The announcement by the Antwerp World Diamond Centre (AWDC) that it “has reached an agreement with the Antwerp diamond banks to provide a temporary additional financial mechanism in support of the Antwerp diamond dealers” through which they will “provide new credit facilities up to a maximum of €1 billion,” seems, at first reading, either a hollow public relations exercise or an ingenious breakthrough to boost the industry’s shrinking financing facilities.

As AWDC’s CEO Freddy Hanard, the CEO of the Antwerp industry’s umbrella group, who is credited as being the architect of the plan’s underlying “warehouse concept,” has an illustrious past in diamond banking, the latter option seems the most plausible.

The fact that the bankers were deeply involved in the shaping of the mechanism – and especially ABN-AMRO’s Victor van der Kwast has been mentioned as a driving force – also ensures its implementation. The arrangement is a win-win for all concerned.

The press release itself gives scant hard information beyond stating the “credit will be provided on the basis of inventory collateral.” But how will that be done? Who will benefit? To fully understand the scheme one must remember the crisis of the 1980s, which caused a collapse of some of Antwerp’s diamond financing institutions.

Around 1984, the Belgian Banking Commission (BFIC) imposed a strict prohibition on the financing of non-current stocks. Rough diamonds purchased from primary producers (Sightholders) can be financed for a limited period, diamonds that are being processed can be financed, and there is export financing. As a matter of principle, the Antwerp diamond banks were prohibited from financing inventories and certainly not dead stock. In fact, during the recent crisis the banks were financing stocks – but strictly speaking, they shouldn’t have done so.

Financing is linked to current activities; the accounts receivables represent the most significant collateral. When exports and imports decreased by 30 to 45 percent, and outstanding accounts receivables fell due, the Antwerp banking debt decreased from a high of $3.6 billion to some $2.8 billion today (plus around $230 million utilized securitizations). As the activities declined, so did the caps on the facilities.

With rough prices (ridiculously) increasing by some 20 percent in the past six to eight weeks, and the DTC’s Varda Shine now juggling how to satisfy $1 billion worth of Sight applications for the forthcoming June Sight, the Antwerp market needs new credits and larger facilities. The producers seem to be set on increasing rough prices in the days ahead, which will exacerbate the need for money – and may also inadvertently create a new mini-bubble.

In any event, all of this made it necessary to find a ways that all Antwerp’s diamond stocks (including the “dead stocks”) could be pledged.

Scheme Based on End of Year Stock Declarations

All Antwerp diamantaires need to report their polished and rough diamond end-of-year inventories to the Federal Economic Offices. Our sources inform us that at the end of 2007, the industry reported stocks worth $5.3 billion. Part of these stocks, such as the rough imports, may already be financed.

It is assumed, however, that 60 percent of these stocks, i.e. $3.28 billion, represents own capital that is not being financed. The AWDC scheme proposes that a “Fund” be established in which these “free” stocks can be deposited. From this amount, a maximum of 40 percent, i.e., $1.31 billion (or €972 million), could be used to secure additional credit facilities and strengthen the collateral base of the existing banking debt. That’s where the €1 billion figure in the press release comes from.

These stocks contain a large amount of slow-moving, or near-dead, inventories (Mostly very cheap goods, as the average value of Antwerp declared stocks are about $45 per carat.) The new credit scheme is indeed ingenious in the sense that it enables Antwerp diamantaires to use these goods as collateral. This is tantamount to the “creation of new money.”

How will it work? An Antwerp diamantaire will deposit his (dead or near-dead) stocks with a new Special Purpose Vehicle, which still needs to be created. Let’s call it “the Fund.” Basically, the Fund will keep the diamonds in trust on behalf of the diamantaire. The Fund will be established and managed by the AWDC and the diamond banks. Diamonds (rough and polished) deposited in the Fund will be valued by the government’s Diamond Office at 60 percent of the market value.

The Fund will then issue a “Warehouse Receipt,” which the diamantaire presents to his or her bank. This 60 percent of the diamond value will then give something both to the diamantaire and to the bank: 50 percent of the amount will made available as new credit, while the remaining 50 percent will be applied to bolster the collaterals held by the bank for the existing debt. “The credit crunch and price declines have not only reduced the availability of credit, it has also eroded some of the quality of the bank’s collateral. To strengthen the existing collaterals, will reduce the bank’s risks – and (in Basel II capital adequacy terms) this will translate in better borrowing terms for clients,” explains Hanard.

That “Warehouse Receipt” becomes the collateral of the bank. If the borrower defaults, the bank can collect the diamonds used for security – the bank will get 100 percent of the diamonds, even though it financed only 50 or 60 percent of the value. In other words: the new credit is only on 30 percent of the money. As such, a small part of the value of the stocks gets financed; the risk of the bank is practically zero. On the other hand, the diamantaire gets money on stocks for which he would otherwise get no financing at all – thus, he gets a very attractive deal. Moreover, as the bank will have more security for the existing debts, the diamantaire gets the bank “off his back,” as there will be less pressure to bring more money or collateral to the bank.

Logistical Issues, Government Guarantees and Duration of the Financing

The Fund will insure the diamonds and guarantee the safekeeping. As the Diamond Office will value the goods, the industry’s transparency will be improved. The government will see that the annual stock valuations are correct, inspiring greater trust in the diamond companies. The Fund wants to have some “balance” in the variety of the goods, thus the values and assortments of specific ranges should not exceed 20 percent per category.

Of course, the scheme doesn’t want the participating diamantaire to be without his stocks for a long time. Therefore, a deposit of goods (and the resulting financing) should not be for a period exceeding six months. With the approval of the banks, this period may be renewable for another six months.

In order to bolster the confidence of the banks, the AWDC is seeking a 20 percent governmental guarantee from the Flemish government. (This guarantee would be 20 percent of the $1.31 million, i.e. $ 260 million.) At a meeting between Flemish government leader Kris Peeters and Freddy Hanard, the request for such governmental guarantee was formally made. It has not yet been issued.

“This guarantee,” says Hanard “will only be used in exceptional Tsunami-size situations. It wouldn’t be applied in individual cases of default, but rather it there is again some kind of sector-wide catastrophe.” The idea is that the governmental guarantee is issued for two years, with two possible additional extensions of one year each. In the event of a loss, an 80/20 rule would apply: 80 percent at the expense of the bank; 20 percent at the expense of government.

What would constitute a tsunami? Hanard explains that the Diamond Office, under the watchful eye of its director, Ari Epstein, who is also deputy CEO of the AWDC, will value the goods at 60 percent. “Only if the value would collapse – let’s say they fall 80 percent below the full value when the goods are presented, or so, we’ll get into a situation that we might need the guarantee. That is a highly unlikely scenario,” says Hanard.

Also in the future – after the government guarantees have expired – the Fund could continue to operate, subject to the approval of the Belgian Banking Commission.

Unintended Consequences; Pitfalls and Benefits

Epstein says the complex scheme was the result of negotiations with all the Antwerp diamond financing institutions and it is meant to give them additional security, additional comfort levels, from parts of the basic equity of a company that hitherto could not be used for collateral purposes.

One banker commented that this scheme will not come in lieu of some other steps that still may be agreed among the bankers. We asked Hanard and Epstein whether they could simply define and summarize the goals of the scheme and identify the benefits to Antwerp. The AWDC leaders made the following points:

            * It will support and strengthen the position of the entire Antwerp community and it will, specifically, enhance the trust between diamantaires, banks and mining companies.

            * It will improve the liquidity of the Antwerp market.

            * It creates an additional (albeit temporary) financing mechanism and widens the options of both diamantaires and their banks.

            * A far greater transparency is created in the market.

            * When diamantaires can finance new businesses, there will be fewer employee redundancies in the market.

            * There will be additional means to settle domestic debts. (The scheme is not earmarked to provide financing for the settlement of overseas debts.)

            * It will maintain and bolster Antwerp’s role as the World Center for Diamonds.

Various Approvals still Needed

Though the Flemish government strongly supports this scheme, the governmental guarantee has not yet been approved or issued. Also, the Belgian Banking Commission has not given yet its fiat. The responses on the street in Antwerp were decidedly mixed. “Why do we need such an elaborate system? Isn’t it far easier to secure the BFIC’s approval to allow banks to finance stocks, something they do anyway?”

Another diamantaire dismissed the whole scheme. “If you have signed a floating charge (lien) of all my business assets to my bank. So in a way my stock serves already as collateral. Why do I need this structure?” A third one was even brutal. “This will only help the mining companies. When there is more liquidity on the Antwerp market, it is easier to increase rough prices. But the prices of the resultant polished hardly move.

No scheme is perfect. The basic idea is exceptionally innovative. A huge amount of energy and time has been invested here to come up with something different –get money for dead stocks, which is almost like getting money for nothing. The “Warehouse Concept” has not been publicly explained, and it took me a few days to put all the pieces together. To me it has become clear that this is not a public relations exercise, but potentially a real solution to a real problem.

The AWDC deserves to be complimented – it shows the Antwerp community that it is truly seeking ways to extricate the business as quickly as possible out of the credit crunch. But two major hurdles still need to be overcome: government approval for the $260 million guarantee and getting the green light from the banking commission.

Will it work? We truly don’t know. Time will tell.

Have a nice weekend.