The Australian government will require litigation funders to be licensed and comply with investment fund regulations following complaints from business groups they were causing a surge in shareholder class actions.

Announcing the changes, Treasurer Josh Frydenberg said litigation funders do not face the same regulatory scrutiny and accountability as other financial services and products under the Corporations Act.

"The Morrison government is committed to ensuring that litigation funders in Australia operate transparently, are appropriately regulated and accountable," he said.

In three months' time, litigation funders will be required to hold an Australian Financial Services License (AFSL), which are also required for financial advisors, sellers of financial products and the managers of investment schemes.

AFSL holders are obligated to act honestly, efficiently and fairly; maintain an appropriate level of competence to provide financial services; and to have adequate organizational resources to provide the financial services covered by the license.

Operators of managed investment schemes, or managed investment funds, are required to meet a range of conditions, including regular audits and reporting to the regulator; providing proof of their solvency; and the lodging of financial accounts.

Litigation funders cover the costs of a plaintiff's legal action in exchange for a share of any damages and fund the actions from their own balance sheet and from funds raised from investors.

Funder Litigation Capital Management welcomed the change, saying it already has an Australian Financial Services Licence.

LCM chief executive Patrick Maloney said that while the changes won't have much effect on LCM, obtaining an AFSL is "expensive and time- consuming" and imposes operational requirements and may affect who is able to operate as a litigation funding business.

"This new requirement may act as a disincentive for less established players to enter the litigation funding market. It may also deter litigation funders with no operational presence in Australia from continuing to fund cases here," he said.

He added: "There is very little information as yet as to how it is proposed that class actions be conducted in compliance with the managed investment scheme regime.  It may be that these requirements are quite onerous which may mean that it is less attractive for some litigation funders to bring any class actions."

Litigation funder Omni Bridgeway welcomed the proposal and said the licensing regime should also be extended to law firms that act as funders of class action arrangements under "no win, no fee" arrangements and those who make use of contingency fee arrangement should they be introduced.

The changes—which come after business groups complained that litigation funders were fuelling shareholder class actions against companies—were welcomed by the business lobby.

"This move is a significant first step in addressing concerns about Australia's securities class action industry," Angus Armour, the chief executive of the Australian Institute of Company Directors, said in a statement.

"The COVID-19 environment has highlighted long-standing issues with opportunistic securities class actions that are not focussed on access to justice as much as profit for funders' investors."

The government has previously claimed litigation funders were earning "extraordinary profits" and questioned whether Australians are receiving a fair share of class action settlements.

Separately, it has convened a parliamentary inquiry into litigation funding and class actions to examine the impact of class actions on the economy and vulnerable businesses already suffering the impact of the COVID-19 pandemic.

The changes come despite a government-commissioned report advising against regulating litigation funders.

The 2018 Australian Law Reform Commission (ALRC) Inquiry into Class Action Proceedings and Third-Party Litigation Funders agreed there were inherent risks that litigation funders may fail to meet their obligations under funding agreements, use the Federal Court of Australia for improper purposes, or exercise influence over the conduct of proceedings to the detriment of group members.

However, it recommended the role of the Federal Court in protecting the interests of plaintiffs be bolstered instead of introducing a licensing regime.

The Australian Securities & Investments Commission is responsible for regulating both Financial Services Licence and managed investment schemes. Yet it has previously said it is not the right regulator to oversee litigation funders, and instead of regulating them as a financial service, they should be regulated as a legal service.

"We question whether licensing by ASIC is an effective mechanism to address the regulatory risks perceived to be associated with litigation funders, particularly the risk that a litigation funder has inadequate resources to meet an adverse costs order," ASIC said in its submission to the ALRC inquiry.

"The AFS licensing regime is focused on the conduct of financial services, and the activities of litigation funders do not sit neatly within the regime. A requirement that a litigation funder obtain an AFS license will not of itself mean that the funder will be adequately capitalized to meet adverse costs orders, continue to fund litigation or distribute funds to shareholders."

The regulator declined to comment on Friday.

The ALRC report found shareholder claims were the most commonly filed class actions in the Federal Court, representing 34% of all class actions filed in the previous five years.

David Taylor, a commercial litigation partner at local firm MinterEllison, said the licensing regime would bring benefits for all class action participants.

For group members, the licensing regime will provide greater certainty that the funder has the financial means to prosecute the action without leaving their claims hanging and will provide for a more stringent conflict of interest mechanism and consumer complaints procedure, he said.

Defendants will have greater certainty that there are funds to access should they ultimately be successful in defending any claim, he said.

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