5 Issues to Watch in the Diamond Industry

1 The Future of Memo

The liquidation of Whitehall Jewelers wasn’t pleasant for the industry. But it’s quite possible it could have taken the rest of the industry down with it.

Whitehall, then owned by a hedge fund and a bank, engaged in a prolonged legal war over ownership of the chain’s millions in consigned goods. The chain contended that since some of the UCCs were not “perfected,” it could sell those goods to its benefit. Many thought, if Whitehall prevailed, it would have changed how the trade dealt in consignment.

The industry eventually retained ownership of its goods, but it was a clear warning that the rules had changed. One of the lawyers involved in the fight, Lawrence Ginsburg of Moses Singer, predicted that, with non-traditional players like hedge funds increasingly playing a role in the industry, these fights will be more common.

“This is no longer a handshake industry,” he said. “You are dealing with people who, if things go bad, will use every angle. We won the battle with Friedman’s. We finessed the battle with Whitehall. Next time, we may not win. Be careful. Be cynical. We are in a different world.”

He warned attendees not to give out diamonds to people “they don’t know.” (This is, nevertheless, very common.)

Another lawyer, Joseph Vann, of Cohen Tauber Spievack and Wagner, suggested lobbying Congress for legislation that protects the industry’s consignment rights.

2 Banking on the Banks

Earlier this year, Fortis won control of Dutch bank ABN Amro, and its famed Diamond and Jewelry Division, which supplies an estimated 30 to 40% of the industry’s financing. Then Fortis ran short of cash was taken over the government of Belgium, and ABN Amro – including its diamond division – was put for sale.

At press time, it wasn’t clear who its new owner was – or whether there would even be one. Regardless, that division seems headed for three owners in one year – a sorry situation for the leading bank in the industry.

There may be future shocks in the banking sector. No one doubts that, in this tough environment, credit will be tighter. Banks are raising interest rates and losing patience with long receivables. Borrowing criteria is toughening up.

And if banks drop out, there might not be people to take their place. The industry is unappealing to many lenders: It is considered non-transparent and vulnerable to money laundering by government agencies like FinCen.

In short, it looks like the jewelry bank sector is consolidating – much like the industry itself.

3 The Future of Beneficiation

First came the calls from the beneficiation – having diamonds cut in the same countries where they were mined. Then came the implementation. And now comes the growing pains.

Beneficiation has barely started, and already there have been a string of labor disputes – including a strike at the Namibian factories of Israeli manufacturer Lev Leviev, who has been cutting in Africa for years and arguably fathered the trend. In South Africa, the government’s State Diamond Trader, intended to distribute diamonds to local manufacturers, is in turmoil, with its longtime CEO resigning. Embarrassingly, a De Beers sight had to be cancelled because of a licensing dispute. And the changes in South Africa might not be over: some are now suggesting the government retain ownership of the country’s mines, as we see in Botswana and Namibia.

Clearly the issues are emotional. Many Africans feel they have not been getting true value for their diamonds – and wonder why people in India, Israel, Belgium and China have gotten rich cutting “their” output, while many African countries remain poor and have double digit unemployment. But people in the industry feel that they are being penalized for the sins of the past, and too much is asked of them. Recently, manufacturers were upset when a former head of Debswana, the joint De Beers-Botswana mining company, suggested foreign companies be forced to relocate their head offices to Botswana.

It’s worth nothing than the success of “beneficiation” is not a forgone conclusion. Labor and other costs in Africa are significantly higher than in low-cost manufacturing centers like China and India. Still, the political will to “add value” is there, and isn’t likely to go away. And the “beneficiation” bug has already spread to less developed countries like Angola and Sierra Leone.

4 Tenders

It used to be that diamond industry had one model for selling stones: De Beers “sight” system, where it gathered a pre-selected group of customers, and the prices, and selection, were set by the seller.

That model has been adopted by other producers – most notably, Rio Tinto, and its “Select Diamantaire” program. But there are now other models, and it’s changing the way the industry does business.

The most popular alternative model is a tender, where diamonds are sold via auction. Even De Beers is experimenting with this model – its subsidiary Diamdel now sells parcels of rough over the Internet.

Still, many manufacturers don’t like the tender system, arguing it’s easier to plan for their factories when you have a steady, reliable supplier.

BHP, owner of the Diavik mine in Canada (and possible merger partner with Rio), has even come up with a hybrid model, which combines the bidding of auctions with the reliability of a sight. In BHP’s system, a “market reference price” is set by an online auction. Manufacturers then bid for two year contracts, where they agree to pay a certain percentage of that price for a pre-selected range of goods.

BHP’s model is extremely complicated, but it’s being touted as a more open and transparent system that lets the market sets prices. Executives say they would like to see it spread to the rest of the industry.

And yet, in the current “down” climate, many tenders have not done well. So perhaps the “sight” system has some logic after all.

5 The Diamond Development Initiative

The “conflict diamond” issue is mostly over—but the repercussions from it remain. The issue brought attention to the approximately 1.5 million artisanal diamond diggers in the world today, mostly in Africa, but also in Latin America, and even Russia. They produce an estimated 10 to 15% of the industry’s production.

Since the artisanal sector is basically unregulated, it’s open to abuse. The diggers are often paid less than one dollar a day. The mines are full of child labor. Environmental and safety issues are ignored. The miners are prone to disease and other ills. And all the money produced by these diamond fields is rarely funneled back to the local communities.

The Diamond Development Initiative is the now-two-year-old group, made up of both industry and NGOs, designed to look at these issues, and hopefully, come up with a solution. It recently appointed its first full time executive director, Dorothee Gizenga.

The DDI is working on several projects right now. It’s created new standards for the artisanal sector in Sierra Leone. There is also “Children Out of Diamond Mines,” which is focused on the Democratic Republic of Congo. Right now, 36,000 children work in DRC diamond mines. The DDI wants to incentivize these children to seek alternative employment and means of support; it’s focused on one specific area with 7,000 child miners.

These are delicate issues, which will not be solved overnight. But Gizenga notes that, if this sector is reformed, it will impact not only the 1.5 million diggers, but millions of others who depend on them. “We are potentially talking about an impact on 15 million people,” Gizenga says.