De Beers and Russia Present New Proposal to European Commission
November 11, 04De Beers and Russia Present New Proposal to European Commission
November 11, 2004
Chaim Even-Zohar
Sometimes patience pays off. The conditions for getting a new marketing agreement between Alrosa and De Beers presently seem a great deal better than they have been for quite a while. Though it isn’t yet “in the bag” – it certainly is on its way to getting there. There are four factors that make a big difference.
1. Since May 2004, there are greatly simplified procedures for getting European Commission approval.
2. Those executives within Alrosa who were not really supportive of a continued relationship have been replaced with individuals who want to continue to work with De Beers.
3. Alrosa and De Beers have now presented the EC with an entirely new proposal, quite different from the initial trade agreement for which approval was requested.
4. Alrosa has closely tied its ability to raise money on the European bonds market to securing an agreement with the EC. It has “locked itself in” – Alrosa cannot afford not to work with De Beers for the foreseeable future and it will make sure that the EC will have sympathy for that situation.
Let’s look at each factor a little bit more closely.
Under the original system in which the EC would grant a so-called “negative clearance” (under Article 2 of Regulation 17), which is basically a comfort letter, the EC certifies that “on the basis of the facts in possession, there are no grounds under the Article 81(1) or 82(2) [which are the two main competition provisions defining the abuses of dominant power and other competition infringements] for action on its part in respect of an agreement, decision or practice.” This process was a lengthy one, often exhausting too many of the human resources of the Commission.
The previous rules have now been replaced by Council Regulation 1/2003. The “negative clearance” process under Article 17 was found to be unbalanced and replaced by a new set of rules which will give much greater legal clarity and which are more in tune with the national legal systems. [It must be recalled that the EC approval of Supplier of Choice has the distinct “honor” of having been “voided” by a Belgian court.]
Article 9 of the new Regulation 1/2003 makes life much easier. Under the heading of “commitments”, the article says basically that if the Commission wants to end an “infringement” (i.e. if the EC wants to stop a violation of competition laws), and the parties involved agree to end the violation (in this instance the parties are De Beers and Alrosa), and if the “undertakings concerned offer commitments to meet the concerns expressed by the Commission”, the Commission “may by decision make these commitments binding on the undertakings. Such a decision may be adopted for a specified period and shall conclude that there are no longer grounds for any action by the Commission.”
What this means is that if De Beers and Alrosa find a way to do business that the EC believes is not harmful to the diamond market, it will simply give the green light – after following a rather speedy approval process.
Last week the parties presented a proposal for a four or five year agreement with a reduced level of sales by Alrosa to De Beers. It includes figures: the first year $800 million, next year $700 million, the following $600 million – and so down. The figures were not confirmed to us; but the principle was. If the Commission thinks the proposal is acceptable – and that is not yet the case at the moment -- the following procedure must be followed:
The EC would issue a notice (Article 27(4) of the new Regulation no 1/2003) in the Official Journal explaining the case, the commitments offered by Alrosa and De Beers, and asking market operators or other interested parties if they think this is a good solution to the antitrust problem and whether it remedies the problems of the market adequately. To quote the regulation: “Interested third parties may submit their observations within a time limit which is fixed by the Commission in its publication and which may not be less than one month.”
Once the EC has received these comments, and provided these confirm that the market perceives these commitments as a good thing, the EC would issue a Decision (Article 9 of the new Regulation). The latter would be a 'commitment decision' which is a new instrument the EC has under Regulation 1/2003 which can make commitments legally binding on undertakings.
The EC will still have the right to reopen the proceedings and withdraw the approval, but only under three very specific circumstances: (1) If there is a material change in any of the facts on which the decision was based; (2) If either De Beers or Alrosa act contrary to their commitment; or (3) If it turns out that the decision was based on incomplete, incorrect or misleading information provided by the parties.
A word of caution is in order. There is now a new proposal on the table and the EC hasn’t studied it yet. So the original trade agreement, for which Negative Clearance had been sought, is, for all practical purposes, “dead” – this is a new ballgame now. A game with new rules – and a much easier game to play - provided that the diamond market considers a De Beers-Alrosa deal to be good for the business.
Alrosa needs the deal – and it needs it especially so it can place a new $300 million (ten year) dollar bond in the euro market. A few years ago Alrosa placed $500 million in bonds that are maturing in 2008. These bonds pay an annual interest of 8.125%, which is enormously high, and they can still be purchased in the market at 102%, making for an effective return of more than 7.4%. The new 10 year bonds will give an effective yield of 8.85% - quite a high return (in dollars) for today’s market. Why doesn’t the market rate the Alrosa bonds higher? After all, the sum is guaranteed by all Alrosa’s assets. The financial markets want to see Alrosa tied to De Beers – that will give the market the confidence to hold and trade in Alrosa bonds.
In a confidential document recently handed to potential bond investors, Alrosa explicitly notes that it will not support any EC decision that might require "a significant reduction or termination of our sales to De Beers." The financial prospectus also contains an Alrosa threat – which certainly will not go unnoticed in Brussels – that a refusal by the EC to approve a deal "could cause significant disruption in our export sales and a corresponding adverse effect on our revenues." [See the JP Morgan and ING Bank Prospectus given to prospective bond purchasers.]
De Beers and Alrosa have confirmed that in recent years – while they are trading on a willing seller and willing buyer basis since the 5-year $4 billion trade agreement has not been approved – the deliveries to De Beers have followed a downward trend. De Beers purchased $868 million worth of Alrosa diamonds in 2001 and this steadily decline to $635 million in 2003. In the first half of 2004, Alrosa’s sales to De Beers fell another 7 percent to $279 million, compared with $300 million in the corresponding period of 2003.
It is no secret that in the past few years Alrosa has given different signals to the market regarding its intentions with De Beers. Recently, a high level Alrosa delegation visited Israel, giving rise to hopes that it was exploring possible sales channels through this market. It is hard to get a clear picture of what Alrosa really wants – but this makes the statements made in support of a bond issue of vital importance. Alrosa cannot say one thing and then act differently – not when you want to improve your financial ratings in the market. Some sources claim that the replacement of German Kuznetsov, who was one of Alrosa’s most vocal anti-De Beers executives in Moscow, may have paved the way for the pro-De Beers forces within Alrosa to regain the upper hand.
London sources, in recent weeks, seem to exude considerable optimism. As the DTC will soon have to set the rough allocation levels for the first half of next year (the Intentions To Offer), it is a fair bet to say that these will be based on continued Russian supplies. That’s certainly good news for Sightholders – and new applicants. Whether the entire diamond market thinks this is a good thing is exactly the question the EC will soon be asking interested parties.