In a short space of time, Environmental, Social and Governance (ESG) has come to sit at the top of many corporate agendas. No longer a movement, ESG is underpinned by the reality that the majority of the billions of individuals, who are both the customers and the ultimate source of the debt and equity capital that support businesses, care about ESG.
In turn, this has elevated expectations that customers, investors, regulators and lawmakers, have of businesses, big and small, to consider sustainability, social responsibility and social justice in the operational and management conduct of their businesses. Get it wrong and it’s going to hurt reputationally and financially. And the bigger the company, the bigger the cost.
With this obligation to be good corporate citizens comes the increased risk of litigation. As one magic circle law firm expressed in their brochure, “…as ESG continues to grow in importance, the number of ESG litigation matters will become self-perpetuating”. In fact, a quick online search for “ESG Litigation” yields umpteen results of the best SEO’d law firms boasting their ESG expert knowledge, advisory capabilities and credentials, in order to win the custom of businesses facing these new risks. If ever there was consensus that businesses are going to be held accountable for ESG compliance by litigation, then this is it.
Yet, it’s only in the last couple of years that litigation funding and ESG has started being spoken about in the same breath, but now that it is, the notion that litigation funding and ESG go hand in hand has gained significant momentum.
It’s not about the industry giving self-congratulatory pats on the back at conferences and on webinars about litigation funding’s role in achieving ESG goals. In a world where money talks, more and more institutional capital managing ESG funds are pro-actively exploring how to enter the litigation funding market. Why? Because litigation is one of the enforcers of ESG compliance; everyone accepts that litigation favours those with money; and litigation funding is an important mechanism of facilitating access to the justice that lies at the heart of ESG.
Some critics would expectedly counter that these ‘justice’ arguments are irrelevant and that it was only inevitable that the vast growth of ESG investing would find its way into litigation funding. (One 2020 research report put the total ESG assets under management globally at USD$35.3 trillion, or a staggering 36% of all professional managed assets.)
However, if litigation funding wasn’t aligned with ESG, then ESG institutional capital inflows wouldn’t have made their way into litigation funding in the first place, validating that litigation funding demonstrably facilitates access to the very justice that supports ESG objectives.
The origins of ESG are found in the philanthropic pursuit of righting the world’s wrongs through the best, non-profit intentions of those with significant disposable wealth. Those wrongs are varied and broad but ultimately able to be classed into a wrong of an environmental, social or governance nature. This led to most private banks – the likes of Coutts and UBS servicing high net worth investors – setting up ‘philanthropy advisory services’, which still operate to this day.
However, philanthropy is only as scalable and sustainable as those willing to be philanthropic. Thus came the birth of ESG investing – the idea that one could invest with social responsibility, sustainability and for the betterment of the world without compromising the commercial principles of profit or returns.
ESG die-hards have for a long time argued that ESG investing delivers better returns and “alpha” (market outperformance) over the traditional short-term profit-taking investing mindset. It’s questionable whether that may have been true in the early days. However, with real societal shifts supported by the role of social media in favour of ESG, it’s now just a fact that businesses are forced to embrace ESG and not get caught out prioritising their own short-term profits at any cost.
And it’s not just customers who are championing the importance of social justice. Major stock exchanges, like the London Stock Exchange, Euronext and Nasdaq, have issued ESG guidelines for their listed companies. Global standards, like the UN’s 17 Sustainable Development Goals (which includes access to justice as one of the goals) and the Sustainability Accounting Standards Board’s Materiality Map, are being reinforced by the rise of ESG certification companies, such as B Corp; similar to a rating agency but for ESG credentials. Legislative attempts to enforce ESG compliance are a reality, for example in the UK under the Occupational Pension Schemes (Investment and Disclosure) (Amendment) Regulations 2019, where pension funds have had a responsibility to integrate ESG into their investment approach since 2018, or in France where in 2017, the French Parliament adopted the Corporate Duty of Vigilance Law, which obligates the largest corporations to report on their compliance with what are effectively ESG objectives.
The role of litigation
Litigation exists because non-compliance does. There will always be those ruthless businesses, whether big or small, who choose to pursue profit by cutting corners, breaching agreements or breaking the law, armed with the knowledge that: (i) the chances of being found out are small, (ii) the victims likely won’t litigate because of the costs and risks associated with it, (iii) they can still afford to defend it anyway; and (iv) even if they lost, the amount they’d suffer would still leave them better off than if they had complied in the first place.
It is because this same mindset lies behind much of what ESG is trying to fight that litigation has such a critical part to play. Words championing ESG are cheap and might be very effective in keeping customers and shareholders happy in the short term, but compliance is expensive and the delivery of justice through litigation is a key regulator of, and deterrent to, non-compliance. And because justice favours those with money and power, litigation funding does more than facilitate access to justice. It actually supports the very principles that defendants are claiming to champion.
ESG in class actions
Class actions warrant a mention because in the well-publicised debates over the impact of litigation funding on class actions, ESG has not been the focus, despite the fact that class actions, whether funded or not, and whether the actual underlying litigation is an ESG matter or not, are often about the pursuit of justice for the many that could not challenge the deep-pocketed defendants they fight; in itself an ESG objective.
Of course, defendant lawyers claim it’s got nothing to do with justice and the real issue is that litigation funding encourages a compensation culture driving frivolous claims at unfairly expensive pricing to the victims.
But funders also assume the risks of doing so, often risks that claimants cannot afford to take. Funding a losing case often carries proportionately far greater consequences for a funder than the worst-case outcome for a defendant, making litigation funding not for the faint-hearted even for the broader sophisticated investment community. This also explains why most funders have rejection rates of over 95% of cases they see, most of which have been given prospects of success by lawyers of 60% or greater. And, as I’ve written about previously, litigation funding pricing is expensive precisely because it reflects the sizeable risk funders assume, making the pricing on a risk-adjusted basis quite reasonable and certainly in line with other financial markets.
Take a step back though, and the contradictions between the defendant lawyers and their ESG credentials are quite obvious to see. If defendants have nothing to hide, why are they so worried about letting justice take its course with the added bonus of seeing funders bleed themselves dry? And why would corporates not like to take the opportunity to have a court-verified, litigation-proofed stamp of their ESG credentials when the commercial value of having ESG credentials continues to increase?
Litigation funding is not just relevant in the context of ESG litigation matters but as part of the drive to achieving ESG objectives. The very reason why litigation funding exists is because litigation ultimately costs money and it addresses the sad reality that justice favours those with money and power. Litigation funding facilitates access to the kind of justice that makes those with deep pockets accountable to drive sustainability, social responsibility and justice for the betterment of society.
And for those who feel litigation funding shouldn’t be monetising others’ misery, it should never be forgotten that litigation funding wouldn’t exist if the misery didn’t exist in the first place, much in the same way that ESG, which promotes its ability to monetise in a way that allows it to deliver “alpha”, only exists because of the wrongs that exist in the first place.
Litigation funding and ESG go hand-in-hand because ultimately both only exist to address injustices that should not exist in the first place. If businesses feel that litigation funding is ultimately damaging to their interests, then they should remember the role litigation funding has in delivering the ESG objectives they like to champion.