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Memorandum submitted by the Scottish Agricultural Organisation Society Ltd (DFoB 03)
Introduction
SAOS is the membership organisation of primary sector co-operatives in Scotland. We have represented, promoted and advised agricultural co-operative businesses, and those interested in forming co-operatives in farming, food and rural industries in Scotland, for more than 100 years.
SAOS has approximately 75 member co-ops, which in turn have more than 600 directors and more than 44,000 members. The financial throughput of the membership in 2007/08 was £1.6 billion. 72 of SAOS' members are registered Industrial and Provident Societies (IPS). Some of our members are capital intensive, vertically integrated businesses, while others are horizontally integrated with little members' capital employed. Key capital intensive sectors are dairy processing, red meat processing, cereals and potatoes / vegetables processing and storage.
SAOS is a not for profit democratic organisation (an IPS), owned by its member co-ops and governed by its Rules in conjunction with a comprehensive Governance Charter.
Our Purpose in Making a Submission to the Inquiry
Dairy Farmers of Britain was not a member of SAOS, and we do not believe it had farmer members in Scotland. However, having observed the failure of this co-op, and the instigation of the Inquiry, we have an interest in the Inquiry on three counts:
1. The role of agricultural co-ops, their capitalisation, and issues of governance have a wider agricultural co-op development context than that of any individual co-op business. We believe it is important that the Committee is informed of at least some of the broader context. Any Committee findings that relate to the broader development of agricultural co-ops will help inform our contributions to future policy development.
2. The circumstances that result in the failure of any business, however constituted, are always highly individual to that particular business. We are concerned at the risk of unintended collateral reputational damage to other agricultural co-ops should circumstances or shortcomings that are highly specific to Dairy Farmers of Britain be inappropriately represented as applying to other co-ops. We would request that the Committee recognise this risk, and guard against this outcome.
3. We do however recognise that valuable specific lessons may emerge from the Inquiry. We would wish to fully understand those lessons, and to take a proactive role through our advisory services, to assist co-operatives to put in place whatever measures are necessary to minimise the risks of similar shortcomings arising in future.
For these reasons, we are pleased to make this brief submission to the Inquiry.
The Strategic Role of Agricultural Co-ops and the Drive for Rapid Growth
Whilst agricultural co-operatives of immense, even global, scale have evolved in other EU countries, and other market economies (such as USA, New Zealand, Australia), agricultural co-ops in the UK are small by comparison. The reasons for this relate directly to the market support structures that were deployed in the UK for approximately 50 years from the 1930s to the 1980s. The creation of marketing boards with statutory powers to purchase all farm produce, and various other support mechanisms, removed the need for farmers to create agricultural marketing co-ops to safeguard their position in the market.
In this same period, the Governments of many other countries supported the development and growth of producer co-operatives with a range of incentives and assistance. Many of their early 20th century agricultural co-ops consolidated to become regional, national and international in scale, accumulating member capital in each merger, which was used to invest in vertical integration to add value to commodity farm produce, and develop branded consumer products for both domestic and export markets. Many of their products can be seen today in UK supermarkets.
When EU membership required that the UK abandon marketing boards and other forms of price support, UK farmers found themselves fragmented and weak when exposed to the market, and unfamiliar with agricultural marketing co-ops. The legacy of all this is that many UK farmers now recognise the need to create vertically integrated agricultural co-ops to optimise market position and secure fair returns from the market. One consequence is that the current generation of farmers is being required to invest (or guarantee) the capital required to achieve accelerated growth, and to accept, in some cases, considerable financial risk in so doing.
As vertical integration, through co-operatives, has been proven around the world to be the most sustainable and advantageous long term strategy for farmers, it is perhaps regrettable that Government in the UK has not been more understanding of the strategic role of co-operatives, the necessity for rapid development and growth, and more enabling in helping to overcome constraints to rapid growth.
The Challenges of Capitalising Agricultural Co-ops and Requirement for More Solutions
The defining purpose of a co-operative is that it exists to transfer benefit to members' own farm businesses through their use of its services and facilities, rather than as a direct return on financial investment. (For example, returning the maximum milk price is the primary purpose of most dairy co-ops, rather than maximum return through dividend or capital growth on monies invested in the co-op.) The singular purpose of maximising the commercial benefits to farmers is the reason why co-operatives are attractive, and why farmers around the world have adopted distinct co-operative structures. In addition, a co-operative constitution guarantees democratic control and equitability, thereby providing fairness, with maximum protection from takeover or diversion from the primary purpose.
However, adopting a co-operative structure has several distinct consequences with regard to capitalising the business:
· Farmer members must carry the burden of providing risk capital, as the option of generating funds from the stock market are not open to them. There is no place for external speculative investors in a co-op, as rewarding external investors is inconsistent with the primary purpose and with co-op legislation.
· Given that the number of farmers in any agricultural co-op is limited, the availability of risk capital is inevitably a key business constraint. While farmer members may be able to afford regular, small investments in their co-op (typically by a 'levy' deducted from the sale proceeds of their produce) they are often unable to make large one-off investments. This makes rapid growth, as required now, through acquisitions and large scale investments, quite challenging. Banks may agree to provide what is in effect 'bridging' finance until such time as the co-op generates sufficient capital from members to replace bank loans. This may be an extended period of years. In some cases, a co-op may not be able to secure sufficient finance to implement its plans.
· Under current IPS law, the maximum an individual member may invest in the shares of a co-op is £20,000. This is entirely inadequate in relation to the massive sums required to invest in food processing on a meaningful scale. As a consequence, 'loan' funding or 'debt equity' structures have been adopted by capital intensive co-ops as a way of accommodating member investment. However, such loan funds are a liability, rather than an asset and are discounted by bankers when considering requests for bank loans. There are also differing terms and conditions (including terms agreed with bankers) surrounding the loan funds of individual co-ops.
· Farmers require an exit strategy from their co-op that enables them to redeem their investment, even at par value. This is a necessary condition of investing, given the large sums involved, and relative importance of this in a typical farming family's wealth. However, it places an additional demand on capitalisation as the co-op must plan for the redemption and replacement of some proportion of member capital each year.
These points indicate that although UK farmers recognise the requirement to invest in their co-ops, to enable them rapidly to vertically integrate, there are several constraints to securing the scale of capital required. Whilst current updating of co-op legislation (IPS) is taking the needs of agricultural co-ops into account, it is unlikely to be sufficient to address all the constraints. Farmers and governments in other countries have together developed ways to overcome the inherent constraints to capitalising their agricultural co-ops, in some cases by opening co-ops to a degree of external investment, and in others by providing generous loan guarantees.
We suggest that the Committee give consideration to recommending the formation of an industry / government / FSA task force with a remit to investigate ways to overcome constraints to capitalising UK agricultural co-ops, with reference to developments in other key countries, in order to facilitate their development and growth.
Good Governance Practice in Agricultural Co-ops
The final points we wish to make are in reference to governance practice in agricultural co-ops. The success of any business is contingent on effective governance, and in agricultural co-ops, the burden of responsibility on directors is magnified by the fact that the financial viability of farmer members depends directly on the performance of their co-op. We have summarised points that we believe may be pertinent to the Inquiry under sub-headings below.
a. Involvement of Members in Governance
Participation and democracy are defining features of co-operatives. The members of agricultural co-ops construct and adopt governance structures appropriate to the scale and sophistication of their co-op, that enable members to participate in key decisions. The decisions that must be referred to a member vote are generally specified in a 'governance charter' that can only be amended by the members themselves. For example, investments, acquisitions and sales of assets that exceed specified value thresholds would typically require approval by either a majority, or 75%, of members.
b. Governance Charters
In addition to specifying occasions on which member consent is required, governance charters are important in creating transparency and understanding amongst all members of the roles and responsibilities vested in various governance positions, and governance practices. We would typically expect a governance charter to contain information on the following:
a. The membership and role of member councils or member communications forums. b. Membership of the Board. c. The Board's roles and responsibilities, and proceedings of the Board. d. The roles and responsibilities of the chairman, vice chairman, non-executive directors, chief executive, executive directors, senior independent director, company secretary. e. Matters reserved for the Board and matters to be referred to members. f. The terms of reference and authorities of Board sub-committees. g. Advice for any Board member on engaging external advisers.
c. Board Evaluation and Development
In large and highly capitalised agricultural co-ops, the effectiveness of the Board in discharging it's responsibilities, and the effectiveness of individual directors, require at least bi-annual evaluation. Agricultural co-ops use a variety of external and internal evaluation techniques, which lead to the identification of collective and individual development needs, and shortcomings in Board practices, that must be addressed. Lack of either specific or appropriate expertise or experience usually results in recruitment of external non-executive directors. Farmer directors are required to undergo training and development to equip them better to discharge their responsibilities. We would expect a succession policy to ensure sufficient continuity of directors, and the periodic introduction of new directors. In addition, we expect co-ops to pay realistic fees to Directors in recognition of the responsibilities they carry.
Benchmarking of fees paid to agricultural co-op directors is carried out by SAOS and English Farming and Food Partnerships, and other benchmark surveys are available from a variety of sources.
d. Lack of a Common Governance Code and Availability of Specialist Advice
There is no single comprehensive common code of governance designed to meet the needs of agricultural co-ops, and we do not believe that the codes devised for listed plcs are appropriate, as the core relationship between the co-op and its members differs significantly from that between a plc and its shareholders. However, specialist advice is available from co-op membership and development organisations in different areas of the UK.
SAOS provides the following services that are tailored especially for Boards and farmer directors of agricultural co-ops:
· Advice and assistance on governance structures · Guidelines on governance standards for agricultural co-ops · Foundation skills training for farmer directors · Assistance to co-ops on induction of new directors · Advice and assistance in creating governance and policy charters · Evaluations of Board effectiveness · Advice and assistance in creating corporate risk management systems · Confidential advice line for directors · Update seminars · Directors Update Newsletter · Annual Conference
We suggest that the Committee give consideration to recommending an industry / Co-operatives UK / FSA task force to produce a comprehensive 'code of governance best practice' for agricultural co-ops that could ultimately be made available to all members of agricultural co-ops.
Conclusion
Given the clear imperative for farmers to continue investing with confidence in agricultural co-operatives, we request that the Committee take into account the information we have provided in our submission in formulating any recommendations that arise from its Inquiry into the failure of Dairy Farmers of Britain. SAOS will be pleased to discuss further any of the information we have submitted.
Scottish Agricultural Organisation Society Ltd August 2009 |