The Revolution in Gold Jewellery Inventory Funding

Gerhard Schubert, Precious Metals Expert

My involvement in the international precious metals markets goes back 36 years now and I was waiting this whole time for a development like this with far reaching consequences for the jewellery industry. However, let us have a look at the current opportunities for gold jewellery inventory financing. Firstly, there are the bullion banks (international and local Banks) that have always been willing and able to lend against the balance sheet of the jewellery company on a fully secured, partially secured or completely unsecured basis. The jewellery companies have most of the time offered to pledge the jewellery in their shops and vaults in favour of the lender but the reality is that the financial institution has no control over the “security” as the goods are outside of their reach and influence.

The main worry of credit and risk officers in Banks is that if hard times befall the jewellery company, they might decide one day to not open their shops and could have left the premises with all the jewellery in question gone. This is the reason why most Banks are looking to securitize these working capital loans against other assets within their control (Cash deposits, Stand-by letter of credit). After the world financial crisis, beginning in 2008, the securitization of gold loans was nearly exclusively done on a fully secured basis, until the end of 2013. A significant relaxation of access to gold loans saw a lot of loans in 2014 benefitting from leverage on sometimes very generous margin levels. A cash deposit is obviously the most preferred and best asset from a Banks point of view, as a Standby Letter of Credit (SBLC) shifts the risk from the jewellery company to the SBLC issuing Bank. This in turn requires credit limits for the issuing Bank and the eventual yield will be diminished, as a risk weighting premium will be internally administered at each Bank for taking risk on another Bank.

Secondly, another way for jewellery companies to fund their inventory is through the advance of capital from the owner/owners of the company, with all the relevant capital implications.

Thirdly, the tagging of jewellery allows wholesalers and other big jewellers to entertain larger consignments with other jewellery shops and/or increases deferred sales, subject to Brinks acceptance of these other locations.

Now, let me describe the “new” Gold jewellery funding scheme in a little more detail. The underlying technology in the so called “RFID tagging” technology is not new and was already a part of the jewellery industry of Dubai in the late 2000’s. However, the inclusion of the RFID technology as being just one part of the solution made the breakthrough possible.

There are four constituents involved who are the jewellery company, DMCC Tradeflow, Brinks and the Bank. The jewellery company is inspected by Brinks to evaluate the possibility of their shops being recognised as a so called Brinks vault outside the Brinks main vaults. This means that Brinks will investigate each shop for suitability and security features and install a link so that Brinks can monitor each shop 24/7 on a “live” basis from their control and monitoring centre in Almas Tower. Brinks will then make the RFID tags and training available to the shops, who in turn secure each piece of jewellery with a uniquely numbered tag and enter all the details of each individual piece of jewellery onto the database. Brinks are therefore solely responsible for the RFID technology in question, which in Dubai is provided to Brinks by TJS (The Jewellery Store). Brinks will then audit the newly tagged stock to check it was processed correctly and then on request from the jewellery company, Brinks will issue a warrant including all details of the tagged jewellery in the shop in question. This warrant will subsequently be registered on behalf of the jewellery company onto DMCC Trade flow, a government registry for moveable assets. The Bank can at this stage decide to be registered on the DMCC Trade flow system with full ownership or lend against a pledge of this specific warrant. This obviously has balance sheet implications for both jeweller as well as the Bank. Warrant is then pledged or title is transferred to the Bank after a financing agreement has been formed and signed between them. This will cement the beneficial ownership of the jewellery in question in favour of the money advancing party. The Bank can then release the financing to the jeweller after the DMCC has endorsed the pledge.

To make this perfectly clear: Banks will only get involved once the warrant with all the details of the jewellery (most importantly the exact fine weight of gold) is registered and appears on the DMCC Trade flow system. The staff of the jewellery shop will “sweep” twice a day (Just after shop opening and before shop closing) with handheld devices for scanning the inventory in the shop. This information is relayed to Brinks and from there to the funding institutions.

There are, in my view, three main benefits for Banks involved in this scheme:

Firstly, there are no more requirements for banks on assign a financial value to the gold, which they will lend to the jewellery company, as it is fully secured against gold at all times. Therefore it does not matter one bit if the gold price goes to USD 2000 per ounce or falls to USD 800 per ounce.

Secondly, the Banks will have daily updates of the funded inventory and most importantly, a Brinks guarantee, if anything irregular should occur. This includes reports from their monitoring station or their ongoing physical random audits to the shop. The bank is also secured that the pledge against the warrant can only be released with the acknowledgement and cooperation of the lending Bank.

Thirdly, the risk for the bank, in a case of default, will shift from the jewellery company to Brinks, as Brinks is guaranteeing the funding scheme, excluding force majeure and bankruptcy. You should note that a client declaring bankruptcy and remains in the country has never happened in the history of the jewellery market in Dubai. However if it does in the future, the lending Bank will have a significantly stronger legal enforceability, due to the registration of these movable assets into the DMCC Trade flow (DMCC is a Dubai Government organisation) system.

Each Jewellery company needs to have three agreements in place and that would be an agreement with a Bank about funding against the scheme, including details like LTV, regular purchases or restocking of inventory to hold stock levels within agreed boundaries. Another agreement would have to be the agreement with the DMCC to gain access rights to the DMCC Trade flow system and of course the service agreement with Brinks.

Let me mention just one last but not unimportant detail. The jewellery company will have an immediate gold price risk at the point of sale in the shop and it is up to internal policies on how and when to cover this risk, as long as it does not contravene the agreement with the funding bank. It is easily imaginable that Banks might be willing to extend LTV’s of up to 90 per cent for gold jewellery pledged in this scheme. This scheme should be suitable for all Banks and not just for so called “bullion” banks as it provides a perfect platform for lending in a commodity trade finance environment, without the risk of double or triple pledges etc.

There have been many attempts during my time in the bullion market to make inventory financing simpler and more secure, but this is the first time that I see all components in place and it can only work if all constituents of the scheme play their part as described above.

These are exciting times and this will be a game changer for the industry. The idea of transporting the scheme into countries and states other than Dubai will require exact tailor-made solutions fit for other legal jurisdictions. Nevertheless, I am certain that these efforts and attempts will be well worth it and it would be good to see that jewellery companies in other countries will also be able to benefit from this development. This process is already well on its way in other parts of the jewellery world. This way of refinancing reduces the huge outlay for gold in order to produce jewellery, leaves most of the time only the difference between LTV (gold weight) and the making charges as upfront cost for the jewellery company to stem.

Lastly, I believe that the “traditional” ways of securitizing gold loans, like cash deposits, SBLC’s or other asset backed solutions will still play a vital role in the industry, but it is clear that a new player in the pack has emerged.

Disclaimer: Views are personal and not the views of the publisher.