A combination of increasing competition, rising costs, and a drop in China work has placed international law firms in Hong Kong – particularly those from the U.S. – under significant pressure. This confluence of factors has resulted in a moment of reckoning, when firms need to decide whether they should consolidate, scale down, or exit the territory altogether.

The last few years have been difficult for U.S. firms focusing on capital markets in Hong Kong. In late 2016, Cadwalader Wickersham & Taft closed its Hong Kong office, while Fried, Frank, Harris, Shriver & Jacobson also left the city in early 2015. More recently, firms like Orrick, Herrington & Sutcliffe, Ropes & Gray, and Winston & Strawn have suffered a string of partner losses.

It was not that long ago that Hong Kong looked like a goldmine to U.S. firms, and until quite recently, China was growing at more than 9 percent a year. A stream of mouth-watering capital markets transactions from fast-growing Chinese companies flowed through the Asian financial hub, such as the Hong Kong listings of Agricultural Bank of China in 2010 and Industrial and Commercial Bank of China in 2006, both of which raised more than $20 billion. 

So U.S. firms set up shop in Hong Kong with hopes of building a significant capital markets practice focused on China. But in their over-optimism, a lot of them underestimated the degree of competition they would face, says Colin Law, head of Greater China and the Asia capital markets group team leader at Shearman & Sterling. 

Many U.S. firms were attracted by the headline figures. “If you get it right, you can bill anywhere between $1 million and $4 million for each transaction,” he shares. But the space soon became crowded as a growing number of firms offered the same services, effectively turning it into a competition on price. The firms that relied on M&A and capital markets work were hit the hardest by this race to the bottom, points out Law. “Those are increasingly seen as offerings that are not the preserve of specific individuals or specific firms,” he explains. “They can be handled by anybody.” 

CORNERED BY COMPETITION

Not only did U.S. firms have to compete with each other as well as with long-established UK firms like Clifford Chance, but they also faced another challenge: firms from the mainland. 

PRC firms like JunHe were among the first from China to set up bases across the border in 2006, and, like the U.S. firms, focused on capital markets.

What has become evident in the past decade is that Chinese companies are the drivers of transactional work in Hong Kong, and U.S. firms were too slow to factor in the need to build strong relationships with this new group of clients, says Law. Whereas for PRC firms, many with hundreds – even thousands – of lawyers in China, these businesses basically were their clientele. 

Law continues, “Now that China has woken up to the global demands and opportunities, they will just turn to their relationship firms for help. So for U.S. firms with no deep penetration in the market, they will continue to lose market share to Chinese firms. That’s a big challenge.” 

There are now 26 registered Chinese firms with offices in the city, according to a list compiled by the Law Society of Hong Kong. Red Circle firm Haiwen & Partners is one of the latest entrants, launching its Hong Kong office earlier this year to focus on capital markets. 

SLOWDOWN STING

While there are more firms competing for transactional work on one side, the supply of work has been drying up since the Chinese economy started to slow down in 2012. 

The pinch was especially felt earlier this year, when China’s crippling capital controls took effect, curbing the outflow of funds, according to Raymond Chan, managing partner of local firm Wilkinson & Grist. 

From the perspective of international clients,  the growing political uncertainty in Hong Kong has not helped either. Take the saga of the missing booksellers in late 2015, the election of the unpopular Carrie Lam as chief executive in June, or the more recent disqualification of four pro-democracy lawmakers for improper oath-taking. All these have added to the worries of clients and, by extension, their law firms. 

“There’s lots of political uncertainty, and that has certainly increased in the last five years,” observes Patrick Sherrington, regional managing partner for Asia Pacific and the Middle East at Hogan Lovells. “It undermines client confidence. When clients abroad read about transgressions of the rule of law or booksellers missing, that makes people think: Is this the place I want to do business?” 

Finally, an undeniable fact is that Hong Kong is an expensive place for lawyers not doing a lot of work. Rents are ridiculous in the city’s financial district of Central, where international firms have historically been housed, causing a number to move to Quarry Bay in the eastern part of Hong Kong Island. 

STICK OR TWIST?

The key question to ask then is this: Have things gotten to a point where we can expect to see more exits from Hong Kong as firms reassess their prospects in the region? 

For Chris Howse, a founding partner at local firm Howse Williams Bowers, it will come down to how much firms believe they need to have an office in Hong Kong. “Some of them will stay, if it makes sense to their practice worldwide,” he says. “Other people will take a look and decide that they don’t need to have a presence on the ground, as they’re just wasting money at this point. And then they will close the office.” 

Meanwhile, international firms that don’t have a presence in Hong Kong won’t exactly be queuing up to plant a flag. Law expects firms now have a sense of what it’s like to operate in Hong Kong, so they will be more realistic when it comes to the costs they’re going to incur in rolling out their service. 

“People will have more realistic expectations, and with that I think the growth in Hong Kong will be moderate,” he adds. “I would be surprised if people would come to Hong Kong in a big way, so the movement in the partner levels will more likely be a bite-sized than a whole team movement.” 

Wilkinson & Grist’s Chan agrees  with this assessment. “Those who want to come are here already.”  

That said, lawyers like Sherrington feel that having an office in Hong Kong is still worth it. “There will always be opportunities for law firms,” he says. “I’m relatively bullish about Hong Kong’s prospects in because it’s always been a gateway to China, although it’s less so now. We see Hong Kong being used by China as a test ground for all these initiatives like RMB trading and stock connect. It’s really the international centre where the Chinese corporations can test their ability to go international.”