Few issues in the diamond industry raise more concern than financing. Bank financing is what allows most businesses to expand, overcome temporary cash flow hardships, purchase new equipment, make long-term plans and execute programs. If in many industries a popular figure of speech is, “Bank financing is oxygen” then in the diamond-manufacturing sector of the industry, financing is, quite literally, oxygen. It keeps the manufacturing sector alive.
Diamond manufacturing and wholesaling requires great flexibility and agility. Many balls are in the air at any given time and manufacturers, with their razor-thin margins, can use all the help they can get. They enlist whatever they can and at times, sadly, this has skirted the boundaries of legality.
Skirted? A few times creative accounting and financial “ingenuity” crossed deep into areas where they did not belong. The worst cases, such as round-tripping, were standouts. However, diamond industry financing banks have complained about subtler, and apparently, more widespread approaches that caused them to call foul, although usually in a hushed voice. There were some exceptions that arrived at courts, or situations that were not reported by the media when banks asked clients to take their business elsewhere. Although they were exceptions, still they were red flags to which we all should have paid attention.
[two_third]In the recent past, that has changed. Basel III requirements, the rising cost of lending, higher risks and other issues are forcing banks to change their approach. With a growing need for transparency, banks want their borrowing clients to adopt corporate accounting standards that would make it easier on them to understand what is happening in a company – how the financing is used, what is bought and where the goods are going, and to track buyers and their payments to understand how the money is flowing in.[/two_third][one_third_last]
“Basel III requirements, the rising cost of lending, higher risks and other issues are forcing banks to change their approach.”
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I’ve reported about this in the past, calling the banks the New Custodians of the market. They took responsibility for the situation in several ways (including a decision to cut back on financing Sight purchases) and started to lead a change that may eventually result in a far healthier industry.
New De Beers contract “rigorous on the financial side”
Enter De Beers. The veteran diamond firm is no stranger to change and leading deep fundamental changes in the industry and there is really no need to list them here. The company is now in the process of reviewing its Sightholder contracts for the next contract period and as part of that, it is engaging the Sightholders in a series of discussions on the shape and components of the new contract and the selection criteria.
As was already revealed, the heavy in-depth questionnaire (AKA, the dreaded CPQ) is gone. An important part of selecting Sightholders for the next contract period is demonstrated demand – essentially, purchases in the past. Full compliance with ethical standards as detailed in the Best Practice Principles (BPP) is already a mainstay of these contracts and now another requirement is about to be added – compliance with International Financial Reporting Standards (IFRS).
According to a source in De Beers, the new contract will be “more rigorous on the financial side,” setting a higher bar for financial compliance criteria. IFRS is a set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements. It is not clear how much of a cue De Beers took from the banks, but they have obviously consulted on the topic.
One standout point in this regard is how the value of diamond stocks is reported. Those whose reports are not IFRS compliant, have a comment by the auditors that they cannot attest to the value of the diamond stocks and are relying on company statements and expertise, which means that companies have some leeway in terms of the value of their stocks. Such a comment seems to not be IFRS compliant.
If De Beers implements a requirement for IFRS – compliant reports, such a comment is not acceptable and auditors will need to sign on the value of the stock. Because they are not diamond experts, external assessors may be needed or auditors may rely on internal inventory management software, all of which will result in narrowing a company’s ability to play with the stock’s value. Another aspect of the proposed financial demands includes a company’s leverage and debt ratios. One idea on the table is that the turnover-to-equity ratio will be 20 percent. For very large companies, those with an annual turnover of hundreds of millions or billions of dollars, that could be a tough requirement to meet as it would be for dealers who turn their money 10 times a year.
If adopted, the new, more rigorous reporting standards may usher in a new era for the diamond industry not only because of what will happen with the Sightholders, but also further down the line. The new standards will trickle down to other companies because they’ll be interested in applying for a Sight, because the other main suppliers – Alrosa and Rio Tinto– will also want their clients to comply, and maybe because of a demand that the clients’ clients meet firmer financial standards – just as Rio and BHP Billiton did with RJC compliance.
[two_third]For De Beers, this is essential. It needs financially healthy clients and does not want to lose clients to high-flying accounting gymnastics. The details have not been ironed out yet, but it is understood that while tightening financial standards, De Beers may still choose to be “reasonable” in its demands. How, and in what way it aims to be reasonable is not clear. Will it sign-up clients who don’t report based on IFRS and ask them to make the transition within a period of time? Will it be satisfied with a statement of intent to switch to IFRS at some point, expecting clients to ease into the stricter reporting standard?[/two_third][one_third_last]
“The diamond miner has an excellent opportunity to lead a positive if not essential change that is profoundly needed.”
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I hope this is not the case and that De Beers insists on making these changes. The diamond miner has an excellent opportunity to lead a positive if not essential change that is profoundly needed. With a positive wind blowing in from the leading diamond financing banks, these central forces have the power to push the diamond-manufacturing sector to stand on sounder financial foundations.
