Diamond exchange idea floated

The diamonds business is a lucrative industry. Global diamond jewelry demand grew 2.9 percent to $81.4 billion in 2014, according to diamond miner De Beers.  

If longtime Cayman jewelry maker Dennis Smith’s plans come to fruition, Cayman could well take a share of that market.  

Smith is pitching the idea that Cayman would be an ideal trading hub for diamonds, with a focus on serving the United States, the largest consumer market for diamond jewelry in the world. 

According to his project, diamond firms in Cayman could develop an active and substantive business presence based on the import-export of diamonds and value-added services supporting the industry’s supply chain before finished goods enter the U.S. market.  

These value-added services could include anything from compliance, certification and trading to gem cutting and valuations. Marketing and supply chain management services could also be executed from Cayman, potentially leading to the creation of many new local jobs.  

While more than 80 percent of the world’s diamonds are cut in India, the country only supplies 32 percent of the U.S. market, Smith says. “A diamond trade center in the Cayman Islands would give them same day access to the U.S. and enable their American clients to visit the Cayman Islands on business and return home the same day.”  

South African diamantaire Ernie Blom, president of the World Federation of Diamond Bourses, believes, if handled correctly, Cayman could become a very important exchange.  

Cayman could emulate the Dubai Diamond Exchange, which launched in 2000, and has become a huge success story, he says. “They have now got a 40-story building and they are turning over $34 billion in 15 years.” 

Blom says this is mainly due to the tax-free status of the exchange and because of the ease of doing business, as well as the professional support that is available there.  

“I think that is the same that Cayman can offer. And Cayman feeds into the North American continent, which is the biggest consumer and will be for a long time to come.” 

Unlike Dubai, which is located near the bottom end of the supply chain between the African supply of rough diamonds and Indian manufactures, the Cayman Islands would be placed at the final, high-value aggregation point for the industry’s global supply chain.  

In the region, Panama already opened a similar diamond trading hub four years ago and recently launched the Panama Diamond Exchange with a view to cater to the South American consumer markets.  

The Panama exchange aims to attract some 200 Latin American companies and another 200 international businesses from the U.S., Israel, India, China and Russia. The plan is to generate more than $3 billion direct and indirect income per year by 2020. 

For multinational luxury firms that are frequently registered in Cayman, adding a tangible value-added activity here could also validate any substantive presence requirements, if international rules around tax and intellectual property are tightened in the future. 

 

Positive industry outlook  

The prospects for the industry as a whole are largely positive.  

South African company De Beers controlled the diamond industry for more than 100 years. Founded in 1888, the diamond miner produced 90 percent of the world’s rough diamonds for much of that time and therefore controlled the supply in the industry.  

But over the past few decades, the fortunes of the sales monopoly have changed. The miner’s share of global production volumes declined from 80 percent in 1980 to between 30 and 40 percent today.  

This makes de Beers, which is now part of Anglo American, still the biggest producer by value, but Russian company Alrosa has become the largest producer by volume. 

Other players like Rio Tinto and BHP Billiton also have sizeable chunks of the industry, however, both mining groups have recently been looking for buyers of their diamond interests. 

Blom says De Beers’ previously monopolistic market dominance was not healthy for the industry. “What you have now is a scenario where there is no one company that can control the market. It is consumer demand that is driving the market.” 

Most of the demand for diamond jewelry is coming from the U.S., closely followed by China and India. Compared to other commodities like iron ore or copper, diamonds are less susceptible to supply shocks that can disrupt prices. Likewise, there have been no new significant diamond discoveries in the past 15 years, and in the medium term output, is even forecasted to decline slightly.  

Despite expectations that consumer demand will continue to rise, especially in China where half of couples that are getting married buy diamond rings, prices have dipped recently.  

But in the long term, diamond prices should rise, as the supply curve continues to widen. 

According to Blom, projections show a $10 billion shortage in terms of supply, as a result of growing consumer demand and lack of new big mines coming onto the market. 

 

Banking   

One of the issues the diamond industry is facing is that banks are still hesitant to lend to the niche market.  

Erik Jens, the CEO of ABN Amro’s Diamond & Jewelry business, widely considered the largest lender to the industry, says the industry needs to improve its “bankability” and reputation because regulators still regard the industry as high risk.  

This classification means that a bank’s diamond business is subject to more extensive and more expensive reporting. As a result, the number of banks serving the industry is relatively small and in some areas too small. 

Jens told industry publication Rapaport News in March that banks are willing to support the industry, but they are short on capital and have to comply with new regulations.  

These rules also have an effect on the bank’s clients. ABN Amro introduced a new program this year to make the transactions of its clients and their inherent risks more transparent. The program, which also addresses the notoriously late payment practices in the industry, effectively demands that the bank’s clients become more corporate-like and well governed, and it forces diamond companies to meet International Financial Reporting Standards.  

Blom agrees that banks are demanding more transparency, that they want to track transactions before and after they happen and that they want to make sure the valuations are correct. But he says the diamond industry is working with banks to draw up a global template that the banks understand and diamond traders subscribe to. 

He also notes that three new banks from Dubai have come in to serve the industry. 

The issue for the industry is not so much the overall availability of credit but the way credit is granted in different parts of the supply chain. Mining companies get paid days in advance at one end of the chain, while retailers buy with 120 days credit. 

ABN Amro’s Jens therefore suggests that the industry needs to think of new structures, like special purpose vehicles or asset-based secured lending solutions.  

Such innovative structures for the diamond industry could bring Cayman into play. Smith argues that diamond and jewelry firms in OECD countries are regulated like financial firms under global anti-money laundering guidelines, and have convoluted, industry-specific tax structures with rigid business restrictions. 

“They need a more flexible, first class, compliance and tax-neutral free trade jurisdiction tailored to the industry,” he says. 

 

Diamond bourses  

However, to set up a diamond trading center in Cayman, a number of regulatory hurdles must be overcome. Cayman’s government would have to apply to become a member of the Kimberly Process and set up a special economic zone.  

While there is already sufficient local experience with special economic zones, becoming a member of the Kimberly Process, designed to stop the trade in conflict diamonds, would take at least two years. 

Under the Kimberley Process Certification Scheme, participating states must meet minimum requirements and put in place national legislation and institutions; export, import and internal controls; and also commit to transparency and the exchange of statistical data. 

Only participants in the scheme are allowed to trade in rough diamonds and every international shipment of rough diamonds has to be accompanied by a KP certificate, which guarantees they are conflict free. 

Then the local diamond exchange would have to be accepted by other bourses at an annual Congress of the World Federation of Diamond Bourses.  

Diamond bourses have their own chain of warranties – ethical standards that members have to adhere to – and they have strict arbitration and disciplinary procedures, says Blom, the Federation’s president, who is now in his third term. 

“So if any of our members transgress any of our rules and regulations, they are taken before the disciplinary committee which can give them a warning or suspend them.” If a member receives a warning, the name is posted on the board and circulated globally “and that person is effectively out of the business,” he notes. 

“We are very strictly controlled because of the nature of our products. It is a highly concentrated store of value and it is portable. So we have to look after ourselves.” 

 

Anti-money laundering  

For the same reason, anti-money laundering is an important area that diamond traders need to focus on. The industry has always worried about AML, Blom says, but it has put checks and balances in place and works with the Financial Action Task Force. Given the tight controls of the Kimberly Process, supply chain traceability record keeping, the industry’s own chain of warranties and the lack of cash transactions, money laundering is an issue in theory, but less so in practice, he adds. 

“Do we take cognizance of it? Yes. Do we take precautions to minimize? Of course. Can we ever stamp it out 100 percent? I don’t think we will ever do that but I am comfortable enough to know that my product that my members use, by and large, cannot be used for money laundering.” 

The diamond industry is largely a self-regulatory industry with government oversight of anti-money laundering and the elimination of conflict diamonds. Exports and imports are assessed by government appointed diamond controllers, who check the value, provenance and authenticity of the goods. 

Diamond controllers are thus another stalwart against money laundering and transfer pricing through over- or under-invoicing.  

Still, the industry has a reputation of being opaque or “murky” as the Financial Times put it recently.  

“You can never dispel negative perceptions,” says Blom of the diamond industry’s image problems. Blom, unlike his predecessors, takes as much time as he can to talk to the media.  

“You have just got to combat it all the time. I can prove to anybody the robustness of the diamond industry. It’s a good industry, it’s an honest industry, it’s an honorable industry,” he says. 

Smith admits that the diamond industry used to be very opaque. However, this has changed and Cayman would have to go even a step further if it were to introduce a diamond trading hub.  

“When we open this industry in Cayman, one emphasis will be to make sure everybody understands it,” Smith says. 

“It is the only high-value trade industry that Cayman can develop, where the cost of sending goods from one country to the other is relatively small compared to the value of the package you are sending.  

You can put a million dollars in a FedEx box. Goods are going back and forth all the time.” 

The-Almas-Tower

The Almas Tower is the home of the Dubai Diamond Exchange.

zim-diamonds

Emulating successful diamond exchanges would have to overcome regulatory hurdles and take years. – Photo: Bloomberg
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