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Diamond Trade Banking on Relationships

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Apr 6, 2017 9:14 AM   By Avi Krawitz
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RAPAPORT...
The diamond industry and the banking sector are getting to know each other again, having recognized the gulf that’s developed between them. In that spirit, the diamond financing seminar that took place recently in Mumbai presented a much-needed opportunity to talk.

“Unless the industry knows our problems and the lenders understand the industry’s challenges, we can’t move forward,” said Karnam Sekar, deputy managing director at the State Bank of India.

The bankers still view diamonds as a high-risk sector. Representatives from the diamond trade, meanwhile, feel there has been significant progress in improving the industry’s level of compliance, transparency and so-called bankability.

It appears that both are correct — there has been progress, but more needs to be done given the regulatory environment constraining the banks.

Following the financial crisis of 2008, extra capital requirements introduced under the Basel banking regulation reforms transformed the operations of the financial institutions with which the diamond industry does business, according to Ernie Blom, president of the World Federation of Diamond Bourses (WFDB), which hosted the seminar in February.

“It is essential for diamond companies to understand these changes and adjust their approach to continue to thrive,” he said at the event. “But we must also emphasize the way our industry has embraced self-regulation in order to shatter the myths that unfortunately are attached to our business.”

What Has the Industry Done?

The push toward financial compliance and governance has come not only from the banks, but also from the mining and retail sectors.

Signet Jewelers, the world’s largest jeweler, launched its Responsible Sourcing Protocol for Diamonds in February 2016, requiring its suppliers to enforce proper invoicing throughout the distribution chain in order to ensure their end-product has been ethically sourced.

Similar traceability programs are being implemented at other retailers and through various trade bodies. India’s Gem & Jewellery Export Promotion Council (GJEPC), for example, developed its know-your-customer (KYC) program, called “My KYC Bank,” centralizing the formalities for completing the KYC requirements.

The mining sector, meanwhile, has raised the bar when it comes to financial compliance. De Beers is insisting its sightholder clients adhere to international financial reporting standards (IFRS) and to its best-practice principles for corporate social responsibility in order to qualify for its rough supply. Other major diamond miners such as Alrosa are doing the same.

De Beers reported in December that nearly half of its 85 sightholders had completed the required roadmap to compliance. The rest have to get their books in order so they can submit audited IFRS reports for the current financial year.

Small Company Challenge

The larger diamond manufacturers and trading companies have embraced the new transparency standards, says Eric Tunis, a partner at New York-based accounting firm Friedman LLP, which services diamond and jewelry clients.

Nonetheless, he tells Rapaport News, “there are many smaller players in the US — who are good, ethical people to start with — that still need to improve their compliance standards.”

Considering how long it took for sightholders, who already had organizational structures in place, to comply, we must have realistic expectations regarding how quickly the rest of the industry can get their houses in order, he adds.

Tunis expects there will be more consolidation in the US because small businesses don’t have access to funding, and because there is an oversupply of companies chasing a stagnant market.

Similarly, in India, panelists at the seminar highlighted the need to focus on the small-to-medium-size enterprises (SMEs). The country’s institutions are working hard to formalize the sector, noted Anoop Mehta, president of the Bharat Diamond Bourse (BDB).

That’s particularly necessary in light of the Indian government’s demonetization program, which eliminated high-value cash notes and steered the country toward electronic transactions. Demonetization caught smaller manufacturing units off-guard, since many of their workers don’t have bank accounts — or even convenient access to banks — as would be required for such transactions.

“A large percentage of the industry is made up of SMEs that pay their workers in cash,” GJEPC chairman Praveenshankar Pandya explained at the seminar. “So it will take time for them to open checking accounts and fall within regular banking channels.”

New Sources of Credit

While there is a call for the Indian banks to support SMEs with more credit, there is also concern they’re too liberal with their lending to the industry – especially compared to their counterparts in Antwerp, New York and Ramat Gan.

There are about 40 banks that lend to the trade in India today, but only about five really understand the way the industry works, one banker told the conference.

Pandya estimated that India accounts for about half the $11.5 billion to $12 billion of credit currently extended to the global industry.

Indian banks have gained a larger share of the diamond credit market in the last decade, as an increase in defaults after 2008’s financial downturn led European and Israeli banks to pull back their lending. Dubai also capitalized on that trend, with local banks stepping in to provide a new source of funding as the city emerged as an important diamond-trading hub.

The seminar also explored new avenues of financing that are becoming available to the market, such as equity investors, crowd-funding and the use of block-chain technology.

Not Enough Credit

Those new channels, combined with what funding is available from traditional banks, mean that the industry has no shortage of credit options for “bankable companies,” contended Erik Jens, head of diamond and jewelry clients at ABN Amro.

However, Blom argued that this was not the case, adding that those financing alternatives were still in their early stages.

“The trade’s inability to secure enough credit is the most pressing challenge facing the industry,” Blom said. “The lack of funds has reduced liquidity available to diamond companies, which has affected business flexibility and made companies considerably more vulnerable to market movements.”

Jens countered that the real stress had less to do with financing, and more to do with companies’ profitability, margins, sourcing, and the ability to manufacture the right goods at the right time.

The Banker’s Perspective


Profitability and reputational issues emerged as the biggest concerns for bankers presenting at the seminar.

The level of non-performing assets — or defaults — has been twice the average of other industries since 2008, which is why the diamond trade is in the “negative risk category,” reported PS Jaykumar, managing director at Bank of Baroda.

Before 2008, you didn’t hear about bankruptcies in the industry, but growth has since been flat, and the number of defaults has risen, another panelist added.

The absence of growth has been one of the core issues the banks have faced vis-à-vis the diamond trade over the past decade, along with low transparency and a lack of solid collateral, explained Varda Shine, former De Beers executive and owner of consultancy firm Sky Inc.

Diamond market volatility, regulations, the lack of security on collateral and the absence of a real asset base have all contributed to raising the sector’s risk rating, Jens added. He also noted that banks were highly conscious of the negative perception that regulators, consumers, NGOs and the media have about the industry — a reality that has impacted the diamond sector’s overall bankability.

In that vein, Sekar said he wanted to see the trade take greater responsibility for its members’ actions, in both reputational and financial matters.

“In the past, if one unit went bad, the rest of the trade would pounce on him,” he noted. “You don’t see much of that today.”

Getting to Know Each Other


In fact, bankers have expressed frustration with the trade in such circumstances. They want a more transparent flow of information, so that if a company goes bankrupt, there’s a sharing of knowledge about the case across the industry.

The trade, too, called for greater engagement. Following the seminar, the WFDB set up a financial taskforce to work with the banks and “show that the idea of the diamond industry as a high-risk sector is a misconception,” Blom said.

But such measures need to extend to the personal level in terms of how the banks work with their clients, stressed Russel Mehta, vice chairman of the GJEPC and director at manufacturer Rosy Blue. He urged the banks to invest more in credit appraisal and relationship banking, rather than just lending according to the balance sheet.

That would require the banks to focus on the individual client — the person behind the business — rather than the industry as a whole, Mehta added. It would also put the onus on companies to show they were meeting the compliance and transparency standards required of them.

For that to happen, companies must change their mind-set, particularly the smaller players, says Tunis. They’re still stuck in the old way of doing business, based on trust and a handshake, he notes — a mentality that tends to clash with the need for compliance and transparency standards.

But the lenders and suppliers insisting on those standards cannot afford to compromise, he maintains.

“The industry needs to realize it can’t do business the way it used to,” Tunis says. “How they act and conduct their business must align with what the market — customers, vendors and lenders — requires of them.”
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Tags: ABN Amro, Alrosa, Avi Krawitz, Basel reforms, De Beeres, Demonetization, diamonds, GJEPC, jewellery, Jewelry, Rapaport, Signet Jewelers, State Bank of India, WFDB
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