Sparking the art-backed lending renaissance
When Lorenzo Ghiberti designed the Florence baptistry’s “Gates of Paradise,” he singlehandedly sparked the movement that would become known as the Renaissance. Six hundred years later, wealth managers and family offices are looking for that same spark to set them apart from the competition as they fight to become the provider for ultra-high net worth individuals and families. They need to look no further than Ghiberti and the art market for their inspiration.
The current ultra-high net worth wealth associated with the art market is estimated to be around $1.742 trillion and is expected to grow to $2.125 trillion by 2023 according to Deloitte’s global 2019 Art and Finance Report. Compared to the stock market, or even other alternative asset classes, art is a much more nuanced space for UHNWs to invest in – it is both extremely personal and almost entirely disconnected to the financial markets. But this can offer positives, in volatile market conditions, such as those caused by the Covid-19 pandemic, art can be a safer asset class for investors to pour funds into. Furthermore, not only does art offer a secure investment opportunity, but a growing number of UHNWs are taking the opportunity to unlock liquidity by borrowing against their art (particularly in response to uncertainty as a result of the global pandemic).
According to Deloitte’s Report, 69 per cent of collectors said they would be interested in using their art collection, or parts of it, as collateral. However, wealth managers and private bankers in Europe are not focused on offering art-secured lending services (which typically entail collateralised lending with art as the underlying asset), with only 26 per cent of wealth managers and 32 per cent of private bankers stating that this is an area of focus for 2020. The lack of wealth managers that offer art-backed lending is in huge contrast to the 72 per cent of wealth managers and family offices that offer broader art-related services, such as estate planning (77%), client entertainment (77%), and art philanthropy (67%). By failing to offer art-backed lending services, wealth managers and family offices are failing to take advantage of a rapidly growing and increasingly popular client demand.
This hesitation is due to several reasons, as wealth managers and private bankers perceive art-backed lending as having a high barrier to entry. Concerns over an unregulated art market, lack of market data, a perception of illiquidity, and uncertainty around how to measure and assess risk often dissuade wealth professionals from providing these services.
Some of this hesitation may come from the lack of regulation in the UK and European art markets. This lack of regulation has in turn, given rise to money laundering fears, with Deloitte finding that 76 per cent of wealth managers think money laundering is a key concern across the art market. While Europe is moving in the right direction with the recent AML Directive 5 requiring those involved in an art transaction to carry out KYC and due diligence checks before completing a transaction, there needs to be further steps taken to put regulation in place and increase transparency. Currently, the buying and selling of art in the UK is still dictated by Victorian legislation and art is considered a chattel or movable personal property, while European laws vary from country to country. This outdated way of thinking, and the headache that the plethora of European laws cause needs to be modernised to open up the market.
The United States on the other hand is leagues ahead of Europe, having implemented the Uniform Commercial Code (UCC). This legislation has created a public database that keeps track of art owners who have leveraged works of art – this has the added benefit of allowing US borrowers to keep their art on their walls when they borrow against it, something that UK-based borrowers are unable to do. As the UCC has made it easier for borrowers to secure loans, the United States currently dominates the art-secured lending market, with 90 per cent of the market centred in the US.
Increased regulation will create greater transparency in the art market as more data is publicly available. The creation of a central database that can track who owns a work of art, and if it has been borrowed against, is crucial in increasing this transparency. While unlikely, a borrower in the UK could potentially borrow against a work of art that has already had a loan taken on it, and not repaid back due to the lack of a centralised database. If a work of art has already been leveraged, the case would then end up in court, adding to the headache for the borrower. In addition, a central database can allow for price transparency that provides price results and valuations for buyers and sellers. An increase of data in the market will only serve to change the perception that art is an illiquid asset and lead to more confidence in art-backed lending services.
Wealth managers and family offices need to be able to measure and evaluate the risk of artwork their clients might be looking to buy or borrow against. This is a major concern as according to the Deloitte report, 71 per cent of private bankers said that the difficulties associated with measuring and assessing risk was the key challenge to providing art-secured lending services. Assessing the risk of artwork can be especially tricky when wealth managers must keep in mind valuation, authenticity, condition, ownership and market dynamics.
With presently issued art-secured loans accounting for only 2 per cent of the $1.742 trillion UHNW art and collectables global private wealth today, wealth managers and private bankers need to close this gap between demand and the services they can provide in order to take advantage of the market. By replicating the conditions of the financial markets through greater regulation and transparency, increased data to navigate liquidity, and tools to measure the risk of borrowing against a piece of art, private wealth borrows can spark their own renaissance, just like Ghiberti did, through art-backed lending.
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Harco van den Oever is the CEO of Overstone, founding the company after spending 12 years in capital markets and 12 in fine art. Read more about him here.