Toby Daglish says new devices like the TAF mitigate the difficulty of spreading dairy risk and that is good for both farmers and investors alike. Your view?

Toby Daglish says new devices like the TAF mitigate the difficulty of spreading dairy risk and that is good for both farmers and investors alike. Your view?

By Toby Daglish*

Introduction of new securities into a financial market can help to move the market towards the Holy Grail of ‘completeness’.

Why is this important, and what does this tell us about Fonterra’s Trading Among Farmers scheme?

Investors generally seek to balance the tradeoff between risk and return when deciding how to spread their money through the financial market.

Holding lots of different stocks, bonds and other assets enables investors to avoid having all their eggs in one vulnerable basket.

However, frequently we encounter situations where unbalanced holdings are unavoidable. Buying a house, for example, often results in the homeowner having a large portion of wealth tied up in a single asset.

Small-business owners face a similar problem; and so do farmers, whose livelihood depends on the profitability of their farm (which is itself largely determined by commodity prices beyond any individual farmer's control).

On the opposite side of the fence, a nonfarmer ‘city slicker’ may look enviously at the farmer's exposure to commodity prices.

These may offer high returns and may be exposed to risks that are not common to many other investments.

To the non-farmer, being able to introduce dairy or other commodity price risks into his or her portfolio may seem like an attractive proposition.

The inability to move dairy exposure to the non-farmer's portfolio arises because of incompleteness of the financial market.

Since there are no securities that have payoffs contingent on milk prices, the two individuals are stuck: one unable to invest in dairy; the other with too much at risk because of it.

A possible solution to this problem would be for farm ownership to take the form of companies with tradable shares.

Then ownership could be spread among many investors, and the risks and returns could be diversified among them. But since most New Zealand farms are not traded companies, this is not a solution.

Furthermore, the problem is exacerbated because the major dairy processors (Fonterra, Tatua) are farmer-owned co-operatives and do not have tradable shares either.

Fonterra’s Trading Among Farmers scheme helps mitigate the difficulty of spreading dairy risk.

At present, farmers selling their milk through Fonterra receive initially a farmgate price for their milk and then a share (proportional to their milk production) of profits realised by the co-operative from selling the processed milk in the wider market.

Under the Trading Among Farmers scheme, farmers can elect to sell a portion of this profit margin while retaining the voting rights they have through their existing shares in Fonterra.

Allowing farmers to separate and sell some of the volatile component of dairy revenue from their farms allows a mutually beneficial trade to occur. The farmer now has money that can be invested in other securities (or used for physical investment, or to pay down debt). This allows farmers to diversify, and their nonfarmer counterparts to expand their portfolios into previously inaccessible dairy markets.

Trading Among Farmers is not the only example of introduction of a new security that allows diversification.

The use of weather derivatives (securities that pay off as temperatures vary) allow power companies to hedge risks of high demand for heating or cooling. Securities that pay off in the cases of natural disasters allow insurance companies to hedge their exposure to risk from claims. Interest-rate swaps allow banks to shift interest-rate risk among themselves or on to other investors.

Trading beyond farmers

It's interesting to reflect on the effect of this gainful trade on farms and other assets in the economy.

Allowing farmers to partially diversify away the risk from downstream effects makes farming a less risky activity.

With farming being less risky, would-be farmers require a lower return to induce them to purchase a farm and this would translate into a higher price for rural properties.

Similarly, investors who examine other investments in the economy know that they can mitigate their risks by including commodity risks in their portfolio.

Less exposure to what economists call ‘idiosyncratic risk’ (risk associated with a single security) should make investors willing to pay a higher price for assets. Hence owners of existing securities should reap the benefits of an enlarged pool of securities available. Trading Among Farmers therefore ultimately benefits the entire New Zealand economy.


Toby Daglish the the research director of the ISCR (New Zealand Institute for the Study of Competition and Regulation). This article was first published on their website here » and is reprinted with permission. You can contact him here »

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.


Comment Filter

Highlight new comments in the last hr(s).

If you are wondering why this article appears a little detached from the real world, a look at the membership of ISCR may help:
Contact Energy
Victoria University

I wonder if Kerry (Group) dairy suppliers have the same views on risk mitigation?
An unsuprising (and uninspiring tone) given sponsers, but why is Victoria University involved in this think tank?
I thought by belonging to a cooperative and adhering to cooperative principles was a way for shareholders (suppliers, farmers...) to mitigate risk and whats more realise whatever potential value is in their product through unified self determination?

but why is Victoria University involved in this think tank?
That is a question Victoria University may wish to reflect upon. To my mind their involvement in ISCR damages their reputation and credibility.
Meanwhile others at Victoria produce some valuable analysis:
The situation at present seems to be that by carefully structuring a wide range of its transactions, and by arranging to have parents and associated parties as counterparties, an overseas-owned New Zealand bank can potentially pre-position itself so that open bank resolution would become simply the occasion for large-scale stripping out of the best-quality assets by the Australian parent.

What is this article really about? It's confusing

Toby Daglish says:- The inability to move dairy exposure to the non-farmer's portfolio arises because of incompleteness of the financial market. Since there are no securities that have payoffs contingent on milk prices, the two individuals are stuck: One unable to invest in dairy; the other with too much at risk because of it.

That seems to be a misleading statement, because:-

Modification of Rules relating to Fonterra Supply Information. 22 September 2011
NZX Limited ( operates a market in dairy futures contracts which are cash settled against GlobalDairyTrade prices for Fonterra AMF, SMP and WMP. To operate effectively, all information which may have a material effect on the prices of these NZX dairy futures should be available to all futures market participants no later than when that information is available to GlobalDairyTrade bidders.

GlobalDairyTrade therefore advises that, as provided by Rule B4.4 of the Market Rules, information on Fonterra’s products offered on GlobalDairyTrade is deemed to be public information in terms of the confidentiality requirements in Rules C2.5 and C2.11.

The longstanding inadequacy of inexperienced, but nonetheless paid, ideologues posing as never employed market professionals.

Infuriating isnt it. I know little about Fonterra and modern dairy farming. Have never worked for Treasury, but I do have enough experience in treating mastitis and putting suction cups on cows to question the validity of this article. Wonder if Mist142nz has any insights

Do people actually beleive this drivel. Fact is Fonterra was built on a cooperative risk sharing basis. Applying theoretical "best business" type practice will tear it down bit by bit, primarily by exposing farmers to new risk which these helpful people will then supply a new way to mitigate.

This is a PR job by a paid lobbyist
Lobbying describes paid activity in which special interests hire well-connected professional advocates

Since 1995, the Lobbying Disclosure Act (LDA) has required individuals who are paid for lobbying at the federal level to register with the Secretary of the Senate and the Clerk of the House. Lobbying firms, self-employed lobbyists and organizations employing lobbyists must file regular reports of lobbying activity
As of November 2009, there are approximately 40,000 registered lobbyists at the state and federal levels, nearly 15,000 of which are federal lobbyists. Many of the major lobbying firms and advocacy groups are located on K Street in Downtown Washington DC

Australian Government Lobbyists Register

New Zealand ??
Couldnt find one
Does One exist? - you do need to submit some of these articles to an external sub-editor
The motto or "mission statement" or "statement of purpose" of is "helping you make financial decisions", just not necessarily the right decisions

If you don't agree with the points made in a story, as always you are welcome to critique them.
But it is weak argument to attack the author personally based on some unfounded perception of bias just because you disagree with the arguments made. For some of you that is SOP; but others, you know better than that.
Personal attacks will be subject to editing or removal. Stick to the subject matter.

From the horse's mouth - ISCR's people:,13.html

Let us note the date and time of the article....

dang it, he sucked me in for a while there. Good one, nice to know still has a sense of humor.

Thing is
Remember the 1980's 35f2d - anyone?

Friday 13th June 2003

Text too small?

Another attempt is being made to establish a wool futures contract in New Zealand, on a broader base with appeal to more woolgrowers.
Two previous wool futures contracts, one in the 1980s and another in the 1990s, were withdrawn after three years due to lack of trading.
Wool exporters and brokers were keen to participate, it was claimed, but farmers were not interested. In the first home-grown attempt, the wool description for the contract, 35F2D, was quite narrow and the unders and overs calculations reportedly confused farmers.
We are Disappointed cause TD seems to have copied something out of the NZX brouchure.
and we really have a problem with this:
Allowing farmers to partially diversify away the risk from downstream effects makes farming a less risky activity.
(please on what basis you say.)
With farming being less risky, would-be farmers require a lower return to induce them to purchase a farm and this would translate into a higher price for rural properties.
So is the current farm debt problem really is the farmers fault, in that we are not wishing to pay enough, and not willing to accept a return low enough ....
If sources had been mentioned, we could look thru, otherwise the bucks stops with he..

Yes, true, and there weren't any casinos in new zealand in the 1980's either
Plus, there is a bit more to the history than that.
The NZ Futures market never really flourished across all of it's offerings - probably due to new zealands disastrous love affair with financial markets in general. The SFE (Sydney Futures Exchange) was in its infancy in the 1980's also, and didnt really come of age until about 2002 when it was taken over by the ASX. Today it is huge. And, more importantly the SFE took over the NZFE around 2000. It is interesting to note that the NZX is trying to go it alone with Dairy Futures. Perhaps Fonterra should have gone with the SFE (now known as ASX-24)

Anyway the NZX Dairy Futures Market is there, it's up and running, and getting healthier by the month.
Reasonable volume considering .. just needs a bit of marketing ..

You can trade New Zealand Electricity Futures on the ASX 24

While the local NZ Futures Electricity market founders

Up until recently Fontera had a simple mission in life. To maximise returns to its dairy farming co-operative owners. It did this primarily by maximising the milk price paid to those farmers. Now that Fontera has non-dairy farmer owners it has become a two beast organisation.
One beast wants to continue to maximise milk prices while the other beast wants to minimise milk payouts so that profits and dividends can be maximised for the non dairy farming shareholders.
Currently the reins are only attached to the milk price maximising beast and the other beast is tethered alongside. Because only dairy farmers have voting rights. But articles like this are all about creating the arguments for changing that.
If non dairy farming shareholders get there way the profit maximisng beast will gallop away and dairy farmers will lose the profits they have built up over the last century.

you mean like the um ah NDA?
Further examples can be found in the were Oz farmer co-ops that gone off, often to overseas masters...

I think your analysis misses a very important beast - managerial capitalism - that all shareholders need to see reined in.

Maybe the managers will align themselves with the profit maximising beast because they see higher short term profits as a way to higher salaries and bonuses.
Personally I think the farmers have created a huge problem for themselves. They will need to constantly defend their turf in exchange for what? A little extra capital that was needed for what strategic development?

Agree 100% with your first paragraph. It is though not a new phenonium and goes back to at least the period prior to the formation of Fonterra.
Your second paragraph is also true, but farmers were seriously misled by both politicians and said managerial capitalists.
Fonterra has pulled off the big debt for equity swap (TAF) but redemption risk hasn't gone away - just become a much slower and less catastrophic process. If Fonterra doesn't improve its performance the end result will still be the same but just take much longer.


....... as much as we appreciate people getting directly to the point .....
Your's is taking brevity of the argument to an extreme , methinks ...

What are you doing awake at this hour Gummy Bear?

.... currently I'm lubricating my gizzards with a cheeky little drop of Aussie shiraz , awaiting my ciabatta bread dough's arisal ....
How goes it with you , Mr Wolly ...... is the Easter Bunny simmering gently in your pot with a mirepoix of vegetables and a bouquet garni ?

A mouse ran up my leg Gummy much for weeding....have you run far enough to escape the pump and dump SOE grab for cash?

....... the Gummster clan are still in ruddy Jewelia Gillard land ....
But the Kiwi leeches ....... oooops , sorry ... I meant to say that the " Kiwi brokerage houses "  continue to send me screeds of emails regarding the benefits of participating in the SOE spruik & puke grab for cash ...

.... huh ! ....... double post ..... wonder if it's tanalised ?

Thanks Gummy.
I have been considering improving my verbosity quotient. Who knows, that may even lead to lucrative work with local or central government.
Even grander, perhaps a shot at a guest post on on a public holiday.

Gummy, what is your take on that Deloitte advert that seems to accompany this thread?
Putting aside the sexual connotations, what does a grey dot in the bottom left corner of a square box and a light green dot top right outside the box really infer? And we do both? Wow!
I am sure you are a man with the analytical skills to address this.
Be warned thought, I presume reflections on an advertisement ranks even higher on the list of David's sins than sound analysis of an article's author's background.

The grey dot inside the box is representative of all those appalling marble tiles that the Christchurch City Council bought from China at great expense  , and installed in Cathedral Square ....
..... and the green dot outside the box represents how envious the slack-jawed jokels at Deloittes are that they didn't think of it first , and charge the CCC a hoofing great fee for the idea ....

Thanks Gummy.
And there I was wondering whether Deloittes had something new on offer. But no, just poor marketing and accountancy by colours.