Louis Edgar is a family-owned premier fine diamond house and bespoke jeweller headquartered in Melbourne, Australia. The business was established in 1964 by Louis Leblanc - who is an immigrant from Montreuil, France, and a third-generation jewellery design artisan - and his wife, Miriam Edgar. The business started from a small workshop in Bourke Street, Melbourne, but now has nine showrooms in metropolitan Melbourne, Sydney, Perth, Brisbane and Adelaide. Louis Edgar's approach is to sell quality, ethically sourced diamonds to retailer jewellers and direct to the public.

Louis Edgar has been sourcing diamonds from dealers and certified diamond importers who are specialists in sourcing and importing diamonds directly. All the diamonds it acquires that are 0.5 carats and over are certified by the Gemmological Institute of America (GIA), are of premium grades (in terms of carat size, colour, clarity and cut) and sell at premium prices. As required by consumer law, Louis Edgar must ensure that its customers are aware whether the diamonds are GIA certified and, if so, that they are supported by the relevant documentation. All stones have been sourced from suppliers that have a good understanding of their supply chains and support sustainable procurement.

Louis Edgar is also an Authorised Partner for Rio Tinto's Argyle Pink Diamonds, which have soared in value following the closure of its Argyle mine in Western Australia in November 2020. A large proportion of Louis Edgar's purchases comprise loose diamonds that can be used to make bespoke pieces and are calibrated in size and shape for specific applications.

The business operates four workshops across Australia that are staffed by a team of 102 skilled artisans and master jewellers. When working within each of the Louis Edgar workshops, all artisans and jewellers must adhere to the safety rules that are posted on the main door and throughout the workshop.

To offer more personalised services and targeted marketing, Louis Edgar runs two e-commerce platforms - a business to-business (B2B) platform and a business-to-consumer (B2C) platform, on which private customers can browse a wide range of stones and create shortlist before making an appointment for an obligation-free viewing.

In 2016, Louis and Miriam's son, Peter Leblanc, joined the business and was later appointed as the Chief Executive Officer (CEO) in 2018 when his parents retired.

The diamond industry has experienced significant shifts in recent years. Although industry performance and growth improved in 2022 from 2021 due to the recovery from the COVID-19 pandemic, the second half of 2022 was dominated by geopolitical tensions, high inflation and economic instability, which resulted in a squeeze on margins. Further, changing consumer preferences, higher costs and interest rates, and decreased savings have negatively impacted discretionary sales. These challenges are predicted to remain throughout 2023. To remain competitive and grow, the sector must find solutions to these issues and capitalise on new prospects. For one, the less-expensive, lab-grown diamond business is expected to grow, particularly in urban areas, and consumer source verification is also expected to become an increasingly relevant concern.

As a proactive measure to secure reliable supplies of quality diamonds and mitigate price volatility, Peter is negotiating an exclusive, three-year supply contract (exclusivity is restricted to Australia) with White Nile, a manufacturer and international supplier of polished diamonds, headquartered in New Delhi, India.

White Nile is a multi-generational family business headed by Ankita Rahman, whom Peter met at a diamond conference in Dubai in early 2022. White Nile sources rough diamonds from various producers in Botswana and has its manufacturing operation in Gaborone, Botswana. Its polished diamonds are sold through its service houses to wholesalers and retailers in New York, Dubai, Hong Kong and Shanghai. White Nile believes in sustainability and ethics and conducts its own due diligence over human rights at its manufacturing operation as well as over its supply chain annually. In July 2022, Ankita invited Peter to tour its manufacturing operation and Peter was impressed by the craftsmanship and technology employed at White Nile's factory.

In return for exclusivity of supply, except for Argyle Diamonds, Louis Edgar must not purchase from other sources without explicit approval from White Nile. This arrangement opens up a new market for White Nile, with minimal effort and cost. As with all international diamond trades, the diamonds will be paid for in US dollars (USD).

Louis Edgar does not employ any financial instruments to mitigate its exposure to fluctuations in the USD. Louis Edgar's Finance Director, Adrian Edgar (Peter's maternal uncle), considers financial instruments too expensive and complex to derive profit from. Instead, he maintains a level in the USD account based on historical trade cycles. Due to the Australian dollar unexpectedly falling to 62 cents against the USD in October 2022, the business suffered substantial foreign exchange losses, which hurt its working capital and forced Louis Edgar to increase its debt funding to levels just below its bank debt covenants.

Louis Edgar's debt structure changed dramatically when it successfully acquired two extremely rare diamonds at the final Argyle Signature Tender in October 2021 - a Fancy Intense Pink Diamond and a Fancy Vivid Purplish Pink Diamond. The acquisitions would raise Louis Edgar's debt levels to an all-time high and increase its debt-to-equity ratio to 0.72; however, Peter was convinced of the potential profits from selling the investment-grade diamonds and believed the opportunity would raise Louis Edgar's profile, and so convinced the Board to proceed with the tender. Furthermore, the Finance Director was confident that the business would be able to fund the interest payments since interest rates were at an all-time low.

As at December 2022, Louis Edgar had still been unable to sell the rare diamonds. The holding costs of the rare diamonds, especially following a series of interest rate hikes were becoming unmanageable. In response, Peter commissioned White Nile to tap into its deep networks and sell the diamonds. In April 2023, the diamonds were successfully sold at a silent auction in New York for a total of USD$16 million. However, the return net-of-cost was only 13%, which was too low to justify the transaction risks.

The cash from the sale of the rare pink diamonds has allowed Louis Edgar to consider new business opportunities. At the recent Board meeting, two ideas for opportunities were discussed:

1. Lab-grown diamonds

According to a report commissioned by the Antwerp World Diamond Centre (AWDC), the less-expensive lab diamond business is expected to grow as younger diamond buyers, who are the main purchasers of diamonds for engagement rings, are drawn to them by price and for environmental reasons. The growth is expected to continue as more jewellers start to sell lab diamonds. Further, technological advancements in this space have allowed producers to grow better quality diamonds more rapidly and more cheaply.

There are two methods of making lab diamonds:

The first method is via high pressure and high temperature (HPHT), where the diamonds are produced by simulating the conditions that form natural diamonds in the earth. Upon completion, a distinctively shaped, lab-grown diamond crystal is created.

The second method is known as chemical vapour deposition (CVD). It incorporates the disintegration of molecules of a carbon-rich gas, like methane, into carbon and hydrogen atoms. Following, the atoms are deposited onto diamond seeds, resulting in a square, broad and flat diamond crystal.

The Board is considering acquiring a small lab diamond business called New Diamonds, owned by a Melbourne-based gemmologist couple since 2014. The business operates fully online and does not have any brick-and-mortar stores, and caters to customers in Australia, New Zealand and South Korea. New Diamond employs three jewellers, three designers, eight sales staff and an accounts person. The owners are responsible for sourcing lab diamonds from around the world and the business markets itself as providing more sustainable and ethical options to mined diamonds. The owners source diamonds based on quality of the stones and do not critically examine the origins of the diamonds.

The owners of New Diamonds are seeking to sell their business as they are planning to emigrate to Italy.

2. Tech-Trace app

During lunch with a friend, Peter learned of Tech-Trace, a leading Israeli technology and service provider that offers an app for tracing diamonds, both natural and lab-grown, from their origin and journey through the supply chain. The app tracks and stores diamond producers' inventory data and the movements of diamonds they produce. Given it is expected that consumers will increasingly prioritise sustainability and ethics alongside the traditional attributes of design, quality and price, Peter is keen to implement this app into Louis Edgar's supply chain.

You are a newly employed management accountant in Louis Edgar's finance department. The Finance Director has asked you, as a qualified Chartered Accountant, to prepare a risk-focused response for inclusion in the finance department's semi-annual risk monitoring and review reporting pack for the board.

Required:

Review Appendix 1 - Louis Edgar's Risk Appetite Statement.

Draft response covering the following:

In a table, address the risk management strategies to address financial and non-financial risks affecting an organisation. 1. A review of Louis Edgar's current risk management analysis and evaluation:

(a) Identify and explain four (4) misaligned areas between Louis Edgar's risk appetite statement (RAS) set by the Board and Louis Edgar's current risk culture.

(b) For each misaligned area identified in 1(a), recommend a change to address each misalignment.

(c) Advise on two (2) additional risk categories that should be included in Louis Edgar's RAS and explain why these additional categories are important to Louis Edgar.

(d) Identify one (1) key risk for each of the risk categories identified in 1(c) and recommend how to mitigate each risk.

2. In relation to the opportunity for Louis Edgar to acquire lab-grown diamond business, New Diamonds, identify and explain two (2) risks and two (2) opportunities that Louis Edgar could face that specifically relate to the potential acquisition of New Diamonds.

3. For safety risk and compliance risk:

(a) Describe two (2) controls that can be implemented for each risk.

(b) For each control, state the control objective and explain how the control would mitigate the risk identified.

Appendix 1: Risk Appetite Statement Louis Edgar Since 1964 1. Risk - Strategy Risk Appetite - Moderate Description - Risk of potential failures in strategic planning and decisions, which may lead to Louis Edgar not achieving its core objectives or adversely affecting Louis Edgars financial position and/or performance.

2. Risk - Environmental, social and governance (ESG) Risk Appetite - Low Description - ESG factors impact the risk context for Louis Edgar. These include, but are not limited to, procuring diamonds that are not ethical or sustainably sourced, and not conducting proper due diligence on the businesss supply chain integrity.

3. Risk - Financial Risk Appetite - Low Description - Louis Edgar will avoid practices and investments that may result in financial instability or adversely affect the business. Louis Edgar will maintain a debt-to-equity ratio of no more than 0.5 at any one point in time. Louis Edgar will actively manage polished diamond price fluctuations resulting from exchange rate movements.

4.Risk - Internal capability Risk Appetite - Low Description - Louis Edgar is committed to ensuring that industry expertise and trusted networks are maintained to ensure high-quality products. 5.Risk - Supply chain Risk Appetite - Moderate Description - The supply chain network could be disrupted by geopolitical tensions, closure of mines, natural disasters, sabotage, social unrest and other factors. These disruptions could impact stock quality and levels through shortages and/or significant delays.

6.Risk - Commodity Risk Appetite - Low Description - Risk that products offered for sale do not meet consumer preferences, adversely impacting discretionary sales.

7.Risk - Safety Risk Appetite - Low Description - Louis Edgar is committed to ensuring all stakeholders in the value chain have safe work environments. 8.Risk - Compliance Risk Appetite - Low Description - Louis Edgar must comply with laws, regulations and Standards relating to health and safety, intellectual property rights, anti- corruption, employment and human rights, and trade sanctions.