The Global 100: The European question – Have years of cuts left the Magic Circle exposed as Brexit looms?

 

London’s top firms have been quietly retrenching for years in mainland Europe. As Brexit looms, where has that left the Magic Circle?

‘Welcome to Europe, the haven of legal certainty,’ quips Burkhart Goebel, Hogan Lovells’ managing partner for continental Europe.

Quite. As the UK faces up to the decade-spanning implications of the Brexit negotiations that began last month – following June’s shock general election that severely weakened the Conservative administration – such sentiments are common in Frankfurt, Paris and Milan.

‘It feels like paradise in Germany,’ reflects Latham & Watkins German managing partner Oliver Felsenstein. ‘A calm political landscape, no Brexit – a pretty picture for investors and advisers alike.’

Contributing to this improving mood in mainland Europe’s leading economies has been the receding eurozone crisis and the boost of May’s election of reformist French president Emmanuel Macron, seen as a victory against the forces of populism threatening to sweep the EU. Confidence surveys for European businesses have been edging up all year while the eurozone economies grew at an annualised rate of 2.3% in the first quarter of 2017, well ahead of the US and UK.

But while the commercial outlook in mainland Europe has not looked this bright since the 2000s’ boom, the region has been problematic for London’s top firms for years. Having aggressively expanded in the late 1990s and early 2000s for an expected EU integration play, hopes that the Continent would generate a wave of big-ticket deal work at City-level fees have been continually frustrated.

Instead the Magic Circle found themselves after the banking crisis facing significant pressure on margins and over-staffed, their European networks diluting profits as US rivals targeted their London rainmakers.

One former Linklaters partner now with a US law firm sums up a common view on the Magic Circle’s Europe networks: ‘It’s all funded out of London. It’s never showed any payback. Money poured into a project in which they won’t succeed instead of focusing on what they are good at.’

‘It feels like paradise in Germany, no Brexit – a pretty picture for investors and advisers alike.’
Oliver Felsenstein, Latham & Watkins

In response, London leaders have pared back their European networks, most dramatically in the case of Clifford Chance (CC) but also significantly so at Linklaters and Freshfields Bruckhaus Deringer. Years of tough performance management have impacted on their once-unchallenged market positions, while practices have been forcibly shifted away from domestic work.

The interesting question is where years of restructuring their local offices have left their business as the London elite face up to their two biggest strategic issues: the impact of Brexit on their City heartlands and their ongoing battle to break into the US.

The big deal

Twenty years since the dawn of London leaders’ European assault and there is still no doubt which remains the defining legal merger in the region. Freshfields’ 2000 tie-up with German leader Bruckhaus Westrick Heller Löber reshaped the firm and handed it a top-tier practice in Europe’s largest economy.

For years post-merger Freshfields fashioned its governance on Anglo-German lines. While this reflected the clout of the German practice – additionally in 2000 it merged with Cologne practice Deringer Tessin Herrmann & Sedemund – it also stoked tensions internally. The Anglo-German governance model was largely phased out in 2006. Freshfields never attempted another substantial merger.

Freshfields, which had managed its German operation with considerable collegiality, avoided much of the restructuring and exits seen at rivals in the immediate wake of the banking crisis. However, the last three years have seen more scrutiny on Germany, as the firm has moved to boost profitability to support its US ambitions and ushered in more flexibility into its once rigid lockstep partnership.

The firm in late 2015 announced the closure of its 18-partner Cologne arm – the spiritual home of Deringer – to merge the practice with its Düsseldorf arm, the kind of move that typically leads to substantial reductions in staff as German lawyers dislike relocating. The move left it with five offices in Germany and over 500 lawyers. Freshfields today continues to have the largest German base of all of the Magic Circle.

Other moves have impacted Germany. The firm also ushered in a lower lockstep several years ago, which is now being commonly used in Germany. The lower band runs from ten points to 30, against 17.5-to-50 for its core lockstep.

Having been introduced sparingly around three years ago, the firm is expected to expand its use by around 2020, when partners are talking of having approximately a quarter of its 400-partner lockstep on the lower tier. In addition, Freshfields in 2016 put forward proposals in a paper called ‘Germany 2020’ to reduce the size of its 103-strong partnership to around 80-90 within three years, a significant reduction.

While such prodding in a core market normally leads to sniping from rivals, the overwhelming consensus is that its German practice remains as formidable as ever, while many see the shake-up as being astutely handled.

One rival Magic Circle managing partner in Germany says that Freshfields has ‘done its homework’, adding: ‘It is still a very large practice in Germany, even if it reduces numbers by 20%. It’s pretty obvious that all other Magic Circle firms have shrunk significantly, so this is more of an adjustment for it.’ And another German managing partner agrees: ‘Even if it downsizes, Freshfields remains a fierce competitor.’

‘We are very confident of the set-up we have on the Continent. We are relaxed about the effects of Brexit for the firm.’
Andreas Steck, Linklaters

 

 

While Freshfields remains superbly positioned in Germany, its Spanish and Dutch outposts are also cited as effective arms and well-proportioned businesses. Spain has, despite the turbulence in its national economy, since the banking crisis been one the most reliable national markets for City advisers, with all of London’s big four sustaining profitable operations. In Spain, Freshfields has 70 lawyers in Madrid, after closing its office in Barcelona in 2014 and counts local heavyweight partners such as José Armando Albarrán and David Franco among its ranks.

But the sharp contrast for Freshfields is its Paris office, which is viewed as one of its weakest outposts. The office, which in April last year lost four partners to Orrick, Herrington & Sutcliffe, currently houses 120 lawyers and represents clients such as EDF, LafargeHolcim and Danone.

‘Paris has been a mess for some time, a big office without a big result for a while and I don’t think it has been able to find its niche,’ says one former Freshfields partner.

As such there is a lot riding on Freshfields’ high-stakes team hire from Ashurst, which was announced in February. The team is believed to control over £8m in billings and aside from plugging a particular hole in its French deal practice, the move reinforces Freshfields’ ambitions of dominating Europe’s high-end private equity (PE) market.

‘In France we only had two partners covering PE, it was simply not enough. The nice thing about the French additions is that not only do they cover the M&A PE side but financing as well,’ says Freshfields co-managing partner Stephan Eilers. ‘But in the rest of Europe you should not expect anything in terms of lateral hires, just pretty solid growth from partnership promotions. In a lockstep firm it’s always difficult to grow exponentially without laterals bringing their own book of business.’

The other challenge for Freshfields has been its Italian practice, though this reflects wider cultural problems that most London firms have had integrating Italian lawyers into their more institutional confines.

Freshfields’ Italian practice, in a smaller and historically more difficult market for the Magic Circle, totals 74 lawyers. The firm can at least also cite several highly regarded Italian lawyers with corporate partners Enrico Bazzano and Nicola Asti identified as key players in the market.

Overall, Freshfields has retrenched somewhat in the region. While it had 1,322 lawyers in mainland Europe back in 2008, this has fallen to 1,037 in 2017 and looks set to continue drifting downwards.

‘More complete’

The big news for Freshfields’ arch-rival Linklaters is that its German practice appears to have turned the corner… just 15 years behind schedule. Sniping about its German practice had become symbolic of the loss of grip at a firm that during much of the 2000s appeared to be unstoppable.

Linklaters’ European mergers – with Oppenhoff & Radler in Germany; Lagerlöf & Leman in Sweden; Loesch & Wolter in Luxembourg; and De Bandt van Hecke Lagae in Brussels – had never been happy experiences for the City giant.

The Oppenhoff union was a particular flashpoint. The German firm had submitted to the takeover in the expectation that Linklaters would reshape and modernise it but years of restructuring and exits never seemed to get the practice right. Some key partners in London were open with their scorn for a practice that could never challenge Freshfields or Hengeler Mueller for key deal mandates.

‘Paris has been a mess for some time, a big office without a big result for a while and I don’t think it has been able to find its niche.’
A former Freshfields partner

But the consensus is that the practice has been a much more coherent performer in the last three years, cited by most peers as the only serious foreign rival for Freshfields in the national market.

Many put that revival in its fortunes down to the 2007 recruitment of corporate heavyweight Ralph Wollburg from Freshfields in Düsseldorf. This does lead to claims that Linklaters is over-reliant on the veteran deal lawyer – a contrast to Freshfields’ wide bench of quality lawyers – and has no natural successor to the elder statesmen. Likewise, references to Wollburg’s large office and imperious behaviour are common.

‘I don’t see anyone else at Linklaters here in Germany ready to step into his shoes,’ says one German managing partner of a leading local practice. ‘There is no apparent successor or group who will follow suit.’

Nonetheless, Linklaters is getting the best notices it has ever managed in Germany. German senior partner Andreas Steck says Linklaters set itself the key target of being a leading adviser to DAX 30 clients in Germany and abroad and argues this has been achieved.

With mandates in their portfolio last year like the split-up of E.ON and the merger of the Deutsche Börse and the London Stock Exchange (albeit later vetoed by regulators), Linklaters’ German practice covers four offices and a total of 254 lawyers across the country.

Steck says the firm is currently expanding in Germany in regulatory and disputes, while seeking to manage its exposure in commoditising areas, including finance. He notes: ‘Long term we are very confident of the set-up we have on the Continent. We are very well shaped and relaxed about the effects of Brexit for the firm.’

Linklaters also boasts consistent coverage across Europe, including one of the largest Spanish practices of the UK elite, with 127 lawyers in Madrid, including 17 partners. The firm, via lead partner Alexander Kolb, advised Siemens on the largest M&A transaction in Spain last year, the €6.6bn merger of its wind power business into Gamesa.

While Paris veterans still cite the 2009 death of French playmaker Thierry Vassogne as impacting its M&A practice in a market still defined by well-connected veterans, Linklaters has a robust and well-balanced Paris operation, with just over 160 lawyers.

‘We are certainly a bit more complete than some other international firms in Paris, which would not have intellectual property for example. Some have arbitration, but not litigation too. We cover more,’ argues Linklaters Paris managing partner Arnaud de La Cotardière.

The firm has also avoided much of the fall-out that has plagued rivals in Italy, having launched its practice later than peers in 2007 with a team from White & Case, Allen & Overy (A&O), and several Italian firms.

The practice also includes one of Italy’s top securities lawyers in the shape of Claudia Parzani, who on 1 January 2016 took over as Western Europe’s managing partner, and also sits on the firm’s executive committee. The high-profile Parzani, who has scored an interview in the Italian edition of Vanity Fair, is also that rarest of legal creatures – a corporate lawyer with an active Twitter account, boasting more than 3,000 followers.

Parzani characterises Linklaters’ development: ‘Yes, Italy is a difficult market but the fact that we entered in 2007 meant we found ourselves in good shape at a moment of crisis in Europe, so we did not have to go through a process of rethinking ourselves.’

Overall, the firm has shrunk its practices, falling from 1,279 to 1,115, though much retrenchment has happened in the secondary markets such as Sweden.

‘Continental Europe had a great year for us. Our profitability is now in line with London.’
Yves Wehrli, Clifford Chance

 

 

‘Key clients and efficiency’

Of London’s Big Four, CC has shrunk by the most from its boom-time high. The 2000 union with 125-partner German practice Punder, Volhard Weber & Axster and New York’s Rogers & Wells made it the largest law firm in the world back in 2000, a crown it has long since handed over on revenue and headcount.

Between 2008 and 2017 CC’s European practice has reduced dramatically from 1,625 fee-earners to 1,181 currently. Between 2012 and 2016 alone, CC shrunk by nearly 10% in Europe.

However, there is a considerable amount of vagueness behind CC’s continental headcount, as the firm claims to have included ‘non-legal fee-earners’ in its 2008 accounts, which would not be a like-for-like comparison with today’s 1,181. However, as the Global 100 survey criteria has not changed since 2008, arguably the big drop in headcount does not favour its image in Europe.

Influential continental Europe managing partner Yves Wehrli, argues that CC’s rationalisation has been about focusing on key clients. ‘Firms have clearly shrunk in Europe by withdrawing or reducing their presence. The common trend in the region is to focus on key clients and efficiency. This means some of us are probably smaller now than we were ten years ago,’ Wehrli admits.

‘It’s fair to say there is a share of non-strategic, non-profitable work that we no longer do. But for us Continental Europe still had a great year and our profitability is now in line with London.’

The firm today has three offices in Germany and a total of 285 lawyers overall. The practice is believed to have been substantially impacted by a 2015 shake-up of CC’s partnership that introduced a 70-point gate in the firm’s core 40-100 point core ladder, which has been frequently used in its European offices to manage lower profitability. The firm in May this year voted on a further shake-up, which could allow top performers in the US and UK to earn the equivalent of 150 points, a reaction in part to the post-Brexit weakness in sterling, which is expected to bring renewed pressure to cut the points in circulation.

Across Europe, Wehrli adds that the firm is considering operating through hubs in certain regions and practice areas for efficiency in the future, which could mean further downsizing.

The consensus among rivals is that the firm has lost some ground in Germany, despite maintaining a well-regarded practice, with many noting the departure of PE star Felsenstein to Latham and corporate head Arndt Stengel to Milbank, Tweed, Hadley & McCloy, both in 2015.

Set against that, the firm in 2015 created ripples with the recruitment of Freshfields heavyweight Anselm Raddatz to co-head Germany’s corporate practice. He was also named head of PE in Germany last month.

CC global PE head Jonny Myers is bullish on the firm’s positioning for leveraged buyout work in Germany, citing Raddatz as ‘phenomenal’.

Myers is also confident that CC’s PE practice is strongly positioned in Europe on the foundation of its German and French practices and wider network. Arguing the cross-border strength of its offering in France, where the firm totals 173 lawyers, Myers says ‘in PE it’s all about the capacity to operate across borders, not just domestically’.

He points to two large parallel deals last year for Cinven when it acquired German business Synlab and France’s Labco, forming one of Europe’s major diagnostic businesses with an aggregate size of approximately €3bn.

‘After ten years of crisis, everyone should be in good shape.’
Claudia Parzani, Linklaters

 

 

As one of the first London firms to move substantively into Spanish law, CC’s Spanish practice has historically been one of the strongest in the Iberia region, with its Madrid and Barcelona offices counting 112 lawyers in total and includes Spanish deal playmaker Javier García de Enterría, cited by rivals as ‘one of the most prestigious corporate lawyers in Spain’.

 

The growth story

If the general story in Europe, especially post-Lehman, has been one of retrenchment, A&O has – just about – bucked the trend, reflecting the firm’s substantive growth rate since the mid-2000s when it was by far the smallest of the big four. After a robust 2016/17 run A&O is now the second largest of the group and only just behind CC in revenue terms.

In 2008 the firm had 959 lawyers in the region, a figure that had edged up 4% to 1,000 by 2017. The firm has long been established as the top foreign adviser in the Benelux region, thanks to its 2000 merger with Belgium’s Loeff Claeys Verbeke.

Despite A&O’s expansive form in general, France and Germany have not been without their reverses. As the only one of its peers to avoid a large German merger, A&O had invested substantially in the market, having built a 260-lawyer practice currently. Several years back the firm was seen as moving up the pecking order thanks to headline-grabbing hires like the 2013 recruitment of Shearman & Sterling M&A heavyweight Hans Diekmann. But some peers argue it has lost momentum and remains stuck outside the top half dozen practices. In recent years, the firm has lost several noted individuals in Germany, including corporate partner Michael Ulmer to Cleary Gottlieb Steen & Hamilton in Frankfurt and German international capital markets group head, Oliver Seiler, to Latham, both last year. Ulmer was seen as well connected with Deutsche Telekom and other bluechip companies.

‘We hear there is a lot of internal pressure at A&O. It’s a bit of a surprise because everyone supposed it would be the main challenger to the big four, five in Germany,’ says one managing partner of a local German firm.

As one Magic Circle managing partner in Germany concludes: ‘The practice, nevertheless, last year secured a marquee instruction to advise Bayer on its $62bn bid to acquire US agriculture business Monsanto acting alongside Sullivan & Cromwell.’

‘It’s absolutely critical for us to build out our offering in Europe. It’s not done yet.’
Andrew Ballheimer, Allen & Overy

 

 

A&O’s 168-lawyer Paris office is seen as having lost some pace in a market in which London players have slowly ceded some ground to the US advisers, with Gibson, Dunn & Crutcher recruiting a four-lawyer TMT team earlier this year led by Paris TMT head Ahmed Baladi.

Similarly to Linklaters in Germany, A&O’s French practice was seen as centred around a few corporate partners, including Marcus Billam, who left for Darrois Villey Maillot Brochier in 2015 with clients such as telecoms giant Vivendi. Paris-based global competition head Olivier Fréget also quit in 2014 to set up his own boutique.

With 94 lawyers jointly in Madrid and Barcelona, A&O has performed steadily in Spain, and remains one of the top banking teams. In 2015, the firm hired high-profile banking head Juan Hormaechea from Ashurst. Head of litigation and arbitration Antonio Vazquez-Guillen is cited as a key player.

The mood internally is that the firm is generally confident of its European platform. The firm is also the only one of the big four that has avoided ushering in some form of lower pay ladder for Europe, though its actively managed lockstep makes it relatively easy to cut the pay of individual partners.

‘Unlike some of our peers, we did not buy something in Europe which was too big and now we have to shrink. We built more sustainably, over time, with people who fit,’ counters one A&O partner.

‘As an economy, Europe is and will continue to be strong and it’s here for the long term. It’s absolutely critical for us to complete the build-out of our offering. We are largely built, but it’s not quite finished yet,’ says A&O managing partner Andrew Ballheimer.

For what remains London’s most expansive leading firm, Ballheimer forecasts some moderate expansion in Spain and France and more substantive investment in Germany.

A viable model?

Law firm strategy is like turning the proverbial tanker, tending to move slowly and lag long after market conditions have changed beyond all recognition.

Having built European practices for an integration play that did not happen, London’s top four have dragged their feet on overhauling their partnership models in ways that would have allowed them to deal with the reality that client behaviour and pricing in Europe was not falling into line with the City.

The resistance to changing their rigid lockstep models until the last three years has left the Magic Circle with the half measure of restructuring local practices and led to a revival in fortunes in elite independent practices as they pulled back from such markets.

The group are betting on London’s post-Brexit-resilience as a legal services hub. If that wager proves wide of the mark, London’s elite will need a sharp course correction.

What is apparent is that the London elite is still operating largely on the basis of the pre-Brexit reality in which London’s dominance was unchallenged. As yet there is no sign that London’s elite is shifting tack to invest back into mainland Europe, even as a substantial currency boost from a strong euro has flattered their top lines. On average throughout 2015 €100 would have gotten you £73, by 2016 the dramatic improvement in strength of the euro in the wake of the Brexit vote meant it would buy you £82.

There is also a danger that UK firms will face a more potent challenge in a few discrete but important European markets, notably in PE, where Latham has been investing heavily, and in Paris where US advisers have slowly gained ground (see below).

Perhaps surprisingly, given its chequered history in the region, of the big four Linklaters appears to have made the most progress over the last three years in Europe. The firm can now count on the momentum of a robust 2016/17 year and the impact of a popular leadership team of Gideon Moore and Charlie Jacobs. A&O, likewise, has the benefit of firm-wide momentum, even if it has traditionally lagged its peers in Europe’s key economies. Freshfields, coming off a soft performance in 2016/17 and a sluggish five-year growth track, looks to have a delicate balancing act ahead as it aims to reposition its German practice over the next two years.

In essence, for now the group are still betting on London’s post-Brexit-resilience as a global finance and legal services hub. If that wager proves wide of the mark, London’s elite will need to make the kind of sharp strategic course correction that they have proved poor at in recent years, most strikingly in the resistance to modernising their partnerships to accommodate dislocating global markets.

As one former Linklaters partner fumes: ‘A single global lockstep is not a viable model. A ten-year partner in Amsterdam being paid the same as one in New York is absurd.’

Linklaters’ Parzani concedes that leading firms will need to be increasingly nimble in the future. ‘After ten years of crisis everyone should be in good shape. We have to be able to listen to our clients and understand the signals of the market.’

Or as Ballheimer puts it: ‘The world is very uncertain. I don’t think anyone has any confidence in how it’s going to look in the short-to-medium term. Uncertainty is the new normal.’ LB

georgiana.tudor@legalease.co.uk

madeleine.farman@legalease.co.uk

Additional reporting by Dominic Carman.

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