Statement to the Commerce Commission of the Economic Policy of the Government: The Dairy Industry To the Commerce Commission Pursuant to section 26 of the Commerce Act 1986, I hereby transmit to the Commerce Commission a statement of the economic policy of the Government on the dairy industry. Government's Policy Objectives The Government's overall objective is to maximise the economic welfare of New Zealand. This overall objective is achieved by policies that facilitate the efficient use of resources across the economy. The growth of an internationally competitive export sector, of which the dairy industry is a significant part, is a key component of the Government's policies. The Government recognises that New Zealand's dairy industry is the most efficient producer of milk in the world. It also considers that there is room to generate greater wealth for the sector while enhancing competition in domestic markets. The Government's role is to provide the regulatory framework to facilitate wealth creation and efficient resource use. The industry's role is to develop commercial strategies within that framework with a view to creating wealth for its owners. The Government has encouraged the dairy industry to develop a strategy for growing the wealth of dairy farmers and New Zealand. In response, the dairy industry has developed a strategy and structure that industry leaders are confident will increase the wealth of dairy farmers and New Zealand. That structure involves the amalgamation of all those existing co-operative dairy companies whose shareholders vote to join the new co-operative (``new co-op''). The Government will promote economic efficiency by providing a regulatory framework that encourages accurate transmission of domestic and international price signals. The dairy industry's economic performance will be further improved by: Continuing and enhancing real and sustained downward pressure on costs; Efficient pricing signals; and Strong innovation. A regulatory package that enhances the performance of the dairy industry and the economy is outlined below. The Government has introduced legislation on matters relating to taxation, regulatory, industry good and quota issues. Issues relating to competition within New Zealand markets are for the Commerce Commission to decide. Key Features of Reform Changes to legislation are required to achieve the overall goals of the Government and the dairy industry. The Government will: Provide arrangements for markets where foreign governments exercise a high degree of control over the economic terms of access to their domestic markets. These arrangements will maximise benefits to New Zealand dairy farmers while phasing out barriers to competition in the export of dairy produce from New Zealand over time; Ensure competitive neutrality in the regulatory environment: Through a review of all aspects of the regulatory regime associated with the dairy industry to remove and/or reduce regulatory barriers to entry; and By providing for non-discriminatory access for all market participants where any regulatory functions are undertaken by the industry; Ensure the Commerce Act applies to domestic markets without exception; and Remove the statutory powers providing for a single exporter for New Zealand dairy products. The Government considers the dairy industry must ensure that effective and efficient corporate governance arrangements are in place, including: Adequate commercial, including appropriate capital market, disciplines; Mobility of capital, which would include efficient price signals to shareholders and/or suppliers; Adequate protection of the interests of all shareholders; The separation of commercial and non-commercial activities in a manner that improves the accountability and transparency of operations; and Clearly defined end points for any transitional arrangements. In general, the Government sees full tradability of shares (not linked to supply) in large commercial entities as conducive to effective corporate governance and efficient resource allocation. While co-operative companies, where shareholding is fully tied to supply, have been a feature of the dairy industry for many years, the new co-op is expected to provide a reasonable degree of tradability. To the extent that shares in the new co-op are tradable, the range for trading shares delinked from supply must be sufficient to provide efficient signals for the valuation of the shares. To the extent that shares in the new co-op are not tradable, provision in the initial constitution of the new co-op for shareholders to enter and exit at fair value in a timely manner is important to the creation of effective corporate governance, efficient resource allocation and a competitive environment in all relevant markets. ``Fair value'' in this context and at this stage in the dairy industry's development, means the value that would be expected if: The shares were tradable among supplying shareholders on a willing buyer and willing seller basis in an arm's length transaction; The earnings attributable to equity were fully unbundled and delinked from the milk price and distributed to shareholders as dividends or are reflected in the exit value; and The duty of directors is to maximise the earnings attributable to equity given the separation of a milk price which approximates that which would be paid in a competitive market. For both trading among suppliers or the redemption of shares at fair value, it is essential that the rules for separation of earnings attributable to equity from the milk price be objective, independently managed and transparent. The Government expects an increase in the degree of tradability and unbundling of returns to be a feature of the transition to a more responsive structure to external factors. Policies to be Implemented in Legislation Specific features of the legislation introduced, include: 1. The removal of the statutory powers providing for a single exporter for New Zealand dairy products with effect from 1 September 2000, conditional on: An amalgamation of two or more co-operative dairy companies under Part XIII of the Companies Act 1993; and The amalgamated firm being the beneficial owner of more than 75 percent of the shares in the Dairy Board; and The amalgamation being authorised by the Commerce Commission. This will be achieved by: The repeal of the Dairy Board Act 1961; and The repeal, without replacement, of all existing Commerce Act exemptions in the Dairy Board Act 1961; and The conversion of the New Zealand Dairy Board to a company under the Companies Act 1993 using the provisions in Part II of the Fifth Schedule of the Dairy Board Act 1961. 2. Arrangements for designated markets as follows: Designated markets are defined as: The European Community ``country specific tariff quota'' markets for butter, cheddar cheese and cheese for processing; The United States markets for cheddar cheese, low-fat cheese, NSPF cheese, and other American type cheese; The Canadian market for butter; The Japanese market for prepared edible fat and natural cheese; and The Dominican Republic market for milk powder. The new co-op is granted the exclusive right to export to those markets for between 6 years and 6 and a half years (depending on when the relevant quota year ends); The new co-op is granted further rights to export to those markets for a transitional period during which: The exclusive rights to the European Community markets are reduced by 25 percent each year; and The exclusive rights to other designated markets will be reduced on the basis of 4 successive reductions, on a basis to be determined by a new quota allocation company; The new quota allocation company will be established by regulation and its shares will be owned by supplying shareholders in existing dairy co-operative companies; Other access to designated quota markets will be allocated by the new quota allocation company; and The allocation by the new quota allocation company will be on a competitively neutral basis among dairy exporters. 3. The introduction of competitive neutrality in the regulatory environment. This will include: The repeal of sections 10, 22 to 26, 29 and 32 (1) (t), (u), (w), (x) and (za), (2), and (3) of the Dairy Industry Act 1952, and regulation 42 of the Dairy Industry Regulations, which have the potential to impose unnecessary restrictions on competition; New regulation-making powers under the Dairy Industry Act to regulate technical market access, and export certification and to carry out residue monitoring functions; New regulation making powers under the Dairy Industry Act to provide for the collection of data for the national dairy herd improvement database, the licensing of herd testers, and the provision of non- discriminatory access to that database. To ensure efficient and effective corporate governance arrangements are in place for the longer term, the Government will conduct a review of the Co-operative Companies Act 1996 as a consequence of reforms in the dairy industry, with a view to facilitating competition and good governance arrangements. No new registrations under Part III of the Co-operative Companies Act 1996 will be allowed from 1 September 2000, except that co-operative dairy companies not participating in the new co-op will be able to continue under that Part. The Government considers that this legislative package provides the regulatory foundation for the transition to a competitive environment in the dairy industry. Signed at Wellington this 30th day of July 1999. Hon. MAX BRADFORD, Minister for Enterprise and Commerce.