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The Case for Transparency – Inventories and Banks

The Case for Transparency – Inventories and Banks

Exactly three years ago, De Beers was in the midst of reviewing applications for the next Sightholder contact period. One item in particular that it required from applicants was compliance with International Financial Reporting Standards (IFRS). IFRS is a common accounting format that includes, among others, a standard stating how particular types of transactions and other events should be reported in financial statements, including the value of inventories. From the standpoint of the diamond industry, this means diamonds – rough and polished. Compliance with IFRS would determine how the value of diamond stocks is reported.

Most diamond firms report their financials according to other accounting standards. Those whose reports do not comply with these other standards (and I must stress here that they are all legal, relevant reporting standards that were selected by the relevant country authorities and qualified company accountants) include an auditors’ comment, stating that they cannot attest to the value of the diamond stocks and are relying on company statements and expertise. Again, these are perfectly normal accounting systems that mean that companies have some leeway in terms of the value of their inventory – be it shoes, art, or any one of many other products. Under IFRS, such a comment cannot be made. If the accountants cannot determine the value of an inventory, instead of asking the company to valuate it, an independent third party will be required to do this.

The banks demanded that the industry move to IFRS, and in my opinion, justly so. It is important to remember that bank financing is what allows businesses in all industries to grow, expand, invest in research, develop their abilities, purchase new equipment, and turn plans into action. In the manufacturing sector of the diamond industry, financing is much-needed oxygen for smooth operations. This is because our expenses are very high, revenue comes in many months after the expenditures are made, and margins are slim. In short, and without any overly-dramatic tone, bank financing keeps the diamond manufacturing sector alive. It is because of this that open and clear communication lines must be maintained between the diamond industry and its financing banks.

The banks have in-depth knowledge about the companies they finance. If the company is a contracted client of one of the major rough diamond suppliers, they have very intimate knowledge about the costs, values, types and quantities of the rough diamonds these clients purchase. Under such circumstances, where banks are very knowledgeable about a company’s business, they have a certain comfort level in providing financing against the value of the inventory to such a company. The question usually arises when it comes to the value of rough diamonds sourced from other suppliers, and the value of polished diamonds. What is the value of these items? Knowing the costs is good, but if goods are in inventory for a while, and it is not unusual for prices to rise and decline, what are they then worth? Further, when buying diamonds, the bank wants to know if the company paid according to market prices. Sometimes, a company pays high prices (because having the goods is important enough to pay a little extra for them) but their inventory value should perhaps be lower - from the bank’s perspective. At other times, a company has an opportunity to buy at a great price, in which case the company has a higher-value inventory that the cost reflects.

Be it longstanding inventory, inventory purchased from other vendors, goods purchased in the market at a variety of prices – everything boils down to a simple question: what is the current value of each and every diamond? If the request for IFRS-compliant reports is implemented, and considering that accountants are not experts in diamond prices, external tools will be needed to determine these values. To be accepted by banks, diamond companies, government authorities and even insurance firms, this third party assessment system should be transparent, in order to be accepted by all. This is possible if prices of all diamonds are known, if the reason for the variations in prices are clear and understood, and if the methods by which the data on prices is collected are verified and monitored. Each and every component of this process requires full disclosure to the market and its stakeholders. In one word, transparency.

As stated here before, when determining a diamond’s value, many factors come to play: demand, availability, urgency of purchase, payment terms, and more. On top of these factors, the price of a diamond is determined by its characteristics, its 4Cs. Combining reporting on the 4Cs with a list of irregularities and their attendant discounts and premiums, as well as regularly-updated data on transaction prices, will create a new level of professionalism in the industry. All stakeholders, not just diamond traders, will know the components determining diamond prices, and will able to track, valuate and understand the current price of every diamond on the market.

Last week, I stated that price transparency will simplify the process of understanding the price of a diamond, and will bring this information to the consumer. This week, I’m extending this up the diamond pipeline. Transparency also extends and strengthens the confidence in diamonds to the banks financing the diamond industry. With a few banks deciding to cease their financing of diamond operations, and others decreasing their financing of the diamond industry, this confidence-building measure can play an important role in bringing back and increasing financing to the industry.

More bank involvement in the diamond industry could be beneficial in a number of other areas, including the creation of a market for diamonds as a possible wealth preservation asset.

A couple of weeks ago, I published an article about a price list system that I have created, the Mercury Diamond™ Price List. This pricing system has all of the components needed to support this move, and reinforce the diamond industry’s position with the banks. The range of transactions we collect is very wide, and includes manufacturers, traders and retailers, all of which reflect polished diamond prices as they are bought and sold around the world. It covers more than 18,000 polished diamond categories across the 4Cs of polished diamonds weighing up to 30 carats, and clarities ranging from Flawless to I3 in colors from D to P. The polished diamond pricing system was reviewed and validated by one of the Big Four accounting firms, and that firm continues to audit the price list monthly to provide an added level of confidence, and to reinforce the pricing system’s integrity. Valuators, banks and traders will not only find the current transaction price of each diamond, but by applying their manufacturing costs, they can also “reverse engineer” to calculate the cost of rough diamonds. This last component will allow banks to check the value of rough diamonds independently, and to provide valuators of rough diamond stocks a verification of their assessments that has the ability to give IFRS accountant reporting the data they need.

To evaluate a free copy of the latest Mercury Diamond™ Price List, click here. Currently, we publish the price list on the tenth of every month. It is also available as a ticker.

Considering the issues that the diamond industry has faced with financing, and considering the desire to improve banks’ confidence in the diamond industry, the Mercury Diamond™ price list offers solutions that we can be confident about. Add to that the difficulties in demand for diamonds in the consumer market, the shortcomings of the current price setting systems available for diamonds, the need to improve consumer confidence in diamonds while addressing consumer confusion over the prices of polished diamonds, as well as the possibility of forming a wealth preservation venue with diamonds, it is obvious that a transparent polished and rough diamond pricing system can greatly contribute to a positive turnaround for us all. Therefore, I urge you to consider the Mercury Diamond™ price list as an important step forward.

         The views expressed here are solely those of the author in his private capacity. No one should act upon any opinion or information in this website without consulting a professional qualified adviser. 

 

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