Regional Focus: The honey pot

Australian law firms may be benefiting from the country’s continued economic growth, but they are also facing intense competition from international firms, reveals Gavin Bell, managing partner and CEO at Freehills.

Key Facts

1) Australia recorded real GDP growth of 1.3% in 2009, compared with -2.4% in the US and -4.9% in the UK.

2) Australia’s economy will grow by 3% in 2010 and 3.5% in 2011, says the IMF.

As with other major legal markets, over the past few years Australian lawyers have been living in interesting times. Thankfully, in our part of the world the economy has remained relatively strong and the future looks positive.

Australia was one of the very few developed economies to avoid recession in recent years. We enjoyed 16 years of uninterrupted economic growth leading up to the global financial crisis and this growth has continued, albeit at a slower pace.

By the time this is published, Australia will also have had a federal election. However, it is unlikely to dramatically change the direction of the Australian economy, regardless of whether it will have returned the incumbent labour government under Prime Minister Julia Gillard or instated the more conservative coalition under Tony Abbott. The coalition has indicated that, if it is elected, it will not implement the mining resource rent tax proposed currently by the government.

This strength in the economy has been reflected in the legal services market both in Australia and the region. DataMonitor says the Asia-Pacific legal services market grew by 5.7% in 2009, whereas the UK legal services market shrank by 0.6% in 2009, and the US market by 0.9%. Average growth forecasts to 2013 suggest the UK can expect 2.6% annual growth and the US 4%, while Asia-Pacific is predicted to grow by 8.2% a year. Australia and Australian lawyers are well placed to participate in this growth.

There are a range of reasons for Australia’s performance. Certainly our strength in resources and proximity to Asia help. However, our economy was also substantially less exposed to the financial markets turmoil and our banks proved more resilient. The strength of the Australian banks was a key factor in the balance of the Australian economy weathering the crisis well (at the height of the crisis there were only 12 ‘AA’ rated banks in the world, four were Australian).

That doesn’t mean that Australian law firms didn’t feel some pain last year. Revenue for most of the major firms plateaued at best and there has been increasing price pressure from clients, which have had a greater focus on managing costs. What was already a very competitive market has become even more competitive.

Australian law firms have responded in different ways to this pressure. There have been redundancy programmes in some firms and most firms froze solicitor salaries to a degree. Action in this area was not however as dramatic as it was in London and New York. There has also been an increasing focus on firms’ costs generally and, on the revenue side, a continued move toward alternative billing arrangements with clients.

International firms dip in

Beyond the economic climate, the most topical development in the Australian legal market in recent years has been the increased interest of international firms. The issue now for Australian firms is whether and at what pace this interest will continue.

Some international firms have been in Australia for some time. Baker & McKenzie has been here the longest but, as with other jurisdictions, is somewhat of a special case. Among the other American firms, Sullivan & Cromwell recently celebrated 25 years in Australia and Skadden has been here for almost as long. However, their operations are relatively small, focusing largely on US capital markets work for Australian clients. There has been a peaceful co-existence with domestic firms.

More recent entrants have taken a different approach. In the past few years, DLA Piper, Norton Rose, Jones Day and Allen & Overy have all entered the market and are attempting to compete with Australian firms. There are also constant rumours of others scouting the market or about to open shop here.

Whether this increased interest and change in approach reflects the strong Australian economy and dollar, the increasing flow of international capital into Australia, the need to service global clients or the ability to service Asia, is unclear. All of the recent entrants have given different reasons and taken quite different approaches.

DLA was the first of the new arrivals. It linked up with Phillips Fox and the two firms are currently co-branded. They are attempting to move Phillips Fox from being predominantly insurance-focused to being a more general commercial firm, reflecting DLA’s global approach.

Norton Rose established a presence in Australia via a name change for local mid-tier firm Deacons. Their stated intention is a full merger at some later point. They are investing heavily in advertising and marketing in Australia, including an extensive high-profile outdoor campaign. Norton Rose appears intent on using the Australian firm and its resources to bolster its Asian operations.

Jones Day has now been here for several years and has a stated aggressive organic growth strategy. It is still a small operation and the Jones Day brand is not as well known in Australia.

Allen & Overy, more recently, has announced plans to establish in Sydney and Perth. The offices will initially be staffed primarily by 14 partners poached from local firm Clayton Utz. Allen & Overy is the first of the magic-circle firms to come to Australia. There are questions around whether this was a strategic or an opportunistic decision, but it seems intent on building a presence. To compete for large-scale Australian work, its current lack of depth will be an issue; the firm is currently trying to address this through further recruiting. It has also indicated that it intends to use its Australian offices to assist in serving its regional network.

How successful these entrants will be has yet to be seen. While Australia has a very open market, the legal market is already highly competitive and sophisticated. The top-tier firms are large by global standards, have been regular competitors and collaborators with global law firms for many years and are long established in the market. They also have extensive international experience through their own offshore offices or through working with Australian clients as they expand offshore.

The Australian firms are staffed by lawyers who are all well trained and experienced and are themselves sought after by the international firms. The regular recruiting drives by the international firms are testament to this. In addition, Australian billing rates are still significantly below UK and US rates. Many general counsel have made it clear that they will not pay ‘London’ rates in the Australian market. This is significant in that a model based on poaching established Australian partners with full London equity returns may not be sustainable in the longer term.

Snapshot: Australia’s legal services market

· A sophisticated and competitive legal services market with strong ties to Asia.

· Large established local top-tier firms with global reach.

· UK- and US-based law firms showing renewed interest in Australia.

· A relatively strong economic outlook, driven by China and energy & resources.

Threats to domestic firms

The bigger question for Australian firms is: what next? Will Australia follow the continental experience, where most of the larger markets are dominated by the London or other international firms, or is the nature of the Australian market different? There are some similarities, but there are also some significant differences including distance, profit, size of market and the size and experience of the incumbents.

If international firms are to dominate the Australian market, will they follow the A&O approach and try to poach partners, or will they associate/merge with domestic firms? The London firms’ approach to continental Europe provides examples of both.

The advantage the established firms offer to global firms is instant size, quality and credibility in the market. They also offer a large well-trained workforce in the same timezone as Asia, many of whom have extensive experience in that market. This allows a global network to service the region much more cost effectively than staffing distant offices with expatriates from London or New York.

More generally, will law follow the way of accounting? The consolidation in that profession led to four dominant global players. In the Australian context, this model would see mergers or associations between global firms and larger Australian firms, which are able to provide the quality and depth to properly serve global clients. As we have seen with accountancy firms, modern structures can address some of the old impediments to mergers such as profit sharing, control and liability.

There are, of course, significant differences between accounting and law, which mean that some of the reasons for consolidation of global accountancy firms do not necessarily apply to law firms. There is much more jurisdictional difference in law than in accounting and, whilst global law firms may want to serve clients globally, there is no equivalent to a global audit. Time will tell.

Drain on talent

Australian managing partners are dealing with many issues common to our international counterparts. Managing and retaining talent remains a key issue. While turnover rates have reduced in recent years, they are starting to increase as the economy continues to improve.

A significant drain for Australian firms prior to the global financial crisis was London and New York. This has all but ceased now, but any improvement in those markets is likely to lead to increased pressure. We have also started to see investment banks recruiting again.

Firms have responded to turnover issues in various ways. There has been a lot of discussion about the move away from lockstep associate salaries to remuneration being more closely linked to performance at international law firms. This has been the approach in Australia for over a decade and is likely to continue.

There has also been a lot of focus on providing alternative career paths for lawyers (for example, we recently introduced an executive counsel role for some of our talented senior lawyers), flexible approaches to work and career planning from early in an associate’s career.

Regulatory challenges

There have also been a number of regulatory changes affecting the legal profession. Australia currently has eight different regulatory regimes (six states and two territories). The legal profession has been fighting for decades for consistency across these regimes but we still face different requirements for issues such as continuing legal education, trust accounts, professional conduct rules and the like.

The current federal government has been leading a push for national consistency. Progress has been made on the consistency front, but this has created new issues. Current proposals include creating a regulator staffed primarily from outside the profession and subject to the policy direction of the federal government. This has given rise to considerable concern about the ongoing independence of the profession, particularly among judges.

It can be challenging to live in interesting times but in a globalised economy, many of our greatest challenges are common.

– gavin.bell@freehills.com