Sunday, June 24, 2012

"Pig Trust" Investment Product

China's 12th five-year plan aims to transform the mode of production in agriculture and break down the dual rural-urban economy. A big part of this is transitioning to larger-scale production that requires high up-front cash expenditures to buy inputs months before products are produced and sold. The pattern of cash flows in "modern" agriculture poses a problem for small farmers who can't get credit. It also poses risks when product prices fluctuate--what if the price of your product goes down so much you can't pay back your loans. There are a lot of experiments with financial innovations in Chinese agriculture and the pork industry is the testing ground for quite a few of them.

The state-owned COFCO conglomerate recently announced a "Pig Trust," an experimental financial product for raising capital and spreading risks of raising pigs. The trust is offered by COFCO Trust co., a COFCO subsidiary set up several years ago to peddle investment products that raise funds for agriculture.
According to terse descriptions in a news article and the company web site, the trust works as follows (please note, this post is not an endorsement of the trust).

Funds invested in the trust are used to purchase feeder pigs at about 20 kg and finance their production through the fattening and slaughter stages. The pig production is managed by COFCO meat (another subsidiary of COFCO) for a 2-percent fee (2 percent of what?) plus an unexplained "float." After the pigs are raised to slaughter weight (about 100 kg) and sold at the market price, the profit (or loss, presumably) goes to the trust. There is no guaranteed rate of return to the trust; it depends on profits earned from the pigs. Thus, the trust scheme provides capital to producers in exchange for the possibility of big profits in the future for investors. Investors in the trust appear to bear the risk.

The initial trust product will raise 15 million yuan and will cover a 12-month period. Production for the experimental trust will take place in Jiangsu Province. It's not clear who will invest in this trust--banks, institutions, or retail investors. The article describes the trust as a means for general citizens to join the stampede of companies--chemical, coal, steel, real estate, and software companies--investing in the pork industry. Neither is it clear who will do the production. Presumably, COFCO Meat will supply the feeder pigs and slaughter them. It seems likely some part of COFCO will also supply the feed. The article describes the model as "company + base + farmer + finance." The article reports that people in the industry say this trust product is experimental and it will probably be hard for most investors to participate in the pilot. The announcement of the trust is symbolic. However, if it works, the pig trust model could be used to finance hog barns and other industries like chicken farming and could be adopted by other companies.

The new "community supported agriculture" (CSA) movement imported from western countries and Japan  also has a financial angle. Little Donkey Farm in Beijing explains that the CSA concept includes joint ownership and bearing of risk by producers and consumers (Little Donkey's business is mainly in vegetables but also includes pork). Consumers pay a subscription fee to the farm before the growing season that provides producers with funds to pay for inputs. Consumers pay up front for their food, not knowing what they'll get. This also sets the price before harvest. If the harvest is bad consumers are out of luck. Thus, the CSA is also a model that transfers some of the risk from producers to consumers. Of course, the prospect of paying for something before you know what you'll get is also an impediment to the spread of CSA's that will help keep them a fringe part of agriculture.

Another financing model is an elaborate "six party + insurance" experiment in Ziyang, Sichuan. Ziyang's "six party" model includes two input suppliers--a feed mill and a breeding farm supplying piglets. It also include producers organized into pig farmer cooperatives, a slaughter/meat company. The innovative part is to include financial organizations: a bank, a loan guarantee company, and an insurance company. The bank makes loans to the feed mill and breeder, and they sell the feed and pigs on credit to the farmers. The pigs are sold to the meat company which deducts the funds to repay the farmers' loans. The bank loans are guaranteed by a loan guarantee company. The insurance company insures the pigs while they are being raised by farmers.

The six-party model has heavy government involvement and uses a number of small subsidies. The bank is the government's Agricultural Development Bank. Loan guarantee companies are usually capitalized by county governments in Sichuan. About 80% of hog insurance premiums are paid by government subsidies. Breeding farms also get subsidies for "improved breeds" and buying breeding stock. Several years ago the New Hope feed company signed an agreement with Ziyang authorities to become at least three of the six parties: feed, breeder, and meat company. While the "six party" model has been praised in a number of news articles the model does not seem to have been adopted elsewhere. Some assessments made passing references to "low compliance by farmers," weak negotiating position of farmer cooperatives, and the potential for the scheme to collapse if one of the parties runs into problems.

There is a lot of experimentation and varying degrees of innovation as China searches for ways to finance agriculture, an inherently risky activity that is mostly conducted by farmers who have few assets and uncertain ability to pay back loans. Lack of profitable investment vehicles for China's compulsive savers is also giving this a push. On one hand this could lead to more innovation, but on the other hand it could lead to more reckless investment and money-losing schemes.

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