A decade ago the magic circle firms enjoyed an unrivalled position in China. Throughout most of the 2000s the country’s economic growth was driven largely by foreign investment, and competition in its legal services market was relatively low.
Back in 2007 King & Wood – now King & Wood Mallesons – was still a budding national firm with 400 lawyers, while Dacheng (now Dentons) only had six offices and 300 lawyers. Top-notch Wall Street firms such as Davis Polk & Wardwell, Simpson Thacher & Bartlett and Sullivan & Cromwell maintained a small presence in Hong Kong back then, offering only US law advice.
That was the heyday for the UK’s top players. Linklaters led the pack, with nearly 200 lawyers in Hong Kong, Shanghai and Beijing, bagging mandates in many of the country’s largest M&A transactions, corporate finance deals and infrastructure projects.
A former senior-level partner of the firm’s China practice recalls that China was the firm’s most profitable part of the business in that period. A handful of Chinese partners raked in $50m (£35m) in revenue in its best year. Although it only accounted for a small proportion of Linklaters’ firmwide revenue, which was around £1bn at the time, average revenue per partner and profitability was high given the size of the team.
But much has changed in a decade. Life has become much tougher for the UK’s most successful group of firms in the world’s second largest economy. Not only they have been regular targets for top talent when US firms are pushing into Hong Kong and China, they are also losing the market share in cross-border deals they traditionally enjoyed to fast-maturing PRC firms and aggressively expanding US outfits (see Timeline on notable US raids).
“US clients are leaving the magic circle to go back to US firms for China matters”
More worryingly, an inflexible lockstep structure, a high cost base and a top-down management style have put some of them at a disadvantage in a highly competitive environment, making them less nimble in adapting to change.
Linklaters’ and Allen & Overy’s (A&O) dwindling corporate practice and partner headcount in China is a ramification of the tectonic shift in the market and the unprecedented challenges they are facing.
In 2007 Linklaters had 27 partners in Greater China and, despite steady promotions and relocations of partners from other offices to the region each year the number of partners declined to 22 at the end of March this year. A&O has seen a steeper rate of decline, from 34 partners to 24 in the same period.
Many market participants in China’s top-end legal services market have testified to the growing challenges magic circle firms are facing, largely because of strong competition brought about by the Wall Street firms.
US firms have ‘stronger relationships’
“US firms can now deliver the same, if not superior, services,” says a partner of a Wall Street firm in Hong Kong who used joined from a magic circle firm. “They also come with stronger relationships with private equity [PE] firms and US banks. The biggest challenge for the magic circle is that US clients are leaving them to go back to US firms for Hong Kong and China matters.”
While Hong Kong law capability is undoubtedly critical for cross-border deals in China, US law is becoming much more widely used in many of China’s big transactions these days, especially in the internet and technology sectors, according to the partner.
“A lot of pre-IPO deals are dominated by PE houses, and investments in the tech sector are mostly US-style financings such as series A, B, and C funding rounds. They are governed by New York law,” he says. “In China magic circle firms don’t have advantages over the US firms, and the US firms have given them real headaches.”
While all magic circle firms are feeling the squeeze, a common market perception is that Linklaters, particularly its corporate practice, has been the biggest casualty of US firms’ China push.
“Linklaters is still a highly respected firm with top-quality services and products, but it is not the Linklaters of five or 10 years ago,” observes a partner in a leading Chinese firm that regularly works alongside the likes of the magic circle and Wall Street firms.
“Looking at the market and the deals it’s doing, Linklaters’ position seems to have weakened the most among all the magic circle firms,” adds a partner in a US firm in Hong Kong.
Linklaters in crisis
Sources close to Linklaters consider the two years prior to the 2008 global financial crisis as the peak for its China practice. The line-up of lawyers in place at the time is described as a “dream team”. Key members included then-Asia managing partner Zili Shao, China co-head Celia Lam, Hong Kong partners Teresa Ma, Paul Chow and Betty Yap, Beijing partner Thomas Ng and Shanghai partner Fang Jian.
But Shao’s departure in 2009 to become chair and CEO of JP Morgan in China marked as a turning point – a long period of gradual decline was to follow. The dream team has diminished over the years. Today, only Fang Jian remains at the firm, serving as national managing partner for China. Apart from Ma who has recently retired, all other core members have jumped ship to either a Wall Street firm or a magic circle rival (see timelines for notable US raids).
Despite the firm’s clear ambition to grow in China, including plans to launch a China law offering via the Shanghai Free Trade Zone Pilot Scheme, the downward spiral of its Greater China corporate practice, particularly in its Hong Kong office, has gathered pace in the past 18 months.
In the space of just one year the number of partners in Linklaters’ China and Hong Kong offices has plummeted by 12 (see table for a detailed list of partner exits). It is a staggering rate of attrition, accounting for a fifth of Linklaters’ entire Asia partner headcount and more than a third of its Greater China partnership ranks.
These exits can be categorised into three main groups: natural retirement, performance-related cases of partners being ‘managed out’ and voluntary moves. While a few of the partners who moved voluntarily did so for family and personal reasons, the majority left to join either a US firm or a magic circle competitor.
Linklaters’ corporate department in Hong Kong, especially its PE team, has been hit hardest by the recent raft of partner departures and retirements.
With global corporate head Matthew Middleditch due to return to London later this year after a four-year tenure in Hong Kong, Linklaters will only have two corporate and M&A partners in the major financial hub: Asia practice head Robert Cleaver, who was relocated from London in late 2010, and Craig Dally, who was made up in 2012.
Hong Kong PE partner Betty Yap and Beijing corporate partner Judie Ng Shortell are the latest partners to leave the firm, both moving to Paul Weiss Rifkind Wharton & Garrison’s Hong Kong office. Their departure is expected to have the most disruptive impact on the firm’s Asia PE practice and China practice.
“Betty is a big loss.,” says a source close to Linklaters. “Her move with Judie to Paul Weiss does change the dynamics,”
The sensitivity around Yap’s departure was not only because she is a highly regarded PE partner but also because she is a key member of the firm’s China practice. She joined Linklaters in 1998 in Hong Kong and was made up in 2004 before her appointment as head of China practice in 2011. She was mentored by, and worked closely with, Shao, who played a fundamental role in building up Linklaters’ China practice in the early 2000s.
A highlight of the pair’s deal list was China Mengniu Dairy’s $1.7bn acquisition of Yashili International in 2013 as part of China’s milk production industry consolidation. The pair acted for Hong Kong-listed Yashili as well as its main shareholder Zhang International Investments and the Carlyle Group, which sold its 24 per cent stake in the listed company in the deal.
Apart from her technical skills and client relationships Yap was the only Chinese-speaking, Hong Kong-qualified corporate and M&A lawyer in the Hong Kong office. Shanghai-based China managing partner Fang does not advise on Hong Kong law. Although six of the eight mainland China-based partners are qualified in Hong Kong, five have only been partners since 2012.
Responding to the series of departures Linklaters’ Asia managing partner Marc Harvey insists that the reason for each exit is different and that departures open opportunities for new talent. The firm also indicates that partner promotions this month will include “robust additions to our dynamic Asia team”.
In the four years between 2012 and 2015 the firm’s promotions had a strong focus on Greater China (see table). But last year Linklaters only elected one Beijing corporate lawyer to partner in Greater China. In 2012 all five of the firm’s Asia promotions were from Greater China .
The firm’s rivals, however, expect a more trying time for Linklaters to rebuild its corporate and PE offerings in Hong Kong.
“Any law firm that has lost three- to five-star partners should be concerned,” says a partner of a US firm in Hong Kong. “It needs to do some soul-searching and rethink how to keep partners motivated.
“Linklaters lost some high-profile and high-quality people in the market. It’s one thing to lose older partners who are reaching retirement age, but not the sort of partners they are losing, who are at their peak and really should be the engine of the firm’s growth in the next 10 years.”
Timeline of US raids
No centre of gravity
Sources familiar with the situation claim that although Linklaters has been prioritising investment to its China team and maintaining its partner ranks in China through promotions and relocations, lack of a centre of gravity in its leadership team has been a problem since Shao left.
After Shao’s departure Linklaters parachuted a string of London-based partners into Hong Kong in a bid to strengthen capability in Greater China. For example, Cleaver was transferred to Hong Kong in 2010, and this was followed by energy and infrastructure partner James Douglass’ relocation to Beijing and Middleditch’s move to Hong Kong in 2012.
“The office is neither an expatriate office nor a local outlet,” says a source. “It’s more of a personality issue than anything. The Hong Kong management doesn’t have a clear strategy and is more about managing the process and day-to-day running of the business.”
Another Linklaters alumnus shares a similar observation.
“When the firm promoted Zili to Asia managing partner it was a very encouraging sign to the Chinese team – it showed the firm’s commitment to and trust in the China practice,” says the lawyer who used to work at Linklaters’ Shanghai office, adding that the London management made little intervention in the running of the strongly performing China team.
“But since he left, the firm has moved several partners from London to China. The move caused some friction between the local and expat partners due to cultural differences and different approaches to business development.”
The lawyer specifies that fee rates was an area where disagreements frequently arose.
“It’s hard to win new mandates from Chinese clients – sometimes, even when we fought hard to get a lead on a project we had to give up the instruction due to the firm’s high requirement for fees,” he says, citing flexibility in fees as one of the reasons drove him to join a PRC firm.
An A&O alumnus in Hong Kong also doubts the strategy of parachuting London partners in.
“If you look at the market, the number of partners parachuted in who are successful here is very small, unless they have the specific expertise the market needs,” he says. “Otherwise, they’re stepping into other people’s practices.
“From the client’s perspective the people making decisions for Asia are based in Asia, such as the regional general counsel of a global investment bank. It’s hard to walk into the general counsel’s office at headquarters and say – please send more work our way to Asia. Winning work in Asia is about being around in the market for a long time and having relationships with the right individuals who hand out the work.”
Unwilling to invest
Magic circle firms in China are facing a double-whammy – increasing competition from US and local firms and decreasing foreign investment into China, where economic growth is slowing.
“The investment landscape has changed significantly in China,” says a partner at a leading Chinese firm. “Before 2008 magic circle firms’ global banking and financial services clients invested heavily in China but the flow started to dry up after 2010. Many of the deals they’ve handled since are these clients’ exits and divestments.”
With inbound referrals from home market clients slowing and the ability to develop local clients limited by firms’ fee structures and strong local partners, achieving the same level of profitability in China as in London is increasingly difficult.
The difficulty in making good money has resulted in the magic circle firms becoming reluctant to continue investing in China corporate practices.
A partner who left A&O to join a US firm in recent years unveils the magic circle firm’s downfall in Hong Kong and its unwillingness to invest.
“Hong Kong was rarely profitable for the firm and average profit per partner in Hong Kong was consistently below the firmwide figure by around 20-30 per cent. Hong Kong was always on the take-side,” comments the partner on A&O’s Hong Kong financial performance in the years he was a partner at the firm. “The downfall of the firm’s Hong Kong office dates back to 2008 when a big corporate team left for Latham & Watkins. It’s never been able to recover from that and has gradually gone from having a premium corporate practice in the region to having no real corporate practice at all.”
In October 2008 a team of seven partners led by A&O’s former China corporate head Michael Liu left to help Latham launch a local Hong Kong law practice. The move came after former board member Liu was passed over for the role of Asia chief in favour of project finance partner Thomas Brown in June that year.
“The firm dealt with the big team exit by relocating people from London who are not well-connected to Asia,” says the ex-A&O partner. “The talent pool in Asia is not that deep. After suffering a significant loss like that replacing talent is extremely difficult.”
A&O’s Hong Kong partner exits are continuing, with recent leavers including international capital markets head Walter Son, capital markets partner David Kuo and corporate partner Vivian Yiu. Yiu is moving to Morrison & Foerster and Kuo has joined Milbank Tweed Hadley & McCloy, but Son’s next move is yet to be announced.
What is more disappointing, in the view of ex-A&O partners, is that firm’s unwillingness to invest in rebuilding the practice. In other words, the firm is unwilling to make competitive offers to attract senior talent in areas it deems commoditised and oversupplied, such as capital markets and general corporate.
“When the office’s profitability is below firmwide average it’s difficult for people from London to buy in to the idea of investing more money and people here, so there wasn’t a huge amount of interest in pouring huge amounts of money back into Hong Kong,” the ex-A&O partner explains.
In 2012, the firm took an even more drastic decision intended to improve its profitability by culling five partners at the top of its equity ladder in Hong Kong.
“These people have been in the market for a long time and have strong practices,” he continues. “The cull was a combination of personality issues and the fact that the office is not doing super-well,. But they were trying to address underperformance without a real plan allowing the firm to perform better.”
According to the lawyer, a number of the firm’s clients in the corporate practice space have expressed a lack of confidence in being advised by juniors who have only been partners at the firm for two or three years, and some have replaced A&O with firms that can offer teams led by more senior partners.
Despite its diminishing corporate and capital markets practices, A&O has been focusing on niche service products such as high-end banking matters and its financial regulatory practice in Hong Kong. It has also leveraged its global network to secure several outbound transactions by Chinese companies, such as Anbang Insurance’s acquisition of Dutch insurer VIVAT and ChemChina Petrochemical’s acquisition of a minority stake in Swiss commodity trading company Mercuria Energy Group.
Inflexible lockstep
Apart from external factors such as changing market demands and competition, magic circle firms’ lockstep structure has put them at a disadvantage in retaining and attracting talent in a competitive talent market.
Linklaters has the least flexible lockstep system among its peer and is suffering a pronounced problem that has driven several partners to defect to rival firms.
It operates a 10-year lockstep, with partners joining on 10 points and adding 1.5 points per year up to a plateau of 25. In the 2014/15 financial year the firm’s equity spread ranged from £711,000 to £1.8m, signalling a 1 per cent increase at both ends of the equity.
The firm is understood to have discussed for a number of years plans to introduce gates to its equity, bringing a merit-based element to its lockstep structure. However, there has not been any real progress on this.
“If you ask most people, the firm is not as much a fun place to work as it used to be,” says a former partner of Linklaters. “It has become an increasingly tightly managed firm. Its culture and collegiality isn’t what it used to be. The good things a lockstep system aims to promote are under strain.”
Another former Linklaters partner claims the culture change was first driven by the old global management led by managing partner Simon Davies, who left the firm at the start of the year.
“Management focuses heavily on individual performance and numbers but its inflexible lockstep means partners can’t be moved up or down the ladder,” he says. “The only tool management has is to encourage people to leave.
“It has driven some unhappy behaviours as individual partners try to maximise their individual performance. People started to be protective of their own business and less willing to share clients or work with other partners.”
Political infighting over clients and business origination is mentioned by a number of former Linklaters partners as a pressure point, criticising the experience as “demoralising” and “draining”.
“The firm’s lockstep system doesn’t reward good lawyers or hard-working partners contributing strongly to the bottom line,” says another former partner. “Instead, people who are politically savvy will be better rewarded. There was too much politics. I just wanted to be a good lawyer and was eager to build the business, but it’s very difficult to do in Linklaters.”
“A&O has gone from having a premium corporate practice in the region to having no real corporate practice at all”
Issues relating to lockstep aside, the wide gap between the average profit per equity partner (PEP) in the magic circle firms and the Wall Street firms itself has led to US firms appealing to strongly performing dealmakers in UK firms. In 2014/15 Linklaters’ PEP stood at approximately $2m, but PEP figures at Davis Polk & Wardwell and Paul Weiss in 2014 reached $3.3m and $4.8m respectively.
“The difference in compensation is just incredible,” says a former magic circle partner. “If you’re not happy where you are and know you can earn much more money elsewhere the decision is easy.”
PRC law offering is no game-changer
While A&O has responded to China’s changing market by moving away from less lucrative work to focus on the very high end in a number of product areas where it has strong global expertise, Linklaters is contemplating a different solution to strengthen its China offerings.
The firm has been looking for a Chinese ally since 2014, having held talks with a large number of Chinese firms ranging from elite firms such as Global Law Offices to Shanghai-based boutiques Capital Law & Partners and Kai Rong.
A final plan will be discussed at the firm’s global partner conference in Berlin later this month. Several sources familiar with Linklaters suggest the firm is more like to go with the greenfield option, whereby it would set up a new PRC firm with some of the PRC-qualified lawyers working in the firm, then enter into association with the firm under the Shanghai Free Trade Zone Pilot Scheme to ensure full control of the China offering.
Courting China’s elite firms, which are still enjoying exponential growth and gaining financial strength, is almost a mission impossible for Linklaters. Linklaters’ small practice in China is noted by a few Chinese lawyers as a deterrent to China’s full-service firms. They see a deal as bringing limited benefits and maybe stopping referrals from other international firms.
If Linklaters does launch a PRC offering either through a tie-up with a mid-sized or boutique local firm or setting up its own outlet, the local practice will be small in comparison to the established elite Chinese firms, such as King & Wood Mallesons, Zhong Lun, Jun He and Fangda.
“If the firm had done a deal 10 years ago there would have been a chance of creating a strong PRC practice comparable to some of today’s leading firms,” says a well-positioned source. “But now it’s almost impossible to achieve.
“Foreign firms are underestimating how strong the top-tier Chinese firms have become,” adds the source, who expects the top earning partners in a small number of Chinese firms to catch up with their magic circle counterparts in three to five years. “They will face a real battle with leading Chinese firms in the mid-cap market space.”
To Linklaters’ closest rivals, its plan to launch a PRC law offering will hardly be a game-changer for the firm or the market.
“For top-end cross-border deals PRC law is not that important,” says the partner at a Wall Street firm. “If it’s important everyone will be looking at it. But it is a nice capability to have. The sense in the market is that Linklaters’ China ambition is not going to be a huge game-changer but a nice complement to its present offering,”
Linklaters’ ‘Project Trident’, the code name for the firm’s China strategic review and plans, may not deliver a game-changing advantage in China, but it does offer the firm a glimmer of hope. To recreate its glorious past in China many more things need to change.