Simplifying Complexities—The Future of Legal Practice in China

Since China's first Free Trade Zone was established in Shanghai in 2013, the State Council has created a negative list to regulate the industries where foreign investment is restricted or forbidden within these zones. For any industry that does not appear on the negative list, foreign companies will receive the same treatment as domestic ones.

The 2018 Nationwide Negative List reduces the sectors in which foreign investment is restricted from 63 to 48, and includes openings in finance, infrastructure, transportation, commercial logistics, professional services, agriculture, coal and nonmetal mining, and the manufacturing of autos, ships, and aircraft. In many of the newly liberalized sectors, limits on the proportion of equity that foreign investors may hold have also been lifted. With respect to the finance sector, under the new Nationwide Negative List, the maximum ratio of foreign-held equity in futures, life insurance, securities and fund management companies is increased to 51 percent.

Furthermore, the new Nationwide Negative List sets out a schedule for removing all foreign equity restrictions in the automobile and finance sectors. In the automobile sector, restrictions on the proportion of foreign equity in commercial vehicle manufacturing will be removed by 2020. In addition, restrictions on the proportion of shares in passenger vehicle manufacturing and limits on the number of joint ventures that foreign companies can establish will be removed by 2022. In the finance sectors, the restrictions on the proportion of foreign equity in securities companies, futures companies and life insurance companies will be removed by 2021.

The new FTZs Negative List cuts restrictions on foreign investment from 95 sectors to 45 and eases restrictions in the culture, petroleum and natural gas, agriculture, mining and finance sectors. Similar to the new Nationwide Negative List, the new FTZs Negative List also offers a clear timeline for the opening-up of the automobile and finance sectors to foreign investment. The list applies to all of the free trade zones in China.

The newly issued Negative Lists demonstrate that China is taking concrete and significant steps to open up previously restricted sectors to foreign investment at a faster rate than has been seen in previous years, says Danian Zhang, Baker McKenzie's chief representative in Shanghai.  They should also present many opportunities for existing and prospective foreign investors active in the liberalized sectors, Zhang adds.

Belt and Road Encourages Outbound Acquisitions

As restrictions on inbound foreign investment relax, Chinese companies have also increased in size on international expansion and overseas acquisition, opening up a growing need for access to legal expertise in foreign jurisdictions. M&A, banking & finance, and compliance lawyers have reported an increasing proportion of their practice taken up by outbound work. And one of the drivers for outbound work is the Belt and Road initiatives.

“The Belt and Road Initiative will continue to be a major driving force in Chinese outbound investment,” says Stanley Jia, Baker McKenzie's Beijing chief representative. According to Baker McKenzie's Belt and Road report, China-linked Belt and Road initiative projects will be worth $350 billion over the next five years.

Many Chinese companies are already actively developing their Belt and Road projects, particularly in infrastructure and power, especially in South Asia and the Middle East. They are also helping to develop rail systems in Southeast Asia, Eastern Europe and Latin America.

“Cross-border transactions of this kind can involve multi-layered local regulations for financing, contracts, and environmental considerations,” says Jia says. “This drives up demand for advisory services not only in M&A and project finance, but also in other related advisory areas, including antitrust and competition, compliance, regulatory, employment and tax.”

The increase in inward and outbound opportunities has prompted domestic law firms to develop their international capabilities in order to assist Chinese companies with cross-border transactions and disputes, and steer through the complex regulatory landscapes of foreign jurisdictions. It has also encouraged many international law firms to strengthen their foothold in China to serve this growing market.

“For law firms, having the right mix of capabilities will be the key to unlocking this opportunity,” Jia adds. “Indeed, for the local Chinese firms that are now supporting their Chinese clients to expand into unfamiliar markets, this poses a significant challenge as they often need to build third-party law firm relationships from scratch. That is why the FTZ joint operation model has also gained such traction; these bedded down relationships mean firms such as FenXun Partners can rely on established relationships and be confident in the quality of work being done in markets from Indonesia to Turkey.”

For international firms wishing to serve the China market—which has the potential to become the largest in the world—it is important to establish a strong presence in China, as clients typically value having their legal representatives “within arm's length” and prefer to obtain counsel in Chinese.

Getting a Foothold in China

Historically, foreign law firms have been restricted in their ability to advise on Chinese law or make representations in court. A major shift happened in 2015 with the introduction of the Shanghai Free Trade Zone Joint Operation regime, which allowed firms to overcome these issues by setting up joint operations with local Chinese firms to provide clients with advice on PRC law while each firm remains structurally and financially independent.

In April 2015, Baker McKenzie became the first international law firm to take advantage of this change and to be granted a “Joint Operation” (JO) license with FenXun Partners. The Baker McKenzie FenXun (FTZ) Joint Operation Office was able to service clients with a global and PRC law capacity from a single and aligned platform.

“The restriction on practicing Chinese law had limited our ability to grow the business in China,” says Milton Cheng, managing partner for Baker McKenzie's Hong Kong office. “Clients used to go to Chinese firms for onshore matters in China,” Cheng says. “Now we are able to follow through those components for them as well.” The Joint Operation has represented clients before regulators such as the Ministry of Commerce and the State Administration of Foreign Exchange as well as in Chinese courts.

As Chinese clients become more sophisticated buyers of legal services, a law firm's ability to distinguish itself with high-end legal services from those that offer commodity-type services becomes even more critical.

“That is why we opt to partner with FenXun via the Joint Operation model, as opposed to joining up with a 2,000-lawyer firm. Partner relationships are a key factor in legal procurement in China, and they also bring work opportunities to other parts of our business outside China,” says, Milton Cheng, Hong Kong managing partner for Baker McKenzie.

According to Cheng, “Baker McKenzie's play in China—and globally over the past 70 years—is never just about building and hiring domestic practice capability on a stand-alone basis. It's about building a cross-border practice capable of being part of a global matrix of top domestic practices. You have to have strong domestic capability to support the inbound work and hire domestic talent, but you also need to bring in people with a clientele and an international outlook, that which can help grow a cross-border practice to meet clients' cross-border growth needs. The Chinese local law capability that FenXun brings is key to executing this strategy.”

The First Joint Operation

According to Yingzhe Wang, managing partner at FenXun Partners, 2015 was a “very big moment for China,” and a “key step in opening up the legal services market to international law firms.”

As China's first Joint Operation, Baker McKenzie and FenXun Partners had overcome multiple challenges. Finding the right partner was only the start. Cheng says, “FenXun was the right domestic partner for us because of their international mind-set and their vision of creating a different kind of Chinese law firm that would be much more international in outlook, strategy, management and culture. The chemistry was good from the start and we felt that the partners at FenXun would fit well with the Baker McKenzie culture of collaboration and friendship.”

The next step was to ensure the local firm understands, and adapts to, the international firm's way of doing things. “It took time for people at the local firm to understand and adapt their modus operandi. It takes a culture change and a lot of patience to align the two firms,” says Cheng.

This was also a big opportunity for local law firms to get access to international law firms, which meant that a combined entity could offer a one-stop-shop legal service to all clients, Chinese and foreign. For FenXun it meant “an opportunity to upgrade our management techniques to international standards of management practice,” Wang adds.

“For us, this meant a significant expansion of our client base,” says FenXun's Wang. “[Some] 100 international clients, principally European and American, started to use FenXun for services in China.”

In the last three years, the Joint Operation has quadrupled in size to more than 100 lawyers and timekeepers, and have worked on more than 1,800 transactional and advisory matters. Cheng notes that the growth is, first and foremost, driven by the firm's business strategy. In addition, at a macroeconomic level, China's pushing forward of the Belt and Road Initiative and the Cybersecurity Law (网络安全法) for example, are opening up ample new business opportunities for law firms with the right capabilities.

Wang cites Excel Partners China Fund's recent term loan facility on which the firm advised as a compelling example of how clients are benefitting from the Joint Operation's integrated service. “Having helped Excel with its purchase of the Excel Center in Beijing in 2005 and 2006, our Joint Operation assisted Excel on a ground-breaking $175 million secured term loan facility from a consortium of five leading international banks, led by Deutsche Bank A.G. as mandated lead, to three Barbados subsidiaries of Excel as borrowers.”

The loan was secured by a complex security package, including the mortgage of the Excel Centre, a Grade A office building on Beijing's main financial street indirectly owned by the three borrowers, through three wholly foreign-owned enterprises established in Tianjin.

Other types of security included cross-border guarantees, onshore and offshore share pledges, debentures and charges on accounts receivable. The transaction leveraged the international reach of Baker McKenzie and involved multiple jurisdictions including China, Barbados, Hong Kong and the United States.

This transaction is particularly noteworthy because it was one of the first of its kind and provided a compelling new model for how offshore lenders can benefit from a direct recourse against onshore assets through “Nei Bao Wai Dai” (内保外贷) arrangements (providing domestic security for foreign loans).

By Baker McKenzie