Banking and finance: Money puzzle

As financial regulation piles up and budgets get pinched, banks are expecting firms to share their pain. But panel places are still worth it – for now at least

Unless you’ve been hiding under a large rock for five years, the news that banks have been tightening their purse strings will come as no surprise. A variety of overspends, restructurings and regulatory misdemeanours have been splashed across the pages of mainstream newspapers most days since the start of the financial crisis. It has made for pretty dismal reading.

money

In one of the most recent cases it emerged this month that JP Morgan is facing a record fine of more than $13bn (£8bn) to settle investigations into its mortgage-backed securities, while Bank of America is being pursued for more than $6bn for its role in misleading mortgage agencies.

While fines for UK banks are yet to reach such dizzy heights they have also had to pay their share of compensation – Barclays for breaching listing roles, HSBC for money laundering and mis-selling, and Lloyds for delayed redress for mis-sold PPI. Add to these the pressures of increasing regulation and Sir John Vickers’ report that includes such details as retail ringfencing and British banks have some meaty problems on their plates.

 Changing focus

By the end of this year Britain’s four biggest banks – Barclays, HSBC, Lloyds and RBS – will have cut around 189,000 jobs from their peak staffing levels, bringing employment to a nine-year low. The four firms posted £108bn of revenue for 2013, 13 per cent less than in 2008.

“There’s a huge amount of legal work involved,” muses one renowned City finance partner, “and it is clear banks aren’t able to cut corners as there’s so much at stake in getting it right.”

No wonder banks’ in-house legal teams are feeling the pinch. Some have seen their budgets trimmed, while for others it’s simply a case of trying to do more with the same.

Morris
Morris

“Cost challenges have had an impact on legal,” confirms Nationwide deputy general counsel Claire Morris. “Our external spend has stayed static, but we need to be mindful of how we manage our resources. We’ve put the focus on high-risk, added-value work.

“Work in-house is changing. Banks no longer have traditional litigation divisions or departments focused on small claims and employment. Now they’re focused on different things, such as those that pose a big risk to the organisation. They’re more geared up to deal with investigatory work, and things such as thematic reviews and challenges from the regulator. That automatically drives a change in the way you procure services.”

Earlier this year Morris undertook a review to ensure her team was the right size and shape to deal with the new regulatory landscape. The rejig resulted in merging four areas into two – retail property and commercial in one bucket, and corporate and treasury in the other. Two jobs were lost.

“It was natural attrition and we never replaced them,” notes Morris.

There has also been a significant amount of chopping and changing at Lloyds. In addition to a new general counsel for group legal (reporting to the bank’s two GCs) – in the form of promoted corporate and M&A head Hugh Pugsley – the bank is reportedly in the early stages of talks with a number of its panel firms to outsource its retail and wealth, and asset finance litigation teams. The deal is thought to be on hold but if it goes through the chosen firm could co-opt 70 staff from the bank.

Barclays, meanwhile, is in the throes of a £514m programme dubbed ‘Project Transform’, designed to patch up the bank’s damaged reputation and rein in spending. Reports suggest the bank is looking to cut £2bn from its overall cost base of £20bn and could shrink company-wide staff headcount by as much as 30 per cent.

As part of Project Transform Barclays invited a group of panel firms to a supplier summit in June. The event featured senior executives, including CEO Antony Jenkins and deputy general counsel Michael Shaw, addressing the bank’s legal advisers on the impact of Transform. Sources say the bank has been involved in in-depth consultations with its advisers, with a speculative eye on overhauling its panel review process, due to kick off imminently.

 Tarnished gold

In the past, bank panels were seen as a golden ticket for law firms looking to secure a hearty helping of high-level work from financial institutions. The reality of this is increasingly in doubt.

“For prestige reasons we like to be on big bank panels, but it’s becoming increasingly challenging,” lam-ents one City banking partner. While every bank’s panel procurement process has distinctive characteristics, as this partner adds, “they all have the same cost issues and all want their pound of flesh”.

The use of procurement teams in panel selection is nothing new. But, for a number of City partners, dealing with specialised teams rather than in-house lawyers is cause for concern. 

“Every bank’s process is a little different but they all seem to have got the same lecture on procurement,” says the partner.

“Some tenders are more painful than others, but that one is particularly in-depth,” says one source of Nationwide’s panel review process, which is currently under way. “They ask for a lot of detail around each individual service line and want you to answer the same questions around how you’d price it and what the final result would look like.”

There is the sense among banking partners that the more disconnected approach of procurement teams and increased red tape, is having a knock-on effect on the quality of advisers banks select.

“When we used to deal directly with in-house lawyers they cared about quality,” grumbles one source. “Now, you get the feeling that all firms are considered fungible. Banks aren’t valuing the quality of the lawyers they’re appointing.”

Of course, the banks themselves would have a thing or two to say about that. In fact, despite procurement teams having an increasing hand in panel selection in the past few years, it is also the case that in-house teams have made a particular effort to get to know potential advisers on a more personal basis.

While Barclays has been courting its legal advisers publicly, as part of Transform, in-house teams have had an eye on the importance of building relationships with their potential hires for years.

“Every year Barclays has away-days where they get firms together,” one law firm partner says. “The head of legal talks through the aims of the bank, the culture and what they want out of their panel firms.”

Sources also describe having conversations with in-house lawyers and procurement from Barclays with a view to helping the bank redesign its panel review process.

“There’s a genuine desire to get our input,” another source agrees. 

Sharing the pain

Ultimately, however, partners agree their conversations with banks always come back to one thing: cost. And who could blame them?

“It’s not just them being tight,” notes one partner. “It’s where the market is right now.”

As banks’ budgets are squeezed, firms are being asked to share their pain.

“Every time there’s a repanelling our fees go down,” says one leading City partner. “They say that one thing they want is for fees to drop by at least ‘x per cent’.”

That figure can range from 1 to 25 per cent.

For bank panels, there’s a sense that hourly rates have been consigned to the graveyard of history.

“There is a strong message they don’t want to use them,” a City source sighs. Rather, banks are looking to alternative pricing arrangements based on fixed fees and other innovative ways of doing business. These include taking heavy write-offs for broken fees when deals fail to complete, or ‘value accounts’, whereby firms donate a number of free hours to the bank.

Of course, there is little that is innovative in such features for most firms. It is more a case of the informal being made formal. However, there is a sense among partners that banks are clamping down on fees with renewed vigour.

While all banks are feeling the pinch, RBS reportedly pushes on fees particularly hard. 

“The bigger the bank, the more clout they have as they have more work to hand out,” a partner at a mid-tier firm elaborates. “A bank like RBS has in excess of £100m a year to spend on English firms. It’s a brave firm that chooses not to seek any of that business.”

That’s the decision Slaughter and May took back in 2011 when it opted to stand down from RBS’s legal panel. The firm indicated that its decision was at least partially due to the bank’s prohibition on panel advisers limiting liability on individual transactions, but sources suggest that its tough terms were not irrelevant.

Slaughters is not the only firm to have taken a step back from the panel review process – with firms including Mayer Brown and Olswang also thought to have opted not to pitch. 

“I get the impression there’s an awful lot of grumbling and reluctant signing up to the panel,” says one magic circle partner.

As fees are being driven down, firms are clamouring to demonstrate other value-added incentives. While secondments have always been popular they have had something of a revival in popularity in the past few years. As banks’ have been falling it makes sense to top up the numbers with some of the brightest legal minds in the market, courtesy of their panel firms.

“Who can blame them?” says one partner. “You can get good quality people with all the support they bring – they’re only a phone call away from their mates and colleagues. Because of risk exposure there’s more work to do and banks have been cutting their headcount, so the number of in-house lawyers has been falling. If you can tap into that resource, why wouldn’t you?”

Outsourcing is another consideration, leading to an increasing number of firms moving support staff from the City to regions such as Belfast (Allen & Overy and Herbert Smith Freehills) or Glasgow (Ashurst), or effectively launching subsidiaries (Taylor Wessing’s New Street Solutions).

“We have paralegals we hire at around £20 an hour to do document review,” says one source. “Anything like that they’ll be interested in.”

Mouths to feed

While Barclays and HSBC have been gradually growing their panels, in November 2012 Lloyds slimmed down its own-account appointments. And RBS in its last group and UK legal panel review, undertaken in October 2012, reduced the number of firms on its panel by 40 per cent, from around 100 to between 55 and 60, slashing the number of sub-panels from 13 to five in the process.

“Perhaps it’s because it has realised it can’t feed all those mouths,” muses one partner.

Another speculates that banks are reluctant to cut the number of firms they enlist as it ultimately costs them in free secondments. However, they continue, “in the last round, we’ve definitely seen them cutting their numbers”.

For firms competing for the elusive remaining panel spots it means there’s more to play for. The issue is compounded by banks becoming reluctant to turn to ‘off-panel’ for legal advice.

“It happens much less than it did two years ago,” says one source. However, another partner insists that “if it’s a job where they conclude you’re the right firm or lawyer to do it, they’ll generally find a way to get you the job”.

Banks traditionally turn to alternative firms to conduct work that is not in the public eye, such as tax-efficient work.

“We’ve done a lot of work in dispute resolution and on the regulatory investigations side for banks without necessarily being on their panel,” adds a partner at a City firm.

Barclays, BNP Paribas, Schroders and Société Générale are reportedly among the banks particularly rigorous in sticking to their panel appointments, while banks including HSBC and JP Morgan have been known to exercise more flexibility.

As banks seek to save cash wherever possible some partners at mid-tier firms claim to see a wealth of opportunities opening up. 

One notes: “Some work that was exclusively magic circle is now available to us. It’s cheaper for banks to come to us than to go to, say, Allen & Overy.”

There may be something to this. After all, even a larger London firm such as Simmons & Simmons’ cost base is dwarfed by the magic circle.

“Compare the magic circle to Simmons,” says a finance partner at a US firm. “One haemorrhages money like a giant and one haemorrhages money like a pygmy. It comes down to costs or production, and Simmons is more nimble.”

Of course, the magic circle is unlikely to go down without a fight and there are countless rumours of top-tier firms lowering fees to previously inconceivable levels.

“You occasionally see very low bank-side fees on syndicated loans, and then a firm like Linklaters will come along and offer to do it for a 10th of that,” claims one source.

Tipping point

Given the fee pressures felt by the banks and private practice, will the panel procurement process survive in its current guise? It’s easy to sense partners’ frustration.

“There’ll come a point when we just can’t continue dropping fees,” admits one magic circle source. “Certain banks expect everything with not a lot in return. It’s fine for now, but there may be a tipping point.”

On the other hand, perhaps as market conditions improve, banks’ legal advisers will be able to share the benefits. For Morris, that is the killer point. “It depends on what happens in the external environment,” she says. “Obviously a lot is driven by what’s happening in the economy and in Europe. There are big changes as a result of external demands in regulation and law, and in terms of what happens in the economy and financial sector.

“If the economy and environment becomes more benign there’ll be a great deal more innovation and development, and a boost of activity in those areas rather than retrenchment.”