“John Gapper has an excellent column on Thursday about art auctions, focusing on the degree to which they are fixed or obfuscated by insiders and long-standing established practices.
As he notes, the auction market is a duopoly geared towards protecting and serving vested interests through a system of guaranteed bids and sales incentives, which to some degree obscure public price discovery.
Herein lies the similarity with modern market structure more generally. By providing the means to disguise the hands of “informed” players, the duopoly of Sotheby’s and Christie’s behaves like a dark pool system within a wider market which has no public alternative to cross check prices against.
That is to say, it is a public market, but one that’s structured specifically to reduce the impact of the informed players who have most to lose.
As Gapper says:
Art auction houses bring together buyers and sellers in what is at least an approximation of a public market (allowing for tricks of the trade such as “chandelier bids” made up by auctioneers to meet the reserve). Without some transparency at such auctions, the entire market is vulnerable to fraud.
As Gapper also notes, the auction houses will sometimes waive the 10 per cent seller’s fee to secure prestigious works and even offer something of a rebate to the seller for the opportunity to gain his business. Some sellers may demand a guaranteed bid as well, i.e. the promise from the auction house that they will buy their work if a better price doesn’t appear.
Just like in the world of stock market trading the battle is over top quality flow, with auctioneers acting both as the platforms that facilitate exchange as well as market-makers who can internalise order flow and take real risk if and when it suits them.
That market-making side of the business proved risky for Christie’s in 2008. The auction house was left holding up to $50m worth of work it could no longer shift.
But in another parallel with what’s happening with stock markets, the auction houses have learned a valuable lesson. Yes, they still provide guarantees — since those guarantees generate business, flow and help to support prices — but they offset that risk by striking up deals with collectors or dealers.
As Gapper notes:
The latter put up their capital in return for a fee, and a share of takings of a strong auction. Sotheby’s disclosed in April that it had made $279m of guarantees, of which $65m had been laid off to third parties, and the latter figure has since risen.
This, of course, echoes what happens with exchange traded products (ETPs) in regular markets. It’s just that rather than pre-agreeing arrangements in which risk is passed off for a fee, market-makers in regular markets use ETPs as an extremely cheap parking lot for inventory which it doesn’t suit them to budge right away. In fact, it’s better than that. With ETPs institutional money is actually paying the dealers — or the market arbitrageurs — a fee to provide them with the opportunity to absorb flows no-one else wants at that time.
When guarantees are forthcoming (indicated by strong ETP inflows) the dealers can shift ever greater portions of risk off their own books. In the inverse scenario (indicated by strong ETP outflows) the risk passes back to the dealers who are then inclined to dump stock into the market, but with the advantage that they know what’s about to hit the market as a result.
In the art market, Gapper says a sophisticated collector can get a good return form being a guarantor (by sitting on stock). In financial markets, a sophisticated collector of stock, will end up paying the middle man for what is basically the opportunity to liquidate the stock he holds on demand.
Seen from this perspective, the dynamics can to some degree be compared to those of a risk-transferring futures market.
In fact, when it comes to the art market the work of Prof. Rachel Pownall of Maastricht University, argues this point eloquently.
As she notes in a presentation shared with FT Alphaville via John Gapper, the guarantees offered by the business represent formal structures and contracts for transferring risk. This provides the market with the opportunity to introduce further structured products for hedging purposes using an index as the underlying asset if it so desires.
The problem the art market faces, however, is that any such index would suffer feedback loop effects from the products themselves. The more people who invest, the more likely the index goes up in price, irrespective of any physical demand for the underlying products themselves.
But then who needs to enjoy the aesthetic beauty of art if it’s real purpose is providing the world with investment assets that only go up in price?
In that sense modern art is much more Bitcoin than Leonardo.
It also means the more financialised the artworks get, the greater the incentive to have them go dark, ideally by storing and forgetting about them in bonded warehouses in tax efficient jurisdictions.
On that basis we presume a bunch of limit-order, hoard exposing HFT types would not be appreciated in this market either.”‘