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.