The Secret Ingredient

What is the one thing that will elevate the diamond industry, that one secret ingredient that when added will transform the diamond industry from one that survives to one that thrives? In discussion after discussion with those that look into the industry from the outside – bankers, government officials, researchers, investors, advisory teams, financiers – all point to the diamond industry’s low level of transparency as a big challenge.

 “Challenge” is a euphemism for “Barrier.” An obstacle preventing money from entering the diamond industry.

More than ever before, financial institutions are considering investments in the diamond industry and are concerned by their inability to truly understand the financial structure of companies, the multi-layered configurations that move money from one country to the next, tangled webs of ownerships, including offshore accounts and tax-haven entities.

It’s About Corporate Governance
When ABN AMRO asked to seal Arjav’s diamond stocks in December 2012, the backdrop was the bank’s demand that Arjav hire a Chief Financial Officer, submit detailed monthly reports on all financed receivables and pass an independent business review. ABN demanded from a company that reportedly owed it $154 million to be transparent.

In the past couple of months, I have spoken with the CEOs, presidents and heads of diamond departments at a number of banks that provide financing to the diamond industry. The banks are all under pressure to be more transparent. When Basel III will come into effect, banks will be required to be more transparent, which means that they’ll need their clients to be more transparent. Clients that don’t meet the transparency requirements will find it difficult, if not impossible to get bank financing.

All the bankers with whom I spoke said that the biggest challenge is transparency.

Because of the desire to see simpler corporate structures, a demand that income is deposited into accounts at the lending banks, and due to high leverage, banks view diamond firms as high risk compared to firms in other industries. Specifically they cite manufacturers and polished diamond wholesalers.

In the words of one bank president, “Much work is needed.”

Banks have risk standards. When assessing a business, they want to know how it operates. When the business cannot provide this with clarity– because of poor management or to cloud some of its activities – a bank is reluctant to provide  credit.

A couple of years ago, the board of a bank earmarked money for financing diamond firms for the upcoming year. Because many diamond clients did not meet the bank’s risk standards, the bank utilized only about 70 percent of the earmarked money. Naturally, the board did not like the missed opportunity and allocated the unappropriated funds to a different industry in the following year. In other words, this money left the diamond industry.

The Case for Protecting Margins
Transparency is needed throughout. The diamond industry, justly or not, continues to suffer from reputational issues, resulting in a hidden cost. Those who look at two investment opportunities, diamonds or something else, and don’t choose diamonds because of ethical issues do not state that reputational issues tipped the balance and the industry is none-the-wiser.

Price transparency is another significant problem. If the real selling price of diamonds is not known, the financial markets will not allow the formation of financial instruments such as diamond ETFs, a futures market or anything else of this type – and the industry will lose the funds that this will inject into circulation.

Price transparency will also allow traders to increase prices downstream. All jewelry retailers accepted the rising cost of gold jewelry because they knew – from independent sources – that the price of gold went up. Now imagine that retailers knew that diamond prices increased. They will accept the new prices and manufacturers margin erosion will no longer be a matter of attrition.

These changes are needed, and they’ll come, even if it means dragging the industry into making them – with all the casualties it will involve. Instead, moving forward early will resolve these issues early, a healthier outcome for the industry as a whole.

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