Regulation & Law

China: Game Changing [Focus 2015]


The New Normal

It is no longer secret that the world’s second-largest economy has been flagging over the past few years, leaving behind decades of noteworthy double-digit growth: in 2014 China grew at its slowest pace since 1990 with a rate of 7.4%; capital exodus, decreasing exportation and the drastic volatility of the stock market have just added insult to injury.

 

But if you felt pessimistic about the economic outlook for China, think again. As a matter of fact, China is moving from an investment and export-driven economy to a consumption-driven economy, its rising middle class is gaining purchase power, and the urbanization and infrastructure construction will continue to generate a large chunk of investment opportunities. As a reminder, the IMF predicted growth in China at 6.8% in 2015, compared to global growth of only 3.3%.

 

The term “the new normal,” coined by Chinese President Xi Jinping to describe China’s current transformation, is probably one of the most popular expressions for the moment. China will continue to evolve and lead change in Asia over the next few years, but everybody needs to adapt to its new development model and grasp the new opportunities.

 

Towards Further Liberalization

Due to historical reasons, China has a tightly-controlled legal services market. 1980 marked the reinstitution of the legal profession, but it was only in 1988 that private law firms were allowed to set up, and most of today’s leading firms were established in 1992. Since, the number of law firms and lawyers has surged to reach 19,361 and 232,384 respectively by the end of 2012, according to the latest statistics of the All China Lawyers Association on mainland China.

 

Although in the 1970s a handful of foreign experts based in Hong Kong could provide legal advice related to Foreign Direct Investment (FDI) in China, foreign law firms were not officially permitted to open a branch or a Representative Office (RO) in China until 1992. By August 2014, 232 law firms from more than 20 countries and regions were registered with the PRC’s Ministry of Justice (MoJ), most of which are Anglo-Saxon firms.

 

Subject to a number of restrictions in China, foreign law firms are barred from advising on local law and representing clients in Chinese courts, and they can employ locally-qualified Chinese lawyers under the condition that these lawyers suspend their Chinese practicing licenses. Neither can they be owned by qualified Chinese lawyers.

 

At its WTO accession in 2001, China was committed to further opening its legal services industry for international competition. A recent encouraging sign of the long-awaited liberalization was the experiment of the cooperative mechanisms initiated in late 2014 by the newly-established China (Shanghai) Pilot Free-Trade Zone (FTZ), allowing a foreign law firm and a Chinese one to set up joint operations and mutually dispatch lawyers between two firms under certain conditions. Baker & Mckenzie and Fenxun were the first to stake a claim with their joint-operation in April 2015.

 

In the future, China is likely to follow the example of its Asian peers such as Singapore, Japan and South Korea, who all opened up the market gradually and step by step, as Shanghai Bureau of Justice official Ma Yi put it clearly: “if we open the market all at once, it will have adverse impact on the domestic legal industry, which is only 30 years old.”

 

Dilemma of Outposts

In the early years, the first group of international firms in China enjoyed robust business as FDI flooded into the country. With Chinese firms gaining maturity and competitiveness, things quickly changed at the beginning of 2000s.

 

“International firms were hit hard by the financial crisis as their primary source of revenue – inbound work – was significantly reduced, coupled with their disadvantage in terms of price, these firms are experiencing a downturn and have largely reduced to a dozen or even a few head figures, and the existing firms are shifting from inbound to outbound work,” Warren Hua, ex-Gide partner in Beijing who works for JunHe now, analyzed, “the survival space of international firms is shrinking, which limits the quality of cases and the career development of lawyers, so an increasing number of lawyers in international firms returned to Chinese law firms after the credit crunch.”

 

Despite the tough competition, no wide tide of retreating from China has been observed, but a few exits, among which are Vinson & Elkins (2013), Stephenson Harwood (2014, then re-entry through alliance with its ex-team), Fried Frank Harris Shriver & Jacobson (2015) and Chadbourne & Parke (2015). According to Dr. Li Su, Research Methodologist and Statistician of Empirical Legal Studies at Berkeley Law, “the rarity of exit reflects perceptions that a China presence is a valuable symbol of global commitment and a worthwhile bet on future growth.” Given the difficulty in obtaining regulatory approval to launch an office, and peer pressure, most firms are more likely to maintain a leaner presence and hope for more flexible regulatory changes that could add flexibility and a more favorable economic climate. After all, nobody can afford to miss the importance of the market and its potential.

 

From Ugly Duckling to Beautiful Swan

When talking about Chinese law firms, people always tend to ignore the basic fact that they are extremely young: the oldest firms have barely crossed their 25-year mark, and the few top Chinese firms truly began to take a more substantive role in inbound work only around 2001. Although Chinese firms are making impressive progress and working on more sophisticated and complex deals, it would be unreasonable to make an apples-with-apples comparison if we were to evaluate Chinese firms by western standards.

 

Over the past few years, Chinese firms have been experiencing four waves:

  • Wave of integration

Intertwined inextricably with the economic growth, Chinese?firms?have been?growing at an extraordinarily rapid pace in ­sophistication and scale, but the firm culture is still being cultivated, and practice capability and quality is as yet uneven from one office or practice group to another.

 

Following a decade of rapid scaling-up, many local firms such as Decheng and Yingke started shifting from pure expansion to strengthening their capability in specialized practices and organizational excellence. The management team has been focusing on the integration between practice groups and offices, as well as on improving the quality and consistency of client services.

 

  • Wave of internationalization

Since the early 2000s, Chinese firms have been stepping onto the ­international stage by spreading across borders into ­various major jurisdictions outside of China (cf. List 2). Although many international firms regard this expansion as a map-­dotting to serve marketing and client-sharing purposes rather than true internationalization, such overseas offices can fill the gap in the market where certain clients’ overseas matters are underserved. Furthermore, a number of independent law firms outside of China are likely to benefit from these Chinese firms’ international referrals.

 

Another aspect of the internationalization is recruiting international talent. In order to improve their ability to run cross-border deals and leverage a rich reserve of local ­knowledge, many Chinese law firms are hiring high-end legal talent from international firms, be it capable Chinese lawyers who are qualified and trained overseas and have practiced with international firms in China, or international lawyers who have rich experience in China.

 

  • Wave of consolidation

2014/2015 has witnessed several mergers between mid-tier Chinese firms, such as the deal between Shanghai-based Boss & Young and JoinWay, Beijing-based East Associates and Concord & Partners, and most recently, Beijing Tianchi Hongfan and Juntai.

 

In March 2014, there were rumors that Jun He and Zhong Lun would merge, but talks were suspended due to difficulties in gaining partner support, along with cultural compatibility issues. Nevertheless, an attempt of such an unprecedented magnitude in China sheds new light on the firms’ desire to bring themselves to another level. This is a natural progression as the market matures and becomes more sophisticated.

 

  • Wave of innovation

Whereas some international lawyers hold that the overwhelming role of government approval reduces the creativity and innovative ability of lawyers in China, others tend to believe that the adaptation to such limitations requires creativity. As a matter of fact, innovative practices are not rare among Chinese firms: Yingke, for example, has set up “Yingke Cloud,” an online and mobile legal service platform that provides affordable and accessible virtual legal advice to individuals and small to medium-sized enterprises in China and overseas; in July 2015, Shangdong Deheng Law Firm started selling shares on the Qingdao Blue Ocean Equity Exchange to partners of the firm, setting a precedent in the history of China’s legal market.

 

Towards Convergence

The development of law firms is subject to the development of economy, and the convergence between western firms and their Chinese counterparts is the natural result of the international aspirations of Asian companies that require full-service support and of the need for localization of international clients.

 

The combination between King & Wood Mallesons and SJ Berwin in November 2013 was a head-turning moment for the global legal community, but it is likely that nobody expected the next big news would come so soon: less than one and half years later, in January 2015, the world got excited again at the announcement of the tie-up between Dentons and Dacheng to form the largest law firm in the world by lawyer head count: more than 6,500 lawyers and professionals in 120 locations in more than 50 countries.

 

The advantages are obvious: Dentons will benefit from the strong presence of Dacheng in China’s second-tier cities, which are considered as the future engine of China’s growth; whereas Dacheng will gain the global network of Dentons and gain access to and leverage top-notch international management processes and enhance its ability to support clients overseas. What remains is integration.

 

Practices on the Rise

Since the leadership change, the Chinese government has taken a tougher stance against corruption and commercial bribery, triggering investigations into both multinationals’ and large Chinese companies’ practices. High-profile cases such as the GSK bribery probe in late 2014 have certainly drawn global attention to China’s determination, and such regulatory enforcement action is likely to continue in the future, with a number of consumer industries such as food, pharmaceuticals, petroleum and telecommunications as highly-targeted areas, as the Chinese public’s interest in food safety and health care is at an all-time high. Facing greater regulatory scrutiny and potential dawn raids, companies in China are in need of greater legal assistance and advice in compliance.

 

Outbound work is also picking up pace. Fuelled by increasing financial strength and a desire to internationalize and compete on a ­global basis, Chinese companies are increasingly bidding for assets overseas, and their investment sectors and locations have largely diversified from the early stage, when they concentrated on the resources and energy sector and mature markets. In addition, the profiles of Chinese investors have also extended from State-Owned Enterprises (SOEs) to large and medium-sized privately-owned companies and sovereign wealth funds.

 

In addition, the initiative of "public innovation" or "grass-roots innovation" firstly proposed by the 2015 NPC and CPPCC[1] Report on the Work of the Government, as well as the recent setting up of three Intellectual Property (IP) courts, will boost China's future IP development. Other hot topics include anti-monopoly, Public-Private Partnership (PPP), the securitization of corporate equity, equity management of banks and corporates, red-chip return, to name only a few.

 

Navigating Uncertain Tides

The many issues that firms are facing in China are characteristic of an important developing market. This is a long and inevitable development process as China becomes a more sophisticated jurisdiction and an international powerhouse. Many challenges and obstacles may occur during the journey, and only those who have a clear strategy and great flexibility will flourish in this changing landscape.

 

[1]The National People's Congress (NPC) is China’s national legislature and the National Committee of the People's Political Consultative Conference (CPPCC) a political advisory body. 

 

10 milestones in the history of China’s legal market

1. July 1983: The first Chinese law firm, Guangdong Shekou Law Firm, was established in Shenzhen

2. May 1988: The first Chinese partnership-modeled private law firm, Duan Wu Liu Law Firm, was established in Shenzhen December

3. 1992: Four international law firms obtained the license to set up in China: Adamas, Denton Wilde Sapte (now Dentons), Lovell White Durrant (now Hogan Lovells) and Coudert Brothers (now defunct)

4. July 1993: Jun He became the first Chinese firm to open an office overseas (in New York)

5. December 2001: China became a member of the WTO and promised to further liberalize its legal market

6. April 2006: The Shanghai Bar Association issued a memo accusing foreign law firms of conducting illegal business activities, creating tension among Chinese and international legal professionals

7. March 2012: King & Wood PRC Lawyers merged with Mallesons Stephen Jaques to form King & Wood Mallesons, marking the first merger between a Chinese and a foreign firm

8. November and December 2014: China opened its first three IPR courts in Beijing, Guangzhou and Shanghai

9. January 2015: Dentons announced the merger with Dacheng, marking the first combination between a Chinese firm and a top-10 global firm

10. April 2015: Baker & McKenzie and Fenxun formed the first Joint Operation under the pilot scheme of the China (Shanghai) Pilot Free-Trade Zone

 

Global reach of major Chinese law firms by September 2015*

Asia

Osaka: Co-effort

Tokyo: KWM, Shimin, Zhong Lun

Seoul: Yingke

Ulaanbaatar: Dacheng

Singapore: Dacheng, Yingke

New Delhi: DeHeng

Tel Aviv: Yingke

Riyadh: Zhonglun W&D, KWM

Dubai: DeHeng, KWM, Yingke

 

Oceania

Brisbane: KWM

Canberra: KWM

Melbourne: KWM, DeHeng

Perth: KWM

Sydney: KWM, W&H

 

Europe

Berlin: Zhonglun W&D

Hamburg: Zhonglun W&D

Frankfurt: KWM, DeHeng

Munich: KWM, DeHeng

 

Brussels: DeHeng, KWM, Yingke, Zhonglun W&D

Luxembourg: KWM

Paris: Co-effort, DeHeng, Dacheng, Grandall, KWM, Zhonglun W&D

The Hague: DeHeng

London: KWM, Yingke, Zhong Lun, Zhonglun W&D, YangTze Law (2015 in the form of Alternative Business Structure)

 

Madrid: Grandall, KWM, Yingke (2014)

Lisbon: Yingke (2014)

Verona: Yingke

Milan: Co-effort, KWM, Yingke

Athens: Yingke (2015)

 

Budapest: Yingke

Warsaw: Yingke

Moscow: Dacheng, Yingke

Istanbul: Yingke

 

North America

Atlanta: Hui Ye

Chicago: Dacheng, Yingke

Los Angeles: Dacheng

New York: DeHeng, Dacheng, Jun He, KWM, Shimin, Yingke, Yue Cheng, Zhong Lun

Silicon Valley: Jun He, KWM, W&H, Grandall (2015)

Seattle: DeHeng

Florida: DeHeng

Orlando: DeHeng

Philadelphia: Shimin

 

Mexico City: Yingke

 

South America

Sao Paulo: Yingke, DeHeng

 

* Non-exhaustive list

 

Jeanne Yizhen Yin

Feel free to contact me if you are also interested in the Chinese legal market.

 

Photo: © Wonderlane

Read the full Special Report: China: Game Changing

The growth story of China’s legal and financial industries is both a product and a testimony of this country’s continuous economic transformation: nascent but fast-growing, vastly different from a decade ago and still rapidly changing. The game has started, and faced with various issues, both international and domestic firms are constantly responding, rethinking, reshaping, readjusting… To survive and thrive, they need to master the fine art of balance between growth and profitability, expansion and quality control, opportunities and risks.
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