merger of Kiwi Co-operative Dairies Limited, the New Zealand Co-operative Dairy Company Limited and the New Zealand Dairy Board.

To allow the merger to take place, the Government granted an exemption to the mergers and acquisition provisions of the Commerce Act 1986.

Upon formation, Fonterra collected 96 percent of the milk supplied by dairy farmers in New Zealand. Given this, it was necessary for the Government to regulate Fonterra to ensure that New Zealand dairy markets are contestable and efficient.

2. How does it work?

The two main parts of the DIRA pro-competitive measures are:

  • The open exit and entry provisions: Fonterra must accept all applications from farmers to either enter or exit the co-operative and accept the volume of milk the farmers wishes to supply.
    Fonterra must also issue and redeem co-operative shares in accordance with farmers’ milk supply decisions. The price of co-operative shares issued and redeemed must be the same in any given season.
  • The Raw Milk Regulations: Require Fonterra to make available to independent processors, up to 600 million litres of the raw milk it collects from farmers at either an agreed price or the default price specified in the Regulations.

In addition the DIRA also requires Fonterra to:

  • treat new entrants and existing farmer shareholders the same in the same circumstances;
  • allow at least one third of all milk supply contracts within a 160km range to expire each year;
  • allow farmer shareholders to divert up to 20 percent of their weekly milk supply to an independent processor without having to redeem their co-operative shares; and
  • sell the milk vat of an exiting farmer at a market price to the dairy farmer or to an independent processor.

The DIRA pro-competitive provisions work in parallel with, and are supplementary to, the general competition provisions of the Commerce Act 1986.

3. What is Fonterra’s Trading Among Farmers (TAF) proposal?

The proposal is that farmers buy and sell their co-operative shares, in accordance with their milk supply decisions, through a market system rather than directly with Fonterra as they do at the moment.

The market system would broadly involve:

  1. Fonterra Shareholders’ Market – a market for trading in co-operative shares in which only Fonterra farmers may participate (‘the share market’);
  2. Fonterra Shareholders’ Fund – a fund to which Fonterra farmers may transfer a proportion of their shares in exchange for cash and a certificate;
  3. Fund securities - both Fonterra farmers and other investors would be able to purchase from the shareholders’ fund a ‘fund security’ that provides the beneficial rights (dividends and other distributions) to the shares that Fonterra farmers have transferred to the fund;
  4. Fund market - a second market for the trading of fund securities. Both Fonterra farmers and other investors may participate in the fund market;
  5. The fund market would be closely connected to the share market because both Fonterra farmers and registered volume providers may trade in both markets and may convert shares to fund securities and visa versa.

Other key features of the TAF proposal are:

  1. Voting in Fonterra would be based on milk solids supplied that are backed by either shares or certificates (“share backed milk”);
  2. The minimum share standard would be based on a three year rolling average of milk supplied;
  3. Farmers would be able to meet the share standard by either holding shares or certificates (certificates are issued to farmers in exchange for transferring shares to the fund);
  4. Fonterra’s Board may, at its discretion, allow a period (envisaged to be initially three seasons) over which new entrant farmers and growing farmers could buy shares to meet the minimum required share standard (that is, purchase at least one-third of the required shares per kilogram of milk solids supplied each season). Farmers that are exiting or reducing their milk supply would have the same period to sell their shares (that is, sell at least one-third of shares held each season).

4. How does the DIRA relate to TAF?

The DIRA currently requires that Fonterra issue shares to farmers when they enter the co-operative or increase milk supply, and redeem shares from farmers when they exit the co-operative or reduce milk supply. The issue and redeem price must be the same in any particular season.

This issue and redemption requirement would be inconsistent with a market system where farmers trade shares and the two different systems would be unlikely to be able to work well in parallel.

5. I supply milk to another company, not Fonterra. Why is this relevant to me?

The DIRA legislation affects New Zealand’s entire dairy industry because it regulates Fonterra to allow all farmers’ the choice to enter Fonterra in future if they want to (subject to some limitations) Because farmers have the choice to join Fonterra, it is worth while understanding how TAF may affect that choice.

6. I am an independent processor. Why is this relevant to me?

The DIRA legislation affects New Zealand’s entire dairy industry because it regulates Fonterra to allow for farmers to choose whether or not to leave Fonterra to sell some or all of their milk to an independent processor, rather than Fonterra. Therefore independent processors may wish to understand how TAF may affect a farmer’s choice to supply them, instead of Fonterra.

7. Why is the Government getting involved in Fonterra’s capital structure?

The Government’s objective is to promote efficient dairy markets by ensuring that farmers have freedom to enter and exit Fonterra.

Therefore before making an amendment to the share issue and redemption requirements in DIRA, the Government needs to be assured that Fonterra’s TAF proposal can provide an adequate means for farmers to buy and sell their shares in a timely manner and at efficient prices.

If the Government is assured of this then legislative amendments to the Dairy Industry Restructuring Act 2001 would be required to:

  • replace the current requirement for Fonterra to issue and redeem shares; and
  • introduce an alternative regulatory regime that would both ensure the freedom of farmers to enter and exit Fonterra and allow Fonterra’s TAF proposal to be implemented.

8. What is the Government trying to achieve?

The Government is trying to promote the efficiency of the New Zealand dairy markets by ensuring the freedom of farmers to enter and exit Fonterra.

This means that the Government is trying to ensure that Fonterra’s TAF proposal would:

  • provide a sufficiently liquid market for farmers to trade their shares in a timely manner; and
  • deliver efficient prices for shares.

These two key elements are needed to ensure that farmers’ milk supply decisions (the volume to produce and the processor to supply) are not influenced by an inability to trade their shares when they need to or by inefficient share prices.

9. What is the Government recommending?

The Government is presenting a range of regulatory options and consulting with stakeholders on those options.

The options are essentially choosing between the status quo (no change to DIRA and therefore most likely TAF could not proceed), and a pre-condition on the minimum fund size with alternative regulatory options relating to milk price governance and disclose, and ongoing liquidity requirements.

The Government is not recommending a preferred option at this stage but considers that some regulation is likely to be necessary to ensure that the TAF proposal, if adopted, remained consistent with the Government’s aim of promoting the efficiency of the New Zealand dairy markets by ensuring the freedom of farmers to enter and exit Fonterra.

10. What are the key things the Government is looking for from TAF?

The Government is looking for assurance that Fonterra’s TAF proposal will provide for farmers to buy and sell their shares in a timely manner and at efficient prices.

To achieve this Fonterra’s TAF proposal would need to have two key elements:

  • The share and fund markets must be sufficiently liquid; and
  • Fonterra’s milk price must be set efficiently - to ensure that the share price is determined efficiently.

11. What does this have to do with raw milk?

Nothing. The Raw Milk Regulations are a separate part of the DIRA and are not affected by Fonterra’s TAF proposal. MAF will be commencing work on a review of the Raw Milk Regulations in March 2011. A public consultation process, led by the release of a discussion document, is expected to begin by the middle of the year.

12. What is the timeframe on this work?

MAF’s consultation will be open for a month, closing on March 7. MAF then has to review submissions, make recommendations to the Government and, if required, present a final bill to Cabinet, outlining the changes that could be made to the DIRA.

This bill would then need to pass through the normal legislative process. If legislative amendment is recommended, then MAF’s objective is for the amendments to the DIRA to be passed by November 2011.

 

Last Updated: 15 March 2011

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