Federation considers the DIRA dilemma


Behind the heated debates around the Government's plans for milk price setting and Trading Among Farmers (TAF), all parties, including Federated Farmers, are working on the review of the Dairy Industry Restructuring Act (DIRA) so New Zealand's dairy industry will have the strong regulatory foundation it needs to continue to thrive.

With the current legislation now a decade old and governing a much more pluralistic market, the current review is

timely and needed. Legislation needs to be clear and clearly show the intent behind it. Despite the best intentions of those who drafted the initial DIRA legislation, the past 10 years have seen numerous court cases over the interpretation of it.

The law has not been clear enough, so now the Federation is keen to eliminate any inconsistencies to keep future cases to a minimum with the re-drafted Bill.

Federated Farmers' aim in this process is for the legislation to deliver a settled and successful dairy industry. In large part that is ensuring the legislation will remain unchallenged until the sunset clauses trigger the end of this competition law.

Federated Farmers has been heavily involved since the beginning stages of the Act's re-drafting and is committed to ensuring it results in the best outcome for farmers and the industry when it passes into law, possibly at the end of the year.

''We have been out there lobbying the MPs and making sure we get our members' point of view across,'' Federated Farmers Dairy chairperson Willy Leferink says.

''It is vital we get the legislation right, so the New Zealand dairy industry can grow and make the most of the  opportunities on the horizon.''

Those opportunities are colossal; the global population is expected to increase by about another two billion over the next 20 years. Growing middle classes demand more protein, including more dairy products. New Zealand's reputation as a safe supplier of high quality food products will help it brand itself as a preferred supplier of high  end goods at the upper end of the market.

As a whole the industry is looking for ways to add value beyond the obvious milk and cheese products. Where there are opportunities, there are also challenges. This was evidenced by this year's falls in dairy commodity prices which have led to Fonterra lowering its forecast payout last month, only two weeks from the end of the 2011/12 season. As a trade dependent industry, dairy farm incomes are also heavily tied to where the New Zealand dollar is sitting in the currency markets.

With so much volatility it is important the mechanisms which all our dairy companies operate under are flexible enough to allow them to adjust to market conditions, while maintaining the ethos of a competitive internal marketplace.

The next step in amending the DIRA is for the primary production select committee to report back, probably over the next few weeks. Having made a number of recommendations in its submission, the Federation is eager to see what the report's findings are.

''Federated Farmers understands this is an enabling Bill and, where that is beneficial to the industry, we support

that,'' Leferink says.

Trading Among Farmers

One of the major criticisms levelled at Fonterra over the past 10 years has been the so-called ''redemption risk'' inherent in its structure of supplier shares.

If for some reason it became attractive for most of Fonterra's farmers to choose another processor, and cahsed in their shares in a short space of time, the cooperative would have to find a lot of money very quickly. A similar  outcome could be from a change in milk volume due to shock events such as floods, droughts, disease or cow prices.

The TAF proposal would allow Fonterra farmers to trade shares among themselves in a market. That way, while it would shift the burden of the redemption risk, which is thought to total around $5.5 billion from Fonterra, its critics say that would only relocate the problem to farmers.

While farmers may be surprised by the appearance of a Shareholders Fund, they need to remember it was part of the 2010 vote.

This Fund will be required by the government to cover liquidity in the market and is an integral part of TAF's  implementation. This fund is the contentious part of the whole deal, with many farmers feeling this could become the ''thin end of the wedge'', leading to outside shareholding in the future.

This could lead to the needs of these outside investors being given more consideration at a governance level than the needs of the farmers. To alleviate these concerns, Federated Farmers has asked for a cap to be included in the DIRA limiting the number of dividends which can be passed to outside investors and also a cap on the fund itself, stopping it becoming too big.

The Federation has also lobbied Fonterra successfully for a second farmer vote on TAF. This is to happen later this month.

The Federation is continuing to ask Fonterra to give more information to farmers around TAF's benefits and how the co-operative intends to prevent the slow growth of non-farmer influence into the future.

While TAF has dominated the media coverage of the DIRA review, there are a number of other changes equally important to the future of the New Zealand dairy industry.

Base milk price

In its submission on the DIRA, the Federation's key point was that getting the right mechanisms in place for  setting Fonterra's base milk price is the fundamental ingredient to a successful New Zealand dairy industry.

The base milk price is instrumental in setting the income for farmers, the price farmers have to pay in order to supply Fonterra, the level of the dividend and the price of milk in the Raw Milk Regulations. It is also central to the price of rural land.

Given these points, it is essential the rules around setting the base milk price are fair, equitable and, above all the

Federation believes, transparent.

''We don't have a problem with having Commerce Commission oversight on how Fonterra sets its prices,''  Leferink says.

''The co-operative should have nothing to hide and, so, nothing to fear.''

The Federation agrees with the oversight by the commission, but only if it is true oversight. Leferink says this would leave the milk price open to gaming. As the proposal stands, however, the Bill is ambiguous and does not give the commission the guidance required to say that the milk is neither under nor over priced, something the Federation says is essential for the industry.

''Only something, for instance a model, which can be set in concrete can give the industry the right signals upon

which good business decisions can be made,'' Leferink says.

With that in mind the Federation has asked the Government to ensure that competition for milk at the farm gate

continues to exist by giving a clear purpose statement on setting the base milk price. The Federation is keen to get

the purpose stated as clearly as possible so there is little room for misinterpretation, which would lead to litigation.

A clear purpose statement would set a goal for the whole dairy industry, so there is room for any dairy processor

which proves itself efficient and sustainable.

This, in turn, would encourage Fonterra to be efficient and successful and also allow a milk price to be found that will not preclude efficient processors from potentially competing.

Setting a share price

When it comes to share price, however, Federated Farmers is against government interference.

''We rejected absolutely the notion that should Trading Among Farmers not eventuate, Fonterra would have to link

its farmer supplier shares to any kind of market value, something that is commonly referred to as a 'fair value share','' Leferink said.

''That would mark Fonterra out from both of our other dairy co-ops, Westland Milk Products and Tatua.

''Westland sets its share at the nominal value and Tatua is a closed co-operative.

''Making Fonterra follow one set of rules that were not applicable to all other similarly set up companies in the sector would give those others an obvious unfair advantage.''

In its submission, therefore, the Federation said it preferred the status quo and that it was not the role of the government to get involved in share price setting.

Federated Farmers submitted that Fonterra's entry and exit clauses were tough enough without requiring Fonterra

to set its share price in direct opposition to the other dairy co-operatives.

''When Fonterra chose to restrict the share price, its farmers agreed at the ballot box. Shareholders, not  government, should determine how the share price is set.

''To date it has run smoothly, with farmers who have wanted to enter or exit the co-op being able to,'' Leferink says.

Independent processors

Another area which Federated Farmers feels needs more clarification in the revised DIRA is the definition of ''independent processor'' because it directly feeds into the Raw Milk Regulations.

In the current proposal there is no change proposed to the interpretation of independent processor.

''We have said it is essential for this to be carefully reviewed,'' Leferink says. ''Especially with the current review of the Raw Milk Regulations which is also going on.

''We see this as an ideal time for the Government to clarify this once and for all.''

This has already been put before the courts.

In March, Fonterra lost an argument in the Supreme Court around toll processing, where one firm contracts with another to process this regulated milk.

Fonterra argued its rivals should not be able to outsource processing while claiming rights to the regulated milk supply, saying it would limit milk available to companies that do process their own product.

The court disagreed, saying, ''There is nothing in the text of the definition or in the act or regulations to suggest that a processor must make use of its own facilities when undertaking the processing.''

The 20 per cent rule

Another point which the Federation believes needs some serious reconsideration in the DIRA is the 20 per cent rule allowing Fonterra farmer suppliers to divert up to 20 per cent of their milk to an independent processor on a weekly basis, without reneging on their obligations to Fonterra.

''At present very few farmers do this and so it is not a high profile issue for Fonterra, farmers or the Ministry for

Primary Industries (MPI). However, we predict the volume of milk processed under this rule will increase  dramatically in the future, so it is important to make provision for that while we are looking at the DIRA,'' Leferink says.

''The reason we believe the use of this rule will increase is because of proposed changes to the Raw Milk Regulations.''

While these have not been finalised, it is likely that independent processors will be unable to continue to take DIRA milk indefinitely and will therefore be asking farmers for 20 per cent of their weekly supply, especially in the shoulder months.

This will deprive Fonterra of milk when Fonterra's own factories need it the most and when it is at its most valuable.

While small farmers won't bother, those with large holdings will find this prospect most attractive. ''Given that the original intent of the 20 per cent rule was to help small cheese makers and the like, who only wanted five buckets a week, we think farmers should only be able to divert a certain volume to this purpose,'' Leferink says.

''Or perhaps this could be tied to the amount taken in October, at the flush of the season.

''Whatever way, the Federation believes 20 per cent on a large holding is too much to be diverted from Fonterra,

particularly in the shoulder months.''

Federation's role

Whatever the outcome on DIRA and TAF, the Federation will remain committed to doing its best by all of its  5500-plus members and New Zealand's dairy industry as a whole.

''Dairy is an incredibly big cornerstone of the New Zealand economy,'' Leferink says.

''We need to be active in making sure the regulations which underpin it are right so it stays that way.''

- Hamilton News

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