Rival attacks Rapaport's diamond plan

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Martin Rapaport, founder of the world's largest diamond-trading platform, will this week begin the open diamond tenders that will pave the way for a regulated futures market by the start of 2009. But his main rival says it will not work.

The four-day auction that starts on Monday marks the start of the monthly internet-based sales of individual stones that Mr Rapaport's New York-based company hold. Data from these tenders will form a pricing index from which he plans to develop diamond-based futures contracts overseen by the US Commodity Futures Trading Commission.

Derivatives for commodities such as gold and pork bellies have long existed, but the absence of reliable pricing data so far has held up their application to diamonds. The huge variation in value between different stones is part of the problem. But appetite for diamond derivatives is strong, with a market worth $200bn a year by some estimates.

"When you break that wall between the financial sector and physical diamond sectors, a cornucopia of opportunities is going to open up," Mr Rapaport says.

Transparent pricing would end the secrecy that has until now decided prices behind closed doors. It would also remove resale opportunities for the many intermediaries found between manufacturer and retailer. Diamond derivatives would allow retailers and manufacturers to hedge against future needs – important, given the surge in demand from India, China and the Gulf region – rather than buying up large inventories to ensure supply. Industry debt has doubled in the past four years to more than $12bn, largely through the buying-up of inventories.

Nonetheless, Mr Rapaport's system is "intellectually flawed", says Charles Wyndham, founder of website polishedprices.com, which publishes price data from a number of diamond traders and is separately in talks with ABN Amro bank to create derivatives.

The narrow range of stones Mr Rapaport will offer in his September tenders – those of one-carat in size and certain grades – will not permit extrapolation of prices for all stones or take into account the weighting of different types of stones according to their frequency, Mr Wyndham says. Tenders are also susceptible to manipulation, he says.

Mr Rapaport says it is easy to spot distortions in a tender process. He concedes that his system does not solve all the problems, but says it is a start. "The imperfection here is real. It begins the process of mitigating issues of risk management and finance," he says.

Copyright 2007 Financial Times