Law firm competition heats up in China

International law firms have been hit by a double blow in the last two to three years: a slowdown in inbound investment has pushed them to rely on outbound work. At the same time, domestic firms have increased their share of inbound work, with foreign companies turning to them instead when they enter China. The rising status of top local firms even challenges the international firms in outbound capabilities and deal volume.

According to a KPMG report on investment in China in 2013, inbound investment for the year totalled US$117.6 billion (Rmb731.6 billion), up by 5.25% from the previous year. While total outbound direct investment was less at US$90.17 billion (Rmb560.9 billion), the annual increase of 16.8% confirmed that the growth rate of outbound investment continues to outpace that of inbound. A Capital predicts that outbound investment will equal inbound within three years.

“If you look at the dynamic of outbound vs inbound deals, more and more inbound work goes to local law firms with less going to international firms,” said Jian Fang of Linklaters.

“This has been compensated by the volume of outbound work for international firms increasing, but until the Chinese legal market opens up, the share of international firms' work in the market will continue to go down.”

As they mature and expand, domestic firms with offshore operations have even emerged as capable outbound advisors, threatening the status of mid-tier international firms. An increasing number of foreign lawyers are also joining local firms, adding to their depth and breadth.

“We do a lot more outbound deals than inbound now,” said Basil Hwang, a partner in Zhong Lun's Hong Kong office, where the bulk of work is cross-border. “There will be a lot more adaptation of law firms to come, given clients benefit from a solid understanding of Chinese law.”

The ascent of domestic firms

All law firms have had to adapt over the past decade. In 2010, a group of five ministries including the Ministry of Commerce, China Securities Regulatory Commission (CSRC) and State Administration of Foreign Exchange issued Article 10, which governs the acquisition of Chinese firms by foreign investors. It imposed highly specific and rigorous approval requirements for foreign investors looking to buy or invest in local companies, producing an immediate chilling effect on onshore deals and driving them offshore.

“Many inbound M&A deals were since taken out of the hands of international firms and into those of domestic firms,” said Hwang, who joined Zhong Lun from US firm Dechert in January.

Hwang argues that as lawyers are ultimately individual consultants, the market is going to see more foreign lawyers joining Chinese firms and Chinese law firms acquiring foreign counterparts. Another way for the legal market to adapt would be to allow foreign lawyers to practise in China, but this is unlikely to happen soon as the legal market is heavily protected.

Hwang also noted that since moving to Zhong Lun, clients have considered him an insider expert as opposed to an outsider looking in, in contrast to when he was at Dechert. The King & Wood Mallesons merger prompted him to make the move. “So far it's been pretty helpful being on the domestic side,” he said.

Foreign partners who have also jumped ship to local firms in the last five years include Robert Lewis, who moved from what was then Lovells to AllBright and then to Zhong Lun, Michael Hickman from Simmons & Simmons to Haiwen and Stephen Wozencroft to Jun He from Dewey & LeBoeuf's Hong Kong affiliate Arthur Marriott & Associates.

“It seems only natural that more and more lawyers from international firms are moving to larger local firms,” said Fang. “These firms certainly have the strength relative to smaller local or international firms.”

The fate of international firms

Although large local firms and international firms battle for outbound deals, each have their own distinct markets. SOEs and private companies still rely on international firms, but many medium- and smaller-sized Chinese companies going abroad prefer to use local firms. Investment destination also determines the type of firm companies engage. Companies seeking deals in the US or Europe will almost certainly use international firms, but for deals in Africa or Southeast Asia they tend to be more comfortable using local firms, Fang explained.

Fang said he was not threatened by the growing reach of domestic firms. “We work with a different market with more multijurisdictional transactions and act for big SOEs. The Chinese firms are unable to compete with us on this,” he said. “It would take them a couple of years at least. Even looking at the Hong Kong market, the leading firms still have the leverage on the more complex transactions,” he added.

Even though top local firms such as King & Wood Mallesons, Zhong Lun and Jun He have opened multiple overseas offices, the leading international firms have long-secured their position and reputation in the Chinese market. “It's a greater challenge for the second and third tier international firms, since they are directly competing with the local firms,” said Fang.


By Katherine Jo