Hedge funds target catastrophic ESG cases

More regulation in Europe “will bring more litigation”, Pogust Goodhead's Salomao said. — Bloomberg

BRUSSELS: In a corner of finance that rarely generates headlines, investors are busy mapping out paths to huge returns as they contemplate the fallout of new laws in Europe.

The area in question is litigation finance and the focus is alleged environmental, social and governance (ESG) transgressions.

Regularly bankrolled by hedge funds and other alternative investors, the lawsuits target supposed corporate misdeeds such as broken environmental pledges, exploited workers or corporate governance failings.

A successful case can leave a litigation funder with returns well in excess of 25%.

Last year, citizens in the European Union (EU) won access to the kinds of class-action lawsuits that have long fuelled litigation in the United States.

Another piece of EU legislation close to finalisation exposes firms to unprecedented legal risk if environmental or human rights violations are detected in their supply chains.

And in the United Kingdom, litigation funders face a “spike” in inquiries thanks to new ESG fund rules, according to Kate Gee, a partner at Signature Litigation.

Among hedge fund managers allocating capital to litigation funding is Connecticut-based Gramercy Funds Management, which recently unveiled a £450mil investment in London law firm Pogust Goodhead.

The money is intended to help pursue mass claims against carmakers involved in the so-called Dieselgate scandal, as well as investor suits against BHP Group Ltd and Vale SA for their role in the Mariana dam disaster in Brazil.

More regulation in Europe “will bring more litigation”, Ana Carolina Salomao, chief investment officer and partner at Pogust Goodhead, said in an interview.

Increasingly, investors are also drawn to the “feel-good factor” of such cases, she added.

Salomso said the EU’s Corporate Sustainability Due Diligence Directive, which won provisional backing from the EU Parliament and Council in December, is key.

“There will be much more information available in the public domain, so bigger scrutiny,” she said.

It will “become more evident when a company has failed” on an ESG issue, and “we are seeing big institutions seeking compliance with regulation”.

Steven Friel, chief executive officer of Woodsford Group Ltd, which operates a large litigation funding business, said his ESG team is “closely monitoring” the regulatory development in Europe, which he added is “highly likely” to shape his firm’s work.

Cases currently on Woodsford’s books include a suit against Airbus SE, in which institutional investors are fighting out their claim in front of a Dutch court.

They want compensation after claiming the company’s shares slumped because of a bribery and corruption scandal that was settled in 2020.

Woodsford also is helping investors fight a case against Standard Chartered Plc related to sanctions violations, as well as an investor lawsuit against Boohoo Group Plc tied to allegations of modern slavery.

“The work represents a high-risk venture for which handsome rewards are available if it’s done well,” Friel said in an interview.

“We go in when there’s a catastrophic breakdown in ESG in major companies with losses for shareholders or customers. We mobilise them, engage with the company, seek a settlement or litigate.”

Litigation funding surfaced two decades ago in Australia, and has since become prominent in the United States and increasingly in the United Kingdom.

Swiss Re said the industry may reach US$31bil of investments by 2028 as investors are lured by returns of 25% or more.

In some cases, returns can be hundreds of times an initial investment.

Burford Capital, a litigation funder based in New York, stands to collect more than US$6bil after allocating US$16.6mil to help fund a case targeting Argentina’s nationalisation of energy company YPF.

With such huge sums at stake, litigation funders are starting to draw the attention of lawmakers.

Axel Voss, a member of the European Parliament, accuses the industry of operating “in the shadows”, while raking in a disproportionate share of any award.

He’s the architect of a legislative proposal now before the EU Parliament that seeks to rein in overzealous litigation funders.

Among recommendations is a cap of 40% on any litigation finance award.

“Funders are always working in their own economic interests rather than that of claimants,” Voss said. “I don’t want to see the legal system becoming a playground for profit seekers.”

Corporate insurers, meanwhile, fear that third-party financing can prolong a lawsuit, increase the cost of claims and drive up premiums.

Swiss Re Institute has estimated that in US cases, up to 57% of legal costs and compensation go to lawyers and funders, compared with an average of 45% in typical tort liability cases.

And that has implications for what the industry is willing to insure, according to Penny Seach, group chief underwriting officer at Zurich Insurance.

The Swiss insurer won’t back contracts “if we feel the risk is one we can’t model or understand”, she said.

In the United Kingdom, the supreme court ruled last year that litigation funders aren’t allowed to strike deals in antitrust class-action cases in return for a cut of the damages won.

The decision means that law firms and their backers will need to “renegotiate funding arrangements and develop a new model going forward”, according to law firm Slaughter and May. — Bloomberg

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