Invest In Law looks beyond Beijing and Shanghai

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31 July 2013

By Michael Yu of Invest In Law

Since the opening of PRC’s legal market to foreign law firms in 1992, many have established a presence in China’s coastal cities. There are now about 200 foreign law firms with registered offices in mostly Beijing, Shanghai and Hong Kong (Regulated by a separate authority, the Hong Kong Law Society). Setting up offices in these cities has its own advantages, being China’s tier-one cities with well developed infrastructure and FDI (Foreign Direct Investment) growth almost every year, but the markets are moving quickly towards saturation. With China’s 12th Five-Year Plan in 2011 shifting its economic focus from coastal to inner cities, such as Shenzhen, Tianjin, Chongqing, Chengdu, Dalian, Wuhan and Qingdao, all having inhabitants of at least one million. Foreign Investors will be drawn into inner China for lower factor cost and new market opportunities, thus generating great demands for the legal sector. But with most international law firms having their major area of operation limited in coastal China, theses demands are not being met.

This is seen clearly with the fact that almost all top 50 law firms of both UK and US have their offices only in Beijing and Shanghai, and while the Chinese Ministry of Justice allows foreign law firms to open a second office three years after their first one in China (negotiation with Ministry of Justice could, however, extend much longer than this period), and even with no upper limit technically speaking, most law firms stopped at two (apart from Stephenson Harwood, which has their third office in Guangzhou). A few law firms , as an alternative, engage in referral work with local law firms in order to build up a client network (network or “guanxi” is of vital importance in Chinese business culture), with the ultimate goal of having an office in these cities.

The report on the opportunities for UK businesses in china’s regional cities in 2011, published by UK Trade and Investment (UKTI) and China-Britain Business Council, has rated 35 second-tier cities in China in terms of overall attractiveness for business. By setting up offices in some of these cities will help international firms to get a foothold at an early stage and give them an advantage to capitalise vast potentials from the greater China market, including both local and foreign investment. But despite its obvious advantages, the report has outlined various difficulties that could make it a daunting task for many firms. That said, there are a few developing cities where foreign law firms can have an easier start, particularly as there are already some other foreign institutions (E.g. HSBC, Citigroup and BNP Paribas in Chengdu) that readily generate demands for the legal sector. They are in Chengdu, Tianjin and the city cluster in Yangtze River Delta (YRD).

Chengdu, the capital city of the Sichuan Province, is on the way to becoming a financial centre of South West China. Its GDP grew 13% to CN¥813.89 billion (US$132.83 billion) in 2012, and is expecting a growth of 12% this year, with an increase in its fixed asset investment to at least CN¥650 billion (US$105.7 billion), according to the Chengdu Development and Reform Commission. Chengdu provides a well-developed transportation network, including the Chengdu Shuangliu International Airport, ranking top 5 of handling capacity of passengers in China. Promoted by government to become a financial hub, many international financial institutions have already established themselves in the city, with a total of 25 banks (including both local and foreign-invested). The big names so far, are Citigroup, HSBC, Standard Chartered Bank, BNP Paribas and JPMorgan Chase Bank.

The development of the financial sector creates strong demands for banking and finance-related legal services and products, and many local firms (e.g. Tahota) claimed banking and finance has been the fastest-growing area of practice, according to the Chengdu Legal Market Annual Report 2010. With the well-developed financial sector, Chengdu has also become a nurturing ground for high-tech and IT start up companies. Many Sichuan-based companies are planning to go public, offering a multitude of opportunities for providing advice on IPOs. The report on the opportunities for UK businesses in China’s regional cities in 2011 has rated Chengdu first-rank, in terms of overall attractiveness for business, among 35 other second-tier cities in China.

The legal sector in Chengdu remains very localised. It includes Tahota, the biggest local law firm in Chengdu by headcount, and a number of national firms based in Beijing setting up offices there, such as King & Wood Mallesons. With little presence of foreign law firms in the area, having an office in Chengdu can capture demand from the financial sector.

Tianjin is also one of the upcoming cities that is within the focus of China’s 12th Five-Year Plan. Being also rated as first-rank city in terms of overall business attractiveness, Tianjin, with total population stood at 13.55 million in 2011, benefits from its geographical advantage, its proximity to Beijing and 11 further large cities within a 500-kilometre radius, each with a population of more than one million people. Tianjin saw its GDP increase 13.8% to CN¥1.29 trillion (US$0.21 trillion) in 2012, according to the Tianjin Statistics Bureau, with the city’s fixed-asset investment increased to CN¥887.13 billion (US$144 billion). FDI of the city has seen steady growth for the past four years.

Tianjin formed an integral part of  the Bohai Bay Economic Zone, one of the three biggest economic zones in China. The city is well-known for its aviation industry as its business pillar, with aviation giant Airbus having its assembly line there in operation since 2008. Tianjin Port is also the largest artificial port in China, serving as a container port along shipping lines and modern logistics centre for the nation and many International all-cargo operations which established a presence there, including China Cargo Airlines and Grand Start (JV operations of Korean Air). Many of Tianjin’s development projects, including the Tianjin Binhai New Area, fuelled the growth in legal services and the city’s infrastructure. The area is home to 219 Fortune 500 companies, according to the Tianjin Legal Market Annual Report 2010.

The Special Report on Tianjin 2011, published by Asian Legal Business (ALB), highlighted the growth in private equity in Tianjin that generates much work for the legal sector. The report pointed out whilst IPOs are almost monopolised by law firms in Beijing and Shanghai, private equity is still quite a new area. With now more than 1,000 PE funds registered in Tianjin, as a result of the government’s encouragement by preferential policies on the registration duties and tax, there is a clamour for legal advice.

Another focus of the 12th Five-Year Plan is the Yangtze River Delta (YRD). Historically, economic development of the area is concentrated in Shanghai, but over the past decade more and more economic growth of the area has shifted to other cities such as Hangzhou, Nanjing, Ningbo and Suzhou, which are also rated first-rank in terms of overall business attractiveness by the 2011 report by UK Trade and Investment and China-Britain Business Council. Total economic output of the 16 cities in the Yangtze River Delta in the first quarter of 2013 continued to grow steadily, with an average growth rate of 9.8%, 1.7 percentage points higher than the national average. FDI inflow amounted to US$50.5 billion in 2011, or 43.5% of China’s total.

The majority of foreign investment in the YRD is engaged in the manufacturing sector, such as the manufacture of computers, mechanical and electrical products, hardware and chemical products. Major foreign companies in the YRD include General Motors, Shell, Exxon, Siemens, Sony, Volvo and LG etc. Hangzhou, which has its major industries on financial services, e-commerce and Information Software, and Nanjing, with an influx of new infrastructure opportunities to support the Youth Olympic Games in 2014, the high speed rail link between Nanjing and Hangzhou, entering service in June this year, will form a transportation network in which the two cities and Shanghai will be the key hubs. With the steady FDI inflow, foreign institutions wishing to invest in this area will generate demand for the legal sector, especially firms with global expertise.

The potentials in these cities are obvious. With the right opportunity, the same success enjoyed by global law firms which established their foothold in Shanghai and Beijing might be repeated there. Some medium-sized firms have already taken the first step. Sabelberg Morcos Lawyers, a firm based in Melbourne, set up an office recently in Nanjing. With little presence of foreign law firms in these cities, competition is relatively lower than that of Shanghai/Beijing. Tianjin, despite being third largest city in China and its proximity to Beijing, does not have any presence of foreign law firms at all, until California-based firm Chang & Cote LLP set up the first office back in 2009. And since then, only one more firm, Wu & Kao PLLC (New York-based),  joined the trend. The two proved successful in niche areas (with clients mostly from the Asian American community) by offering convenience for their clients who have transactions between Tianjin and their US bases, rather than going all the way to Beijing or phone up their US offices at midnight. In addition, many areas, such as International business tax, Chinese company public offerings (IPOs) abroad, financing of infrastructure projects, international mergers and acquisitions and private equity, require big international firms with global knowledge, which not many local law firms can offer. But why is there still no major law firms setting up offices in these cities?

The problem goes to the profitability of setting up an office in these cities. Fee rates outside Beijing and Shanghai drop significantly. Lawyers in Tianjin, for example, can only charge their clients half the amount of their Beijing counterparts. With the higher cost bases and  rates, big foreign law firms may find it difficult to maintain a profitable business in these cities.

Some firms have tried other alternatives to expand themselves. Although a joint venture with a PRC law firm is not allowed, Hogan Lovells, for example, engages in close collaboration with 14 top PRC law firms in its Sino-Global Legal Alliance, giving its clients both international and local legal services by various referrals. Having a pre-existing client base there could be a decisive factor in whether a venture into these cities is successful. Chang & Cote, one of the only two foreign law firms in Tianjin, already had clients who had major transactions between Los Angeles and Tianjin, before setting up its office in Tianjin.

Portuguese law firm PLMJ entered into a similar alliance with Dacheng, China’s largest law firm by headcount, and coordinated work between them, mostly Chinese companies’ investment into Portugal and Brazil, by sending two senior associates to Dacheng’s Beijing and Shanghai office. The alliance has seen some success. One of the transactions they worked on, involved a £3.19bn acquisition of a 30% stake of Portuguese oil company Galp Energia’s subsidiary in Brazil by Sinopec.

But of course, despite such difficulties, it still can be favourable for foreign law firms to grow into a successful business ventures. In areas such as first-time foreign investment in China, and higher end cross-border transactional matters, foreign law firms still have an edge over local ones, as these clients will much prefer a firm they are familiar with to handle their dealings, and given the focus of the 12th 5 year plan, cities outside of Beijing and Shanghai should certainly be considered.


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