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European Commission

Dec 9, 2002 3:27 PM   By Martin Rapaport
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The European Commission (EC) Article 19(3) Notice released on November 9, is a very important document relating to the De Beers Diamond Trading Company (DTC) “Supplier of Choice (SOC) initiative for the supply of rough diamonds by the DTC to its customers.” The EC gives notice that it intends to “adopt a favorable position” with regard to SOC but, before doing so, invites “all interested parties to submit any observations they might have within one month of publication.” The full text of the Notice begins on page 21.

While the EC document is comprehensive, it is incomplete, as it omits significant details necessary for a formal review(1). Furthermore, except for the DTC Best Practice Principles, Rapaport Diamond Report (RDR) has been unable to obtain from the EC, or the DTC, any background documents, including nonconfidential versions of documents submitted to the EC.

Surprisingly, the EC review is limited to SOC and its effect on the relationship between the DTC and its clients. The EC review does not address the critical issue of the impact of SOC on the overall (nonsightholder) diamond trade or the consumer markets. The effect of DTC dominant market position and/or monopolistic practices not relatedto SOC are not covered in this notice.

The Real Issue

The real issue is not only the DTC Supplier of Choice (SOC) initiative, but also the dominant role of De Beers in the diamond industry and what government, De Beers and the trade must do about it. The issue of De Beers monopoly power and its effect on the diamond trade — not just sightholders — is of vital importance to all of us in the industry. Clearly, De Beers market power extends far beyond the close-knit world of some 120 sightholders. De Beers and DTC pricing and allocations of rough diamonds directly and regularly impact the livelihoods of tens of thousands of people in the diamond trade.

Governments in general and the EC in particular, must accept responsibility and regulate De Beers significant market power in a manner that is fair and correct for both De Beers and the diamond industry. Such regulations must not be based on private and secret agreements between the DTC and the EC. Government regulations and guidelines must fully consider the impact of De Beers market power on the overall diamond trade and consumer markets. This can only be accomplished if the views and perspectives of the overall diamond trade are incorporated into the EC decision-making process. Honest, open and transparent discussions that incorporate the perspectives and legitimate interests of the nonsightholder diamond trade are a prerequisite for a fair resolution of the problems brought about by De Beers monopolistic market power.

De Beers management is to be applauded for SOC’s re-engineering of internal DTC workings related to sightholder selection and rough allocations. They deserve credit for their stated commitment to legitimize De Beers business practices. Management must understand and accept that such legitimization cannot be partial and limited to the relationship between the DTC and its sightholders. DTC management must take full responsibility for the impact of DTC policy on the overall diamond trade and the “public good.” If any proposed DTC policies harm the public good or utilize illegal market power in a way that restrains the legitimate rights of other diamond industry stakeholders, then such policies must be rejected by the EC and the diamond community.

EC/SOC Considerations

Let me make it clear, the fundamental goals of SOC are extremely beneficial to the diamond industry and De Beers. I fully support these goals and encourage everyone else in industry and government to support them as well. My concern is not with the goals of SOC, but rather with the regulatory environment controlling their implementation. I am deeply concerned that, absent proper regulatory controls, uncontrolled implementation of SOC by the DTC has the potential — and is likely — to severely damage free-market competition in the rough, polished and jewelry sectors of the diamond industry.

If properly managed, SOC will be the best thing to happen to the diamond industry in the past century. If improperly managed and regulated, SOC will be a Trojan Horse that, once adopted by the diamond trade, will turn on us and be used to destroy our free and competitive diamond markets.

Consider this observation: If a high percentage of rough diamond supply is distributed to a low percentage of polished distributors and retail outlets, then freely competitive diamond markets will disappear. What are the critical percentages? What if De Beers allocates 40 percent of worldwide rough supplies to SOC? What if they allocate 60 percent or 80 percent? What if De Beers gives this percentage to 100 sightholders, or 50 or 20? Clearly, if a large percentage of world rough output is distributed to a very limited number of outlets, then there will not be enough goods available to support open market activity.

Has anyone at the EC ever considered what these percentages should be? Shouldn’t SOC be limited to a certain percentage of worldwide rough supply, so that it does not starve competitive markets? Clearly, as long as the DTC is a dominant diamond distributor, there must be limits as to the percentage of worldwide rough supplies that are allocated to its exclusive SOC distribution system. There must be enough diamonds left over after SOC allocations to support free competitive market trading.

What if in the future De Beers does a deal with Russia and/or Congo and/or Angola, and once again regains control of 80 percent of worldwide rough supplies? What if the DTC then allocates all of its better quality rough to about 25 sightholders who sell direct to retailers?

Would this be okay with the EC? Has the EC imposed specific limitations on the market-share of the DTC and SOC, before giving SOC blanket approval?

Consider this statement from the EC Notice, paragraph 16: “According to De Beers, one of the aims of supplier of choice therefore, should be to develop DTC’s business relationships with sightholders in a manner, which will encourage long term growth at the retail level by the creation of a multibrand environment and shorter distribution channels. In order to do this, the DTC through the notified agreements intends to limit the number of selected sightholders, encourage them to work with downstream partners in order to improve the efficiency of diamond distribution and interest in retail branding.”

Clearly, SOC is an alternative distribution system that bypasses and competes with the freely competitive polished diamond markets. This is not a bad thing. It is a good thing. If properly handled, SOC increases and improves competition. SOC is only a bad thing — a very bad thing — if the DTC uses its monopolistic distribution power to give unfair market power to SOC and thereby restrain trade.

For example, if select categories of diamonds (say rough yielding carat and up G+, VS1+) all get allocated to SOC, resultant shortages of this polished in the open market will make it impossible for nonsightholders and retailers who are not customers of SOC suppliers to buy these goods. Such firms would not be able to compete in the marketplace for and with these polished diamonds. Would anyone be surprised if the price of these goods went up to monopolistic levels — under the cover of added value marketing programs, of course?

Perhaps some free-market firms could apply to De Beers for a sight, but what if they don’t want a sight, they simply want to design a new bracelet or call up the market to get a nice 2 carat F VVS2 for one of their clients? Certainly one cannot argue that SOC should have the power to limit or define what competition is.

The point here is that SOC has the potential to destroy legitimate polished diamond markets by starving them of goods. Furthermore, it has the potential to extend De Beers monopoly power down the distribution system into polished. If there is no critical mass of goods in select polished markets, who will set prices for this polished? Will it not be De Beers, the DTC and their proxy cartel members — the sightholders? Are we not in danger of establishing a new polished diamond cartel controlled by a “limited number of selected sightholders” that are controlled by the DTC and De Beers? Are not sightholders part of an effective DTC diamond cartel?

Favorable Position?

The EC has said that they are about to “adopt a favorable position with regard to the notified agreements as amended.” I am afraid that the EC has not considered the impact of these agreements on the overall diamond trade. Has anyone at the EC considered that SOC may restrict goods from competitive markets and restrain free trade? Has the EC created guidelines limiting the extent of DTC/SOC control over specific types of rough and polished diamonds? If so, what are these controls? What are the percentages above which the DTC cannot control rough distribution, or below which they cannot restrict distribution to select sightholders?

Before the EC goes ahead and gives blanket approval to SOC, have they made sure that it cannot be used by De Beers to corner select diamond markets? Is the EC about to give the DTC a blank check regarding the use of its market power in relation to the overall nonsightholder diamond industry?

I know that it is not the intention of SOC to corner markets, but the possibility for abuse is there and must be negated by government regulation.

How about non-SOC issues? We know that the EC is considering horizontal issues such as the agreement with the Russians and how this directly relates to DTC market power. But what about Diamdel? Can Diamdel be used in coordination with the DTC sales department to buy up select qualities of diamonds — say rough that yields carat and larger G+, VS+ — to create shortages that support monopolistic prices? Bad enough that De Beers controls around 60 percent of worldwide diamond supplies, but it is also able to use Diamdel to buy up select qualities of rough and further control select markets. What impact do Diamdel sales have on DTC market power? Do they extend it further than it already is? Does Diamdel increase or decrease the competitive nature of the rough markets? Should Diamdel be allowed to exist? Has the EC ever considered these questions? Should they?

So What Do We Want?

We want SOC. We want free competitive markets. We want them both, together, coexisting and competing with each other. We want detailed EC regulations and DTC undertakings that make sure that the DTC does not use its market power in combination with SOC to restrain trade and/or restrict competitive market power in the rough, polished and jewelry diamond markets.

We want an immediate provisional EC approval for SOC. Such approval must be subject to further conditions and DTC undertakings once a complete study of the impact of SOC on the overall nonsightholder diamond trade is completed and analyzed. We respect current DTC management and are confident that they will not use SOC in a negative way in the short term. However, over the medium- to long-term, we are categorically opposed to giving the DTC a blank check to use SOC in any way it sees fit, and/or without due consideration as to how DTC use of SOC may impact free competitive markets.

We want the EC to extend the scope of its vertical investigation of the DTC and De Beers beyond “the supplier of choice initiative for the supply of rough diamonds by the DTC to its customers.” The EC must move forward and examine the entire DTC package of economic activity. De Beers and the DTC, to its everlasting credit, has accepted the need to legitimize its operations and to ensure that De Beers and DTC activities are in compliance with EC law and regulations. We ask for this investigation not because we are against the DTC, but because we are for them. The activities of the DTC and the diamond industry are highly interdependent. Each needs the other. The diamond industry needs a strong, healthy and, above all, legal DTC. Half measures and partial legitimization of DTC activities are insufficient. The DTC cannot be half kosher — the DTC and the industry deserve better.

We are opposed to EC issuance of a blanket negative clearance for SOC, unless EC experts truly believe, after careful and detailed study of De Beers and the DTC, that these entities do not have monopoly power. We believe that any negative clearance will be misunderstood by the trade to imply that the DTC is free of all monopoly power.

We strongly encourage members of the diamond trade, particularly representatives of trade organizations, to take an active role communicating the concerns, needs and interests of the nonsightholder diamond trade to the EC. While many industry leaders are also sightholders, and they may be afraid to discuss DTC antitrust matters with the EC, it is important to recognize that trade involvement with the EC is not something negative or against the interests of De Beers. De Beers and the DTC want to be legal. It must become legal if it is to fulfill its great potential. It is the role of the trade to work together with government and the DTC to make this dream of legitimization a reality.

Conclusion

The DTC's Supplier of Choice (SOC) initiative is a good plan and must not be derailed. Implementation should begin immediately. SOC should coexist with and be part of a vibrant competitive marketplace. The EC should play a role ensuring that the special dispensation given to the DTC to implement SOC is not used in any way that “has the possibility of eliminating competition” in the diamond industry or reduces the economic power of competitive players in the marketplace.

The DTC has given our diamond industry a great gift — Supplier Of Choice (SOC) — a gift that will revitalize us and refocus us on creating new diamond demand that will grow our industry. Some of us do not like the DTC gift because it forces us to change in ways that we do not wish to change. But change we must.

Another part of this SOC gift is the restructuring of the DTC. A restructuring that is good for the industry because it promises an objective competitive system of sightholder selection and rough allocation. A system that will be fair and approved by the EC.

It is time for the diamond trade — us — to give De Beers and the DTC a gift. The gift of legal legitimization. A gift that will further revitalize the DTC and give it new opportunities for expansion. Some folks at the DTC will not like this gift because it will force them to change in ways that they do not wish to change. But change they must.

Footnote: (1) Please note, comments in this article are not designed to present a complete overview of trade concerns regarding EC approval of SOC. Our immediate objective is to provide a few examples of our concerns. A comprehensive review would require analysis of additional topics that are beyond the scope of this brief article.
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Tags: Angola, Compliance, De Beers, Diamdel, DTC, Government, Jewelry, Regulation, Russia, Sightholders
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