Chinese businesses have shown significant resilience in reacting to challenges thrown at them this year, be it the trade war or the pandemic, and the market continues to offer plenty of opportunities for international law firm, but presents unique hurdles, too. The key to staying on top is being patient, watchful, agile and constantly evolving. Mithun Varkey reports
The primary factor in the Chinese growth story of the past few decades has been its ability to attract unprecedented levels of foreign capital. The country has become one of the biggest investors internationally, but it continues to be a magnet for global investment, especially in manufacturing and technology.
The past few years, however, have been less than ideal, with a host of issues including rising costs, a trade war and now the pandemic weighing on the country’s attractiveness. Refusing to sit back, China has reacted by delivering on its commitment to open to the world, and has taken several legislative measures to allow freer access to its markets for foreign businesses.
From a new foreign investment regime and a spruced-up intellectual property (IP) framework to a complete overhaul of the country’s civil code, China is responding with a flurry of measures that make investing in the country easier and more attractive.
The legal market here hasn’t been free of challenges either, and recent times have seen a number of international law firms exiting the market. Bryan Cave Leighton Paisner, Stephenson Harwood and Vinson Elkins were a few notable exits from China earlier in the year, which came following the exits of Orrick and Osborne Clarke from Hong Kong. However, some of the other international firms have doubled up on their commitment to China, for example, Magic Circle firm Allen&Overy kicked off its joint operation in the Shanghai pilot free trade zone with Lang Yue in February this year.
The impact of the covid-19 pandemic has yet to be fully accounted for. While China seems to have brought the spread under control, the rest of the world being under the grip of the virus bodes poorly for investment across the world, including for China.
Cheung Kwok-kit, a partner at Deacons in Hong Kong, says the outlook for China is cautiously optimistic. “Due to the economic downturn, there seem to be more disputes between parties,” he says. “Although we are receiving a lot of enquiries about China-related businesses, clients tend to be more cost-conscious. As a result, the market is more competitive now and we have to negotiate fees with them frequently.”
Chong Ik-wei, Shanghai-based partner and managing director for Asia at Clyde & Co, says: “We remain cautiously optimistic with our China-related business. Business activities are starting to pick up now that normality has returned to corporates in China. In sectors that we focus on such as insurance, marine and trade, we have in fact seen an uptick in advisory and dispute work all through the year.”
Christopher Bickley, partner and head of the Hong Kong office for offshore firm Conyers, says his firm has seen less interest in PRC businesses investing or raising capital overseas. “This was a trend that started a few years ago, but it has been exacerbated by the trade war with the US,” he says. “The net result is reflected in strategies where PRC companies are concentrating on Asia and markets closer to home.
“Our outlook for China-related businesses is quietly optimistic. By all accounts the PRC is likely to be one of the first economies to emerge from the covid-19 crisis. China-based business will continue to look to raise funds to support their growth strategies as the economy recovers.”
Roy Chan, co-country managing partner for DLA Piper based in Shanghai, says the pandemic has had a minimal impact on the firm’s China business. “Naturally, our firm is not exempt from the impact of external global factors such as a slowing economy and geopolitical tensions,” says Chan. “However, we have always invested in developing long-term strategic relationships with our Chinese and international clients … which stands us in good stead during uncertain economic times.”
He says that while there are understandably fewer greenfield projects, many of the firm’s practice areas are stronger than ever. “In particular, we have seen a substantial increase in restructuring and insolvency work and advised Air China on its participation in the HK$39 billion (US$5 billion) high-profile recapitalization plan for Cathay Pacific earlier in the summer. Our finance and corporate practices are also performing well.”
Fieldfisher China’s domestic business has been impacted negatively by covid-19, says Zhou Zhaofeng, the firm’s Beijing-based managing partner. “Many ongoing projects have been suspended since the outbreak of covid-19,” he says. “Our Chinese clients have extended their payment periods by more than six months, and foreign clients have either suspended or postponed their ongoing business in China where possible.” However, he adds that the trade war “has not impacted us materially”.
Brian Ho, a partner and co-head of the China practice at Hong Kong-based Howse Williams, says the pandemic had some impact on corporate work at the firm in the first half of the year, particularly as people were restricted from travelling due to the lockdown. “But we are seeing good recovery and more enquiries on corporate work in the past few months,” says Ho. “We are also seeing more activity and enquiries from Chinese businesses wanting to do M&A and capital markets transactions.”
Richard Crump, global senior partner at Holman Fenwick Willan (HFW) in Singapore, says: “To our knowledge, so far there has been no significant decline in interest of PRC businesses to come to Hong Kong to get listed. Probably all clients are impacted to an extent by covid-19 – some positively and some negatively. Our role is to assist clients to continue to do business whatever the underlying political situation.”
Conventional transactional practices may have taken a hit, but other avenues have opened up for firms servicing China-related business.
Ulrike Glueck, Shanghai-based managing partner of CMS China, says cross-border M&A activity and generally cross-border trade has taken a hit. “This also had an impact on our business,” she says. “However, since we have a large client base, general corporate work continues, and we are also strong in specialized areas such as employment law and compliance – even during the height of the crisis, we still did ok.
“Starting from July, we can see that business is bouncing back and there is an increase of new instructions,” she adds.
Michael Chin, a Simmons & Simmons partner based in Hong Kong and Shanghai, notes a slowdown in the firm’s China-related business on the transactional front as a result of both covid-19 and the continuing trade war. “Keys reasons are a ‘valuation gap’, where buyers want a covid-19 discount and sellers are resisting; and buyers are reluctant to consummate deals without being able to travel and meet face-to-face,” he says.
“As the economic effects of the pandemic bite, we will eventually see more default situations, and as a result more activity on the distressed M&A and special situations side. This has yet to really kick-off, but there will be a wave of this activity coming.”
Liu Zhen, a partner and head of China practice at Gunderson Dettmer in Beijing, observed a slowdown earlier in 2020, as investors were more cautious to make investment decisions as they evaluated how the pandemic would affect business. “The deal flow and pipeline of our China-related business remains consistently strong,” she adds.
Neil Torpey, a Hong Kong-based partner at Paul Hastings, says: “Despite a recent moderation in China’s GDP growth rate, the PRC has navigated the pandemic effectively, and commerce in the country is continuing to develop at a very rapid pace.
“China’s growing companies continue to need access to capital and sophisticated capital markets, and they are engaged in very large amounts of M&A, private equity and other investment activity; and companies based in the PRC, and their trading partners, are generating significant work for Paul Hastings. We think that our China-related practice has a very bright future ahead.”
Words of caution
While there is a strong sense of optimism among market practitioners in the ability of Chinese businesses to bounce back from this year’s setbacks, it is hard to lose sight of the challenges. The pandemic that continues to grip the world, the bleak global economic outlook, continuing trade war and regulatory challenges all add to market apprehension.
“The key issue will be whether there will be a second wave of covid-19 infections in fall and winter,” says Glueck of CMS China. “If not, we are confident that in 2021 our business will be back to normal. Further, we already see increased demand for employment law advice and restructuring advice.”
Chin, from Simmons & Simmons, says a key challenge is the continuing restriction on travel. “Buyers, whether Chinese looking at ODI [overseas direct investment] or foreigners looking at FDI [foreign direct investment] are wanting to meet management of target companies face to face; it’s difficult to get comfortable just through remote meetings,” says Chin. “We are having to adapt by conducting much of our business online and work even more as teams between those in China and those outside China. Also, given the current situation, it’s a buyer’s market, so firms are having to compete for work heavily based on price, and it becomes a bidding war to the lowest price.”
Clyde & Co’s Chong says the pandemic remains serious in many overseas markets, which has made outbound investment and activity by Chinese clients more challenging.
Rossana Chu managing partner of Hong Kong-based LC Lawyers, a member firm of the EY global network, notes her Chinese clients are no longer very active in investing overseas due to the potential hurdles of foreign investment reviews by host countries.
“Our advice depends very much on the clients’ business strategies,” says Chu. “Some clients still place a lot of focus on the mainland China market and re-align their strategy to put more resources into the China market, which is considered by those clients as one of the fastest growing in the world. Also, the potential changes in laws and regulations, or even sanctions and bans, imposed by host countries on Chinese-invested companies are another major concern.”
Glueck says that for Chinese clients, investment overseas is currently difficult for the following reasons: “Less liquidity supply in China; covid-19 being in full blow in some countries abroad; a changing political landscape, and a more critical look on Chinese investments.”
Liu, of Gunderson Dettmer, says Chinese outbound investors need to pay more attention to FDI restrictions imposed by governments. “They should consider the risks of heightened scrutiny and a potentially longer timeline for transactions, and whether the target’s business would be vulnerable to the pandemic or trade war,” she says. “Finally, they need to analyse if there will be any export control measures applicable to their operations/investment.”
Ho, of Howse Williams, says Chinese clients investing overseas should be more aware of the length of time in closing a transaction, especially in obtaining relevant approvals, as a lot of countries are not yet fully functioning due to the pandemic. “Also, the Sino US trade war means there maybe more regulatory hurdles to overcome,” says Ho. “It is important to plan well ahead of the transaction to cater for any unforeseen hurdles.”
While Chinese businesses that have built a reputation for taking aggressive outbound bets may have been slowed by the pandemic, inbound investment into China is also facing hurdles. “For foreign companies that have their Asian operations concentrated in China, diversification is the key,” says Ho. “For those have investments or operations in China, the continuing trade war between the US and China may make it more costly and risky to do business in China. Some of their operations should be moved to other countries, such as the ASEAN.”
Chong says he sees “international clients adopting a more cautious approach in China” due to geopolitical issues and the need to preserve cash due to financial strain caused by the pandemic.
Glueck adds that foreign companies also face difficulties due to the lockdown in their home countries, which has had a negative effect on their liquidity. “With some companies struggling in their home base, there is no appetite and no funding for new investments,” she says. “Cross-border trade and even operating their existing investments in China is still impacted by lack of travel opportunities, restrictions on visas and quarantine requirements for travellers.”
Conyers’ Bickley also raises the challenges of practical issues surrounding covid-19 that apply to both foreign companies investing in the PRC and PRC companies operating outside the mainland. “Social distancing and restrictions on travel have affected everyone’s ability to interact,” he says.
“Zoom and other technologies have managed to help fill the gap, and it will be interesting to see how much they replace in-person meetings once the world recovers. From a corporate governance perspective, it is important to ensure that clients’ constitutional documents are as up to date as possible to allow for board and shareholder meetings to be held virtually if the need arises.”
Chu, of LC Lawyers, says foreign companies operating in China are concerned about the interruptions, or at least the uncertainty, brought about by the China-US frictions. “However, most of our clients have confidence in the China economy, which was the first to bounce back during the covid-19 outbreak,” she says.
“More importantly, China is strengthening the development of its domestic market by way of ‘internal circulation’ of resources, and that may provide new opportunities to committed investors, but there is likely to be value proposition in overseas investments going forward.”
DLA Piper’s Chan points out that the Chinese legal system is heavily regulated, and rules and regulations can change rapidly. “Since the onset of the global pandemic we have been advising all of our clients to keep a close eye and continually monitor the regulatory environment in which they operate, in terms of both local and foreign rules,” he says. “Many new rules and regulations have been introduced globally, particularly in terms of travel restrictions, and it is imperative that our clients are aware of the latest developments and potential implications.
“In terms of forward planning, we encourage our clients to be forward-looking and anticipate what could impact their business. For example, new investment projects are likely to be delayed, while existing investment projects may be put on hold due to the travel restrictions.”
Chan adds that cultural misunderstanding can cause conflicts, so it is important that both parties recognize cultural differences and work to reach a mutual trust to ensure a successful investment relationship.
Glueck’s advice to both inbound and outbound investors is to “be patient”. Chinese businesses “need to watch developments in the next months. Due to restructuring needs of companies abroad there may be opportunities coming, subject of course to the development of the political environment.”
As for foreign investors in China, Glueck advices them to do their homework to ensure the core business is healthy. “Use this time to restructure and streamline your operations in China, including cutting costs and making your operations run more efficiently,” she says.
Chan expects to see continued growth in capital markets, restructuring and litigation, as well as in the life sciences and technology sectors. “The technology industry, in particular, is a key focus for DLA Piper,” he says.
Cheung, of Deacons, believes dispute resolution and insolvency work are sectors that will see growth in China, while Clyde & Co’s Chong says contentious and dispute resolution work in insurance, marine and trade will increase. “There will also be a rise in bankruptcy and restructuring-related work. Growth will continue in these areas as they are counter-cyclical.”
Nicholas Lum, a Clyde & Co partner based in Shanghai, says: “The magnitude of the Chinese economy and its position as the largest net importer of raw materials no doubt contribute immensely to these growth areas.”
Corporate restructuring and employment law will be practice areas with strong demand as companies are driven by a need to cut costs and streamline their operations, notes Glueck. Compliance is another area. “In times of economic difficulties, more
entities and individuals may be tempted to breach the law for economic benefits, and on the other side, due to cost-cutting needs, companies will pay more attention to this and will want to separate from employees who breached their compliance rules,” she says.
Contract-related litigation will see a surge, predicts Zhou of Fieldfisher, “because many companies might not be able to execute contracts due to covid-19. Compliance will also become important due to the worsen- ing overseas investment environment.”
Bickley expects to see more US-listed PRC business- es look to dual listing in Hong Kong but acknowledges that covid-19 will have a significant detrimental effect on the businesses of many companies, and this will likely lead to more restructuring and debt work.
Technology and life sciences are widely considered to be the sectors to see strong demand for legal services. “I would expect technology-based industries, the pharmaceutical sector, fintech and logistics will see growth in the next 12 months,”
says Chu, of LC Lawyers. Torpey, of Paul Hastings, expects strong growth in capital markets in Greater China, as more Chinese companies listed overseas turn to domestic PRC markets for listings and capital raising. “While the US-China trade conflict continues to motivate market participants to adopt new strategies and tactics, a number of Chinese companies are mulling secondary listings or dual listings in Hong Kong,” he says. “Some Chinese entities are also re-orienting their initial public offerings from the US stock exchanges to Hong Kong. With economic stimulus in the pipeline in mainland China, we are confident in a positive IPO market outlook in 2H 2020.”
He also anticipates growth in M&A in China as a result of the new Foreign Investment Law (FIL) and the government’s relaxation of controls on foreign exchange capital accounts. “The FIL allows more options and flexibility for foreign investors and their subsidiaries to acquire and invest in businesses in China, thus encouraging foreign M&A activities in the healthcare, auto and financial sectors,” he says.
Liu, of Gunderson Dettmer, says the healthcare and biotech industry will see demand consistent with the global trends and “coupled with more mature routes for exits on the HKSE and SSE”.
Crump, of HFW, believes construction, corporate, dispute resolution and international trade will continue to be sectors that will adapt to changing conditions, covid or otherwise.
Ho, of Howse Williams, says, “The sectors in China that will see growth include retail, healthcare, biotech and online trading. New economy businesses will continue to grow and be well sought after by investors.”
A mix of unique challenges and an abundance of opportunities create interesting circumstances for firms operating in the market. Staying ahead in these tough times requires firms to face challenges head-on.
“A unique characteristic of the Chinese legal market that can create significant challenges for international law firms is its sheer size,” says Chan, of DLA Piper. “There are plenty of opportunities, but the competition is intense. It is important that in such a fast-growing market we don’t lose focus of the core areas where we excel by expanding too quickly in an effort to compete with the breadth of coverage of Chinese law firms.
“Many Chinese law firms are very large and extremely competitive in terms of their offering to international clients,” he adds. “Our challenge is to ensure we remain focused on our key strengths and continue to provide high-quality, cross-border legal advice in key areas such as M&A, joint ventures, capital markets, finance, and energy and infrastructure projects.”
Chan says the legal services industry is still relatively young compared with other global legal markets, and operating in China can bring unique challenges. “The legal regime is continually evolving, and as a firm, we need to closely monitor market development and be able to adapt to changing trends, while also maintaining our international standards of practice.”
Chong, of Clyde & Co, says pricing pressures are not new in China, and his firm has adapted by being nimble on fees, constantly listening to the needs of clients, and offering value-added propositions.
Cheung, of Deacons, also notes that pricing pressure is a challenge. “Fierce competition on fees and more demanding clients are pressing challenges, as most big companies have big teams of in- house counsel looking after their business. They now expect law firms to provide specialist legal services to their matters,” he says.
Chu says that, as economic activities slow down, Hong Kong law firms should look for ways to widen their variety of clients to be able to provide a more extensive scope of services. “The most pressing challenges facing our law firm is the hesitation of some Chinese clients in commencing new projects, staying on their investment plans, or even raising new funds,” she says. “We have been widening our client base in terms of numbers and variety so that even when some clients slow down their projects, we obtain legal work from other clients.”
Attracting high-quality, fully bilingual legal practitioners can also be challenging for international firms in China. Difficulty finding qualified personnel, increases in labour costs and rentals, and strong competition from both domestic and foreign law firms are some of the problems Glueck identifies. “We are used to dealing with these challenges … our answers to them are evolving constantly and continuously,” she says.
Chan, of DLA Piper, adds that maintaining flexibility is key in addressing clients’ needs in an evolving and uncertain market, an observation upon which there seems to be consensus.