A new vision for agriculture
momagri, movement for a world agricultural organization, is a think tank chaired by Christian Pèes.
It brings together, managers from the agricultural world and important people from external perspectives,
such as health, development, strategy and defense. Its objective is to promote regulation
of agricultural markets by creating new evaluation tools, such as economic models and indicators,
and by drawing up proposals for an agricultural and international food policy.
Focus on issues

Private risk management tools for markets: The report from the House of Lords reflects the analytical shortcomings of their supporters



House of Lords, European Union Committee, 15th Report of Session 2015-16



The British referendum on leaving the European Union on 23rd June 2016 resulted in a narrow victory for the leave campaign. Hostile to a European structure beyond the single market, the British played and important role among supporters for the deregulation of the CAP. In the event of an effective exit, London will have a free hand in agricultural policy.

Not forgetting that the British were among the first, well before their entry into the European Community in 1973, to adopt strong measures in terms of agriculture (Boards of marketing, deficiency payments, protection of farmers, etc.), it will now be interesting to follow their future choices in terms of agriculture: will they implement the non-interventionist measures they systematically put forward during CAP debates? Conversely, will the “perfidious Albion” demonstrate its legendary pragmatism by continuing to support its agriculture, thus demonstrating that opposition to the CAP resulted primarily from their fear of continued European integration?

That being said, with Brexit, the prominent “Northern Europe hostile to the CAP” has lost its dominance, and the procrastinators of all things agricultural have lost their favourite scarecrow. Will Brexit enable the European Union to lead the CAP out of its current deadlock? We can only hope so, because giving back meaning to the principal European Community policy will help revive the “European dream” and as a result curb the Euro scepticism currently overtaking campaigns.

Whilst waiting for the next few months to provide some answers to these questions, below we have reproduced excerpts
1 from a recent report from the House of Lords which covered the problem of price volatility and the resilience of the agricultural sector. Though we might disagree with many of the conclusions, this report, which is essentially a synthesis of the hearings conducted by the House of Lords, is instructive on the analytical shortcomings of the backers of market risk management based solely on use of futures markets and revenue insurance. In simple terms, we remarked three biases detrimental to the relevance of the analysis.

First of all, comparisons with the risk management policies of other countries is unrealistic. US and Canadian examples are quickly outlined and highlight insurance by omitting countercyclical aid, nonetheless predominant in these two major producing countries. Secondly, we regret that farmers do not sufficiently use the futures markets, which are seen as a solution to the withdrawal of government intervention. If futures markets are undeniably useful, we must remember that in the event of low prices, they are ineffective hedging instruments. In addition, not all produce disposes of liquid futures markets as does dairy produce in Europe for example, and as demonstrated by the Class III Milk contract on the Chicago Mercantile Exchange, it is thanks to the policy for collective marketing that a reference price exists and allows for cash settlements on futures contracts.

Finally, the weak growth in insurance for economic risks is explained by rivalry with other aid packages, without understanding that such insurance can only cover intra annual risks and, like the futures markets on which they are based, they do not provide sufficient coverage when prices are low long-term. But on the subject of insurance, the report's conclusions are unambiguous: “(190) subsidized insurance systems should not replace the current provisions for support for the CAP. Uncertainty about cost and administrative complexity weighs against such a change. Nevertheless, we believe that insurance-tools can play a complementary role in helping to counter the effects of extreme weather events, for example, and therefore should not be completely excluded”.


Momagri Editorial Board



The challenges facing EU agriculture
    1. The agricultural industry provides jobs for 22 million people across the EU who are directly involved in farm work and for many more in related sectors. While a secure supply of safe food is the industry’s most visible output, farmers also play an important role in the management of the land and the environment as well as in the wider rural economy.

    2. Farms across the EU vary enormously in size and type, from family smallholdings to large commercial agribusinesses. Developing and implementing a common policy to meet the different needs of all farmers presents a serious challenge. The Common Agricultural Policy (CAP), launched in 1962, is the main framework within which EU agriculture is managed. The CAP has undergone incremental change since its inception and, over time, has reduced support provided through prices in favour of support unrelated to production decisions. As a consequence, many farmers are now more exposed to market prices and therefore price volatility.

    3. The effects of price volatility are felt differently by different farming sectors and by farms of different sizes. The presence of support under the CAP for certain sectors can also affect levels of resilience, with some less supported sectors even emerging as more resilient than those with a history of substantial support. Price volatility can be an opportunity for some farmers, but for others it can severely affect their livelihoods.

    4. In the face of pressure on their incomes, many farmers have turned to diversification to supplement their income and reduce their risk exposure, but not all are able to do so.

    5. The capital intensive and long term nature of farming limits the sector’s ability to respond quickly to sudden market disruption caused by, for example, extreme weather events or unpredictable political decisions.

    6. Against a backdrop of reports of an ongoing crisis in UK agriculture
    2, the Committee undertook an inquiry to examine the extent to which price volatility was increasing and how agricultural resilience to withstand price and other shocks could be strengthened.

    7. As a global phenomenon, price volatility is here to stay, and is beyond the control of the individual farmers who feel its effects. Their best defence is to draw upon a range of mitigation measures to improve their resilience, and we have examined various options available in the EU and elsewhere in the world. We have also offered some thoughts on the future of the CAP.
(...)


The United States of America
    149. The United States Department of Agriculture (USDA) explained that agricultural policy in the US was governed by the Farm Bill, an omnibus legislative package. It told us that the 2014 Farm Bill amended previous agricultural and related policies and established new policies on a 5-year cycle: “The 2014 farm bill debate took place in a period of high farm prices and record farm incomes, and centered on the replacement of fixed decoupled payments that went to farmers regardless of market conditions. A key element of the ... debate was how to target commodity programs to provide a safety-net in time of unexpected distress and better help farmers manage risk.”

    150. One particular public policy tool arose time and time again in discussions about the American approach to supporting agriculture: insurance. As the US removed direct support, it began to support commodities through subsidised insurance schemes.

    151. The USDA outlined the main benefits of government-backed insurance schemes. First, they told us that the schemes were a positive substitute for ad hoc disaster assistance because producers gained a direct role in managing their risks and participated in pooling risk with other producers, by providing net contributions in good years to offset losses in bad years. Second, they told us that from a budgetary perspective, the cost of a crop insurance programme was more predictable, because producers received indemnity payments in a timely manner when funds were most needed rather than having to wait for the processing of ad hoc disaster payments.

    152. The USDA was cautious about recommending such a scheme to the EU. The insurance market for agriculture in the EU is underdeveloped, and the evidence suggests that were the EU to move towards an insurance based model, premiums would probably need to be subsidised, as is the practice in the US. The Minister questioned whether the level of premiums would be affordable for farmers drawing on insurance schemes on a regular basis: “Sometimes the difficulty is in insuring risks where there are regular calls on that insurance. Farming is famously a very risky thing to do because none of us can control the weather, and crops are particularly exposed. Sometimes, the cost that an insurance company will put on underwriting that risk is very high.”

    153. The Minister also questioned whether such a method of insurance would be best offered by the private or public sector and expressed caution about the complexity of the US model: “The big argument against what they are doing in the US is that it is incredibly bureaucratic and administrative. We are in the business of trying to get away from an incredibly bureaucratic and heavily administrative CAP in Europe. We would like to move to something simpler and more logical.”

    154. DG AGRI explained that the two models were not directly comparable, and reflected significant institutional, budgetary and structural differences: “US agriculture is characterized by a legislative process whereby the representation of farm interests in one legislative body is disproportionate to demographic reality, no budgetary constraint exists on farm policy implementation, and the agricultural sector is essentially supplydriven, relying on land abundance and on primarily bulk commodity production. It is thus rather simplistic, naive and deceiving to consider that such a comparison could be useful for EU agriculture.”

    155. It added that another difference was that over 90% of US payments to risk management schemes went to just three crops—maize, wheat and soybeans

Canada
    156. Under the Canadian Growing Forward 2 (2013–2018) policy initiative, a suite of programmes is in place to enable farmers to cope with variations in income over time and improve their resilience, collectively known as the Business Risk Management (BRM) tools127. These comprise:
    • AgriStability—a margin-based programme that provides income support to an individual (or business entity) who declares agricultural income for tax purposes when that producer experiences substantial falls in earnings;
    • AgriInvest—savings accounts for producers that provide flexible
    • coverage for small income declines and support investments that help mitigate risks or improve market income;
    • AgriInsurance—which provides producers with cost-shared insurance for natural hazards in order to minimize the financial implications of production and/or asset losses;
    • AgriRecovery—a framework (rather than a single programme) that guides how federal-provincial-territorial governments work together to assess the impacts of disasters on Canada’s agricultural producers and respond with timely, targeted initiatives where there is need for assistance beyond ongoing programming.

    157. The similarities between AgriInvest and the New Zealand Income Equalisation scheme are significant. The AgriInvest account builds as a farmer makes annual deposits based on a percentage of his Allowable Net Sales (ANS) and receives matching contributions from federal, provincial, and territorial governments. Since 2013, farmers have been able to deposit up to 100% of their ANS annually, with the first 1% matched by governments. The limit on matching government contributions is $15,000 CAD per year. The financial institution notifies Agriculture and Agri-Food Canada once a deposit has been made and the matching government contribution is credited to the account. This approach supports farmers who invest and take responsible long term decisions.

    158. The Minister, George Eustice MP, praised the simplicity of the Canadian AgriStability scheme: “The US has one, which is very complex and looks at different incomes, state by state, crop by crop. It makes it a very difficult scheme to manage administratively. Most people would agree that the Canadian model is probably the simplest, where they simply target a sharp fall in farm incomes and basically take that as a proxy for something going wrong in the sector, either with price or indeed with crops … I think the Canadian model is the closest we have got to an insurance scheme that works, just because of the complexity of the US model.” He went on to say that the EU might be able to learn lessons from the Canadian model in the next round of CAP reform, and could even design a system that was simpler still.

    159. There are fundamental differences between the organisation and structure of the EU agriculture sector and those in Canada, New Zealand and the US, especially with regard to scale and amenity and environmental use of land. These differences render the models used by these countries unsuitable for general application in the EU at the present time.

    160. Even though the Canadian and US experiences have rather different contexts, lessons can be learned on where and how subsidized insurance and disaster compensation may be applied.

    161. We recommend that the Commission and the UK Government undertake a structured review of public investment deposit schemes in other countries, with a view to identifying approaches that would work in the EU. This would give farmers a secure and guaranteed option to save in times of plenty and withdraw in times of need.

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.”

    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.
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.

    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. 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”.

    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.
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.

    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.

    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.

    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.”

    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.”

    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.

    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”.

    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.

    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”.

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

    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.”

    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”.

    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.

    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.

    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.”

1 The entire study is available from
http://www.publications.parliament.uk/pa/ld201516/ldselect/ldeucom/146/14607.htm#_idTextAnchor055

2 ‘UK farming faces two more years of pain says Carr’s boss’, Daily Telegraph (11 April 2016):
http://www.telegraph.co.uk/business/2016/04/11/uk-farming-faces-two-more-years-of-pain-says-carrs-boss/
[accessed 5 May 2016]



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