Banking & Finance

Firm bids?

Auction house IPO offers an insight into client defaults

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“Gone to the gentleman in the front row – provided he actually pays”

Brian Sewell’s memoir The Outsider provides a fascinating insight into the workings of the British auction trade in the late 1950s and 1960s. It’s not always a flattering picture. Sewell worked for Christie’s during the period, having been hired because of his training as an art historian at the Courtauld Institute.

On his first day he recalls being asked by his boss if he could identify a painting set for auction. He replied that it was an El Greco, to which his boss groaned “Oh, Gawd”. Why the distress? Christie’s had considered it a painting of little importance and included it in a low-key sale with works the author describes as “comparatively worthless”. Worse, the sales catalogue even attributed it to another artist.

Sewell says the sensible course would have been to remove the painting from that particular auction but a Christie’s boss “obstinately resisted”, instead ordering that a note be pinned next to the frame revising its attribution. At the auction in question, Sewell recalls, no wealthy foreign buyers bothered to turn up and a local dealer scooped up the El Greco. “The mishandling did Christie’s memorable damage,” Sewell reminisces. “It was soon reported that Agnews had sold the painting to the New York collector Charles Wrightsman for double their outlay plus another £100,000.”

A great deal has changed since then, as Sewell is the first to acknowledge. Indeed in the ensuing decades – as professionalism has supplanted the rather amaturish spirit he came across when he joined Christie’s in 1958 – both it and Sotheby’s have become the world’s dominant auctioneers. But this week in Hong Kong, all eyes were on another auction house, this time a Chinese one that could challenge its international rivals. Poly Culture’s Hong Kong IPO raised $331 million, and – wait for it – was 606 times oversubscribed.

Poly is China’s leading art auctioneer and the third biggest globally by revenues. The mainland company is the culture and auction subsidiary of Poly Group (see WiC203), a state-owned conglomerate involved in arms trading, real estate, arts and media, that currently holds assets totalling more than Rmb382.9 billion ($62.56 billion). The cash raised from the IPO will help Poly Culture’s auction unit grow internationally (as well fund the development of its cinema and live performance arm).

Is the investor exuberance justified? Sewell’s account makes plain that auctioning is rife with reputational risks. But in China there’s another risk that should be a concern for those buying Poly shares. In the firm’s prospectus, the ‘risk factors’ include this sentence: “We generally collect auction receivables from the winning bidder after auction.” And the operative word here is ‘generally’. As the prospectus goes on to admit, there is a genuine problem in China of winning bidders not paying up – something the industry terms as default risk. This leaves the auctioneer exposed. In a large number of instances the seller of the art is prepaid, so if the buyer doesn’t pay up Poly faces a loss. “There is no assurance that we could settle all the amount from the relevant buyer in due course, or at all,” the prospectus warns.

One of the most revealing numbers to emerge from the listing document is the settlement rate. This expresses the amount that clients have paid versus the value of items sold under the hammer. Anything below 100% indicates buyer defaults. In 2010 the rate was 74%, but it has declined since then. The most recent figure is for the first 10 months of 2013 when it was 52.9%. That is the say, almost half of the proceeds for items sold at auction went uncollected as buyers walked away or only part-paid for items that they bid for.

Auction houses also find it difficult to seek redress from nonpaying clients, since many can be VIP bidders, or belong to a small cadre of elite collectors.

This isn’t just a problem for Poly. Sotheby’s now takes aggressive measures against deadbeat auction winners. Since 2006, it has filed 13 lawsuits regarding cases of payment default, according to the Economic Observer. Some auction houses also demand deposits from potential buyers as a method of safeguarding sales. But although refundable deposits may seem like a neat solution to the problem, they can spark a backlash from buyers: to be forced to provide one suggests that the bidder may be untrustworthy. As one dealer explained to Bloomberg, “It’s a difficult balance to strike between being stringent with the buyers and not making them discouraged.”

For instance, the lacklustre results from the auction of Sotheby’s Meiyintang Collection in Hong Kong could have been the result of the auctioneer requiring deposits for “premium lots”. (According to Xinhua, of the 77 lots offered, 23 failed to reach their reserve price and did not sell.)

But why is default such a problem in China – and much more so than elsewhere. Excuses for non-payment or delayed payment range from money transfer issues – Chinese banking regulations control the movement of money in and out of country which can lead to delays – to refusals to pay for pieces, claiming that they are fake (as reported in WiC222). One collector has even cited patriotism as his reason for not paying. In a famous 2009 case, Christie’s sold two bronze sculptures to Cai Mingchao, a local art dealer. But after the sale Cai refused to pay. His rationale? The sculptures were looted from Beijing’s Summer Palace during the Second Opium War. His goal had all along been to disrupt the sale of the items at the auction, he later admitted.

Some instances of non-payment appear to be more the result of overzealous bidding. This may be more prevalent in China, where bidders do not want to “lose face” to a competitor or simply get too excited and bid beyond their means. Consequently, people bid then walk away from payment. As inexperienced or nouveau riche bidders start to come to the auction houses, these stories are becoming increasingly common.

Alan Lo, a Hong Kong art collector, attributes the payment problem phenomenon to cultural issues. “With big-ticket items, it’s becoming more and more of a concern with mainland buyers. To a certain extent, they have less of a tendency to follow the rules of the game. Sometimes, it’s not so much about the money. They just can’t be bothered. Their attitude is, ‘I’m such a big customer, I can’t be bothered. Maybe I’ll pay a third now and then another third later,’” Lo told the Economic Observer.

In 2012 Poly Culture started holding auctions in Hong Kong. Some industry insiders think this was an attempt to alleviate the worst of the situation as clients who bid for items in the city are more likely to pay on time. Wang Wenjia, a specialist in Poly’s modern Chinese paintings and calligraphy section, told Bloomberg: “People who come to Hong Kong are more civilised buyers and they respect the rules, so we don’t have a lot of clients who don’t pay.”

Nonetheless, not everyone is willing to travel to buy art, which creates a quandary for the auctioneers: to grow revenues, more auctions have to take place in China, closer to the clientele.

All this means that investors in the auction sector must look beyond the headline numbers. In recent years China has been touted as the largest and fastest-growing market for art sales. But as the European Fine Art Fair points out, 40% of auction proceeds were unpaid or only partly paid (a percentage that tallies broadly with Poly’s figures). The conclusion: “If you deduct that percentage, total sales in the art market for the Chinese mainland will not be number one as the non-payment rate at European and American auction markets is almost zero. So the art market in the United States is still the strongest one.”

Will China’s culture of non-payment improve? Perhaps in the medium term. But in the short term the chances are that default risk will get worse rather than better. A lot of business folk face a cash-squeeze – it’s a no-brainer they’ll default on an art purchase if it means they can still service a loan. The ongoing crackdown on corruption may have consequences too. Those who’ve used the art market as a ruse to bribe officials may be doubly reluctant to pay up for fear of being found out (again see WiC222 for a more detailed explanation of how some auctions have been dragged into the world of graft).

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