"The government's expectation that Fonterra and its farmers should fully utilise the flexibility afforded by the proposed exceptions to open entry, including to manage discharges and greenhouse gas emissions, will be clearly signalled through the explanatory note to the bill, Hansard, media statements and other influencing (rather than regulatory) tools," he said.
The changes will require new legislation, which will be included in this year's parliamentary programme.
Holding legislation to prevent the expiry of Fonterra's contestability and efficiency provisions was needed after independent processors collected 22 percent of all milk solids in 2015, triggering a review of the law.
The previous administration had planned to relax some of the conditions on Fonterra to accept milk supply from new dairy conversions and would phase out the need to sell regulated raw milk to large rival processors. Those proposals followed a Commerce Commission review that found Fonterra's market dominance still warranted regulation.
O'Connor's review of the governing legislation wanted to see whether the dairy sector is operating in the long-term interests of New Zealand consumers in terms of prices, availability, quality and product range.
MPI found the legislation largely provides a cheap and effective way of managing the risk of Fonterra behaving in a way that was against the long-term interests of New Zealand dairy farmers, consumers and the wider economy, and didn't directly interfere with Fonterra's strategies or investment plans.
O'Connor plans to limit Fonterra's ability to determine a key assumption in setting the base milk price, known as the asset beta.
He will also be able to nominate a member to Fonterra's milk price panel, although that wasn't taken to cabinet in the paper and regulatory impact assessments.
MPI did say external appointments to the panel were proposed in submissions but not considered.
"MPI considers that this would create issues of confidentiality and commercial sensitivity, potentially placing Fonterra at a competitive disadvantage," it said.
Independent processors with their own supply of 30 million litres or more in a single season will no longer be able ask Fonterra for additional regulated milk.
However, the proposals will raise Fonterra's obligatory sales volume of regulated milk to rival Goodman Fielder to 350 million litres per season from 250 million litre, albeit at a higher price.
Fonterra noted the outcome, saying it welcomed the veto on the open entry requirements, but was disappointed it still has to supply milk to large, export-focused businesses.
"We look forward to constructively participating in the upcoming legislative process and will continue to push for an outcome that is in the interests of all dairy farmers and New Zealand," chair John Monaghan said in a statement.
