6 May 2019
Utilising derivative tools to enhance your business, andNew Zealand Production Outlook
Nick Morris, Head of Derivatives, NZX
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DisclaimerThe information provided in this document is a guide only and intended for general information purposes. It shall not constitute investment advice. In particular it does not constitute an offer, solicitation or recommendation to acquire or dispose of any investment or to engage in any transaction.While reasonable care has been taken in the preparation of this document to provide details that are accurate and not misleading NZX Limited ("NZX"), its subsidiaries, directors, officers, employees, contractors and agents (a) do not make any representations or warranties regarding the use, accuracy, correctness, quality, reliability, completeness or timeliness of such information, and (b) shall not be responsible or liable for any use of any information contained herein under any circumstances. All descriptions, examples and calculations contained in this document are for illustrative purposes only.To the maximum extent permitted by law, NZX and its subsidiaries, directors, officers, employees, contractors and agents shall not be liable for any loss or damage arising in any way (including by way of negligence) from or in connection with any information provided or omitted or from anyone acting or refraining to act on this information. NZX and its subsidiaries offer services to market participants and to participants in its clearing and settlement system. Those who desire to trade any products available on any NZX market or to offer and sell any such products to others or to become a participant in the clearing and settlement system, should consider the requirements of the applicable Rules and other legal and regulatory requirements relevant to them, as well as the associated risks, before doing so.All intellectual property, proprietary and other rights and interests in this document are owned by NZX and its subsidiaries including, without limitation, all patent, registered design, copyright, trademark and service mark rights. No part of this document may be redistributed or reproduced in any form or by any means or used to make any derivative work without the written consent of NZX.NZX Derivatives Market is a licensed market operated by NZX, a licensed market operator regulated under the Financial Markets Conduct Act 2013.©NZX Limited 2019
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1. Introduction to NZX dairy derivative markets
2. Overview of dairy market volatility
3. Hedging as a concept
4. How are derivatives and other hedging tools used?
5. Considerations for implementing price risk management
6. Update on New Zealand production
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Agenda
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NZX global dairy derivativesProduct overview
Contract description Contract size
Contract length Currency
Whole Milk Powder Futures (WMP) – cash settled to average winning price WMP Fonterra Regular CP2 in the two GDT auctions for the relevant month
1 tonne Monthly (18 months listed)
USD
Whole Milk Powder Options – physically settled with one options contract equating to one WMP Futures contract
Skim Milk Powder Futures (SMP) – cash settled to average winning price SMP Fonterra Medium Heat CP2 in the two GDT auctions for the relevant month Skim Milk Powder Options – physically settled with one options contract equating to one SMP Futures contract
Anhydrous Milk Fat Futures (AMF) – cash settled to average winning price AMF Fonterra Regular CP2 in the two GDT auctions for the relevant month Butter Futures (AMF) – cash settled to average winning prices for unsalted 25kg - NZ, CP2 in the two GDT auctions for the relevant month Milk Price Futures (MKPF) – contract size of 6,000kg/ms, cash settled to the Fonterra Farmgate Milk Price annually
6,000 kg milk solids
Annual NZD Milk Price Options (MKPO) - physically settled with one options contract equating to one MKP Futures contract
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NZX global dairy derivativesMarket overview
$-
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
2010 2011 2012 2013 2014 2015 2016 2017 2018
USD
/MT
WMP front month price and NZX dairy derivatives monthly volumes since launch
-
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
Ope
n in
tere
st (n
umbe
r of c
ontra
cts)
Open interest across all NZX dairy derivative contracts
Commodity FuturesCommodity OptionsMilk
Our dairy journey 2018/2019: records on records
Source: NZX Data & Insights. Note, dairy derivatives customers globally, not exhaustive
+36%CAGR in active
traders since 2011
+54% volume CAGR since
2011
Millionth lot traded, May
2018
106,199 lotsrecord quarterly
volume, Q3 2018
45,923 lotsrecord volume month, March
2019
+57% growth in lots traded in Q1
2019
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A truly global marketplace
Source: NZX Data & Insights. Note percentage of trading accounts located in each region based off 2018 whole milk powder, skim milk powder, anhydrous milk fat, butter known underlying customer numbers, not exhaustive
• NZX dairy derivatives
are being traded in
over 50 locations
globally
• On average 31% of
volumes are from Asia
– 21% from China
16%
2%
9%
11%
17%
32%
13%
Location of our customers
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NZX global dairy derivativesOnward and upward to global benchmark status
0%
2%
4%
6%
8%
10%
12%
14%
16%
1 2 3 4 5 6 7 8
Perc
enta
ge o
f und
erly
ing
trade
d
Years since launch
NZX dairy derivatives vs LIFFE Milling Wheat volume comparison
NZX Milling Wheat
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Overview of dairy market volatility Significantly more volatile than other ‘risky’ assets
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
% p
rice
chan
ge
NZD price percentage change
4 week % change
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Overview of dairy market volatility Significantly more volatile than other ‘risky’ assets
-45%
-35%
-25%
-15%
-5%
5%
15%
25%
35%
45%
2010
2011
2012
2013
2014
2015
2016
2017
2018
NZX WMP price percentage change
4 week % change
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Overview of dairy market volatility
$-
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
1991
1993
1995
1997
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
WM
P Pr
ice
(USD
/MT)
WMP Price
1990-2005Volatility: +/- ~9%
2006-2019Volatility: +/- ~28%
Globalisation and emerging market demand for protein drive new era of heightened volatility
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Overview of dairy market volatility Price risk management tools around the globe
UnitedStates
Europe New Zealand
Futures & Options ✓ ✓ ✓
Processor Agreements
✓ ✓ ✓
Bank Swaps ✓ ✓ ✓
Margin guarantee programs, subsidies, tariff protection
✓ ✓ ✗
Hedging is about
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Hedging as a concept Why hedge?
Reliable budgeting/forecasting
Being counter cyclical
Reducing risk
Ability to make strategicdecisions
ProfitstabilityCertainty
Cash flow management
However: Doing nothing is still doing something…14
Hedging as a concept Risks of hedging with futures
1. Cash flow implications – cash collateral required
2. Basis risk
3. Calendar risk
Time
Price
Futures price
Spot price
Basis risk
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Hedging as a concept Liquid financial markets are crucial to the dairy industry
Flexible price risk
management tools
Price discovery
Reduced credit
exposure
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How are derivatives and other hedging tools used?Commodity price volatility
Finished commodities (WMP, SMP, AMF, BTR)
• Selling futures to fix price• Using options to hedge against
larger moves• Selling options to add additional
premium to GDT sales prices
Farmgate Milk Price
• Buying milk price futures to lock in a portion of cost line
Using both finished Commodities and Milk Price hedging together • Lock in gross margin• Aim to deliver sustainably higher margins• Taking advantage of market pricing differentials when opportunity
presents itself
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How are derivatives and other hedging tools used?Competitors customer/supplier contract terms
Offering customer and farmer price risk management (PRM) solutions to attract business
Customer• Fixed price contracts• Collars• Structured products
Clear risk via the exchange or vs contracts to farmers
Farmer• Seasonal fixed price contracts• Price floors
Clear risk via the exchange or vs contracts to customers
Advantages• Add preferential terms to
customers in a competitive market• Provide price certainty for own
business
Costs• Administrative/operational cost of
managing/laying off risk
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Considerations for implementing price risk managementSteps to implementing a risk management function
Quantify risks/identify opportunities
Define risk appetite
Set parameters
Implement Governance framework
Review/monitor performance
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Considerations for implementing price risk managementTrading activity should be strictly governed and reported on
Back OfficeTreasury & Operations
Settlement
Board of DirectorsApprove Strategy and business plan, Approve policy & delegated authorities
Middle OfficeAccounting, Treasury &
Capital MarketsValuation and reporting
Front OfficeTrading team
Take commodity positions
Financial Risk & Portfolio Management CommitteesManagement oversight of price risk management and commodity derivative activity. Compliance and controls
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Update on New Zealand productionProduction journey 2000 – 2018
-
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
3,500,000
4,000,000
4,500,000
5,000,000
5,500,000
Total Cows Milksolids production million kg
kgMS Millions
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Update on New Zealand productionSnapshot 2019 season
Mild Production kgMS June 2018 – March 2019
1,658,992,000 3.5% head of YTD for 2017/18 season
Weather
• Mild winter • Wet Spring • Drought in high producing
regions late summer early Autumn
Sentiment
• Emission trading scheme • Environmental pressure
• Water clarity and Access • Nutrient leaching
• General public perception
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Update on New Zealand productionHeadwinds
Climate Change, Environmental, Human,
Animal Health
Land use regulation
Emergence of alternative animal milk
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Update on New Zealand productionOpportunities looking forward
Pay forecast $7.50 2019/20 season Capped Production
Consumer focused Production
• Strong financial performers are emerging within the producers space laggards not tolerated
• Processors increasing focus on value play
• Limitations are driving innovation and science to look for solutions to produce more with less
• Focus on engaging digital technology and data to allow or precision decisions as resources are limited
• Producers engaging more with community and consumers domestic and internationally
• Diversification of farming businesses to provide multiple income streams
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The Team
Save the date NZX Global Dairy Seminar
Be part of the dairy industry’s leading Asia-Pacific risk management conference. Save the date for our annual Singapore seminar in October.
When: Tuesday 22 – Wednesday 23 October 2018Where: Singapore
The theme of this year’s seminar is ‘A Sustainable Outlook’ examining the economic and environmental factors influencing the evolution of our global market in New Zealand alongside other key dairy producing and trading regions.
Ticket sales and agenda will be released in May.
To express an interest in becoming an event sponsor, please contact Head of Derivatives Nick Morris at: [email protected]
For all other queries please contact the NZX derivatives team on +64 (9) 309 3672 or at: [email protected]
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Thank you!
Contact Nick MorrisHead of DerivativesDDI: +64 9 308 3703Mobile: +64 21 33 7781Email: [email protected]
NZX Derivatives DDI: +64 (9) 309 3672 Email: [email protected]