Chinese walls

The world’s fourth-largest economy is gradually liberalising its legal services market, but significant obstacles remain.

‘Not a single month goes by without some international firm planning to open up in Beijing, Hong Kong or even Shanghai,’ reflects Alastair Da Costa, DLA Piper’s managing director of Asia. How times have changed: for City firms, China has long represented an unparalleled and irresistible opportunity, but one that has come with more than a few logistical headaches.

The ban on practising People’s Republic of China (PRC) law is still in place. However, the ‘one firm, one office’ policy, which stymied expansion, was lifted back in 2002. There are now around 250 branch offices of foreign firms in China – 21 are UK (15 of which are in Shanghai). By contrast, in 2002 there were just 91 foreign offices in all of mainland China.

The world’s largest law firm, Clifford Chance, claims to be the first major practice to have a presence in both Beijing and Shanghai under its own name, and reports a recent period of frenetic growth. ‘We’ve grown at a rate of more than 30% each year for the last five years in our two offices,’ comments Stephen Harder, managing partner for Beijing and Shanghai.

So what is driving this new business? Harder reckons it is a combination of cross-border investment by global multinationals – ‘running at about $50bn or $60bn a year for China in the last few years,’ he says, representing about half of Clifford Chance’s Chinese practice – and a mixture of private equity work, regulatory advice, project finance and energy issues, including carbon trading. Staff numbers at the firm have also grown significantly in the last financial year – by more than a half in Beijing (36 fee-earners are there now) and just under a quarter in Shanghai (44). The firm is also reporting significant outbound work; for example, representing Aluminum Corporation of China Ltd (Chinalco), which recently bought a stake in Rio Tinto, as well as work for the China Development Bank and China Investment Corporation.

‘It is a market that we couldn’t afford to miss,' says Peter Burrows, Shanghai partner at Norton Rose. He cites the recent signing of a bilateral trade agreement with New Zealand as ‘an indication of how China is opening up’. ‘There will be more of these agreements I’m sure, and there will be more trade with the rest of the world.’

The firm has been in mainland China since 2001, when it poached two French-qualified partners from Vovan & Associés, Jean-Marc Deschandol and Virginie Deslandres, to run its Beijing office. Deslandres reckons that, when she first arrived in Beijing 20 years ago, there were no more than 15 foreign lawyers there – and they had to act as consultants. Before 2001, a ‘very tough restrictive covenant’ in the firm’s agreement with its former joint venture partner, Johnson Stokes & Master, kept the firm out of Hong Kong for three years. A licence for a Shanghai office was granted in 2006.

Deng Xiaoping’s economic reforms have led to the creation of a prosperous middle class in China. Burrows estimates the size of the new Chinese bourgeoisie at 35 million people now – and it looks set to grow to 100 million by 2020. Audi sold 100,000 cars there last year, Volkswagen 900,000, Mercedes-Benz and BMW probably around 40,000 each, he says. ‘Many of these are locally built but, for imported cars, there is a hefty luxury goods tax, so these figures perhaps show the spending power of the middle class. There is a big demand for quality western goods. All this, whether in terms of direct investments, joint ventures, manufacturing agreements, distribution agreements and so on leads to work for international law firms like mine.’

That wealth has led to external investments by Chinese banks and enterprises. ‘There will undoubtedly be more of these,’ says Burrows, ‘especially if there is recession in the US and Europe, since there will be Chinese companies out bargain hunting.’ Again, the hope for a firm like Norton Rose is ‘to serve the needs of such companies’. He points to BA’s $1.7bn aircraft financing deal last year – his firm acted for the syndicate of banks, and the two biggest players were Chinese banks.

US law firm Salans is a relative newcomer, having only established a presence in 2003 after taking over a ‘small but profitable’ office of another US firm of five lawyers. According to John Flanigan, co-managing partner in Salans’ Shanghai office, a presence in Asia was not ‘a key part’ of the firm’s strategy. There are now 21 lawyers in the Shanghai office, and the firm has just been granted a licence for Beijing.

Why the change of heart? ‘If people are going to China almost every day it is for a good reason,’ says Flanigan. ‘That good reason for us relates to the fact that there is lots of contact with the government, state-owned enterprises (SOEs) and first movers in terms of the international investors. China is developing very quickly and it will continue to do so, not just because of the Olympics.’

Flanigan draws a comparison with Paris, the European city with most resident foreign law firms. ‘There are more foreign firms in Shanghai than there are in Paris, but the big difference is that there aren’t a lot of established law firms in Shanghai. A lot of firms just have a presence.’ Salans plans to open in Hong Kong to capitalise on its relationships with leading global real estate investors, private equity houses and investment banks, he explains. The firm has one of the largest real estate practices globally and claims to be ‘the only one with an emerging markets focus’. The firm has just moved to new offices in Shanghai to accommodate its growing team. ‘It was amazing to see firms taking two or three times as much space as they actually needed because they were thinking that they were going to fill up.’ But that was 2006/07, he adds. ‘Things are slowing down now and lots of firms have pared back their ambitions.’

Harder at Clifford Chance reckons that, although increasing numbers of international firms are in mainland China, that does not necessarily reflect serious ambition on their part. He reckons that there are ‘a few more than a baker’s dozen’ who are ‘real players’ plus ‘another baker’s dozen who are here defensively’ to keep clients on board, but who aren’t willing ‘to make an investment to have a top-notch practice’. ‘The feeling is of a very competitive market though,’ he says. ‘That first baker’s dozen of firms comprises the best in the world and those who are viewing China strategically are willing to compete for the very best people.’

The ban on practising local law for international firms (see box above) means they are dependent on local firms. Most international firms have a network of good relationships with local practices.

Lovells has formalised its relationships into what it calls the Sino-Global Legal Alliance. In May the firm announced the expansion of that network, with the addition of Chengdu-based law firm Tahota. Chengdu is the capital of Sichuan province, which provides a gateway to the west of China. There are now ten firms in the alliance, launched last September.

‘The work law firms have been doing in China has principally been FDI [foreign direct investment] work, acting for multinationals investing in China,’ explains Crispin Rapinet, Lovells’ Asia regional managing partner. ‘The centres from which the work is serviced have been Beijing and Shanghai. While we are permitted to operate in China, we aren’t permitted to practise Chinese law, so we have had to undertake work usually in conjunction with a Chinese firm in order to sign off on the Chinese law aspects.’

Lovells claims to have identified ten leading Chinese firms in the major provincial cities. ‘The significance of the provincial cities in which the firms are based is increasing all the time,’ reckons Rapinet. ‘These are not village outposts.’ Chengdu has a population of more than 11 million with a number of major international financial institutions such as Citigroup, HSBC, Standard Chartered Bank and ABN AMRO all there. He says: ‘Many of the large SOEs still have their headquarters in Beijing, but these huge provincial centres also include very substantial corporations. They have all been issued with an edict by the central Chinese government to "go forth and multiply" overseas.’ Lovells has advised Morgan Stanley and UBS on two of the larger China IPOs this year.

It is clear from this spate of activity that the once-notoriously protectionist regime has come to an accommodation with the international law firm community. But Anna Prag, international policy manager at the Law Society, reckons the licensing process for firms wanting to open up can still be lengthy and bureaucratic. ‘One firm told me that it was about six months from beginning to end,’ she says, which is consistent with Salans’ recent experience.

‘There are also restrictions on branch offices,’ Prag reports, ‘so you have to wait a certain amount of time after your first office has been opened before you can open a second branch. For a market as big as China, that is a major restriction.

‘Ultimately, to make it a truly open market, foreign lawyers would want to be able to employ Chinese lawyers and advise on Chinese law,’ she continues. ‘At the moment Chinese lawyers have had to suspend their practising certificates or licences while they work for a foreign firm, and foreign lawyers are often precluded from Chinese court hearings.’

Prag was in China in January and reports that UK firms are ‘quite comfortable at the moment’. ‘They don't seem to be concerned about pushing [for further liberalisation] too openly at the moment because they don’t want to be seen rocking the boat.’ There was some alarm in the expat legal community in 2002 when Shanghai’s local government set an upper charging limit of £255 an hour. It was never clear whether the notice applied to foreign firms and the fuss soon passed, but it served as a warning that nothing in China can be taken for granted.

Prag makes the point that the greater concern of firms, above practice rights, is the dearth of sufficiently qualified Chinese lawyers. ‘The Chinese are very pragmatic about the need for professional service firms,’ explains Harder at Clifford Chance.

In their mainland offices, eight out of ten lawyers are native Chinese. He acknowledges the recruitment problem: ‘There is a finite number of individuals and no matter what market demand is you cannot create that overnight. You cannot fake Mandarin and you cannot fake the fact that you are a US securities lawyer.’

But, he says, ‘All of us need to be able to advise our sophisticated clients, and the more that firms like Clifford Chance advise businesses about China, I would argue the lower the perceived risk of investing in China is.’

In summary

• Number of foreign branch offices has almost trebled in six years
• Ban on practising People’s Republic of China law remains
• Licensing process can still be lengthy and bureaucratic

Opening upAccording to the World Trade Organisation (WTO) Trade Policy Review (May 2008), structural reforms in China, including trade liberalisation, have resulted in annual real GDP growth rates in excess of 10% over the past four years, rising per-capita income and poverty reduction. In the process, China has become the world’s third-largest trader.

The report reveals that the numbers of Chinese law firms, foreign offices and Hong Kong firms have all grown steadily since 2002. In 2002, there were 25 Hong Kong firms, 91 foreign firms and almost 11,000 domestic firms. By the end of July 2007 there were 60 Hong Kong firms, 191 foreign firms and more than 13,000 Chinese firms (the report says the last figure relates to 2006).

The WTO report also explains the regulatory regime for foreign firms in China.

A representative office is allowed to provide consultancy services on the laws of its home jurisdiction, international conventions and practices. It can handle, for clients and Chinese firms, the legal affairs of the country where lawyers are permitted to practice and provide clients with information on the impact of the Chinese legal environment.

Foreign lawyers are not allowed to practise Chinese law. Chinese nationals permanently resident in Hong Kong (and allowed to practise law there) may requalify to practise Chinese law if they pass an exam.

Foreign lawyers working in representative offices must be members of a bar or law society of a WTO member and have practised for no fewer than two years outside China. They must reside in China for at least six months a year. For a foreign lawyer employed by representative offices to have ‘representative’ status, the foreign law firm must apply to and obtain approval from the competent authorities. A representative office may not employ Chinese national registered lawyers – if a Chinese lawyer joins a foreign firm they have to suspend their licence while they work there.

Zhonglun’s trail‘We're surrounded by firms and lawyers with hundreds of years of history. We’re the only Chinese law firm here that can provide unrestricted legal services covering the whole area of Chinese law, supported by some 300 lawyers back in China,’ says Haibin Xue, managing partner of the London office of Zhonglun W&D.

The office opened last year to be ‘especially helpful to UK businesses who are considering entering China'. The firm points out that China represents ‘both opportunities and risks to foreign businesses’. As an illustration of the latter, it cited the ‘Industrial Catalogue’, as prescribed by the Ministry of Commerce, which stipulates that, before considering any investment in a particular industry in China, the starting point is to ascertain whether the industry in question is ‘an Encouraged, Restricted or Prohibited Industry’.

Zhonglun, as well as being the first and only Chinese law firm to have set up a London office, has five offices based in Beijing, Tianjin, Shanghai, Chengdu and Shijiazhuang. ‘We certainly feel others will be coming along,’ Xue reflects. ‘We are trying to grab the opportunity to establish our own reputation and branding before our legal market is fully opened.’

So will others follow Zhonglun’s trail? ‘A majority of leading firms have a presence in China already, and when the Chinese legal profession becomes sophisticated enough and experienced enough, then it is only a matter of degree as to [how they develop] their presence overseas.’

As for his home country’s restrictive regulatory regime, Xue argues that the Law Society should concentrate its efforts on making the UK more open to Chinese lawyers before pushing for liberalisation elsewhere. He reckons that, under Law Society rules, Chinese lawyers are not eligible to be considered as registered foreign lawyers. ‘Therefore they’re unable to become a partner in this jurisdiction and that restricts our desired structure at this stage,’ he says.

‘The Law Society keeps on pushing the Chinese to open their legal market by allowing foreign firms to practise Chinese law. If you really want equal treatment, Chinese lawyers should be eligible to be considered as a registered foreign lawyer.’