Is Hong Kong the new New York?

With Europe mired in economic uncertainty and the US still struggling with the economic problems unleashed by the global financial crisis in 2009, Hong Kong continues to build its reputation as one of the world’s leading financial markets, despite current volatility.

In 2010, Hong Kong IPOs raised almost US$58bn, compared to the NYSE tally of US$34.9bn. It is now the largest listing market by fundraising size in the world.

In addition, the M&A market has undergone a substantial rebound. Last year, China-based companies completed 57 outbound M&A deals at an aggregate value of US$13.2bn, a 50 per cent a year-on-year increase in the number of deals. Inbound, 44 deals closed, an increase of a third over 2009. Many of these transactions passed through HK vehicles.

Unquestionably, Hong Kong is a China-focused market. Until recently, the one-stop-shop concept met with mixed degrees of success. While magic circle firms recruited US partners and some US firms localised, the top Wall Street firms practised only New York law and so remained US counsel of choice for most of the cross-border transactions.

Corporate law poachings

US law firms have long been active in big ticket cross-border M&A work, but acquiring a strong Hong Kong team adds significant advantages in substantial China-related transactions, such as IPOs. Historically, a regular income stream has also come from post-listing corporate transactions, and often one of the IPO counsels is retained as corporate counsel for the company’s future deals.

In 2005, Skadden Arps was the first of the top 10 US firms (by PEP) to move into Hong Kong corporate law; its success signalled that the market had come of age.

In 2008, Latham & Watkins’ recruitment of Allen & Overy’s seven-partner Hong Kong corporate team made headlines. In early 2010, Milbank Tweed, Shearman & Sterling and Cleary Gottlieb launched Hong Kong law practices, but these ventures were eclipsed when Davis Polk announced its entry into HK in August 2010 with a stable of high-profile partner appointments from competing firms.

In rapid succession, magic circle firms were raided by Simpson Thacher and Sullivan & Cromwell. In August 2011, Kirkland & Ellis staked its claim to a share of the HK/China corporate pie by poaching partners from Skadden Arps, Latham & Watkins and Allen & Overy. Notably, almost all of the new hires at these firms are fluent in Mandarin.

Competition for associates

To be able to compete successfully, however, firms need associates and it is here that competition is at its fiercest. Demand for bilingual Hong Kong solicitors has always sharply exceeded supply.

With top compensation and pay parity between US and Hong Kong associates, the new market entrants are alluring to local lawyers. The magic circle firms are stoic in their response, pointing to a deep talent bench as a result of years of investment in Hong Kong. At the same time, they are exploring innovative ways of retaining their associates, hoping improved work/life balance, a greater variety of work and fewer billable hours will ensure they remain desirable employers.

With sky-high salaries increasing the costs for all the firms, some pundits feel that the US firms may not be committed long term to this new strategy, citing also price pressures from investment banks on fees and the outlook of a sustained global slowdown.

Market outlook

In reaction to all the bad news, 16 Greater China IPOs worth US$23bn have been put on hold since August. Certainly, US firms have in the past withdrawn from Hong Kong during tough times, such as post-1997 (British handover) and in 2003 (SARS outbreak).

The combination of fee pressure and high salaries will squeeze firms from both sides, reducing margins. It is conceivable that some firms which have made only a tentative foray into Hong Kong law may decide to return to their core practice areas, if their Hong Kong practices prove unprofitable in the long term.

All of the international law firms with newly-minted Hong Kong offices have expressed a long-term commitment to the market, despite the gloomy economic outlook. The firms say it is imperative to their global strategy to be part of the largest fundraising platform in the world. Time will tell if the foray into Hong Kong law will be financially worthwhile and non-dilutive to the profitability of these firms.