Opposing moves by U.S. firms in China show difficulty of overseas practice
In January, New York’s Fried, Frank, Harris, Shriver & Jacobson said it was closing its Hong Kong and Shanghai offices, though it may leave a service center in Hong Kong. A few days later, Dentons announced a merger with Beijing-based Dacheng Law Offices, China’s largest law firm; the combined firm will be the world’s largest with more than 6,500 lawyers.
Superficially, one move seems a setback and the other an expansion, but both underline how economically challenging the China market is for foreign law firms.
Fried Frank was mainly focused on Hong Kong, Asia’s leading international financial center. It’s where mainland Chinese companies most commonly go to raise capital from overseas investors. Hong Kong led the world in initial public offerings for three years, from 2009 through 2011.
But clients in Hong Kong just aren’t willing to pay the same fees for capital markets work as clients in New York. That makes profitability a real challenge for top-tier Wall Street firms accustomed to raking in big bucks on big deals.
When the market was booming, these firms could make it up a little on volume. But in the second half of 2011, just after top shops like Davis Polk & Wardwell, Simpson Thacher & Bartlett, Sullivan & Cromwell and Kirkland & Ellis expanded heavily in the area, the Hong Kong listings market went into a deep freeze that only began to thaw in the last year.
Things still look shaky as the factors that contributed to the downturn—concerns about China’s sinking real estate market, the stability of its banks and the scale of its government debt—haven’t gone away. As a result, some firms have started moving away from the prevailing mindset that China is the future and an investment they need to make at all costs.
“We concluded that our growth potential in Asia was not sufficiently attractive from a commercial perspective without significant additional investment,” Fried Frank Chairman David Greenwald wrote in an internal memo explaining the decision to employees, “and the governance committee determined that it is not the time to increase our investment in this region.”
Though it’s not leaving, Milbank, Tweed, Hadley & McCloy shut down its Hong Kong capital markets practice last year to concentrate on more cross-border work. David Zemans, the firm’s Singapore-based Asia managing partner, says he thinks Fried Frank’s move will cause other firms to question whether Hong Kong is worth it at current fee levels.
In mainland China, the issues are somewhat different. International firms began reconfiguring their practices in Beijing and Shanghai a decade ago in response to the expansion of domestic firms. Firms like Paul Hastings and O’Melveny & Myers, which once had hundreds of lawyers advising multinationals on inbound China deals, scaled back dramatically after foreign investment dropped off in the wake of the global financial crisis.
Not wishing to compete with local firms on price, most foreign firms now only have relatively small offices in Beijing or Shanghai. The fees in China are even lower than in Hong Kong, but mainland Chinese lawyers also earn less—a starting associate at a large Beijing firm usually makes less than $25,000 a year. The numbers fall significantly outside the capital.
Dentons’ merger with Dacheng will use a Swiss verein structure, meaning the two firms will actually remain financially independent and just share a brand and certain administrative functions. Dentons, the product of successive mergers involving American, British, Canadian and French firms, is already a verein of four entities; Dacheng will be the fifth.
Though verein deals carry little economic risk, critics regard them as less than true mergers and question whether they can achieve any real benefit without deeper integration. And typically, Chinese firms are barely integrated at all, with partners more likely to compete than cooperate with each other.
Dentons Global Chairman Joseph Andrew says the firm hopes that the 41 domestic offices Dacheng has will soon send work throughout the network as Chinese companies begin expanding and investing overseas in ever greater numbers. He says incentives will be put in place so that Chinese partners will refer work to their peers abroad.
A look at the major deals listed on Dacheng’s website shows there is a long way to go. Virtually all of the deals were handled by single offices rather than, say, teams from Beijing and Shanghai working together.
The firms say they’ve agreed on a three-year transition period during which Dacheng plans to make strides in integrating its partnership and getting its lawyers to move toward a more collaborative culture. Andrew says no revenue targets have been set.
“There’s no playbook for this,” he says, “no metric for success.”
This article originally appeared in the May 2015 issue of the ABA Journal with this headline: “Chinese Puzzle: Opposing moves by U.S. firms show difficulty of overseas practice.”