Government supports Fonterra capital rejig but imposes conditions

Fonterra is NZ's biggest business and sets the base milk price. Photo / File

The Government is to amend dairy industry legislation to accommodate Fonterra's capital restructure plan - but with significant provisos designed to ease sector jitters about the potential for New Zealand's biggest business to throw its weight around.

The Government's proposals for amending the Dairy Industry Restructuring Act (Dira) will be open for stakeholder comment from now through May and subject to select committee scrutiny, said Agriculture Minister Damien O'Connor.

The proposed Dira amendments focus on enabling Fonterra to partially delink its stock exchange-listed unit fund on a permanent basis, improving the transparency and robustness of the governance and operation of the current base milk price-setting regime, and setting requirements for the way a financial institution "market maker" operates in the restricted Fonterra farmer-only share trading market, to support liquidity and transparency.

To increase the degree of independence of Fonterra's internal milk price-setting processes, the Government proposes increasing the number of ministerial nominees to Fonterra's Milk Price Panel from one to two and requiring the panel chair to be suitably independent of Fonterra and to be approved by the Minister of Agriculture.

The Government also proposes requiring Fonterra to contract out day-to-day administration of the base milk price calculation to an external party, and to replace the contracted party every 4-6 years.

Fonterra would be required to make independent market analysis of share price performance available to its farmer-owners.

Fonterra's wish to partially delink the unit fund permanently could have exposed it to legal action under Dira, said the Government. The company sought this amendment to remove that risk.

Fonterra's 10,000-or so farmer-shareholders voted 85 per cent in support of a capital restructure proposal late last year, but the Government's tick was required because the company's capital structure is regulated under Dira.

In a response statement, Fonterra, the world's biggest dairy exporter, said the Government's aspirations for the $19 billion dairy export industry were well aligned to the cooperative's.

"We all want a high performing dairy industry, and a successful and innovative Fonterra is central to that.

"A strong Fonterra can lead the industry, building New Zealand provenance, lifting the bar on environmental performance and ensuring sustainable returns for all New Zealand dairy farmers.

"A flexible shareholding model will help our co-op maintain a sustainable milk supply. A globally competitive co-op of scale is in everyone's best interests.

"Fonterra's scale efficiencies improve our ability to invest in on-farm support services, innovation, new market and product development - all of which creates value for New Zealand in terms of milk price and profits returned to rural communities, export performance, employment, environmental performance, and community development."

Fonterra said the Government had signaled regulatory changes would not be in place by June 1, the start of the new dairy season.

The cooperative was preparing to implement the flexible shareholding structure as soon as possible, it told shareholders today in an email.

"Share compliance obligations will remain on hold until at least six months after the effective date for the new structure."

Fonterra was created under the enabling Dira legislation from an industry mega-merger in 2001 on the promise it would be "a national champion".

O'Connor said because of its size and influence in the dairy sector, the Government needed to take into account any potential risks to the long-term performance, innovation, sustainability and value creation in the wider industry.

That was why it was taking the opportunity to improve the transparency and independence of the raw milk price setting process, while also requiring Fonterra to produce a dividends and retention policy.

Fonterra collects 79 per cent of the country's raw milk. At the time it was created, it picked up 96 per cent.

The Government wanted feedback on the proposed amendments and had released a discussion paper as part of its consultation on the changes, O'Connor said.

A Castalia consultancy report on the proposed capital restructure, commissioned by Fonterra's nearest export competition Open Country Dairy, sharply criticised the plan.

It concluded the rejig would cause its farmers a short-term loss of $4 billion, strengthen Fonterra's market dominance and push up the price of milk at the grocery chiller.

It would also probably fuel land prices, said Castalia.

With New Zealand milk production flatlining and expected to fall, Fonterra's capital restructure aims to ensure its tanks remain full by making it easier and cheaper for farmers to buy shares in order to be able to supply milk.

The new structure will replace the Trading Among Farmers (Taf) capital structure, in place since 2012 and according to the Government discussion paper, marks a "substantial" shift away from existing Taf arrangements.

The key elements of the intended rejig are a reduction in the minimum shareholding requirement from 1 share for 1 kg milksolids supplied to 1 share for every 3kg, and an increase in the maximum shareholding, from 2 shares for every 1 kg supplied to 4 shares.

Another element is a restricted, farmers-only market for future share trading, with a lower (10 per cent rather than 20 per cent) cap on the size of the listed unit fund.

(This fund was introduced under Taf. It provides for farmer-shareholders, a market maker, Fonterra, and the public to trade non-voting, dividend-carrying economic rights to shares in Fonterra.

The restructure involves partially delinking the unit fund, so that farmers, the market maker, and Fonterra will no longer be able to convert Fonterra shares into units (although existing units could still be converted into shares).

Under Taf, the farmer market and the unit fund are intrinsically linked, so that farmer-shareholders, the market maker, and Fonterra can convert dry shares to units and vice versa.

The Government's discussion document said this link was an essential element of the Taf structure, as the mechanism for discovering the full underlying (fair) value of Fonterra shares.

Farmers will instead trade their Fonterra shares in a restricted farmers-only market,
supported by the market maker.