The Art Market’s Integrity Conundrum

Aleksandra Trajkovic, Senior Associate in our Intelligence & Investigations team, explores the evolving risk landscape of the art market – and the dilemma of how to regulate it.

Erich Chlomovitch perished in the Holocaust in 1943, together with his younger brother Egon. He left behind his mother Rosa and street-wise cousin Mara who survived the war in Bačina, Serbia. But what he also left behind, inside a hidden wall compartment of Rosa’s unassuming village house, was a stash of metal boxes covered with dirty blankets. They contained over 400 pieces of impressionist and post-impressionist art – masterpieces by Degas, Pissarro, Renoir, Picasso and Cézanne – collected during Erich’s time working for the legendary Parisian art dealer, Ambroise Vollard.

What happened next resembles more the plot of a thriller than real life: a sequence of tragic events that claimed the life of Erich’s mother Rosa, a web of spies and art-enamoured Yugoslav communist apparatchiks who went out hunting for the treasure that was ‘the Chlomovitch collection’, a Degas’ ballerina hung on a wall of Mara’s new home in Kosovo that gave away the precious collection’s whereabouts. Today, the Chlomovitch collection is kept in the archives of the National Museum of Serbia, its ownership still disputed by Vollard’s heirs and Erich’s distant cousins from Israel.

In addition to its Hollywood-worthy backstory, the complex legal dispute over the Chlomovitch near-priceless collection highlights several typical risks that an art market participant encounters daily: questions about an artwork’s provenance and legal ownership, challenges in authenticating and evaluating art that has been out of circulation for decades, and integrity concerns about the counterparties in an art transaction. But in addition to these ‘traditional’ risks, new integrity considerations have been introduced into the market through the proliferation of digital art and non-fungible tokens (NFTs); popularisation of art as an inflation-proof, less traceable and relatively liquid asset class; the rise in online sales/cryptocurrency payments; as well as securitisation and fractional ownership of artworks.

Is it deserving of the increased scrutiny?

The dynamism of the art market has long attracted the connoisseur but also the delinquent, with the latter looking to distort and exploit the market’s traditions and idiosyncrasies. It comes as no surprise, therefore, that in the light of the recent geopolitical developments, various art industry observers have already warned about the possible use of the art market for sanctions dodging or trafficking of the artefacts looted from Ukraine’s museums.

Despite this, a recent report by the US Treasury has concluded that, comparatively speaking, integrity risks in the art market are not as high as in some other industries, for example, the real estate sector. Scott Rembrandt, a senior US Treasury official made a case for prioritising the fight against illicit finance in other areas by pointing out that “while certain aspects of the high-value art market are vulnerable to money laundering, it’s often the case that there are larger underlying issues at play, like the abuse of shell companies or the participation of complicit professionals, so we are tackling those first.”

Although the risks are acute and present, it may be that the art market’s inherent glamour and sheer readability of stories about various art adventurers and their sometimes amoral enablers – stories like the one about Erich Chlomovitch – keep bringing the art industry under constant scrutiny of the media, and by extension, the regulators. Articles about suspicious real estate cash transactions in Canada perhaps just don’t have the same ring to them.

Need for a proportionate approach to regulation and due diligence

“We have art in order not to die of the truth”, said Nietzsche famously. So, will the introduction of stricter regulation and compliance-driven oversight bring too much “truth” to the art market, destroy its mystique, and defy the redeeming quality of art? Is the watertight management of integrity concerns worth the risk of turning the art market into a mechanised trading floor devoid of collectors’ passions?

The European art market came under anti-money laundering (AML) regulation as the result of the EU’s 5th Anti Money Laundering Directive (5AMLD). This regulation was turned into UK law in January 2020 via an amendment to the Money Laundering and Terrorist Financing Regulations. Although relatively light-touch, the 5AMLD placed additional costs and bureaucratic burden on art market participants, who dragged their feet over its implementation, mainly due to their concern about preserving the art market’s most precious value: confidentiality.

Business impact of increased regulation is yet to be assessed in the years to come, although the expectation is that the London market – which is already suffering from some (at least short-term) negative impacts of Brexit – may be disproportionately affected. This is especially the case as London specialises in high value art transactions, which often involve higher risk clients, and as such require enhanced due diligence checks.

So, what can we do to keep the art market booming while making it less susceptible to exploitation by rogue actors?

The Geneva-based Responsible Art Market (RAM) initiative rightfully recommends a risk-based approach to conducting due diligence in the context of art transactions, which is harmonious with the requirements of 5AMLD.

This approach is not unlike the one already familiar to seasoned corporate intelligence operatives who have been vetting various deal counterparties for decades. However, in the context of delicate art transactions, proficiency in the cultural codes of the art market sets apart an effective and proportionate due diligence from the usual ‘box-ticking’ exercise.

Such an approach is crucial to making integrity considerations conducive and not disruptive to an art transaction. And although the folklore would have you believe otherwise, it is important to remember that the mechanisms that cause abuse in the art market, i.e. anonymous shell companies, offshore bank accounts and up-to-no-good actors, are a global problem that is neither endemic to the art market nor curable by its increased regulation.

Art market regulation requires art market cultivation

Finally, one should turn to art market participants. What has been their experience? Surely, regulation has added the burden onto them, and some governments – including the UK – are arguably not taking their concerns seriously enough, especially amidst the ongoing cost of living crisis. The demands on art market participants are piling up while there is little reward offered in return. HMRC has (understandably) begun to hand out fines to art market participants who have failed to register for AML supervision, while the government’s new Economic Crime (Anti-Money Laundering) levy payable by regulated businesses has served another financial blow.

In the UK, the much promised Brexit opportunities are yet to materialise, and art market participants’ calls for the removal of import VAT on art seem unlikely to be heard while there are other more pressing items on the agenda. However, although sometimes hailed as an elitist pastime, the art market is a powerful machine for economic growth and source of ‘soft power’ prestige. And with the UK’s share of the global art market now at a historic low, the UK government should come to realise that the public benefit of art market regulation must be coupled with the public benefit of art market cultivation.