Responding to price volatility: creating a more resilient agricultural sector Contents

Chapter 5: Access to finance and financial instruments

162.Access to finance plays a crucial role in farmers’ ability to withstand shocks and improve their levels of resilience. The previous chapter considered financial tools being used elsewhere in the world. This chapter brings together evidence on the current availability of financial products in the EU as well as options for the future.

Access to finance

163.The evidence suggested that while access to finance was not a major problem for most farmers at the moment, certain groups, particularly those without land ownership, were experiencing specific problems. In particular, we were told that a lack of financial instruments to help farmers manage volatility might hamper their ability to make long-term investments.

164.The AHDB argued that banks “appear to be fairly keen to lend to farmers that own their land as debt to asset ratios look generally favourable”, but noted that farmers with limited assets, such as tenant or contract farmers, struggled more with securing finance and coping with the impact of volatility:

“This is important as anecdotally, the businesses / individuals that farm the land are becoming increasingly detached from land ownership. With this in mind, lending longer-term into agriculture could be more challenging and less informal than, say, overdrafts. This may well challenge the industry to think how commercial finance to agriculture works and how it flexes around the commodity cycle.”129

165.We also heard from commercial banks of some of the challenges facing agricultural banking, from high capital costs to a lack of business skills by loan applicants. Barclays Agriculture told us that “the very high capital cost compared with the quite thin margins, especially at the moment with possibly no margins”, pose difficulties in agricultural banking. They also noted challenges in lending to tenant farmers with increasingly short tenancies restricting the period over which money could be lent.130 HSBC added, though, that landlords could provide a source of support and capital to help make projects viable.131 Both Barclays Agriculture and HSBC noted the paramount importance of farmers having the skills to put together a credible business plan.132

Market-based solutions

166.Farmers wishing to mitigate price risk have at their disposal a number of market-based solutions, including forward contracts, futures markets, swaps and options, and similar over-the-counter products. According to Defra, farmers have used such tools for a long time in the United States, where agricultural commodity prices fluctuate widely. They noted that in Europe, in contrast, many farmers were unaccustomed to such hedging instruments, because the CAP had historically supported prices and provided substantial subsidies.133

167.The evidence suggested that the uptake of such instruments varied widely, depending on farm type and other factors such as size, skills and attitude to risk. Futures markets, for example, have been confined to a limited number of sectors, while economically better performing farms are better able make use of such instruments.

Futures markets

168.The AHDB told us that futures markets were already well established in cereals and oilseeds, but that the characteristics of other commodities, such as their scale and perishability, presented challenges.134 The NFU confirmed that market based instruments such as futures worked well in the cereals sector, because the product could be stored and shipped globally, and because there were enough buyers and sellers.

169.The evidence suggested, however, that there may be potential to develop similar markets in sectors identified as more challenging, such as dairy, with public support.

170.Dairy UK, the trade association for the dairy supply chain, noted that a developed futures market for dairy would enable some farmers to manage price risk by fixing some or all of their income in advance, and that by using the market in conjunction with forward contracts covering farm inputs, such as wheat, dairy farmers would be able to fix their margins.

171.The Minister, George Eustice MP, noted that Defra had set up a team to explore how the UK Government could help to develop a futures market for the dairy sector. The plan was to model it on the Chicago cash-settled market for dairy products: “London is the world’s financial centre and we do lots of futures and commodities already. It would be the right place to have such a market”.135

172.The UK Government’s efforts to explore how a futures market for dairy could be established in the UK is a positive step and there may be scope to expand this exploration of futures markets to other commodities in the future.

Insurance schemes

173.Many witnesses displayed an interest in government-supported insurance schemes to assist farmers in managing farm risk, as an alternative to the current approach to public support. Such schemes, as we have noted in Chapter 4, are used extensively in the US and Canada.

174.Defra warned that “genuine insurance schemes” should be differentiated from payments to producers in times of “adverse” market conditions. They told us that a distinction should be drawn between ‘counter-cyclical’ payments triggered by changes in incomes, administered by government and funded by taxpayers, and insurance relating to a single or multiple risks, provided by the private sector with farmers contributing in the form of premiums.136

Insurance under the Common Agricultural Policy

175.There has been a move towards offering public support for insurance schemes in the EU in recent years. The latest reform of the CAP offered Member States the possibility to use Rural Development funds for financial contributions to insurance premiums, covering losses caused by adverse climatic events, animal or plant diseases, pest infestation, or an environmental incident. Other options under the new Risk Management Toolkit included contributions either to mutual funds dealing with the same range of events, or to mutual funds dealing with a severe drop in farm incomes (the Income Stabilisation Tool) (see Chapter 3).

176.Defra noted that this toolkit was designed to comply with WTO rules, allowing the insurance and mutual fund products to cover only losses greater than 30% of production or income.137

177.Nevertheless, EU Member States have so far made little use of the risk management options available. DG AGRI noted that only 12 out of 28 Member States had programmed the whole or part of the toolkit in their Rural Development Programmes (RDPs). A large part of this total public expenditure of €2.7 billion, targeting 644,487 farmers, was programmed under the Italian, French, and Romanian RDPs. Insurance premiums made up the majority of the expenditure at €2.2 billion, while €357 million was programmed to be spent on mutual funds, and €130 million on the Income Stabilisation Tool.138

178.Defra told us that England and the rest of the UK had chosen not to make use of the Risk Management Toolkit, due to at least in part to the small budget available after the risk management options were moved from Pillar 1 (Direct Payments) to Pillar 2 (Rural Development) in the most recent CAP reform. It noted that the UK’s allocation under Pillar 2 was the smallest per hectare in the EU.139

179.The AHDB told us that insurance premiums would need to be subsidised to be commercially viable, as is the case in the US:

“With traditional insurance the policy covers high impact, low likelihood events. In insuring volatility though, the events are high impact, high likelihood, which would make premiums commercially unviable. This would likely require the CAP to subsidise premiums and/or underwrite the risk.”140

180.Farm Europe, a think tank, argued that existing market mechanisms had proved insufficient to respond to crises, as demonstrated by the recent difficulties experienced by the dairy sector, and that the EU, with its greater resources, should take the lead:

“Due to the very large financial requirements associated with price insurance schemes … they should be designed and supported at EU level, with CAP funding. It is unrealistic in our opinion to expect price insurance to be implemented only at national or sub-national level, as it is highly unlikely that the financial needs to cope with sharp price falls would be available.”141

181.DG AGRI disagreed, on the other hand, while acknowledging that 60% of USA payments had recently gone to risk management schemes, noted that more than 90% of these payments had gone to just three crops. Moreover, the percentage of payments going to insurance could be expected to shift substantially each year when prices declined. It argued that the EU’s policy design, spreading support over the whole agricultural sector, had made EU farm income less volatile than that in the US in recent years.142

182.Tassos Haniotis, Director of the Economic Analysis, Perspectives and Evaluations, and Communication Directorate in DG AGRI, pointed out that US insurance schemes were based on commodities with a long tradition of using financial markets with data going back to the 1930s, adding that the private sector did not dare to take up areas covering plant or animal diseases. He said:

“We have seen what an EU-wide risk management scheme … would cost, which would imply cuts in other parts, and would have significant transfers among commodities and among member states towards the ones that are much more volatile price-wise, but not necessarily with lower income.143

183.Many witnesses noted the difficulty of developing well-functioning insurance markets. Teagasc pointed out that the US crop insurance programme started to subsidise premiums for farmers in order to overcome issues such as asymmetric information between insurers and the insured; adverse selection (voluntary schemes attracting farmers with more volatile incomes); moral hazard (insurance against losses encouraging more risky behaviour); and crowding out by government when it offers emergency packages to everyone and not just those insured. These issues were barriers for private companies seeking to enter the market, as they could only offer policies at prices that were unaffordable to most farmers.144

184.The OECD, on the other hand, cautioned that “simply providing the subsidy for an insurance premium does not overcome the reason why the market is not there”. Dr Jared Greenville, Senior Agriculture Policy Analyst at the OECD argued that high transaction costs were the main reason why insurance markets did not exist in the EU:

“There is a real risk that, with poorly designed schemes, workers just count on cyclical payments, which means that you get production that does not respond to changes in prices and events. You could run into environmental problems by encouraging people to hold stock and just continue practices when it is not necessarily a good idea to do so”.145

185.Nick Tapp agreed that insurance schemes could remove some market signals to the farmer, while representing “substantial costs” to the taxpayer.146

Insurance and Direct Payments

186.Several witnesses warned that designing insurance schemes for agriculture would be complex and would divert funding from Direct Payments. According to the NFU, experience had shown that mutual funds and insurance schemes “are likely to be complex and may undermine the value of the decoupled payments”, which were themselves essential risk management tools.147

187.We also heard that Direct Payments could hinder the development of insurance schemes. Lindsay Sinclair, Group Chief Executive at NFU Mutual, a mutual company offering insurance, told us:

“We believe that the presence of direct payments influences our customers’ views about the necessity of business interruption insurance, and there is a much lower take-up among farming customers of business interruption insurance than there is among non-farming commercial customers in the belief that they will have an income anyway.”148

188.In fact several witnesses suggested that Direct Payments and insurance schemes should be seen as alternatives, rather than complementary approaches. Defra noted:

“Other countries, such as Canada, who have extensive insurance support (and who were the inspiration for the Income Stabilisation Tool) have these supports instead of the direct payments we use in the EU, not alongside them. The recent US Farm Bill which moved US policy to being centred on insurance, also removed their direct payments.”149

189.The OECD agreed that US and Canadian style insurance markets “should not sit on top of the income support arrangements”, which themselves brought a degree of risk management.150

190.Subsidised insurance schemes should not replace the current provision of support through the CAP. Uncertainty over costs and administrative complexity weigh against such a change. Nevertheless, we believe that insurance instruments may have a supplementary role to play in helping to counter the effects of extreme weather events, for example, and therefore should not be ruled out entirely.

191.We recommend that the UK Government give further consideration to the use of the mutual fund option within the risk management toolkit available under Pillar 2 of the CAP.

The role of public policy

192.Public policy, both at national and EU level, can play a key role in facilitating the development of and access to various financial instruments to help farmers cope with price volatility.

193.Defra noted that using futures markets to cope with price volatility, or taking out insurance for specific crop risks, targeted less probable and more damaging risks, which were therefore more marketable. Nevertheless, it added that there could be a role for the UK Government to help such private sector tools grow.151

194.The Agricultural Industries Confederation, the trade association for companies supplying inputs to the agricultural sector, argued:

“On an ongoing basis there is merit in EU institutions, in conjunction with national governments, ensuring they have sufficient information to determine to what extent these risk management tools are being used and, through consultation with industry, to determine whether future regulatory change is necessary or desirable.”152

Financial Instruments and the European Investment Bank

195.The Commission, in co-operation with the European Investment Bank (EIB), has already launched work to develop financial instruments that Member States can offer their farmers. Such financial instruments are defined in EU law as:

“Union measures of financial support provided on a complementary basis from the budget in order to address one or more specific policy objectives of the Union. Such instruments may take the form of equity or quasi-equity investments, loans or guarantees, or other risk-sharing instruments, and may, where appropriate, be combined with grants.”153

196.DG AGRI told us: “The idea is to try to provide, in the form of easier loans or guarantees from the money that is available in rural development, the possibility for farmers to get loans with better conditions.” It stressed, however, that the work was still in progress.154

197.Dr Harald Jahn, Head of Division, Natural Resources and Agro-Industry at the EIB, noted that the EIB’s assignment from the Commission was to help commercial banks to grow their lending portfolio for farmers:

“Compared with commercial bank finance, the loan from financial instruments can be provided on preferential terms and conditions, inter alia the lower interest rates that the EIB can generate on the international capital markets. There are longer repayment periods … and perhaps less collateral required for tenant farmers. We are working on guarantee instruments, which can also be used to leverage further investment funding from the private banking sector.155

198.The first new product developed by the EIB, a model guarantee instrument for agriculture to ease access to finance for farmers and other rural businesses, was presented in March 2015.156

199.For farmers to access any financial instrument scheme developed by the EIB, Member States must first create a financial instrument and programme it in their RDP. A farmer may then apply by submitting a business proposal to the financial institutions through which funding is channelled.157

200.EU Agriculture Commissioner Phil Hogan urged agriculture ministers at the Agriculture Council in March to make use of the options offered by the EIB:

“The legal framework is in place and the Commission and the EIB are offering support and guidance to Member States in relation to setting up financial instruments. Colleagues, the ball is in your court—it is time for Member States to act.”158

201.Defra told us that the Government was “actively considering the introduction of financial instruments in the new Rural Development Programme”.159

202.The Minister said the Government was exploring, in particular, whether it would be possible to access rural development funds through the EIB “to make available loan finance to build additional processing capacity for the dairy sector”. The Minister did not, however, commit to actively encouraging the uptake of such loans by farmers: “The reality is that, if you are making available loan finance on quite generous terms, you probably would not have to promote it very hard. I am sure there would be quite a few takers.”160

203.The UK Government has a key role in facilitating the use of financial instruments by farmers as the options offered by the EIB need to be constructed within the Rural Development Programmes. We recommend that the UK Government promote the use of financial instruments and raise awareness among farmers with operations of different sizes and in different sectors.

204.At the same time, there is scope for the EIB to accelerate its work and to communicate the benefits for farmers more effectively. UK farming union presidents Allan Bowie, (NFU Scotland), Meurig Raymond (NFU), Ian Marshall (Ulster Farmers’ Union), and Stephen James (NFU Cymru) argued:

“Work with the European Investment Bank needs to be speeded up. There are a range of financial instruments but we need to understand how best this will work and what farmers can do to benefit from EIB lending.”161

205.In addition to its ongoing work with the EIB, the Commission has announced the establishment of a new High Level Group to work on market-based solutions, as part of its September 2015 package of measures to help farmers. The Group was tasked with focusing on credit for farmers, and financial and risk management instruments such as futures markets for agricultural products.162 Defra noted that: “These markets do not guarantee high prices, but are a way of dealing with unanticipated price volatility.”163

206.We recommend that the UK Government works with the private sector in developing new financial tools which could be accessed under Pillar 2 of the CAP.

207.We urge the EIB to speed up the work on financial instruments and work more closely with Member State governments and agricultural bodies to disseminate their work.

208.The success of the Commission’s efforts to promote the use of financial instruments will ultimately depend on their inclusion by Member States in Rural Development Programmes. It was disappointing that the UK Government was unable to provide us with an assurance that they will make use of any of the options being developed by the EIB.

Barriers to the use of financial instruments

209.Even if useful financial instruments are developed, there are still significant barriers to their use, including a lack of knowledge and experience among farmers.

210.The NFU said that most farmers “lack the technical knowledge and confidence required to utilise market-based instruments”. They added:

“The introduction of new financial products must be accompanied by a campaign to educate farmers on the applicability of such products to their business … As an ancillary activity for farmers, market-based instruments must be easy to implement and manage.”

211.CRM Commodities, an independent grain marketing consultancy, noted that information was available online to educate farmers, but it was “rather complex”, while “only a limited amount can be learnt from reading documents”. It suggested that the solution required continuous training and advice to keep farmers up to date with changing markets:

“Policy and funding can encourage farmers to acquire these skills, but our experience has been that this rural funding has been hard to acquire particularly in recent years and therefore many farmers continue to use relatively primitive forms of marketing without fully embracing what is on offer. Governments could also look into providing ‘education credits’ to farmers encouraging them to take on ongoing education programs on this topic as part of the Common Agricultural Policy.”164

212.The AHDB said that registering trade options and becoming involved in financial instruments to manage risk was a “big change of mindset” for farmers. To find solutions, it had established a volatility forum to bring the academic and commercial worlds together with the farming community:

“There are a number of areas that we are really keen to look at, whether it is forward contracts, forward pricing, the use of derivatives, co-operation and integration, people creating more strategic balanced businesses or how government policy might be involved to help us manage some of that volatility.” 165

213.According to Teagasc, “major education and outreach initiatives” would be required to make financial instruments, such as forward contracts, futures markets, swaps and options, commonplace in European farming. It added that such market-based risk management tools had a much longer history in the US, which also has a very different scale of farming.166

214.Indeed, the size of farming as a business operation and the level of cash-flows involved were identified as barriers to farmers’ use of financial instruments. The NFU argued that the majority of farmers, as individual enterprises, lacked the scale to engage directly in a futures market. They currently relied on processors and traders to utilise market-based instruments to manage volatility: “For farmers to directly benefit, financial products must consider the scale of farming operations”.167

215.Dairy UK argued that Member States should be allowed to use EU Rural Development funds to educate dairy farmers on the use of financial instruments:

“Whilst other agricultural sectors such as cereals are already fully familiar with futures instruments, this is not the case for dairy. It will take an extensive programme of training and education in the sector before dairy farmers can see the benefits of using futures and are familiar with how they can be exploited.” 168

216.CRM Commodities added that farmers trading in futures markets also faced a risk of extra cash flow demands in the period between the hedge being placed and the physical being sold. This was a deterrent for farmers whose cash flow was already tight.

217.We recommend that the European Commission and Member State governments work proactively with the financial sector to develop and promote more accessible and practical risk management tools.

218.Government policy should ensure that provision is made for training and education to farmers in accessing and making use of new financial instruments. We encourage bodies who have a role in providing advice to famers, such as levy boards, to commit sufficient resources for this task.

The availability of data

219.We heard that the availability of transparent price data was a prerequisite to developing tools to manage price risk, and also that there was a role for public policy to encourage the provision of such data. According to the NFU, a lack of publicly available data for price and volumes traded affected price discovery and consequently discouraged farmers from participating in market based solutions by reducing their confidence in the pricing of derivatives: “Greater market transparency will encourage participation in the financial markets as no participant in the supply chain will be able to benefit from asymmetric information.”169 The AHDB called for mandatory price reporting to help price discovery.170

220.Defra noted progress in this area, arguing that the Commission was concentrating increasingly on improving market transparency and on disseminating relevant information within the food supply chain. The Department argued that the EU Milk Market Observatory was “evolving into an important facility for improving price transparency and access to data and analysis of future market trends”. The Commission has since launched similar tools for beef, cereals, pigmeat, poultry and sugar.171

221.The AHDB added that well-functioning insurance schemes, be it for margin, income or other types of schemes popular in the US, would require “robust systems and good quality data”.172 Rural Business Research agreed that supporting the development of such schemes required independent and generally accepted data on farm performance.173

222.Defra also noted that running counter-cyclical payments schemes would require significant data input:

“Indeed this is a substantial barrier in the short-term to medium-term development of any scheme in the UK as information on the individual income of farmers is not available.”174

Regulatory burdens

223.Many witnesses warned of the extra regulatory burden that would fall on farms—often small-scale businesses—with greater use of financial instruments. The AHDB argued that “purely ‘financial’ instruments are unlikely to be of much use to farmers with business size and regulation preventing direct access”. It noted that the increasing amount of regulation aimed at ensuring that such instruments were not misused by speculators could itself give rise to additional volatility. Policy areas such as the revised Markets in Financial Instruments Directive (MiFID II)175, which aims to increase transparency and oversight of financial markets, including derivatives markets, could make it more challenging for farmers to use formal market based instruments.176

224.MiFID II177, was agreed in 2014. The NFU noted that the rules would capture for the first time non-financial businesses producing, trading or processing physical commodities with a futures market in the EU, such as agricultural commodities, including wheat, milk or rapeseed. Farmers could, however, be exempted from complying with the rules.178

225.Regulatory and implementing technical standards under the Markets in Financial Instruments Directive (MiFID II) should not place an unfeasible burden on farmers, which might discourage them from using financial risk management instruments.

National policies

226.Some witnesses identified further opportunities for Member States to provide support to farmers outside the framework of the CAP, notably through taxation systems.

227.The UK Government extended its existing system of tax averaging for farmers in the 2015 Budget. From April 2016, farmers will be able to average out their farming profits over five years instead of two for tax purposes. Defra told us that this should help farmers manage fluctuations in income caused by industry specific factors “from price movements in global markets to swings in yields caused by the weather or by disease”.179

228.The AHDB, on the other hand, called for the development of further products allowing farmers to “save efficiently in good times to offset the bad”.180 One example of such a practice is New Zealand’s Income Equalisation Scheme (see Chapter 3).

229.We consider that national taxation policies can make a major contribution by developing regimes such as sheltered reserves and income averaging. The UK Government’s extension of the system of tax averaging for farmers announced in the 2015 Budget was a positive development.

129 Written evidence from AHDB (RPV0020)

133 Written evidence from Defra (RPV0009)

134 Written evidence from AHDB (RPV0020)

136 Supplementary evidence from Defra (RPV0034)

137 Written evidence from Defra (RPV0009)

138 Written evidence from DG AGRI (RPV0027)

139 Written evidence from Defra (RPV0009)

140 Written evidence from AHDB (RPV0020)

141 Written evidence from Farm Europe (RPV0015)

142 Written evidence from DG AGRI (RPV0027)

144 Written evidence from the Irish Food Development Authority Teagasc (RPV0013)

146 Written evidence from Nick Tapp (RPV0005)

147 Written evidence from the NFU (RPV0024)

149 Written evidence from Defra (RPV0009)

151 Written evidence from Defra (RPV0009)

152 Written evidence from the Agricultural Industries Confederation (RPV0023)

153 Regulation of the European Parliament and of the Council of 25 October 2012 on the financial rules applicable to the general budget of the Union and repealing Council Regulation (EC, Euratom) No 1605/2002, Regulation (EU, EURATOM) No 966/2012

156 European Commission, Press release 23 March 2015,
[accessed 5 May 2016]

157 European Commission, Questions & Answers in relation to the Memorandum of Understanding in respect of cooperation in agriculture and rural development within the EU between the European Commission and the European Investment Bank (23 March 2015): [accessed 5 May 2016]

158 Agriculture Commissioner Phil Hogan at the Agriculture Council, Statement: The use of Financial Instruments in the Agriculture Sector, (14 March 2016):–03-14-agrifish-council-financial.pdf [accessed 5 May 2016]

159 Written evidence from Defra (RPV0009)

161 NFU Scotland, UK Farming Union Presidents Say New Farming Measures are a Step in Right Direction, (15 Mach 2016): [accessed 5 May 2016]

162 European Commission, Annex: Comprehensive package of measures, Fact Sheet (7 September 2015): [accessed 5 May 2016]

163 Written evidence from Defra (RPV0009)

164 Written evidence from CRM Commodities (RPV0022)

166 Written evidence from the Irish Food Development Authority Teagasc (RPV0013)

167 Written evidence from the NFU (RPV0024)

168 Written evidence from Dairy UK (RPV0026)

169 Written evidence from the NFU (RPV0024)

170 Written evidence from AHDB (RPV0020)

171 Written evidence from Defra (RPV0009)

172 Written evidence from AHDB (RPV0020)

173 Written evidence from Rural Business Research (RPV0008)

174 Supplementary evidence from Defra (RPV0034)

175 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (OJ L 173, 12 June 2014, p. 349–496)

176 Written evidence from AHDB (RPV0020)

177 The MiFID II Package comprises two pieces of legislation, the Directive (see above) and Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 (OJ L 173, 12 June 2014, p 84–148).

178 NFU, NFU influences EU directive on futures market (20 April 2016): [accessed 5 May 2016]

179 Written evidence from Defra (RPV0009)

180 Written evidence from AHDB (RPV0020)

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