Russian Diamonds: The Prisoner's Dilemma
April 13, 22
OPINION by Erez Jacob Rivlin, a diamond market analyst and diamond mining consultant. Served as an advisor for the Russian government, (Minister Bychkov), on diamond issues, and for the Angolan President Jose Eduardo dos Santos
The Russian invasion of Ukraine is changing the diamond industry's governing dynamics. The last time something similar happened was after 9/11, when the American Congress adopted the Patriot Act in October 2001. Global business fundamentals had to change including for the diamond and jewelry industries. As a result, the Kimberley Process was born in 2003 and the Responsible Jewellery Council followed in 2005. Strict banking compliance was introduced, with serious KYC procedures, and successful elimination of most cash transactions.
Suddenly, everybody had to Know Your Client, and nobody wanted to know anymore that you were a very good client of a Swiss bank with an untraceable account. But, In the past years it seems that the diamond industry has achieved an equilibrium. KP and KYC became part of the daily routine, and even LGD came out of the closet and became part of the legitimate diamond and jewelry spoken dialect. The Corona crisis has drastically benefitted the industry, so prosperity and relative satisfaction ruled until 24/2/22, when all hell broke loose in the former land of Stalin and the Tsars.
The Big Split
Just like the 9/11 terrorist disruptive milestone created by bin Laden, Putin has created the Russian-Imperialistic disruptive milestone. And now, after almost two months of vicious Russian attacks, the fog of war starts to subside, and we can start identifying the new forces that will redefine the new equilibrium of the diamond industry. When we zoom out for a global perspective, we are witnessing a big split in the diamond and jewelry industry.
On one side are those that have no Russian Dilemmas anymore. Russian diamonds are far from being the core activity of Signet, LVMH, Cartier or any other jewelry corporations. The members of this group, that also includes many diamond manufacturers, understand very well the damage that their business could sustain from the jaws of regulators and harmed reputation. Therefore, even though several members had endured limited losses, the No-Russian-Dilemma group cut all ties with any Russian diamond firms and with Russia in general.
On the other side of the Big Split are all the entities whose core operations depend on the supply of Russian diamonds. This Russian Dilemma group has a lot to lose if it accepts full sanctions on all Russian diamonds, and for some it could even risk the continued existence of life-long family businesses.
The Prisoner's Dilemma was a thought experiment that was formulated by the American mathematician A. W. Tucker in the 50's. It simulated a situation in which two criminal friends were arrested and kept in two separate cells. A shrewd detective offered each one immediate freedom, if he confessed and betrayed his friend, who would then get a very severe sentence. On the other hand, if both prisoners refused to co-operate and confess, the two would get a very light sentence. Each one of the prisoners was faced with the dilemma whether to trust or be tempted to betray his friend. The Prisoner's Dilemma shows how rational people would often not choose the best obvious decision in their best interest, that happens when they are challenged with the need to co-operate and trust other people. The prisoner's dilemma model, which is used in economic and political analysis, could help us better understand the current situation of the diamond and jewelry industry, and consider some future potential scenarios and solutions.
The Russian Dilemma Group
When zooming into the Russian Dilemma Group, we see that it includes the main diamond trading centers, most of the private diamond manufacturers and even the Catoca diamond mine in Angola (Alrosa owns 32.8% of its shares).
The four main diamond trading centers - Antwerp, Dubai, Tel-Aviv and Mumbai - are under heavy pressure to halt all trading with Russian diamonds. But if one of the main four centers would cut its ties with Russia, it risks losing for generations its Russian market share to those that would remain loyal to the Russians. The best solution, as shown also in the Prisoner's Dilemma, is to simply trust and co-operate. If all the trading centers would decide together to accept the sanctions on Russia, they would eliminate this risk.
Mr. Chirag Shah, the founder and managing director of Antwerp-based Anita Diamonds, a leading diamond manufacturer and trader specializing in exclusive sizes, said: "It will not be fair to limit only the Antwerp trading center. In previous years, Antwerp has already marked a huge loss in market share, and without a real global solution, the only outcome will be punishing the Antwerp traders, nobody else."
Many diamond traders that I have spoken to, echoed Mr. Shah's words. Mr. Shah does not buy directly from Russia, but Antwerp is his home, and like all his colleagues, he does not want to see his hometown suffer.
When compared with the four trading centers, the private diamond manufacturers who are still the clients of Alrosa, are in the more sensitive position, and are facing the toughest dilemma. Their know-how and family-wealth were built during generations of hard work. Public companies risk mainly public capital, and when regulators and politicians choose sides, they don't risk losing their own family businesses in the process.
If a private diamond manufacturer decides to cut his relations with the Russians, it means an immediate major loss of investment and leaving some of his close friends and family members jobless. But fairness is not a high priority during wartime, and if some private manufacturers would act individually, and not on a united global level, they would risk losing their core business to others, just like the trading centers would.
The original Prisoners' Dilemma model refers to two friends who were facing the dilemma, but real life is not a black-and-white mathematical model. Despite sharing many global common interests, in daily life, the diamond trading centers, and the manufacturers are at the same time natural ferocious business competitors. Therefore, uniting and co-operating is much tougher, even though it would mean that they would be acting in their own best interests.
The Polished Diamond Country-of-Origin Potential Revolution
All the international diamond and jewelry organizations (KP, RJC etc) failed so far to make the rational move of trust and act in a global co-operation. They are so-to-say still existing, but with what relates to the Russian Dilemma, the reality is that the 'Big Split' transformed them into useless bodies. However, one major force has an impact, and it is starting to make a concrete global change. The US administration armed with the tools that the 9/11 milestone generated, is the one that is currently transforming the diamond industry like nobody has ever done before.
In the past weeks and for the first time ever, POLISHED diamond shipments were blocked by Belgian and Israeli customs due to the missing declaration of the country-of-origin on the export invoice. These were not shipments from Russia, these were exports of polished diamonds from Belgium to Israel and vice versa. Those shipments were released once the country-of-origin information was completed on the export invoices, but this awakening of the customs authorities has a meaning, and it is not just more bureaucratic paperwork.
There is no existing technology that can identify the country-of-origin of polished diamonds, without a follow-up from the origin. But once an investigation started with one of the diamond manufacturers who didn't respect global Russian sanctions (if ever really implemented), explanations for not-being-guilty could prove to be challenging. Polished diamonds originate from rough, and this rough must have an invoice with a Kimberley Process certificate with it.
The bottom line is that the US administration's actions are yielding some concrete results. Their most powerful tool, the banking compliance, and the threat to cut banks off the SWIFT system proves to have real teeth. The new customs regulations and the linked banking compliance, traps diamantaires in a tough real-life Prisoner's Dilemma. Therefore, some are already giving up. According to a reliable source, at least one Israeli company that was regularly buying Russian diamonds, has decided it will soon inform Alrosa that it has no way to continue its purchases.
All the regular clients of Alrosa went through years of a business struggle with management focus and risky investments. Thus, nobody wants to throw such a valuable business relationship down the drain. But the US administration is managing to do what the KP, RJC, WDC and the other industry organizations have so far failed to do. It is very possible that we are witnessing the dawn of the polished diamond country-of-origin revolution.