Posted by Tets Ishikawa, director at Litigation Futures Associate Acasta Europe, and senior adviser to Sparkle Capital
It’s exhausting trying to stay on top of the latest launch or capital injection in the litigation funding market. In the listed world, 2018 saw Manolete and LCM (and almost Vannin) join Burford on AIM. Of course, Burford trumped the newbies shortly afterwards by nonchalantly raising $1bn from a sovereign wealth fund to invest in more cases.
Seemingly oblivious to Brexit, Trump, Russia, China and climate change, this looks, feels and smells like a bubble if ever there was one.
But it is also infantile and that is its saving grace. This is not a gluttonous market about to explode but a child experiencing an awkward growth spurt.
Here are five reasons why.
1. Natural evolution of markets
The evolution of any market can be gauged by the investors it attracts. When a market is born, private investors invest on their conviction for an unproven concept, which if proven will generate unimaginable returns.
Once a concept is proven and established, markets think about scalability, which is prime hunting ground for expensive institutional investors, like hedge funds, venture capital and private equity funds. They ride the wave and, if scalability is delivered, will generate the 20% to 50% IRR-type target returns they seek.
Once scaled, however, everyone and their uncle wants a piece of the pie. Returns are far less attractive but the market can then tap into cheaper mainstream bank lending if they require capital.
But it would be wrong to confuse the litigation funding market developing as a sign that it has developed. The market has been around for a few years, but in real historical terms, it is only at the beginning of attracting expensive institutional investors. There’s still a long way to go before the market matures.
2. Litigation funding is a market still run predominantly by lawyers
Car manufacturers don’t rely on their head designers to run their businesses. Neither do tech companies on their tech geniuses. But they’re not ignored either. It is the marriage of technical knowledge with commercial ability that creates the foundation for success.
Litigation funding is far from striking this balance. Funders often cannot see the real opportunity beyond the litigation at hand. Burford’s 2018 sale of its share in an arbitration award against the Argentinian government was hailed as an evolutionary step in the litigation funding market.
Another interpretation, however, is that a hedge fund thought £77m to buy Burford’s share of the award (estimated at £101m) was good value and Burford therefore gave rather a lot away.
But that’s not all. Only the naïve would believe the same hedge fund is not trying to figure how the next time, it ‘get in’ for the same amount (£9.3m) that Burford invested in the claim.
3. The underlying market is behind the curve in AI
Over the last year, the legal industry has finally come to accept that artificial intelligence (AI) is here to stay. But wondering with a touch of cynicism how AI might replace lever arch files and a fountain pen still seems to be the order of the day.
Consider that the Serious Fraud Office’s Axcelerate technology can filter through 30 million documents at a rate of 600,000 documents a day, or 2,000 times faster than a barrister.
Consider that this also generates visual reports that shows connections between individuals and matters that a human would have taken years to spot.
That is a powerful commercial tool that can drive down the cost and speed of litigation enormously – the two single biggest barriers to attracting mainstream capital. And some would argue this isn’t even the best technology out there.
But will the legal industry adapt? Notwithstanding that lawyers use AI in their everyday personal lives, other industries have been embracing AI for years so they can improve the service they provide to their clients and the margins to their shareholders.
That may also mean less fees but think Social Darwinism and free market economics – the weak will be weeded out, while the strong will not only survive but generate more fees.
4. Expensive pricing reflects an inefficient market
Sparkle Capital was the first funder to launch a fixed-interest-only commercial litigation funding product in 2015, aimed at the mid-value claims market. This flew in the face of most funders who still charge multiples.
But this was not a speculative punt. Rather, it was based on the data of 4,200+ cases that Acasta Europe Ltd, the after-the-event (ATE) insurance provider which administers Sparkle, has received and assessed post-Jackson.
While litigation funding operates in an unregulated framework, insurance sits at the other extreme, regulated under the very stringent framework of Solvency II and strict capital adequacy requirements.
In other words, ATE premiums are priced not from a finger in the air but through a proper pricing model. Compare this to litigation funding pricing on a pure risk-weighted basis and it becomes very apparent that the litigation funding market is in fact very inefficient.
Inefficient does not mean that the pricing is incorrect though – pricing reflects other factors and endorsed by a buyer and seller agreeing to transact at that price.
But this risk-weighted pricing gap would suggest the funding market still has some way to go before becoming truly efficient.
5. Litigation funders are not solutions driven
Professional services are fundamentally solutions-driven businesses. We understand our clients’ issues and seek to address them.
In contrast, the litigation funding, and for that matter ATE, markets have largely been product-led markets – the rather crass ‘find cases that fit our products’ approach.
Naturally, funders have restrictive mandate restrictions. For Acasta and Sparkle, no such restriction exists, allowing us to focus on creating situation-specific solutions for lawyers and claimants. Of course, we have standard products that we’d like cases to fit into without any effort.
But litigation cases are not standard. We often start with the issue, identify the risk and then use our ability to fund via Sparkle or insure via Acasta or a mix of both to create a solution that meets the needs of the situation.
Infantility is not a criticism but an opportunity
Many will read this article as a judgment of failure on the market but this precisely illustrates why this market is infantile. Much like a know-it-all child, there is so much scope for growth, innovation and pricing efficiency in this market than most acknowledge.
Recognising infantility should not trigger angst or frustration but encourage greater forward thinking about how to shape the future direction and evolution of the market.