Pool Management Services Remuneration Model for
AWB Limited & AWB (International) Limited
1. Introduction
As foreshadowed in the AWB Limited (AWB) prospectus dated 6 July 2001, a Performance Based Remuneration Model has been approved by the Board of AWB (International) Limited (AWBI). This payment structure for pool management services has been agreed by the Boards of AWB and AWBI and will come into effect from October 2001 and will operate for the 2001/2002 season.
AWBI operates the National Pool and is the sole bulk exporter of Australian wheat.
AWB, the parent company, of AWBI provides pool management services to AWBI. These services include:
· international sales and marketing (including international supply and demand analysis, market analysis, pricing strategy, marketing, international sales, and the provision of technical training to international customers);
· risk management services (including foreign exchange management and commodity hedging);
· grower services (including grain acquisition, grower payments, communication, and regional office services).
· managing the wheat supply chain (from farm gate to international customer); and
· research and development (to ensure Australia’s wheat growers stay abreast of seed variety and technology developments and ensure AWB delivers value added products to international customers).
The constitutions of both AWB and AWBI require that the business of AWBI is managed with the objective of maximising net returns to growers who sell wheat into the pools run by AWBI by securing, developing and maintaining markets for wheat.
Under the original Services Agreement between AWB and AWBI the payment for pool management services was on a “cost plus” basis. This approach provides little incentive for AWB to maximise net returns for AWBI nor to minimise its costs.
The payment structure was independently reviewed by reference to industry best practice in relation to asset and fixed income management as well as international grain industry models. The result is a new remuneration model which provides an incentive based payment system that encourages AWB to invest its capital in the provision of pool management services and provides incentive for AWB to add value to the National Pool return.
The model balances the risks and rewards to each party. While AWB’s investment in infrastructure and people necessary to provide the pool management services is covered by a minimum payment, AWBI is protected by the requirement for AWB to exceed certain benchmarks and a hurdle before any out performance incentive is payable.
2. Fee Structure
The performance based remuneration model will be based on a two-tiered payment system:
1. a Base Fee; and
2. an Out-Performance Incentive (OPI).
2.1 Base Fee
The Base Fee will remunerate AWB as the “asset manager” for the National Pool at 1.5% of the Gross Pool Value (GPV).
The Base Fee effectively represents the cost of the provision of services related to the management of the National Pool. It does not include a margin over actual costs, but rather allows AWB to determine the most effective level of expenditure to provide those services and encourage maximisation of GPV to growers. This is not dissimilar to fund and asset managers who are paid a percentage equivalent to the value of assets under management to maximise asset value (in this case to maximise the value of pool wheat).
There is a cap and floor on the Base Fee. This protects the National Pool from excess payments that may be otherwise incurred in years of high GPV, with a cap of $60m. Further, shareholders of AWB are protected from years of very low GPV by a floor of $45m. This cap & floor will apply for the 2001/2002 National Pool, and will be CPI indexed in future years.
2.2 Out Performance Incentive (OPI)
An OPI will be paid from AWBI to AWB if AWB achieves a National Pool return which out-performs the AWBI’s Wheat Industry Benchmark (WIB) plus a hurdle.
Three components of net return need to be managed to achieve the best net return for growers:
· USD FOB wheat price obtained;
· AUD/USD rate obtained; and
· domestic supply chain costs deducted from growers payments.
Therefore, any analysis of performance must measure performance against these sub-benchmarks.
3. AWBI’s Wheat Industry Benchmark (WIB)
3.1 US$ Wheat Price Benchmark
AWBI’s model compares the actual USD price achieved for the National Pool compared to an average USD price achievable using a basket of comparable US and foreign grades. Prices substained include results of commodity hedging.
3.2 FX (AUD/USD) Benchmark
AWBI’s model incorporates an assessment of actual foreign exchange risk management relative to a benchmark foreign exchange hedge program, based on the foreign exchange policy set by the AWBI Directors.
3.3 Supply Chain Benchmark
The model has been developed to assess actual costs (standardised for crop size and other factors outside the control of the pool manager) compared to a benchmark based on forward projections of indices of historic supply chain costs. This will ascertain any implied value add through lower supply chain costs.
Costs taken into account include storage and handling costs, freight and port costs.
4. The Hurdle
Achievement of the benchmarks is not considered to be sufficient to drive performance to the degree required by AWBI due to natural advantages that accrue to the operator of the Single Desk. Hence, it is necessary to establish a Hurdle above the benchmark which must be met before out-performance will be rewarded. The Hurdle takes into account any freight advantage plus the inherent value of the Single Desk.
If actual pool returns exceed the Pool Performance Benchmark plus Hurdle, the OPI payment will be paid from AWBI to AWB.
The hurdle is expressed in USD per tonne because it reflects any advantage AWB may have in negotiating FOB prices, which are reflected in USD per tonne. USD FOB prices are the international standard for the quotation of wheat prices.
The AWBI Board has approved a Hurdle of USD5.00 per tonne. Given historical analysis, and the fact that AWB effectively has contributed in the past to the inherent value of the Single Desk, through promotion, research & development, etc, the hurdle is seen as rigorous and demanding.
The OPI payment is 20% of the GPV in excess of the Benchmark plus Hurdle.
In summary, the OPI and Hurdle is as follows:
OPI = [GPV – (WIB + H)] x 20%
where OPI = Out Performance Incentive
GPV = Gross Pool Value
H = Hurdle Value
WIB = AWBI’s Wheat Industry Benchmark Value
5. Cap Total
There is a cap on the total payments payable by AWBI to AWB. The Base Fee and the OPI combined will be capped at 3% of GPV (except where the Base Fee floor is triggered).
6. Industry Assessment
At the same time as the Performance Based Remuneration Model was under development, the Minister for Agriculture Fisheries and Forestry announced a review of the Performance Monitoring framework utilised by the Wheat Export Authority. AWBI’s remuneration model for AWB has been independently reviewed and elements incorporated in this performance monitoring framework.
7. Conclusion
The introduction by AWBI of a Performance Based Pool Management Remuneration Model for AWB represents a shift to best practice. The model is consistent with that adopted by asset managers around the world. It is designed to provide the appropriate incentives to AWB to deliver the most effective and efficient services and to achieve superior pool return out-performance while sharing the risks and costs associated with the National Pool.