The financial crisis has done more than stall investment in Central and Eastern Europe. It has caused a remarkable sea change in the respective legal markets, where the international elite have their work cut out
The crystal balls of Romania’s gypsies would be a valuable tool for many a law firm partner operating in Central and Eastern Europe. Almost precisely to the day of Lehman Brothers’ collapse, the investment appeal of these emerging markets all but extinguished.The former Eastern Bloc countries, many with unstable governments, were suddenly deemed too much of a gamble in a new climate where ‘risk’ had become a dirty word.
However, almost three years on, the ripple of recovery is slowly but surely making its way east. Some countries, in particular Poland, are even posting impressive growth.
‘The further west you are, the earlier you felt the financial crisis, while the further east, the later you went into the crisis and the later you will come out of it,’ summarises Jason Mogg, managing partner at Kinstellar, a leading CEE firm that span off from Linklaters when it pulled out of the region in 2008.
For the plethora of major international firms present in Eastern Europe’s larger markets, namely the Czech Republic, Poland, Hungary, Romania and Slovakia, it is now make or break time. The heady days of lucrative transactions that attracted them in the 1990s the minute the Iron Curtain fell are long gone. Privatisations are largely complete and major infrastructure projects and financings are now slow to get off the ground. Without these big deals, there is a vacuum of work for many foreign law firms, particularly those newer to the region, which now have to cultivate a local client base. Or pull out.
At the start of this year, Gide Loyrette Nouel closed in Prague, its team moving to local firm PRK Partners; DLA Piper withdrew from Sofia, with the bulk of its personnel hired by pan-regional firm Wolf Theiss; while Spain’s Garrigues left Bucharest after just two years there, with top-tier Romanian firm Mus¸at & Asociat¸ii scooping up its fee-earners and Spanish clients, including Inditex, owner of retail chains Zara and Bershka. The trend follows a spate of departures by US and Magic Circle firms much earlier (see box, ‘Stick, twist or bust?’, right). Given the high quality of domestic law firms in many of these jurisdictions, plus competition from a group of elite Austrian firms present throughout the CEE, building up a client base isn’t proving to be easy.
‘International firms came here before the crisis to focus on transactions, when it was appealing to get into these markets,’ reflects Ca˘ta˘lin Ba˘iculescu, co-managing partner at Mus¸at & Asociat¸ii. ‘Many transactions involved competitive tenders, with four to five bidders, so there was a lot of work. Then suddenly, there was very little for foreign law firms to do. They realised they didn’t have the local client base and now they are fighting to get it.’
Competitive tenders
The competitive nature of the CEE, particularly the Czech Republic and Poland, is nothing new, with many describing both countries as over-lawyered. The international contingent is there in force, with CMS Cameron McKenna, Clifford Chance and Allen & Overy among those with a strong presence in the region. ‘The major difference between us and some other firms, like Linklaters, is that we were always much more organically focused here,’ says Jane Townsend, regional managing partner for Central Europe at A&O. ‘All of our partners in the region, with the exception of two of us, are locals. What also helps is a good client base. That is the benefit of our strategy; we always said we must be a premier global firm but at the same time, a premier local firm. So we have a very good local client base, having invested in our relationships with domestic banks, for example.’
Added to the competitive mix are several leading Austrian firms, such as CHSH Cerha Hempel Spiegelfeld Hlawati, Wolf Theiss, Schönherr and e|n|w|c, which simply outgrew their domestic market, so spread their wings east and evolved into serious CEE regional players. Raimund Cancola, Vienna-based partner at e|n|w|c, explains: ‘Austria is still perceived as the gateway to Eastern Europe, and many international investors still use Austria as their base for investing east.’
‘We were the last outpost of the western world after World War II,’ elaborates CHSH senior partner Benedikt Spiegelfeld. ‘There are still a lot of personal and business relations between Austria and CEE countries, and therefore it is an easy appeal for both businesses and lawyers. Austria has a big advantage in the CEE: we understand the culture and their political systems, and the countries are relatively the same size as us.’
‘The further west you are, the earlier you felt the financial crisis, while the further east, the later you went into the crisis.’
Jason Mogg, Kinstellar
Competition also comes from the numerous high-quality domestic firms, which are particularly dominant in countries such as Romania and Hungary. Slower to open up to the western world, this time-lag allowed local firms to organise themselves and flourish, resulting in many that are twice the size of their nearest international rivals. This year’s Legal 500 ranks three Romanian law firms in the top tier for corporate and M&A work – Mus¸at & Asociat¸ii, Nestor Nestor Diculescu Kingston Petersen (NNDKP) and T¸uca Zbârcea & Asociat¸ii – with CMS Cameron McKenna SCA the only other firm to share the limelight.
‘We saw these markets developing very much on a local level,’ confirms Cancola. ‘Many young lawyers spend a few years with international firms, have no chance of partnership and so have opened their own offices. They have learnt western styles of business, speak one or two foreign languages and they are really very good.’
Stick, twist or bust?
There is a long history of comings and goings in the Central and Eastern European legal markets that kicked off in the late 1990s, when US giants such as Skadden, Arps, Slate, Meagher & Flom and Shearman & Sterling left after advising on the large-scale privatisation work. Ten years later, it was the turn of the Magic Circle to reconsider their strategy in some of the region’s under-performing countries, such as Hungary. Freshfields Bruckhaus Deringer pulled out of Budapest in 2007, followed by Linklaters in 2008 and Clifford Chance the following year. Unlike the other two, however, Clifford Chance retains a considerable presence across the CEE, including the more challenging markets of Romania and Ukraine.
The departures of DLA Piper from Bulgaria, Gide Loyrette Nouel from the Czech Republic and the Romanian escape of Garrigues, all at the end of 2010, mark the latest wave in CEE withdrawal. Garrigues’ Warsaw managing partner, Carlos Rapallo says: ‘Our intention is to focus on Poland and to use Warsaw to bridge the other countries. We are doing this to assist our clients’ operations in all these countries, sometimes in co-operation with our friends in the area.’ The ‘best friends’ policy is once again en vogue (compared to the cost of running a local office), as utilised by both Freshfields and Linklaters, the latter of whom retains good relations with spin-off Kinstellar.
Whether the tough times have bottomed-out or more international firms will flee the tougher CEE markets remains a moot point. In the Czech Republic, Stanislav Dvor˘ák, managing partner of Dvor˘ák & Spol, says: ‘My feeling is we may see the demise of other international firms here. There were lay-offs from some and I would expect it is easier for the established firms to stand up than some of the international firms.’ That would be good news for some, particularly the regional Austrian firms, which are keen to stress their commitment to a CEE footprint. ‘The trend for Magic Circle and other big international firms to withdraw is very interesting from our perspective,’ admits Wolf Theiss’s co-managing partner Erik Steger. ‘We fully understand their strategy, that elsewhere in the world they can get more than this region. But “elsewhere in the world” is not our aim, and this frees up firms such as ours to be best friends without being seen as a competitor.’ This was illustrated in the landmark private equity deal where Linklaters and Wolf Theiss represented Apax Partners on its €1.3bn purchase of Takko. Other lawyers in the region, such as Michael Mullen, a partner at Havel, Holásek & Partners in Prague, believe those international firms still present are likely to stay put, having seen the worst of the recession. ‘I don’t sense that there is any firm on the ropes ready to leave,’ he says before adding, ‘But then, those decisions at international firms can come at a whim. A new management board may be elected and there’s a change in strategy, bringing a decision to move.’
Price war
The obvious consequence of a saturated legal market coupled with a stall in deal flow is intense pressure on fees. More surprising, however, is that it is some of the international firms, and not the locals, that are bidding at rock bottom prices, such is the need to cultivate clients. Mus¸at’s Ba˘iculescu reveals, ‘We’ve seen some international firms being extremely aggressive with fees when they very much want the client. It often comes as a surprise and clients get confused – the normal logic is that the international firms are more expensive than the local firms.’ There are reports in the market of partners and senior associates at international firms charging less than E100 per hour, hardly sustainable for firms with a foreign HQ seeking a respectable return.
‘The pressure on fees is nothing new and existed before the financial crisis,’ adds Erik Steger, co-managing partner at Wolf Theiss. ‘But what I am seeing now, is that many firms that have lived the life of being able to bill at high rates or without caps, these firms have seen that their business model is in danger and they have had to see fee rates go down. It is really crazy what firms are prepared to charge in order to retain that juicy matter or client.’
Adina Chilim-Dumitriu, a partner at Romania’s NNDKP, reports hearing fees being offered at 30% to 40% below market rate during tenders. ‘We saw offers from some firms that were very, very low, even dumping offers,’ she confirms. ‘So a lot of firms are lowering rates dramatically just to get the project.’
‘International firms came here before the crisis to focus on transactions, when it was appealing to get into these markets.’
Ca˘ta˘lin Ba˘iculescu, Mus¸at & Asociat¸ii
Other local lawyers report that foreign firms are bidding on projects that, previously, would never have interested them. Ca˘ta˘lin Grigorescu, managing partner of recently merged Romanian firm bpv Grigorescu S¸tefa˘nica˘, asserts that: ‘Some of the late entrants to the market feel the need to justify their existence with work, regardless of how much money they make, and can afford to do so because they are still on start-up budgets. But the top-tier and upper middle-tier firms here do not feel the same pressure to lower fees, especially towards dumping.’
Reports of fee dumping are not unique to Romania. Poland and the Czech Republic, both experiencing far healthier economic rebounds, are awash with ludicrous fee offers to gain market share. ‘Both international and domestic firms have been putting in artificially low bids in order to gain work,’ reveals Dagmar Dubecka, a partner at Czech firm Kocián Šolc Balaštik. ‘It is common knowledge that firms will bid at aggressively low rates that are totally unrealistic for the volume of work that the matter entails.’
Czech’s appeal
Eastern European countries are as diverse as their dialects and some are recovering better than others post-crisis. Markus Piuk, a corporate partner at Schönherr’s Vienna office, explains: ‘The countries are going at a different pace economically. I’m doing a lot of work in Romania, Turkey, Serbia, and the former Yugoslavia, where the recovery is much slower than in the northern countries.’
Of the northern countries, and putting Poland aside, the Czech Republic is a good example of where recovery is well on track. It is the closest CEE country geographically to Germany and benefits from direct trade there, particularly in the automotive and electronics sectors. Modest economic growth of 2.4% for 2011, predicted by the OECD, perhaps defies the country’s potential, where the banking sector, for example, is sitting pretty, with few bad assets, strong liquidity and good capitalisation.
‘Some of the late entrants to the market justify their existence with work, regardless of how much they make.’
Ca˘ta˘lin Grigorescu, bpv Grigorescu S¸tefa˘nica˘
As Josef Vejmelka, name partner at Freshfields Bruckhaus Deringer’s Czech legacy firm Vejmelka & Wünsch, reports: ‘There is definitely progress this year compared to the same period last year. It’s mainly existing clients that want to expand, realising that prices are low.’ He highlights longstanding client Lego, which is dramatically expanding in the region. Prague competitor Michael Mullen, a partner at Czech-Slovak firm Havel, Holásek & Partners, adds: ‘In the past five to six months we have seen a definite uptick in M&A, and we see other positive indicators, such as real estate, which has really jumped back.’
Private equity, too, looks set for a significant revival across the CEE, with a massive E6bn in buy-outs across the region predicted for 2011, over half of which is down to the proposed privatisation of Polish mobile operator Polkomtel. At the start of the year, US private equity house Advent International, advised by Germany’s Hengeler Mueller and Schönherr, sold clothing retailer Takko to Apax Partners for E1.3bn, one of the largest private equity transactions in the CEE in recent years. Apax was represented by Linklaters and Wolf Theiss. According to Helen Rodwell, regional head of corporate at CMS Cameron McKenna’s Prague office, private equity in the Czech Republic and across the CEE is definitely the one to watch.‘There is growth across the board, more so in the Czech Republic, Slovakia, Poland and Hungary. Funds such as Advent International and Mid Europa Partners were here very early, in around 1999. It was fairly courageous at the time and they have benefitted from being so brave. But over the years there have been more and more local players, and the region is seeing a lot more big names, like KKR and CVC Capital Partners.’
‘Austria is the gateway to Eastern Europe. Many international investors still use Austria as their base for investing east.’
Raimund Cancola, e|n|w|c
Unfortunately for lawyers, the Czech Republic is one of the most competitive markets in the CEE. Stanislav Dvor˘ák, managing partner of local firm Dvor˘ák & Spol, notes: ‘It’s quite difficult for new entrants into the market now. We started our corporate and M&A practice after leaving a large firm [Weinhold Legal] eight years ago and at that time it was a much easier thing to do than it is now. It’s very different today. In this mid-market segment, competition is fierce.’
Post-financial crisis, local firms have fared well compared to some of their international rivals with their large overheads and high financial expectations. ‘We are far less dependent on one or two star clients,’ says Dubecka at Prague’s Kocián Šolc Balaštik. ‘So domestic firms have had an advantage during the crisis years and have coped better.’
Problem child
With Poland, Slovakia and the Czech Republic leading the rebound, other countries, such as Hungary, Bulgaria and Romania have been slower to bounce back. Erika Papp, head of banking and finance at CMS Cameron McKenna’s Budapest office, explains: ‘Hungary is not really in economic recovery. The acquisition market is pretty active, but real estate and real estate finance are still dormant, and I don’t see a recovery coming this year. We have a lot of acquisition finance work, a lot of restructuring, bankruptcy, and litigation is very, very active. So firms just need to shift their practice focus and those that have done so are doing very well.’
Romania has been particularly slow to realise its vast potential. In May, the country posted its first consecutive quarter of growth, officially lifting it out of recession. But optimism remains muted. Charles Vernon, US-qualified managing partner at Vernon | David, which has offices in Bucharest and Moldova, sighs heavily when asked if the legal market is picking up. ‘Yes and no,’ he says. ‘Diplomatically speaking, it has been a very difficult past couple of years. Transaction firms like ours have seen deals dry up. But in the past three to four months we’ve seen a pick up in interest and in the number of deals trickling through, but the number is not big.’
‘The signs from the market indicate that foreign investors are starting to pay attention to Romania.’
S¸tefan Damian, T¸uca Zbârcea & Asociat¸ii
Mus¸at’s Ba˘iculescu refers to his nation as ‘the problem child’. For years it has been blighted by political uncertainty, a reputation for corruption, plus delayed entry to the EU (it eventually joined in 2007), which have all held Romania back in contrast to many of its neighbours. Dan Visoiu, head of corporate and M&A at Biris¸ Goran, says that, ‘realistically, we haven’t noticed a significant change in M&A activity. We keep reading that things will pick up, but the number of transactions is still the same as last year’.
Fight back
There is a feeling now, however, that the long-term prospects for Romania are better. ‘We are the second-largest country in the region,’ points out S¸tefan Damian, deputy managing partner at leading Romanian firm T¸uca Zbârcea & Asociat¸ii. ‘I’d love to believe that Romania is ready now to start growing. The signs we receive from the market are an indication that foreign investors are once again starting to pay attention to Romania. It is also important that a number of other major investments that would highly benefit the Romanian economy are continued or implemented.’ He refers specifically to the AGRI project – the Azerbaijan-Georgia-Romania Interconnector – which will deliver liquefied natural gas (LNG) from Azerbaijan to Romania via the Black Sea coast of Georgia. Although it is only at the feasibility report stage, there is already interest from oil and gas companies from Japan, Korea, Norway, France and Turkey. Then there is the controversial Ros¸ia Montana˘ project, which will potentially create Europe’s largest opencast gold mine. Valued at $4bn it is currently the largest chunk of foreign investment into Romania. It has, however, stalled since the IFC withdrew funding due to social and environmental issues.
Energy and infrastructure are key areas for growth in Romania, and indeed across the CEE. Despite its size, Romania has just two motorways, and there is huge demand for the construction of roads, railways, harbours and airports, for example, which have been slow to get going. ‘Everyone has been hoping for the past two years that infrastructure will be a boost for the legal market and the economy,’ notes Grigorescu, ‘but they are sluggish and it hasn’t brought the expected business that we hoped for back in 2008/09.’
‘CEE countries are going at a different pace economically. I’m doing a lot of work in Romania, Turkey and Serbia.’
Markus Piuk, Schönherr
Kinstellar’s Bucharest managing partner, Daniel Torsher, explains: ‘Romania hasn’t had the stable political environment for the significant time needed for such large-scale projects. The time-line is so long that it is hard to get such projects off the ground. Similarly, there is a lot of potential for public private partnerships (PPPs) in the region, but for that you need a strong political consensus, with everyone marching in the same direction. Until now, there hasn’t been the political will to adopt such structures.’
However, on the upside, as Torsher points out, there is a backlog of major projects in Romania and elsewhere in the CEE, so the potential is there. While Romania’s privatisation programme is advanced, there are still several key assets to sell, particularly in the natural resources and energy sectors, and under the influence of the International Monetary Fund the government is preparing to proceed with privatisation at a faster pace.
But is there the expertise on the ground for such major projects, particularly complex finance structures such as PPPs? ‘I was in Hungary in 2004 and was in a team acting for the state in the construction of the M6 motorway,’ recalls Visoiu. ‘But even I or my firm now would not think about being the lead representative to the state or a private party. Any PPP should be a consortium between a local firm and an international firm because it will involve documentation requiring know-how from outside of Romania, while knowledge of the legislation can be implemented from a local point of view.’
Firm future
International firms must be champing at the bit. A&O’s Townsend reveals: ‘We see the key areas of focus as being in energy and infrastructure in the region as a whole, and especially in Romania and Poland. Even countries which, on the face of it, have good infrastructure, like the Czech Republic, their infrastructure will soon have to be renewed.’
Another perceived area of growth is arbitration, both state and commercial. It is a field where leading arbitration practices, such as Freshfields Bruckhaus Deringer, do not need a physical presence but can take advantage of their best friend network of good quality local firms. ‘So we are also competing with the likes of them,’ admits Townsend. And her final prediction for the region? China. ‘There is increasing appetite for investment from China. They are regions with a shared past, so the Chinese feel quite warmly disposed towards the CEE. All our offices have done work with the Chinese in the past year.’
‘We’ve seen a pick up in interest and in the number of deals trickling through, but the number is not big.’
Charles Vernon, Vernon | David
The CEE is both huge and diverse. ‘My outlook is positive,’ surmises CHSH’s Spiegelfeld. ‘The fiscal situation of these countries is really quite good. They don’t have the fiscal problems, the budget deficits, that we see in the West.’
Kinstellar’s Jason Mogg echoes this: ‘The fundamentals of these economies are actually very strong compared to Western Europe and the US. There is not the level of debt at a corporate, state or personal level you would typically find in the UK or US. It is something that is often not understood. Also, they have a very strong, well-educated workforce. So the longer term prospects for the region are very good.’ LB