Art as collateral: Credit default swap derivatives in banking

Rachel A. J. Campbell1
Maastricht University

First draft: Comments welcomed

Abstract There has been a recent increase in demand for banks to securitize lending using alternative assets to back loans. In this paper we propose the use of credit default swap derivatives to transfer the underlying risk from alternative assets used as collateral whose risks are difficult to estimate and are therefore undesirable on the balance sheet. We focus our analysis on art lending and the use of art as collateral. We propose the introduction of art credit default swap contracts (ACDS) as a means to transfer the undesirable risk from holding art on the banks balance sheet, in accordance with Basel requirements; and analyse the resulting relationships of ACDS derivative contracts for efficiency in the banking sector.

All errors pertain to the authors. Corresponding author: Assistant Professor of Finance, Dr. R. A. J. Campbell, Maastricht University, PO Box 616, 6200MD Maastricht, The Netherlands. Tel: +31 433884827. Fax: +31 433884875. Email: r.campbell@berfin.unimaas.nl.

1. Introduction

Wealthy individuals are often asset rich and cash poor. With their capital tied up in assets they tend to want access to asset backed loans. Asset backed securities (ABS) were first introduced in the US in the 1970s in the form of Mortgage Backed Securities. More recent forms are Automobile Backed securities and Credit-Card Backed Securities. These loans all have the underlying asset as the collateral in case of credit default. However the move towards art backed loans has been slow. This is mainly due to the inability to correctly assess the risk from changes in the price movements of art. Since the collection of a number of price indices this is now becoming easier. Price movements may be more easily tracked for the art market in general, however the art market is made up from heterogeneous goods, where the value of an individual artwork is still difficult to evaluate.

In the arts sector a famous example of securitization was the issuance of loans using royalties as cash flows. Another example is the recent move by some private banks to make loans against yachts as collateral. At present only City bank holds this type of risk on its books. Estimated currently at only $80 million. Sothebys also offers an art lending facility. Some museums, like for example the Bonnefanten Museum in Maastricht, artworks can be leased. This is enhancing the rental market for art, particularly in the modern and contempory art sectors, providing an additional return to art prices.

The major problem for banks in the introduction of plain vanilla Art Backed Securities is the management of the art risk. At present the market is highly illiquid, which makes daily

management of art risk almost impossible at market prices; a requirement of the Basel accord for banks capital requirements.

However, through the introduction of art credit default swap contracts (ACDS) banks can transfer undesirable art risk from holding artworks on the banks balance sheet to a third party is willing to hold the art price risk. In return for doing so, a premium is paid. The risk from incorrectly pricing the derivative contract is substantially smaller than the risk from holding the underlying art risk. Hence, providing an efficient solution to transferring risk for the banking sector.

The outline of the paper is as follows. In the following section we introduce art as an alternative asset class, and the characteristic risk and return profile of art. In section 3 we discuss art lending and the inefficient nature of the current practise. In section 4 we show how risk management tools can be adopted to transfer undesirable art price risk from banks to third parties who are willing to protect the bank against the credit default risk on art backed loans because they are willing to buy the art held as collateral at a guaranteed price in the case of default. This insures the bank against adverse movements on art markets, in times of high credit default probabilities. The introduction of this financing structure would result in a more efficient market for lending against art. The mechanism behind the trilateral financing structure is addressed in section 5, with the introduction of art credit default swap contracts (ACDS). Pricing equations for these ACDSs are introduced in section 6. Conclusions are then drawn in the final section, section 7.

2. Art as an asset class

There has been a variety of studies devoted to the estimation of art indices to guage average returns in the art market. Data goes back as far as the 17th century. Art is far too general a term to generate any meaningful analysis, therefore much as traditional assets are categorised, we limit the discussion of art to visual fine art: paintings, drawings and sculpture rather than the performing arts.

There are three main methodologies for producing art price indices. Average prices, repeat sales reression and hedonic regression. Chanel, Gerard-Varet and Ginsburghs study indicates that over long periods the respective methodologies are closely correlated2. Also see Mei, Moses and Ginsburgh (2006) forthcoming paper which looks at the differences in the modelling processes

of the various types of index construction.

Goetzman (1993) points out the selection bias derived from looking only at repeat sales on auction house data. Repeat sales regressions require artworks to put on the block at least more than once to be included as a repeat sale. It is thought that artworks which fall drastically in value tend not to be resold at auction.

The information from databases that collect sales information are problematic for a number of reasons3. Ashenfelter and Graddys (2003) study contends that an empirical discrepancy in one year can materially alter the overall rate of return by up to 5%. Campbell & Pullan (2005)

2 3

O Chanel, et al The Relevance of Hedonic Price Indices Journal of Cultural Economics (1996) 20, 1-24. See Ashenfelter and Graddy, (2003).

also find evidence of this phenomenon for the more recent Mei & Moses All Art Index compared to the General Art Index of Art Market Research for the period 1976-2004.

In table 1 we have provided a summary of the approaches to data collection, extended from an excellent survey by Ashenfelter and Graddy (2003). Average real returns are generally regarded to be significantly lower than for stocks, but higher than inflation and government bonds. Table 1 provides an overview of the average returns and standard deviations for the main studies cited in the literature for art price indices which have been constructed.

Insert Table 1

Behavioural aspects have implications for the cyclicality of the indices. In a boom, artworks sell quickly at prices above their reserve prices and often far above price estimates. In periods of downturn or in bust, artworks not reaching reserve prices are bought in without sale. These observations result in prices being less flexible downwards than buyers offers. McAndrew and Thomson (2003) try and model the left hand tail of the distribution to produce a continuous distribution for modelling art risk for risk management purposes. Data problems arising from these issues have resulted in a lack of loans provided using art as collateral.

3. Art Lending

At present the market for lending against art is inefficient. This is partly due to the inefficient nature of the art market, and the lack of illiquidity in the market. This results in the use of art backed loans as highly risky forms of loan securitisation, with a low percentage of the

artworks value being used as a guarantee for the loan, and also large spreads appointed to credit. In a bilateral agreement for the case of a loan using art as collateral, the bank would normally assign a higher interest rate on the loan as compensation for holding the art price risk stemming from holding art as collateral on its books. Given the highly volatile, illiquid and lack of transparency in the global art market the rate the rate of interest on the loan would certainly occur at a premium. For an overview of art lending practices currently on offer, see Table 2. Insert Table 2

For example Art Capital Group appoints rates in the mid-teens for loans using art as collateral. The large spread covers the additional risk of holding art on the balance sheet, and the associated art price risk.4 A risk which has to be correctly accounted for in daily risk management purposes, as set out in the Basel accords. A further consequence of the greater risk inherent in art prices is that the price at which the art is valued for as collateral is likely to be significantly lower than its market value. Due to inefficient pricing in the art market, a suboptimal amount of lending occurs in the market for asset backed loans, when art is used as collateral. The inefficiencies from the art market are likely to be carried over to the financial sector resulting in an inefficient market for asset backed loans incorporating art as the reference asset in the loan.

By entering into a trilateral agreement, banks are able to transfer the risk of fluctuations in the price of art art price risk. Therefore additional capital is not required for Basel requirements, and the only risk which the bank holds on its books is the default risk on the art credit default swap (ACDS). The structure is conditional on the bank only entering into an agreement with a
4

Citigroup and Bank of America offer existing highly valued private clients a lower spread, often with other assets also required as collateral. Up to 50% of the value of the artwork is adopted as collateral.

credit worthy party. Such a structure would then result in greater efficiency in the capital market for asset backed loans.

4. Risk management to transfer art risk

In managing the art risk for loans using art as collateral, there is a role for a third party to create greater efficiency in the market. As with all financial engineering, and the resulting products, there is a benefit of transferring risk away from the party not willing to hold the risk, to the party who is willing to hold this risk. One way of transferring the art risk off the banks balance sheets is through the introduction of a credit option on the art loan.

Basel II At present the new regulations on risk management practises, from the Basel accord and Basel II mean that banks need to be able to adequately estimate all risks associated with changes in asset prices. The difficulty in being able to estimate and monitor risks associated with art price changes mean that banks are unwilling to hold art price risk on their balance sheets. Since the introduction of the Basel accords banks would prefer to remove liabilities which require a high allocation of capital. At present banks are required to hold 8% of their liabilities as capital. For more risky positions then a higher percentage is required.

5. Art credit default swaps (ACDS)

Credit default swaps (CDS) are contracts which provide protection on the par value of a specified reference asset, where a protection buyer pays a periodic fixed fee or a one off premium to a protection seller, in return for which the seller will make a payment on the occurrence of a specified credit event. (See Hull and White 2000 and Chaudry 2004). In this particular case the bank is the protection seller and another third party, who has an interest in buying the reference asset, is the protection buyer.5 In this case the underling asset is a specific asset, the artwork or the art collection held as collateral on the loan, commonly known as the reference asset. The third party is willing to accept the art price risk for a premium and enters into a contract with the bank which entitles him to also buy the reference asset at a set price if a credit event is triggered. In this case if the reference entity, (the art collector), defaults on the loan. On occurrence of the credit event, the swap contract is terminated and a settlement payment is made by the protection seller, to the protection buyer. The settlement payment in this case is the exchange of the reference asset for a set termination price as specified in the contract from the third party to the bank.

Since the lender has covered his loan with his artwork as collateral, the credit event being triggered, is also contingent on the price of the artwork falling below the outstanding loan payments. At the beginning of the loan agreement the value of the artwork to the bank, used as a guarantee, is the current value of the loan. This is likely to be set as a percentage of the

In a credit default swap going long is to buy the swap, where the buyer purchases protection and pays the premium. The buyer of the credit default swap is frequently referred to in the market as shorting the reference asset.

current market valuation of the artwork.6 Only if the artwork falls below this guaranteed price and the lender defaults on the loan is the credit event triggered and the protection seller has the obligation to buy the artwork at the set price. Since the value of the loan must be less than the market price for the artwork, in order for the credit event to be triggered, the bank with the long position in the ACDS is necessarily out-ofthe-money. This is a necessary requirement for the third party to be obliged to fulfil his obligation on the contract and buy the artwork for the guaranteed price. The risk is transferred from the bank as long as the termination price for the artwork is set at least equal to the outstanding value of the loan.

An Art Credit default swap can be used to enable banks to transfer unwanted credit risk exposure to a third party. In this case the use of risk management techniques transfers the default risk from the loan backed by art off the balance sheet. Since the art is held as collateral the bank is subject to changes in the value of the artwork, and carries art price risk. The benefit is that the bank can make a loan using the art as collateral, however can transfer the risk from holding the art as collateral. By writing a credit default swap on the loan, in case of default on the loan, the bank removes the risk of carrying the art on its books. The underlying value of the art is therefore not required for the banks to fully monitor, and importantly is not required to be tracked for risk management regulations stipulated in the Basel accords for capital requirements.

The basic premise is of course that the bank is able to find a buyer for the art credit default swap. At present parties who would be willing to want to hold such a derivatives contract would be Art funds, (or in the form in which they are more likely to emerge in future, Art

Such guarantees are commonly used by auction houses as percentages of the market value in auction sales, commonly referred to as the reserve price.

mutual funds7), Art Museums, or from a more speculative disposition, by hedge funds, institutional investors, or wealthy individuals wanting to expose themselves to art price risk; willing to pay a low premium for the small probability of being able to buy a wealthy artwork or collection at a fraction of the cost. See Table 3 for an overview of the current art funds on offer. Insert Table 3

The main steps for the financing structure introduced here are as follows:

1. The bank issues a loan to the art collector, with the artwork as collateral. The value of the artwork is estimated, and as is currently the practice, a price is guaranteed on the art, as a percentage of the current value. See figure 3. The bank carries the art risk on its books in lieu for giving the loan. Commonly the uncertainty in the value of the art would be reflected in a high interest rate on the loan; manifesting itself in an inefficient market for asset backed lending.

2. The bank, not wanting to hold the risk of art price fluctuations on its books, issues an art credit default swap (ACDS) to a third party. If the reference entity (art collector) defaults on the loan the bank has the right to deliver the reference entity to the seller in exchange for its face value. This is set at the face value of the loan.

The bank buys protection by taking a long position in the ACDS, but actually shorts the reference asset. The bank therefore transfers the risk of holding the art as collateral in exchange for the credit risk on the ACDS. If the third party is not sufficiently rated,

See Campbell and Pullan (2005) for an overview of the art mutual fund industry.

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the bank may want to enter into a funded credit agreement, and therefore mitigate all risk on the banks books; otherwise if the party is creditworthy it is likely that the bank will be willing to carry the credit default risk of the ACDS. 8

3. The maturity of the reference asset, in this case the loan backed with art as collateral, need not be the same as the maturity on the loan.

4. On the credit event being triggered the ACDS is terminated and the protection seller (third party) makes a payment to the protection buyer. In this case the bank sells the artwork(s) at the termination value, calculated at the time the contract was specified, to the third party. See Figure 1 for an example of the art finance structure. The default occurring is contingent on the market price of the artwork falling below the outstanding loan payments. Otherwise the art is used by the bank in its primary role as collateral, its market price able to cover the value of the outstanding loan.

Insert Figure 1

Another premise for the structure to work is that the ACSD is priced correctly. The risk to the bank is now the correct pricing of the ACSD, which is substantially lower than the risk from holding the artworks on the banks books. In the following section we shall discuss pricing the ACSD.

Many art museums have issued a variety of tax exempt bonds for financing solutions, requiring credit status to be acknowledged.

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6. Pricing art credit default swap derivatives

We follow Hull and White (2000) for the valuation of credit default swaps. As is common in the literature, we assume that default probabilities, interest rates, and recovery rates are independent. The procedure is two-step. Firstly the probability of the reference entity defaulting on the loan must be estimated. Risk neutral probabilities are assumed. The present value of the expected payoff must also be calculated. We also require an estimation of the expected recovery rate in the event of default. In the structure proposed here this can be set to the face value of the loan, plus any accrued interest.

The loan is initially set as a percentage (x%) of the value of the artwork or collection of artworks. At present the common practise is to use a maximum of 50% of the current market price of the artwork to back the loan. The idea of this financing structure using the ACSD is to ensure protection of the art price. We can therefore use a much higher percentage, even up to the full value of the artwork if the collector is of high credit quality. For the example here we shall take the guarantee at 80% of the value of the art (PtArt) at time, t=0.

Art Pt Loan =0 = x% Pt = 0

(1)

Default is contingent on the full price of the artwork at time, t, falling below the outstanding value of the loan at time, t.
Pt Art Pt Loan

(2)

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From equation (1) this is simply equal to the guaranteed percentage on the initial value of the artwork. 9
Art Pt Art x% Pt = 0

(3)

The probability of default is simply the probability that the price of the artwork falls below the percentage of the artwork guaranteed at the initial market value of the artwork at time 0, then the value is negative, giving rise to default potentially occurring on the loan. To value
Art this we therefore require the Pr ob Pt Art x% Pt = 0 0 . This is equal to equation (4).

Art Pr ob Pt Art x% Pt = 0

(4)

To estimate the Expected Credit Loss (ECL), measured by the drop in value due to the possibility of default we simply multiply the probability given in equation (4) by the amount recovered, the price of the reference asset at the time of the default, time t.

Art ECL = Pt Art * Pr ob Pt Art x% Pt = 0

(5)

The premium which is paid by the bank for protection by the third party is equal to at least the present value of the ECL from entering into the ACDS contract. To transfer the art price risk the bank needs to correctly price the ACDS. Given risk neutral probabilities to ensure the bank does not overpay for the protection against changes in the value of art prices the price paid must be set equal to equation (5). This is small in relation to the initial market risk on holding the art.

If this happens the borrower would rationally default on the loan. Status in holding the art and reputation may result in him not actually defaulting.

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There is a small additional probability that the client will not default on his loan even though the guaranteed percentage of the artworks price falls below the value of the outstanding loan, and it would appear optimal to default on the loan. This is due to the additional value the collector places on owning the artwork, or collection and his reputation. The actual probability of default will therefore be marginally less than denoted in equation (4). This probability needs to be weighed against the credit position of the collector, in the case that he is forced into sale of the artwork to cover the loan.

To find this probability and the resulting ECL we require an understanding of movements in underlying art prices. We can use empirical data to find these estimates. Due to the skewness implied in the distribution due to the effect of reserve prices in auction sales data, we assume a symmetric normal distribution using the upper tail probabilities also for the downside and assume a symmetric non-skewed distribution for pricing.

Present numerical example illustrating the properties of the model and estimating spread volatilities from historical data.

The price of the ACDS depends crucially on the probability of the lender defaulting on the loan. The higher the probability of default the greater the value of the ACDS. Also the price of the underlying reference asset set in the contract will affect the value of the ACDS. The lower the price set for settlement for the artwork the higher the value of the ACDS.

Default probabilities requires a credit rating on the individual, as well as on the third party buying the ACDS derivative. The default risk on the ACDS is removed if the product is

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structured as a funded instrument rather than an unfunded instrument, as described here. This choice is dependent on the credit ratings of the two parties involved.

The credit event occurs if the lender defaults on the loan. This would then trigger the art credit default swap and the third party who has received a premium to sell the protection on the price risk of the reference asset would have the obligation to buy the reference asset, the art, at the contractual price. The bank is therefore able to protect itself against art price risk changes in the value of the art, held as collateral on the banks books. It transfers the risk and is left holding the risk of default on the credit swap. This has a number of advantages.

As already stated the major advantage is risk transfer and reduction of total risk. The spread on the loan is lower. Risk is transferred away from the bank, not wanting to hold art price risk, and to the holder of the long position of the ACDS, who is willing to hold the risk of the art price losing value. He gains as the reference asset is then obtained more cheaply. Although exposed to negative movements in the price of art, these are therefore to his benefit. Positive movements in the price of art are favourable to the lender, since the value of the collateral backing the loan increases in value. In the case where the lender would have to default the positive movement in the value of the artwork would render a positive payoff covering his outstanding loan.

7. Conclusions
Art lending and art finance is in its infancy. However, due to both the demand for greater asset backed loans, involving art as collateral, and the willingness of a credit worthy third party to carry art price risk, such as through the emergence of Art funds or a museum, banks

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are now able to transfer undesirable art price risk off its balance sheets through the use of art credit default swap derivative contracts. The structure presented in this paper outlines the concept and highlights the necessary requirements for the introduction of lending against art in practice. Financial engineering improves efficiency in the banking sector, resulting in risk transfer and lower spreads paid for loans using art as collateral.

At present the market is in its infancy for pricing ACDSs. Pricing problems which may occur due to dependent default functions are therefore not yet relevant, however are likely to become an issue once the market becomes more established.

Moreover, the derivatives market for art may bring the necessary liquidity to the art market which would deregulate the market and in turn fuel the move towards greater investment in art as an alternative asset class.

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8.

References

Campbell, R., and J. Pullan, 2005, Art Mutual Funds, Forthcoming: Mutual Funds: An International Perspective, Springer Verlag. Chanel, O., 1995, Is Art Market Behaviour Predictable, European Economic Review 39, 519-527. Chaudhry, M. 2004, Structured Credit Products: Credit Derivatives and Synthetic Securitisation, John Wiley and Sons. Frey, B. S. and R. Eichenberger, 1995, On the Rate of Return in the Art market: Survey and Evaluation, European Economic Review 39, 528-537. Grard-Varet, L. A., 1995, On Pricing the Priceless: Comments on the Economics of the Visual Art Market, European Economic Review 39, 509-518. Ginsburgh, V. and P. Jeanfils, 1995, Long-term Co-movements in International Markets for Paintings, European Economic Review 39, 538-548. Ginsburgh, V. and J. Mei and M. Moses, 2006. Prices and returns for arts Forthcoming Handbook on the Economics of Arts and Culture Elsevier. Goetzman, W. N., 1993, Accounting for Taste: Art and the Financial markets over Three Centuries, American Economic Review, 83(5), pp 1370-76. Goetzman, W. N. and M. Spiegel, 1995, Private Value Components, and the Winners Curse in an Art Index, European Economic Review 39, 549-555. Hull., J. C. and A. White, 2000, Valuing Credit Default Swaps I: No Counterparty Default Risk, Journal of Derivatives, vol. 8, no. 1 Fall, pp 29-40. McAndrew, C. and R. Thompson., 2003, Pre-sale Estimates, Risk Analysis, and the Investment Quality of Fine Art, Working paper Southern Methodist University.

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Mei, J. and M. Moses, 2002, Art as an Investment and the Underperformance of Masterpieces American Economic Review, December 2002, 92(5), pp 1656-68. Mei, J. and M. Moses, 2005, Price Estimates and the Future Performance of Artworks, October, Journal of Finance. Pesando, J. E., 1993, Art as an Investment: The Modern Market for Modern Prints, American Economic Review 83, no. 5, 1075-1089.

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Table 1:
Author Anderson (1974) Stein (1977) Baumol (1986) Frey & Pommerehne (1989) Sample period Type Artwork 1780-1960 1780-1970 1946-1968 1652-1961 1635-1949 1653-1987 1950-1987 1981-1988 1915-1979 1971-1991 1700-1961 1977-1992 1977-1993 1716-1986 1850-1986 1900-1986 1971-1992 1962-1991 1962-1991 1855-1969 1855-1969 1946-1966 1972-1992 1907-1987 1983-1994 1966-1994 1875-2000 1900-2000 1950-2000 1976-2004 General Painting General Painting General Painting General Painting General Painting General Painting General Painting Old Masters Impressionists Old Masters General Painting Modern prints Picasso General Painting General Painting General Painting 19th century US Masters Other paintings General Painting General Painting 19th century Random selected collections Modern-Contemporary paintings Picasso General Painting General Painting General Painting General Painting Repeat Sales Repeat Sales Repeat Sales Art Market Research Index 6.11% Hedonic Hedonic Hedonic Repeat Sales Hedonic Repeat Sales Repeat Sales Repeat Sales Repeat Sales Repeat Sales 3.2% 6.2% 17.5% 9.30% 12% 8% 6.2% 11.0% 10.6% 8.24% 3.89% 8.57% Method Hedonic Repeat Sales Assumes random sampling Repeat Sales Repeat Sales Repeat Sales Repeat Sales Nominal return Real return 3.30% 3.70% 10.50% 1.25% 1.80% 6.70% 10.59% 5.93% 12.30% 2.60% * 3.00% * 7.80% 0.55% 1.40% 1.50% 1.60% 3.20% 2.80% 6.04% 0.91% 1.51% 2.10% 2.0% * 19.94% 23.38% 5.65% 6.50% 5.28% 5.30% 5.00% 4.70% Annual SD

Frey & Serna (1990) Deutschman (1991) Buelens & Ginsburgh (1992) Pesando (1993) Goetzman (1993)

Agnello & Pierce (1996) Barre et.al. (1996) Chanel et.al. (1996) Fase (1996) Goetzman (1996) Candela & Scorcu (1997) Czujack (1997) Mei & Moses (2002)

3.25% 5% * 1% * 4.9% 5% 7.50% 1.10% 2.42% 0.21% 2.99% 4.90% 5.20% 8.20% 4.28% 3.55% 2.13% 8.27%

Campbell (2005)

* As many of the surveys report nominal returns, Ashenfelter & Graddy calculated the real returns as follows. For the Anderson and Baumol studies, an annual inflation rate of 0.7 was used. This number is based on Baumol's estimate of inflation during the 300 year period of his study using Phelps-Brown and Hopkins price index. Goetzman's estimate of inflation during the period of his study (also based on Phelps-Brown and Hopkins) is 1.2%. French price inflation between 1962 and 1992 according OECD statistics was 7%.

Source: Ashenfelter & Graddy (2003), Burton & Jacobsen (1999) and the respective articles of authors listed in table

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Table 2: Art Lending

Art Lending
Due Diligence and Valuation Private Banks Negotiation

Credit Committee Risk assessment

Sign off by credit Committee.

Completion Signing
Wiring Funds

Implementation

Assess client credit and

ability to service debt.

Discuss structure and terms with client

Art Lending Platform

Research the artist and the market.

Draft loan documents

Assist Bank with assessing risk. Participate in presentation to Credit Committee. Help client understand Bank lending conditions

Perfecting security interest art works. Arrange storage in secured facility.

Monitoring Collateral

Arrange valuation and Assist with negotiating monitor valuation methodology terms with client. to ensure standards of compliance. Review ownership documents, export licenses, insurance, title. Confirm authenticity, provenance and condition. Undertake search with Art Loss Register

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Table 3: Overview of Art Funds

Overview of Art Funds

ArtVest
The Fine Art Fund

More like a syndicate than a fund, this Swiss based group of collectors is buys art together in the hopes of selling at a profit at some later date.
Only fund currently up and running. Has raised close to $200 million to invest in 500 works in 4 categories including Old Masters, Modern, Impressionists and Contemporary. seeks to raise $100 million by year end to buy and sell American fine art.

American Art Fund

China Art Fund

Hopes to raise $100 million to purchase Chinese Art targeting developing wealth in China who wish to collect their artistic heritage. Planned launch in 2005 with up to $200 million for post war and contemporary art.

Collectors Art Fund Fernwood Art Investments Plans to launch two funds in 2005. Raising $150 million for a sector fund to buy art and an opportunity fund finance art transactions. Plan to launch a series of Artist Pension Trusts, a product designed specifically for artists providing pension planning. First fund dedicated entirely to Russian art set up by Ukraniun Russian mining billionaire Vicktor Vekselberg.

Mutual Art

Russian Art Fund

Source: Business W eek, by Toddi Gutner, 14 February 2005

13

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Figure 1: Art Credit Default Swap (ACDS) Relationship between the parties involved in an Art Credit Default Swap and the transfer of risk.

Art Collector

Loan Art as collateral

Bank buys protection long ACDS

Bank
Third party sells protection for a premium - short ACDS Loan default risk Art price risk

Art Fund / Museum

Loan default risk

Art price risk

ACDS default risk If default occurs: ACDS exercised and artwork traded at termination price

Default on loan triggers ACDS

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