Dancing on a Tightrope
January 06, 05 by Chaim Even-Zohar
The Diamond Trading Company doesn’t want to sell rough diamonds to Sightholders who are also mining competitors, but to implement that policy it has adopted a system which may well have serious ramifications on investments in worldwide diamond exploration and mining development. A sightholder becomes a competitor if he controls or is controlled by a mining company and the production volume passes a certain threshold. The resulting de-facto creation of new entry barriers into the diamond mining business – again potential strengthening the dominant position of De Beers – may actually infringe on competition laws.
One can have sympathy with a producer’s desire not to sell to competitors – but I wonder whether a company that already controls (through Supplier of Choice) so much of the downstream behavior of its present and potential Sightholders, doesn’t go too far by also intervening in their clients’ upstream behavior. As long as the DTC only provides a part of their clients' rough requirements, the latter should be allowed to pursue upstream (mining) options.
Much of what De Beers says on this doesn’t seem to make sense. De Beers has confirmed that the new regulations, announced on the eve of the Christmas holidays, have not been formally approved by the European Commission authorities, nor were they required by the EC to begin with (something which had been assumed in some quarters). I naively would have thought that on such legally and commercial intricate issue the DTC would want to cover itself before announcing a policy that it may be forced to review or withdraw a few months later. The DTC’s External Relations Director, the frank and straight (verbally) shooting Rosalind Kainyah clarifies “that the terms of the policy were not dictated by the Commission. When we met with the Commission recently, on our own initiative, to bring them up to date with the progress of SOC arrangements, we brought to its attention our very legitimate concerns about supplying competitors. The Commission officials indicated that they understood and appreciated why we had concerns. The details of the policy were developed by us, having very close and careful regard to our legal obligations and our commercial responsibilities. We therefore believe that the resulting policy is commercially sensible, reflective of standard business practices in many other industries and appropriate in all the circumstances. It is also consistent with the framework and objectives of Supplier of Choice and within the requisite legal parameters,” says Ms Kainyah.
There are quite a few major diamantaires who have made investments in diamond exploration companies or in junior diamond mining projects. A BHP-Billiton subsidiary, Kalahari Diamonds, which shortly is expected to launch an IPO on one of the London stock exchanges, has presently a shareholder register which features some of the largest Indian and Belgian diamond companies as prominent investors. Exploration companies are looking for the downstream diamond industry players to come up-stream, to invest in their projects. The main interest these investors have is that, at some time, in a yet not always clearly defined manner, this will widen their access to rough diamonds.
De Beers knows better than anyone else that one doesn’t walk into Marks and Spencer’s and buys a diamond mine. Mine development is a result of decades of exploration, decades of spending money (with no income, no returns) in the hope to eventually make a great discovery. When spending exploration money, one is not thinking “let’s hope that the mine I may get involved in will not produce more than $25 million a year or represent more than 5% of my annual turnover, because then I would be in trouble with De Beers.”
Let’s look at what the DTC rules actually say: DTC Sightholders will have to declare their material interest – or their lack of a material interest – in a diamond mining company. Sightholders have been advised that they are considered having a “material interest in diamond mining” “if you are a relevant diamond mining business and/or that you control or are controlled by a relevant diamond mining business as a matter of fact and/or law.” In most cases it will be obvious that there is a material interest, but in others more detailed consideration ought to be given to this issue. The DTC puts the onus to decide whether the rules are applicable to any specific sightholder squarely on the shoulders of the clients.
The DTC defines as “relevant diamond mining business/company” any business and/or company where: (1) Over 5% of annual group world-wide turnover is derived from the mining of diamonds; and (2) where over $25 million of annual group world-wide turnover is derived from the mining of diamonds. [Note that both conditions must prevail.]
The quantitative limits are quite easy to establish. To define whether you are in control or being controlled by is a more difficult issue. The DTC explains that control for these purposes means that “one has the possibility to decisively influence the strategic commercial behavior of a diamond mining business or that a diamond mining business has the possibility to decisively influence a sight holder’s strategic commercial behavior.”
To make things slightly more complicated, the DTC cautions its clients that (1) Control can be direct or indirect; (2) Control is not just a matter of law but it is also a matter of fact; (3) Control can result from minority as well as majority shareholdings; (4) Control can be joint or sole, and (5) Control is normally evidenced by persons or business entities which are the holder(s) of rights or are entitled to rights conferring control by virtue of their shareholdings, rights and/or by virtue of shareholder or other relevant agreements.
This control provision, for example, will make it impossible for Harry Winston jewelers ever to get a DTC sight, since it is controlled (51%) by Aber Diamonds, a producer. To be precise, Harry Winston is disqualified because “a diamond mining business with an annual mining production value in excess of $25 million holds directly or indirectly a majority of the voting rights in excess of 50% in the potential sightholder.” [Rosalind Kainyah insists that I stress that these are my own examples and readers may not infer that De Beers is citing these or any names.] Most public reactions in the past week mention both Lev Leviev and Beny Steinmetz drawing the conclusion that the first one is most definitely “out” and the latter is most definitely “in”. Somehow, the dividing line has been drawn in between these companies – and, as it is the sole prerogative of De Beers to decide at what levels it faces competition, that line may become a perpetuam mobile.
The last thing I would ever worry about is the De Beers’ “fear” that it may supply rough to a competitor and that in this manner the competitor will find out “vital confidential data” on De Beers. In practice, that competitor will have to “commercially striptease” and give the DTC an enormous amount of info (through the DTC sightholder profiles) before he would even be considered as a potential sightholder. These (always smaller) competitors have far more reasons to worry than De Beers. But I am not really concerned about.
What scares me is that the very positive trend that we have seen in the past few years, in which “upstream discovered downstream” and vice-versa, may be reversed or come to a halt. The downstream players have become the preferred partners in many exploration and mining development projects, because these partners are reliable long-term shareholders who understand the business, believe in the business and bring valuable know-how to the junior explorer or mining company.
The DTC rules may drive away some of the “most precious investment money” – the money from the major players within the downstream industry which “understands” (and has faith in the future of) diamonds.
Rosalind Kainyah, arguably one of the DTC’s most skillful funambulists, reassures that “there is definitely no embargo on entities engaging in diamond mining to apply to become Sightholders or for those who wish to become Sightholders from seeking upstream diversification. We do, however, believe that it is important to have regard to the full picture here. We do not want to prevent diversification or entry to the DTC client base and we are supportive of new competition entering the marketing. However, where a business has material interests in diamond mining and is effectively a competitor to the DTC, then we need to take into careful consideration the legal and commercial issues to which supply to such a competitor would give rise. This is what we have done - just like any business in a similar position.”
And then she continues: “We did take our time to consider all the relevant factors and use reasonable endeavors to ensure that we have a fair and proportionate policy in place. We are confident in being able to fully respond to any questions from third parties. I do however take your point, and we will do all we can to make sure that the policy is not misinterpreted as an indirectly communicated deterrent to the pursuit of upstream strategies within the downstream industry.”
That sounds like good news (and thank you Rosalind). Let’s now wait and see how this “you can go upstream” message will evolve in practice.