Memorandum submitted by English Farming
& Food Partnerships (EFFP) (DFoB 40)
INTRODUCTION
1. English Farming & Food Partnerships
(EFFP) is a membership organisation established in 2003 in response
to recommendations contained in the Curry Report to strengthen
the profitability, competitiveness and sustainability of England's
farm-based industries. We set out to achieve this through the
growth of market focused and professionally run Farmer Controlled
businesses (FCB) and by developing co-operation and partnership
activities not only between farmers but also between farmers and
the food chain.
2. Membership includes over 50 FCBs representing
approximately 75% of all the main FCBs in England.
3. In the last six years we have worked closely
with government and industry to increase knowledge of the sector,
to promote the development of FCBs and to foster collaboration
in supply chains. We have developed a team to create linkages,
build knowledge and deliver activity which has been funded by
DEFRA, industry contributions and fee based work.
4. EFFP was set up as a partnership between
government and industry designed in such a way that would enable
it to evolve into a commercially self-sustainable business. DEFRA
no longer provide any core funding to our business although they
continue to be supportive of our mission and we work on their
behalf on a number of projects.
5. Today, in practical terms, we are a specialist
agri-food business consultancy, working across the full supply
chain with all genres of business structure. We combine our farming
knowledge with food industry expertise to help address structural,
commercial and relationship issues across the industry, from an
objective and independent standpoint.
Our interest in this inquiry
6. EFFP believe that FCBs have a significant
part to play in the challenges faced by the agri-food industry.
Across the world the influence and success of FCBs is considerable
and not just in their own domestic markets as many are now global
players including a number that have a substantial stake and presence
in the UK, for example, Arla Foods and Danish Crown (Tulip).
7. Most FCBs operate in extremely competitive
marketplaces but provide an important mechanism for farmers to
create and capture value from the market and to help a fragmented
farming industry trade with national and global food companies
as well as retailers.
8. In the UK FCBs tend to be less developed
than those in other countries around the world. The historical
development of domestic policies in the UK such as the formation
of marketing boards in many sectors provided stability in agricultural
markets reducing the incentive for farmers to work together through
FCBs. More recently, as the UK market has become more deregulated
and government has moved away from protection and support for
agriculture, farmers have become more exposed to global market
forces and we have seen a more extensive development of FCBs,
particularly marketing FCBs, in the UK.
9. Nevertheless, even the biggest UK FCBs
are small by comparison to their EU and international counterparts.
The UK has no FCBs large enough to feature in the EU top 30. The
turnover of the top 30 FCBs in the Netherlands is three to four
times greater than the UK (€22 billion in the Netherlands
versus €5.6 billion in the UK). The three largest UK dairy
cooperatives including DFOB had a turnover of €2.2 billion
whereas the three largest European dairy cooperatives had a combined
turnover of €14.4 billion.
10. Despite the good progress made by many
FCBs the last 10 years have also seen some notable failures of
FCBs in the UK including Viking Cereals, a cereal marketing business;
Amelca which was a farmer owned liquid dairy in Derbyshire and
Westbury Dairy, a butter powder plant established in 2000.
11. There are many reasons why a business
fails and care needs to be taken not to attribute a single factor
to the cause of these failures when often the situation is far
more complex. It is crucial that we identify the real barriers
to the success of our FCB sector so that we can build on the successful
businesses that continue to exist.
12. DFOB were members of EFFP. We provided
limited support to their member council and some of their board
members attended the forums and conferences we organised.
13. The EFRA enquiry has asked that EFFP
provide our thoughts to the following points:
(a) The difficulties FCBs face in raising capital
and how this could be addressed.
(b) Good practice with regard to the governance
of FCBs.
(c) The tax treatment of contributions to FCBs.
(d) Whether the Industrial and Provident Society
Act is fit for purpose.
The difficulties FCBs face in raising capital
and how they can be addressed
14. We recognise the considerable difficulties
faced by UK FCBs in raising capital. Compared to the leading cooperatives
throughout Europe who have been able to build considerable financial
strength over many decades, UK FCBs are at a distinct disadvantage.
15. As relatively immature businesses, many UK
FCBs in the absence of such financial strength are reliant on
external funding, principally from the retail banks, to fund their
investment and activity.
16. This raises a number of issues, including:
(a) Under investment, reducing the ability of
FCBs to deliver their strategy.
(b) Excessive balance sheet gearing, particularly
given the lack of permanent capital within many FCBs—see
above.
(c) A lack of banks and advisors with detailed
understanding of the sector and its opportunities resulting in
a reduced appetite to lend to FCBs.
17. Moreover, the financial and legal structure
of many FCBs restricts their ability to attract external investment
to the sector, an aspect made more acute by the fact that the
sector is relatively immature and therefore not well understood
by the financial sector in the UK.
18. Over the last two years, EFFP with the
support of Defra has invested significant resource into exploring
ways for the sector to attract capital. This has included:
(a) Considering the feasibility of setting up
an investment fund focused on developing commercial opportunities
in the farming and food arena and focussed on being a source of
medium and long term capital for agri-food businesses.
(b) Exploring the appropriateness of using equity,
bonds and mezzanine debt to fill the gap between the finance provided
by the FCB, members and bank debt.
(c) Developing a bespoke funding model which
would link individual investors and agri-food businesses (including
FCBs) and act as a signal fund that over time could be used to
demonstrate the opportunity to the wider investment market in
the UK.
19. More recently EFFP submitted an innovative
proposal to Defra that would utilise unspent Rural Development
Programme funds to act as a cornerstone source of investment funds.
A copy of this proposal is attached to this submission.
20. We would wish to encourage both Defra
and the Treasury to consider supporting the development of such
initiatives and would welcome the opportunity to discuss this
further.
Good Practice with regard to the governance of
FCBs
21. Since EFFP was established in 2003 we
have taken a proactive stance on the governance of FCBs as we
believe that it is fundamental to their success. We recommended
that FCBs should comply voluntarily with good governance standards
and take all possible steps towards raising their own standards
of board effectiveness not only to protect the interests of their
members and other stakeholders, but also to protect the reputation
of FCBs generally.
22. We have developed a suite of governance tools
and services ranging from a short board health check to a comprehensive
governance review based on comparing an FCB's practice with best
practice as outlined in the Combined Code. Over the past five
years EFFP have delivered services to FCBs across England of all
sizes, in all regions and sectors.
23. Much of our early governance work was
funded by Defra through a range of projects meaning that we were
able to offer our services free of charge to FCBs. This, without
doubt, encouraged the uptake of our services in this area. As
our Defra funding streams have declined we have had to move to
a position where we charge commercial rates for governance advice
and support to FCBs. Our experience has shown that this has substantially
limited the uptake of the services we offer in this area.
24. We have learned much from our engagement
with FCBs on governance but are concerned that much more needs
to be done. Notwithstanding the issue of FCBs paying for our services,
engagement with some businesses has been difficult. The reasons
for this can be complex but are likely to include: a belief by
the board that they already adhere to good governance practice;
that past success makes it difficult to contemplate future problems
or because the board don't want to expose themselves to outside
interference and monitoring.
25. The choices these organisations make
in this area can have far reaching effects. The failure of FCBs
can have a devastating impact on producers, creditors and employees
yet they are not subject to the same scrutiny as large PLCs. With
FCBs there is no share market to act as barometer of business
performance and the interest of banks and institutional investors
is more muted.
26. Shareholder apathy is an agency problem
that FCBs have in common with companies. Members of FCBs are generally
too weak, disorganised, distracted, uncoordinated and uninformed
to take an active role in overseeing the company.
27. FCBs are under no compulsion to address
governance issues other than to meet their statutory requirements.
As with ordinary companies, there is no legal basis that compels
them to adopt best practice in governance. Nor is there any sector
agreement that compels FCBs to adopt best practice in governance
as exists with Publically Listed Companies who are required as
part of their adherence to stock exchange rules to comply with
the Combined Code.
28. The industry and government are faced
with a clear choice. They can continue to take a passive role
or take more deliberate action that will exert a real pressure
on FCBs to conform to an appropriate model of board composition
and operation. We suggest that the EFRA Committee recommend establishing
a mechanism that would, at least, consider the feasibility of
this alternative.
29. In drawing out any recommendations consideration
should be given to the following:
(a) Establishing a set of governance standards
for FCBs analogous to the Combined Code. Businesses over a certain
size would be encouraged to comply or explain. Adherence to principles
would be externally validated. The Code should be voluntary—self
regulation being preferable to regulatory intervention—but
the FSA should have role in endorsing the Code and the industry
should take steps to ensure that FCBs are applying the recommendations.
(b) The makeup of the board, the skills and understanding
of directors and the balance between democratic representation
of farmer members and the need for appropriate expertise. This
to include the need for ensuring independence and that the board
is regularly refreshed.
(c) The provision of information, financial and
otherwise, to members and other stakeholders. This would consider
the need for more frequent financial reporting.
(d) Developing effective systems of internal
control that encompass: the effectiveness and efficiency of operations;
reliability of financial reporting; safeguarding of assets and
compliance with applicable laws and regulations.
(e) Encouragement in the uptake of good governance
practice through the provision of advice, support and appropriate
training and development.
The Tax Treatment of contributions to cooperatives
30. In 2004 EFFP submitted a report to Defra
and HM Treasury outlining research into a number of legislative
and fiscal barriers that we believed could impact on the ability
of FCBs to reach their full potential. The report listed ten recommendations
that could help alleviate these barriers. One area that was raised
within the report was the tax liability on allocated reserves.
31. In many FCBs there is likely to be a need
for investment into facilities or infrastructure, as is the case
in the dairy sector. As a consequence the FCB will need to seek
and retain increased levels of capital from its members. Raising
additional capital from members can be achieved via various mechanisms,
but most often it will involve increasing the amount of capital
reserves held in the business by retaining surpluses.
32. In many cases the surpluses are held
in a general reserve which is effectively a common pool to which
no one individual member has a right. As and when a member leaves
they cannot take their proportion of the common fund with them.
This creates a disincentive to invest. As a consequence some FCBs
allocate some or the entire annual retained surplus to member
accounts. These accounts cannot be withdrawn by the member on
demand, but are generally repayable to the member, at par value,
when the member leaves the FCB.
33. The allocation of surpluses to individual
members as part of the retained reserves provides the member with
the right to those reserves at a future date and is not an immediate
distribution of cash—there is no cash actually changing
hands. However, this simple allocation creates a tax liability
in the hands of the members concerned. This can represent an unnecessary
burden on members and provides a disincentive for members to invest
into their FCBs.
34. A taxation provision that would defer
tax until the point of distribution rather than creating a burden
at the point of allocation could boost the capacity of FCBs to
build the capital base required.
Whether the I&P Act is fit for purpose
35. In order to thrive and meet the challenges
of the business environment, FCBs that are constituted as Industrial
and Provident Societies need a legislative framework which is
fit for purpose.
36. In the 2004 EFFP report submitted to Defra
and HM Treasury, we recommended that the Industrial & Provident
Societies Act should be reviewed and modernised to bring it in-line
with the forthcoming company law reform.
37. In July 2008 HM Treasury submitted proposals
for a Legislative Reform Order for Credit Unions and Industrial
and Provident Societies in Great Britain which included six proposals
for changes to the Industrial & Provident Societies Act. EFFP
responded to this consultation and in April 2009 the Treasury
published their response to the consultation feedback and a draft
order is now being prepared and it is expected that the main features
relating to the Industrial & Provident Society Act will come
into force on 1 February 2010.
38. Of the six proposals for change put
forward by HM Treasury it is the modification to the rules on
share capital that we believe is the most relevant to FCBs.
39. The statutory restriction on the level
of individual members' shareholdings is a significant constraint
to adequately capitalising certain types of FCB. Loans from members,
in the form of various loan instruments, have been used to overcome
the lack of member funding through the constraint on shareholdings,
but have the disadvantage that they are liabilities that must
ultimately be reimbursed. Banks, which are important sources of
capital to FCBs, recognise that the member loans are ultimately
liabilities, and prefer a more balanced capitalisation where a
proportion of the capital is permanent and not withdrawable.
40. EFFP therefore welcomes the proposal
and subsequent draft order to enable members to invest more than
£20,000 where the shares are transferable. However, with
regard to the increase on the limit of individual members' holdings
of withdrawable share capital, we believe that doing so merely
in line with inflation will still limit the type of funding structures
that many FCBs require. As a minimum we would urge Treasury to
review the limit every three years.
41. Lastly, whilst we accept the need to
use legal routes that are readily available and achievable in
the short-term to implement the changes proposed by Treasury we
would still wish to encourage a complete review and new Act in
line with that of recent company law reform.
42. A related point is the ease to which
basic information about individual Industrial & Provident
Societies can be accessed from the Financial Services Authority
(FSA), the registration body for Industrial & Provident Societies.
It is possible to access information about Companies with relative
ease through the Companies House website. The ability to access
similar information about Industrial & Provident Societies
from the FSA is far more difficult and much more expensive. EFFP
question why the website platform provided by Companies House
cannot also provide similar input and disclosure of information
for Industrial & Provident Societies.
English Farming & Food Partnerships
December 2009
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