Background - Global Dairy Company: The Package

GLOBAL DAIRY COMPANY: THE REGULATORY PACKAGE

Introduction
1. The Government has announced that it will introduce legislation to Parliament to allow the Global Dairy Company merger to occur. Global Dairy Company has been working with the Government over the last two months on a regulatory package to support the merger and the associated restructure of the dairy industry. A key objective of that package is to ensure that the New Zealand dairy markets remain contestable and efficient.
2. This summary describes the following elements of the regulatory package:
(a) removal of the Dairy Board's sole export rights and repeal of the Dairy Board Act;
(b) the regulatory package, the Commerce Act and the Constitution;
(c) role of the Commerce Commission;
(d) protection for farmers;
(e) protection for New Zealand consumers and processors;
(f) duration of the regulations;
(g) export rights to designated markets (quota);
(h) industry good; and
(i) other matters.
3. While the package described below has been agreed by the Government, it may be amended by the Government or by Parliament during the legislative process. Any aspect may be extended or removed by the Government or by Parliament if either feels that it is necessary. Global Dairy Company is not able to control these changes, but will work with the Government and the relevant Select Committee to avoid unnecessary changes.
Removal of the Dairy Board's sole export rights and repeal of the Dairy Board Act
4. The Dairy Board's sole export rights will be removed after a one year transition period. During this period the existing export permit regime will be liberalised to allow existing permit holders and Westland to export freely to all markets except the specified quota markets. After this period, the Dairy Board Act will be repealed and the Dairy Board will become an ordinary company. New international players will be able to enter New Zealand, ensuring that the dairy markets will remain contestable and efficient.
5. If Westland and Tatua do not wish to merge with Global Dairy Company, they will sell their shares in the Dairy Board largely in accordance with the Dairy Board's present constitution, except that the regulatory package will provide for this process to begin soon after the Global Dairy Company merger rather than at the end of the transition year.
The Regulatory Package, the Commerce Act and the Constitution
6. The protections in the regulatory package do not remove the arrangements already proposed by Global Dairy Company in its draft Constitution and nor do they remove the application of the Commerce Act, except in relation to the initial merger. They complement and add to those arrangements.
Role of the Commerce Commission
7. After the merger Global Dairy Company's behaviour will not only be subject to the Commerce Act but also to a specific set of regulations.
Role of the Commerce Act and the Commerce Commission
8. The dairy industry has a long history of Government involvement. That involvement has evolved over the last 70 years and has been adjusted and developed ever since. Now, the mechanisms that previously achieved unity of a large number of manufacturing dairy companies need to be simplified and the old checks and balances in the Dairy Board Act replaced with a more flexible structure which responds to current and future needs.
9. The Government is best placed to determine that structure. Once that structure has been determined and put in place through the merger, the Commerce Commission will still have its usual role of enforcement and monitoring Global Dairy Company's behaviour, to ensure it complies with the Commerce Act.
Form of the Commerce Act exemption
10. The initial merger will have a parliamentary Commerce Act exemption. The exemption will be in the form of a "deemed authorisation" under the Commerce Act. As a result, the Commerce Commission will be able to take action against Global Dairy Company to enforce the terms of the authorisation and to ensure future behaviour complies with the Commerce Act.
11. The deemed authorisation will be for:
(a) the amalgamation of the co-operatives into Global Dairy Company;
(b) the acquisition by Global Dairy Company of 100% of the shares in the New Zealand Dairy Board; and
(c) the clauses of Global Dairy Company's constitution which enshrine its co-operative nature.
12. The deemed authorisation for the merger will require Global Dairy Company to divest its shareholding in New Zealand Dairy Foods Limited within one year of the merger. The Commission will be able to enforce this undertaking in its usual way.
Regulating Global Dairy Company's ongoing behaviour
13. The deemed authorisation does not affect the Commission's ability to scrutinise Global Dairy Company's future behaviour. The Commerce Act will apply to all of Global Dairy Company's actions in the markets for purchasing raw milk from farmers and selling dairy products to other processors.
14. The proposed regulatory package contains a precise set of rules to govern Global Dairy Company's behaviour in two key areas:
(a) farmers' ability to enter and exit Global Dairy Company; and
(b) the sale of raw milk by Global Dairy Company to other New Zealand processors.
15. The regulatory package, as well as Global Dairy Company's Commerce Act obligations, are expected to ensure genuine contestability, and thus maintain competitive pressure on Global Dairy Company. Suppliers, shareholders and the country will benefit from the efficiencies Global Dairy Company will maintain as a result of this pressure.
Protection for Farmers
16. The regulatory package regulates for open entry and exit to protect farmers in their role both as shareholders and as suppliers. The package embodies goals which are shared by farmers and the Government alike: efficiency, transparency, contestability, potential for future evolution, and optimal levels of regulation.
Protection for farmers in their role as shareholders
17. Underlying milk and share price: Global Dairy Company will have strong incentives to set the correct entry price (fair value for shares and the correct number of capacity notes) and the efficient price for milk. If it overvalues the shares, there will be an artificial demand for exit by farmers; if it sets this price too low, there will be an artificial demand for entry.
18. The regulations will require that the price for shares, milk and capacity notes for new entrants, and the price for exiters, must be the same, at any given time and in any given region. This is designed to produce a market based equilibrium between supply and demand for both processing facilities and milk. Global Dairy Company will not be subject to any direct price regulation but will be subject to this market pressure if it does not establish the correct prices.
19. Entry processes: Subject to normal minimum deliveries and milk quality requirements, Global Dairy Company must accept all new suppliers who make application by the end of February in any year. If Global Dairy Company is capacity constrained such that it cannot accept supply in the season beginning three months later, it will publish a "capacity constraint notice" by 15 December for the region in which the constraint applies. Where a capacity constraint notice has been published, farmers must give 15 months' notice to supply. Global Dairy Company must provide the required capacity so it can accept supply after that notice period.
20. The regulations will require all entrants to pay a 20% deposit 21 days after acceptance of their application to supply or the end of February, whichever is earlier. A 10% refundable deposit is required from farmers in "capacity constrained" regions who give 15 months' notice. That deposit is then topped up to 20% in the following February. The balance of the purchase price of the shares and the capacity notes is payable in late July or two months before supply commences, whichever is later.
21. Exit processes: Any supplier may exit by giving notice by the end of February in any year. The exit takes effect on 31 May in the same year. The only exception is where the supplier has signed a long-term contract for the supply of milk to Global Dairy Company, in which case the contract must be honoured, and the supplier must continue to supply milk for the term of that contract.
22. Option to secure price in advance: The new entrant or exiter will have an option to secure the entry and exit share prices within a range of plus or minus 7.5% from the most recent estimated valuation conducted by the Board. For new entrants who apply to join Global Dairy Company in February, and for exiters who give notice of intention to leave in February, this will usually be the Board's estimate on 15 December. Alternatively, an entrant or exiter can choose not to secure the share price but to take the final share price established as at 1 June.
23. Share liquidity: To ensure that shareholders who exit can receive cash or near cash for the investments they have made, and can therefore switch to a competing processor without value loss, exiting shareholders will have all their shares, capacity notes and supply redemption rights redeemed in cash or capital notes within 30 working days of the end of the season in which they leave the company. The proportions in which they are paid cash or capital notes will be at the discretion of the Board.
24. Global Dairy Company's remaining shareholders will be protected against significant value loss from a "run on the bank". If more than 5% net of all suppliers, measured by milksolids, exit at the end of any season and the Board considers that would materially adversely affect the ability of Global Dairy Company to carry out its current business plan, the Board can issue preference shares instead of cash or capital notes. In this case, all exiting shareholders will receive the same proportion of preference shares, cash and capital notes. Capital notes will be paid up to the 5% threshold and preference shares will be issued for the remaining surrendered shares.
Protection for farmers in their role as suppliers
25. Milk price: The Government's only restriction on the milk price paid to suppliers is that the same price must be paid to all suppliers in a region. The region would be defined by reference to the catchment area for each processing facility in operation at the time.
26. No contractual barriers to entry and exit: The following rules will ensure that Global Dairy Company has no incentive nor ability to stop shareholders exiting the company or stop competitors establishing in New Zealand:
(a) Global Dairy Company must offer one year supply contracts to all suppliers;
(b) It may offer longer term contracts but in that case the regulations will limit how many long term contracts may be offered in any region. 33% of milk produced in a 160 kilometre radius of any point in New Zealand must be either supplied to someone other than Global Dairy Company, or supplied to Global Dairy Company under a contract which expires (or is able to be terminated at the supplier's option without penalty) at the end of the current season;
(c) Global Dairy Company's shareholders will have the contractual right to allocate up to 20% of their farms' daily milk production to non-Global Dairy Company purchasers, without discrimination from Global Dairy Company. Any such split milk must be stored in separate tanks;
(d) Global Dairy Company must agree to sell tanks located on a supplier's farm to either the supplier or the new purchaser if that supplier switches to a competitor. This does not apply to partial switchers. The price would be a fair market price;
(e) Global Dairy Company must accept supply from any farmer whose transportation costs for the collection of milk are no greater than those of any other existing farmer in the region. This cost is established by reference to the highest transport cost incurred in collecting milk to service Global Dairy Company’s nearest processing factory (if Global Dairy Company charges transport or other cost based differentials at some time in the future, this regulation will no longer apply but Global Dairy Company would then have to apply any such differentials evenly throughout a region); and
(f) the Milk Commissioner will adjudicate on disputes over significant changes to the supplier terms and conditions issued by Global Dairy Company each year.
Protection for New Zealand Consumers and Processors
Sale of New Zealand Dairy Foods
27. New Zealand Dairy Group's 50% shareholding in New Zealand Dairy Foods will be sold to provide competition in domestic markets. From the time of the merger until the sale New Zealand Dairy Foods will be operated on an arms length basis.
Domestic dairy product markets
28. New Zealand dairy processors, and therefore New Zealand consumers, will be protected from any market power Global Dairy Company might acquire under the merger by the requirement that Global Dairy Company sell a certain volume of raw milk each year at a price equal to the price paid to suppliers.
29. Global Dairy Company will have the following obligations:
(a) Global Dairy Company must supply raw milk to anyone who seeks it in New Zealand;
(b) the maximum aggregate annual total volume which Global Dairy Company must sell under this obligation is 400 million litres (this is approximately 110% of the volume of fresh milk and other dairy products currently sold in New Zealand);
(c) the quantity of milk to be sold to New Zealand Dairy Foods is being agreed at present. Global Dairy Company is not required to sell more than 50 million litres each year to any other customer. There will be some limits on customers' ability to increase winter milk supplies and all customers will need to give 18 months' notice of their requirements. There will also be notice provisions for non-winter milk to ensure that Global Dairy Company is able to manage its milk supply;
(d) the price of this milk will be the payout to farmers less the annualised capital valuation of Global Dairy Company's shares (which will generally be the milk price determined by the valuer and the Board under the Constitution), plus transport and other direct costs and the winter premium paid by Global Dairy Company to its suppliers for the relevant milk;
(e) Global Dairy Company and its customers will be free to agree alternative arrangements including price and term; and
(f) contracts with New Zealand customers may be terminated by Global Dairy Company on two years' notice given to the customer at any time after the overall regulations cease to apply.
30. There will be no other regulation of domestic dairy markets at this stage, although the Government has expressed a desire to see a wholesale market for milk and could regulate to encourage the establishment of such a market. The Government will retain the ability to impose further regulations in future.
Duration of the regulations
31. The regulations will cease to have effect in each of the North and South Islands when defined tests are met. However, some aspects of the regulations cannot apply to one island but not the other. That means that those aspects will continue to apply until the tests for both islands have been met.
32. The tests require that the following milksolids be purchased by companies other than Global Dairy Company:
(a) in the North Island, 12.5% of the total production in a season; and
(b) in the South Island, 65 million kg in a season, with at least one processor east of the Southern Alps purchasing 25 million kg.
Export rights to designated markets (quota)
33. Term of allocation: Quota export rights will be allocated to Global Dairy Company for about six years.
34. Development of allocation method after initial period: The Government will develop a quota management regime which will apply after that initial period. The Government hopes to have certainty as to the regime by the end of 2002. The objectives of the regime will be to maximise the value of the quota for New Zealand and an understanding that they should benefit the dairy industry.
35. Phaseout to final quota regime: At the end of the initial period, the legislation will provide for the reallocation of the quota over four years in approximately equal steps in each of the specified markets. Global Dairy Company will itself be entitled to participate in this reallocation process.
36. Other dairy companies: The regulatory package will ensure that the dairy companies which do not join in Global Dairy Company (which may be both Westland and Tatua) receive the benefit of the quota by being paid the value of the quota when they sell their shares in New Zealand Dairy Board, or by receiving a right to export to those markets through Global Dairy Company.
Industry good
37. Funding: The Dairy Board will continue to fund industry good spending for the first year after the merger. This will give Industry Good Inc time to conduct the necessary vote and other procedures to establish a levy under the Commodity Levies Act. In order to allow Tatua and Westland to make their contribution to industry good during this transition period, the Dairy Board Act will be amended to allow for a deduction from the value of the Dairy Board paid to them on their exit to be charged against the price they receive for their shares in the Dairy Board.
38. DEXCEL: The approach of the industry in relation to DEXCEL will continue, and will be implemented regardless of whether Dairy Group and Kiwi merge into Global Dairy Company.
39. NZDRI: Global Dairy Company will own NZDRI. Any residual industry good functions in NZDRI (eg animal research, environmental work) will be transferred to industry good bodies, eg DEXCEL.
40. LIC: LIC will be owned by its users (farmers and sharemilkers) as a cooperative. Global Dairy Company will have access to industry data.
Other matters
41. Enforcement: The rules for enforcement of the regulations will be developed prior to introduction of the legislation into Parliament.
42. Tax: The arrangements for tax treatment of aspects of the merger will be similar to those which were included in the Dairy Industry Restructuring Act 1999.

ENDS

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