Hong Kong flu-ey

The economic slowdown in the investment banking world has hit foreign law firms in Hong Kong.

but, as Philip Hoult reports, the growth of the China market means it is not all gloom

In November, Hong Kong's deputy leader Donald Tsang warned that its economy was heading for its second recession in just three years.

The strain of operating in such a difficult business environment is being felt across Hong Kong's legal community.A recent survey by recruitment consultancy Robert Walters bore this out (see [2001] Gazette, 15 November, 6).

There are too many lawyers in Hong Kong, the survey found, particularly in corporate finance and banking, following a significant change in the legal recruitment market over the past 12 months.The survey's authors blamed the economic downturn in the US, resulting in 'a general stagnancy' in the investment banking world.

Given that investment banks are key clients of the major firms, it is not surprising that many have been forced to take tough decisions.Both lawyers and support staff have been hit by redundancies in recent weeks, most notably by US firms Baker & McKenzie and Shearman & Sterling.However, job losses are only the most graphic example of how firms are dealing with the economic climate.There is a lot more happening behind the scenes as well with across-the-board hiring freezes being implemented, lawyers being relocated to London, secondments to Hong Kong being postponed and people at the end of contracts not being replaced.Christopher Clarke, Hong Kong-based Asia managing partner for CMS Cameron McKenna, admits that the immediate outlook is inescapably gloomy but he argues that this cannot be put down simply to the recent US economic downturn.He says: 'It's not a question of what has just happened - it's been dreadful for three years, which is difficult for people in the UK to comprehend.

I've been here now for 18 years and I've never seen two bad years in a row before, let alone three bad years back to back.'Mr Clarke says the first six months of 2001 had suggested that the situation was improving, but those initial signs of hope have fizzled out.Firms with significant corporate finance and banking practices have been hardest hit.

Lucrative work such as stock market flotations has dried up - those few companies to seek a listing on the Hong Kong Stock Exchange or its junior exchange, the Growth Enterprise Market, have tended to be small.

Just HK$25 billion (2.2 billion) was raised in 2001 compared to HK$107 billion in 2000.However, it is not all bad news, according to Chris Roberts, Asia regional managing partner of Allen & Overy.

'It is not a message of doom and gloom,' he says, 'but just a question of good bits and bad bits, although you have to say that at the moment the bad outweighs the good.'Mr Roberts argues that while mergers and acquisitions, listings and joint venture work may be thin on the ground, some areas of practice such as cross-border capital markets work are significantly up over the past 18 months.Other relatively strong workflows can be found in practice areas such as litigation, arbitrations and project finance.The international nature of practices like Allen & Overy, which often handle work in countries such as Thailand, Bangladesh and China out of Hong Kong, also provides a measure of protection.A number of other firms are also better placed to weather the storm because their practices are less exposed to the effects of an economic downturn.One such is Kennedys' Hong Kong practice, Skrine Thomas Sharrock, which was launched in February 2000.

'We have been very focused on insurance and that has worked,' says the office managing partner, Rupert Skrine.

'Even in a downturn claims continue.'What we do notice is that there is pressure on fees because if the insurance companies are suffering they will expect you to join in on that [by demanding lower fees].'Despite the current uncertainties, there is still a relatively high degree of optimism over Hong Kong's long-term prospects.The justification for this is its relationship with mainland China, which is one of the fastest-growing economies in Asia with an expected growth rate of 8% in 2002.China presents excellent opportunities for foreign investment, says Mr Clarke.

'For manufacturing, you cannot beat it.

One client of ours could do some of its manufacturing 18 times cheaper in China,' he says.

China's accession to the World Trade Organisation (WTO) last month is also set to provide a major boost to the region and Hong Kong.

For law firms, WTO membership should mean, within five years, the liberalisation of the market for legal services and the end to the existing restriction that prevents them from having more than one office in the country (the exception being that they may have an office on the mainland and in Hong Kong).Confidence in Hong Kong's long-term future has been demonstrated by the fact that the current economic difficulties have not deterred those firms looking to enter the Asian market for the first time from choosing it as their base.For example, Hammond Suddards Edge has just launched a nine fee-earner office in what it hopes will be its first step in developing a pan-Asian practice.Keith Brandt, the Hammonds partner with joint responsibility for development of its local practice Li Brandt & Co, says the firm considered and rejected opening in Singapore before plumping for Hong Kong.'This has been three-and-a-half years in the making,' he says.

'We certainly can't be accused of rushing in.'Nevertheless, Mr Brandt says the prevailing economic conditions have ensured that Hammonds, which will initially concentrate on construction and engineering work, has been 'extremely prudent'.

He says: 'We are in a climate where we are determined to keep costs carefully under control.'Meanwhile, City firm Norton Rose has recently announced plans for its long-awaited return to the Hong Kong market.It was forced to stay out of Hong Kong for three years after the break-up of its association with leading local firm Johnson Stokes & Master.

It is now hiring lawyers from the Hong Kong Securities and Futures Commission and Nomura in readiness for the April launch.Norton Rose's determination to rebuild a strong practice in Hong Kong demonstrates how it will continue to be an essential part of the international networks of global firms.But this should not disguise the fact that the make-up of these practices is gradually evolving.

It is a well-established long-term trend that the practices are becoming much more cosmopolitan and less dominated by UK expatriates.Hammonds' Mr Brandt says its new practice should in time become 75% Chinese and 25% English expatriate.

He says: 'One of the advantages of being one of the later entrants into the market is that it gives you the opportunity to look at what lessons can be learnt.'The changing nature of practices is in part driven by the fact that it has been made increasingly difficult since the UK handed Hong Kong back to China in 1997 for junior UK lawyers to re-qualify as Hong Kong lawyers.UK lawyers with less than five years' experience are now required to pass four exams to be admitted, although the two years of a training contract count.But the pass rate is as low as 25%, and this means that firms have to allow junior lawyers six to eight weeks off work to prepare.

Most firms are unwilling to fund this in the current climate.Lawyers with more than five years' experience are required to take a property law exam, which also has a low pass rate.As one local managing partner, who asks not to be identified, says: 'The difficulties with qualification are genuine - you can get through the exams but there's no doubt that they have made re-qualifying more difficult.'Despite this setback, firms are committed to Hong Kong.

Since the handover, fears that China would kill the golden goose have proven unfounded.

Mr Skrine says there has been too much pessimism about its future and that it will remain a key centre for business and legal services.He predicts: 'Hong Kong remains a beacon in the region in terms of the rule of law and the enforcement of rights.'Philip Hoult is a freelance journalist