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Magazine Issues » Jan-Feb 2022

Asia litigation finance: A legal and financial mix

BuildingsLitigation finance is an established alternative asset class in the US, Europe and Australia. Now it’s starting to look attractive in Asia-Pacific too, writes Peter Guy.

New opportunities to invest in Asia’s litigation financing market are attracting asset managers. In the past ten years, Asian jurisprudence and courts have legitimised funding sources for litigation, meaning the activity is no longer prohibited as “champerty” – that is, seeking financial returns from the outcome of a lawsuit.

Investment managers are exploring the formation of litigation funds aimed at Asian jurisdictions where, depending on legal jurisdiction, champerty is not necessarily a crime or tort. Common law jurisdictions outside of the US, England, Canada and Australia have abandoned their laws against champerty.

Ireland, New Zealand and Hong Kong still ban certain arrangements. But in Hong Kong, the Court of Final Appeal has over time adopted a more flexible view. An arrangement that seems to involve maintenance or champerty per se is not necessarily violating the law. Alternative asset managers consider this an important development.

Litigation funding has operated globally in both private and listed companies. Asia- Pacific finally appears attractive for this asset class and investment strategy, which is already established in the US, Europe and Australia. Asian wealth managers, family offices and ultra-high-net-worth investors seeking absolute, attractive and non-correlated returns in Asia may now have the opportunity to participate in the formation of fund vehicles and their management teams in their early stage of development.

Potentially attractive returns
As Bloomberg Intelligence analyst Tamlin Bason recently commented: “Sovereign wealth funds and college endowments have also recently staked litigation finance firms, attracted by high margins, IRRs [internal rates of return] in excess of 30% that are generated among top financiers, and to the fact that litigation finance is an uncorrelated asset class.”

The Global Litigation Funding Total Addressable Market (TAM) is estimated to be US$90 billion (€81 billion). One of the major litigation market managers, Omni Bridgeway, estimated in its 2021 annual report that Asia had a TAM of $11 billion.

Evan King, a former investment banker and fund developer, says: “Legal finance in Asia is an important asset class for portfolios. Treating litigation claims as assets that can be financed is a new concept in Asia, although it is established internationally. With improved investment diversification, the asset class can generate steady returns that are uncorrelated to equity or real estate markets, or independent to other types of legal claims.”

King adds: “Because judgments and awards are determined by courts or arbitration settlements, the asset class is considered to be independent of market cycles. Returns on investment are not limited or compared to market multiples. Instead, returns are driven by a settlement amount or damages awarded by a court or arbitrator.”

Richard Clarke, chief operating officer of wealth advisory for family offices, ACCP Global Hong Kong, says: “We continue to reinforce our interest in litigation investments due to attractive uncorrelated returns coupled with more Asia-flavoured opportunities. Asia-based managers will also be attracted to the asset class’s potential for international deal-making.”

Litigation financing managers tend to prefer legal jurisdictions practising English common law. However, China’s growing economy and industries create litigation domestically and internationally. Shenzhen DS Legal Capital Co. Ltd. says it combines venture capital and legal resources that offer one-stop funding for commercial disputes. Up to June 2019, it claims to have made more than 500 investments, collectively valued at over $682 million, with a 78% “success rate”.

King points out that in the EU, US and Australia, sovereigns, ultra-high-net-worth investors and family offices regularly allocate into litigation funding as part of their portfolios.

Large international competitors specialising in litigation and arbitration finance include Burford Capital, which has assets under management (AuM) of $4.8 billion and is listed on the London AIM exchange, and Omni Bridgeway, which has AuM of 2.4 billion Australian dollars (€1.5 billion) and is listed on the Australian Securities Exchange.

A challenging asset class to manage
Asian super-rich investors and family offices have been advised to seek private equity investments or funds not only to diversify, but to produce higher yields in a long-term, low interest rate environment. According to private bankers, a string of hi-tech Chinese IPOs over the past two years in Hong Kong has generated dozens of new billionaires whose portfolios require diversification. However, private equity has proven to be a labour-intensive practice, where the fund managers must combine numerous skillsets to find, make and exit individual deals.

Funding litigation and insolvency cases requires initial funding because an exit value cannot be achieved without settlement. And valuing these cases and assets requires non-public information and due diligence research. King says: “New Asian funds are looking mainly at Hong Kong and Singapore for fresh opportunities as they share English law and strong arbitration cultures. The main engines driving values and exits are courts and arbitration systems that encourage parties to settle.

“From the viewpoint of the fund manager and investor, legal disputes are by themselves very illiquid assets. And liquidity can only be achieved through a determined drive towards a valuation event, which settlements or court decisions represent.”

King believes that Hong Kong and Singapore property development and construction industries appear particularly well suited to this legal and financial strategy due to the amount of commercial disputes arising from large property and infrastructure projects between main and sub-contractors.

Widespread corporate implementation of ESG and carbon-neutral policies could also potentially generate legal and governance issues arising from stakeholders and counterparties with conflicting interests.

Specialised legal, due diligence, sectoral and risk management skills need to be combined and cultivated by the investment manager for sustainable returns. Deal flow sourcing and management are critical for monetising the illiquidity premium inherent in this alternative asset class.

King says: “Only a small number of cases are selected for financing. An experienced investment committee must review all proposals and monitor progress and ensure governance standards and investment strategies are met.”

The fund is effectively making non-recourse loans to support litigation costs and sharing proceeds upon settlement or judgment. The team must be able to assess cases and allocate resources to fund legal opportunities with clear milestones towards a financial exit. King reckons an Asian fund requires a starting size of $100 million to $250 million based on a 2/20 management fee.

He highlights one of the challenges of managing lawyers for litigation returns, versus client fee generation. “Lawyers are not oriented or trained to manage risk relative to returns; they think in terms of mitigating legal risk and liability. So, it’s important to cultivate a team that combines investment and legal skills.”

King adds: “One of the main engines driving value and exits are courts and arbitration systems that encourage and compel parties to settle claims and disputes. Liquidity is determined through achieving decisive valuation events like settlement and judgments rather than financial and market transactions.”

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