Twin towns

Now China has joined the WTO, firms will be able to open more than one office, ending the problem of choosing between Shanghai and Beijing. Helen Power reports on the regulatory changes that will give firms the best of both worlds

When China joined the world's favourite trading club last December, it seemed that the last great econcomic frontier was about to be rolled back. Despite the fact that China extracted significant concessions in the negotiations, its accession to the World Trade Organisation (WTO) offered historically unprecedented access to the world's most populous nation. And lawyers were not to be exempt from this bonanza. Aside from the fact that some of their best clients – namely the bankers and insurers – would benefit from market liberalisation, lawyers were promised a relaxation of the rules in their own sector.
But so far, lawyers have been disappointed – although not surprised – at what the Chinese authorities have proffered. In a set of proposals released in January, the Chinese Ministry of Justice (MoJ) quashed any lingering hopes that foreign lawyers would be allowed to practise Chinese law any time soon. As with other Asian countries, the Chinese have responded to protectionist but legitimate concerns that their fledgling domestic firms would be annihilated by foreign competition. A potential loophole for domestic Hong Kong firms may yet provide a route in for foreign firms, but it is a path that is likely to be blocked if Beijing has its way.
By way of consolation, the January proposals do offer a realistic prospect that the ban on Sino-foreign legal joint ventures may be relaxed, although the ultimate shape of permissible alliances has yet to be spelt out. However, the most important concession so far from a lawyer's perspective is the relaxation of the single office rule. Since 1992, when the Chinese government first let foreign lawyers in, the MoJ has operated a 'one firm, one office' rule when considering applications for licences. Until now, the practical effect has been that law firms have had to choose between Shanghai and Beijing, which is a cumbersome restriction due to Beijing being the seat of government and Shanghai the commercial heart of China.
Kenneth Chan, head of the China group of UK magic circle firm Allen & Overy (A&O), believes that “any firm with a serious China practice needs offices in both cities”. When A&O applied for a China licence in 1993, Chan says the choice between Shanghai and Beijing was quite obvious because “Shanghai was totally underdeveloped, and what big inward investment required was central approvals from Beijing. The city was also the political capital and a good place to get information.”
Proximity to the regulators was also a key consideration for Herbert Smith when it plumped for Beijing. “When we were setting up, our key practice area was equity capital markets,” explains David Willis, the firm's head of Asia until last year. “The relationship with Chinese regulator the CRSC [the China Securities Regulatory Commission], was crucial, and the CSRC is based in Beijing. Energy projects were also a big practice area, and again you need the proximity to authorities in Beijing.”
The development of Shanghai has caused a dilemma for those firms considering a first office in mainland China and for those already there but which are constricted by the single office rule. Ruth Markland, head of Asia for Freshfields Bruckhaus Deringer, believes the reasons behind Freshfields originally opting for Beijing still stand.
“China is a large and devolved country, but Beijing was and is the seat of government,” says Markland. “Major projects need federal approval and our client base tends to have large projects. Relationships with Moftec [the Ministry of Foreign Trade and Economic Cooperation] are particularly important. Shanghai may now be the commercial and financial centre, but most projects worth more than $30m (£21.2m/A$58.3m) still has to be approved by Beijing.”
Chan agrees that a firm's client base is the key consideration. “Where you would locate today depends on the nature of your business,” he says. “For a firm doing mainly medium-sized M&A and joint ventures, a first office in Shanghai would make sense. Beijing is still important for government approvals, but five years down the line smaller projects may not need central approvals. The process has already been relaxed for inland provinces. Delegated permission is available for west and north China to encourage inward investment.”
One lawyer who has seen Shanghai develop is Peter Stapleton, a partner at Blake Dawson Waldron. Unlike many of the UK firms or Mallesons Stephens Jacques, Blakes and Allens Arthur Robinson opened in Shanghai rather than Beijing. “When the opportunity arose for us to come out here in 1997, we plumped for Shanghai not Beijing. We were taking a medium to long-term view,” says Stapleton. “It's not quite the same as deciding between Sydney and Canberra, but it's something fairly similar.”
Stapleton has been a regular visitor to Shanghai for more than 10 years. “In the 1990s, it was all one and two-storey buildings,” he recalls. “The change here is absolutely phenomenal; I haven't seen anything like it anywhere else in the world. Now it's a city of 16 million people with great natural resources and few restrictions to expansion. Plus, it hasn't just developed physically – the people are infinitely more sophisticated.”
Despite not being in Beijing, Blakes acts for the Chinese government (it is currently working on the development of the country's largest water treatment plant) and also acts for major state-owned companies such as Air China. Blakes relies on its relationships with local Chinese firms in Beijing, the offices of which it uses as bases. Stapleton believes it is easier to do this in Beijing than in Shanghai, because traditionally Beijing's local firms have a better reputation, assisted by the standing of Beijing University, from which they recruit. Consequently, the firm has no immediate plans to apply for a licence for a second office and wants to concentrate on consolidating Shanghai.
Although second offices are not officially permitted, a few lucky firms have already been able to duck under the Chinese administrative radar – in the case of the UK's magic circle often via the helping hand of a friendly merger partner. Clifford Chance opened its first office in Shanghai, but gained another through the Pünder merger. Freshfields opened in Beijing, but Bruckhaus Westrick Heller Löber brought a Shanghai office to the merger. The offices are still run under the banners of Pünder and Bruckhaus, but are de facto Clifford Chance and Freshfields offices.
A&O caught on last December and opened a Shanghai office using the abandoned premises of now defunct firm Loeff Claeys Verbeke. A&O took on most of the Dutch and Belgian partners of Loeff Claeys a couple of years ago, and although it is no longer a law firm in Europe, it still officially exists in the eyes of the Chinese.
Other firms have piggybacked on their best friends – Linklaters has its own Shanghai office, but uses the Beijing office of alliance member De Brauw Blackstone Westbroek whenever its lawyers are in town. Beijing-based Herbert Smith is the latest firm to benefit. In January, it hired Simmons & Simmons senior Shanghai partner Gary Lock and installed him in the Shanghai office of best friend Gleiss Lutz Hootz Hirsch.
Markland admits that, for Freshfields, it is very useful to have access to the Bruckhaus office facilities, but she believes, both from a regulatory point of view and in terms of image, that it would be preferable for the offices to have the same name. Chan concurs. “For those of us who already have a second office, the new rules present a chance to reregister with the same name, which is what Allen & Overy is doing,” he says.
The Lawyer understands that a host of other top law firms intend to put in administrative applications for a second office. Leading the field are US firms such as Baker & McKenzie, which have not benefited from the Asian effects of big mergers. Of the UK firms, Herbert Smith wants its own place, A&O wants a rebrand and Freshfields has spoken to the MoJ. Linklaters also wants a licence for Beijing, which is a major move for the firm as it currently has nobody on the ground in the capital city.
However, like most things in China, it is unlikely to be plain sailing. Although there is a primary regulation in place to allow firms a second office, the government is also believed to be drafting some implementing rules, so the devil could yet be in the detail. No firm can apply formally for a licence until the implementing rules are published – so far lawyers have been restricted to filing an expression of interest with the MoJ.
It could be a long haul to get the licences issued, and some barriers remain in place. For instance, law firms must receive clearance from the municipal authorities in Beijing and Shanghai in addition to the MoJ licence; furthermore, firms will also have to put a partner into a new office, a financial constraint for those with smaller China practices. Chan believes that “not many firms can sustain a two-office operation. It's particularly expensive to maintain if you staff the office with expatriates.”
So far, the government has only moved to allow one extra office, but the plan in the long-run is that quantitative restrictions will be totally abolished. Chan says: “It is premature to apply for a third office, but there should be nothing to prevent it in the future.” Law firms are also restricted to a handfull of cities where they can set up shop, although Shanghai, Beijing and other major commercial centres are accessible.
No locations other than Shanghai and Beijing stand out as must-haves for mainstream commercial firms. “In principle, we'd consider another office – it depends on the needs of our own client base,” says Markland. “We're providing a service, so it's a question of where our clients are going to be. In the US, though, a New York law firm wouldn't feel it had to be in all the states.”
Guangzhou and Shenzen are areas where law firms might well consider opening offices. Most light and heavy industry has relocated just over the border from Hong Kong to Guangzhou. Shenzen, a fast-growing city near Shanghai, has also attracted manufacturing companies. “Guangzhou is one of those areas law firms may be interested in, but A&O clients tend to invest in north and central China,” says Chan. “Guangzhou tends to attract investors from Hong Kong and Taiwan.” Several medium-sized firms have opened there, including specialist shipping firms and firms from Singapore and Hong Kong.
Stapleton believes that local Chinese firms will also expand quickly to service the needs of foreign direct investors in the fast-growing urban areas. As for west China, the general view is that it is still the 'Wild West'. While firms might set up out there for a big one-off foreign direct investment project, it will remain largely free of foreign lawyers for the foreseeable future.
So, with resources pouring directly into the People's Republic, what is the future for Hong Kong, the traditional gateway to mainland China?
Linklaters Shanghai partner Andrew Godwin believes that it certainly won't lose out to Guangzhou. “Guangzhou is very active for property and manufacturing work, but a lot of it can be serviced out of Hong Kong,” he says.
The real threat to Hong Kong comes from the development of Shanghai. “Centres like Shanghai will become more important. As companies relocate, law firms will inevitably follow them,” says Godwin. “For the moment, though, most of the financial institutions and banks have their headquarters in Hong Kong.”
Clifford Chance, which traditionally runs its China practice out of Hong Kong, has begun to redeploy resources to mainland China. Last November the firm moved two partners to its Beijing and Shanghai offices.
The development of a Shanghai stock exchange will be crucial to its standing as a financial and legal centre. To compete with Hong Kong, it has a lot of ground to cover on liquidity and investor confidence. “Ultimately, Shanghai will become the leading centre of finance,” Stapelton predicts. “But for now, Hong Kong has a transparent legal system, sophisticated lawyers and almost all the financiers.”
An astounding 58 per cent of the reserve held by all the countries in the world is held in Hong Kong, the People's Republic and Taiwan. Markland believes that “with 1.3 billion people, the idea that you can only have one successful commercial centre in China is ignoring the realities of geography”.
Willis sums up the majority view. “Shanghai will continue to grow and Hong Kong may see much slower growth,” he says. “For the next 10 years Hong Kong will remain more important, but I wouldn't like to make the same bet for 20 years time.”
Law firms in China face a difficult dilemma. On one hand, the commercial development of cities such as Shanghai has been exponential, offering tantalising opportunities for businesses that can almost smell the money. On the other hand, the development of the government and regulatory system is decades behind. Factionalism and infighting is rife between different organs of the government and steering through new offices will require delicate negotiation to allow all the parties to walk away with face.
For the moment, the new offices are also a matter of face for law firms, a vital name on the letterhead. But partner numbers there will be eclipsed by those in Hong Kong for the next few years. However, they are crucial to law firms' gamble on the potential of China. It may take a while to pay off, but any law firm desirous of a stake in the country must get in there now and do the spadework.