Rules and laws

LAST October China’s Communist Party announced an “extensive and profound revolution” aimed at establishing the rule of law by 2020. It was a tacit admission that the country so far has relied more on connections than on statutes and contracts. China did not permit private firms until 1992, and its legal sector is underdeveloped: it has $7.6 billion in annual revenues, or 0.1% of GDP, compared with more than 1% in big European countries.

So scoffers abound. But on January 27th Dentons, a Western firm, merged with Dacheng of China. Called Dacheng there and Dentons abroad, the new law firm is the world’s biggest, displacing Baker & McKenzie. Its 6,600 lawyers make it 50% bigger than its rival.

The tie-up also highlights change in the global legal market. Unlike accounting, legal services are fragmented: the new firm will have a market share of well under 1%. One reason is lawyers’ liking for autonomy. Another is regulation: many countries, including China, bar foreigners from their legal system.

But globalisation has stoked demand for global legal services. More than a decade ago Britain’s elite “Magic Circle” law firms began merging with similarly well-positioned counterparts abroad. Lowlier outfits such as Dentons have used a Swiss structure called a Verein to form international mega-firms, which retain separate local profit pools but have the scale to lure giant clients. Dentons grew from an Anglo-American merger in 2010 and a tie-up with French and Canadian firms in 2013.

Dacheng’s story in China is similar. Unlike the “Red Circle” of elite firms that grew up in the 1990s to serve Western clients, Dacheng focused on the domestic market, merging with local firms or poaching their partners in major cities. In its early days it was more like a confederation of English barristers’ chambers than a full-scale law firm: lawyers worked in autonomous offices and kept the bulk of their earnings. Decentralisation let Dacheng grow fast—but it also meant quality varied and made it hard to build capable teams.

For many foreign firms, China has been a money pit. As befits a country where the rule of law remains a distant goal, Chinese executives tend to view attorneys as a bothersome transaction cost rather than trusted advisers. They tend to opt for the lowest bidder and start price negotiations from there. Global firms eager to advertise their standing in China have grudgingly accepted this—though they sometimes provide inferior service in exchange for inferior fees. Thin pickings have led many to pack their bags: on January 19th Fried Frank, an American firm, said it would close its Hong Kong and Shanghai offices.

Dentons is betting that the tide is turning. As China’s currency has strengthened and economic growth in its eastern conurbations has slowed, companies are turning elsewhere: towards less developed interior cities and foreign markets. Last year Chinese acquisitions abroad exceeded inbound purchases for the first time.

In theory, these trends should play to Dacheng’s strengths. Whereas blue-chip Chinese businesses need no guidance in choosing a Western firm to advise on foreign deals, Dacheng’s clients are less sophisticated, and may thus be more likely to accept a referral to Dentons when they venture abroad. Less prestige-heavy Chinese law firms “have the most value” to Dentons, says Joseph Andrew, the firm’s chairman, “because they have the relationships with the CEOs of Chinese clients” (whereas Red Circle firms focus on Western clients). And for foreign firms operating in China, Dentons is now one of only two players that can practise both Chinese and foreign law. The other, King & Wood Mallesons, was formed in a merger between a Chinese Red Circle member (which boasted neither a “King” nor a “Wood”) and Mallesons of Australia in 2012. Its 42 offices dominate central and western China and enjoy a near-monopoly in smaller cities.

Even if the rationale for the merger is sound, executing it will be tough. Foreign clients will need reassurance that confidential information will not reach local rivals or the Chinese government, which is notorious for economic espionage (Dentons has hired a cyber-security firm to assuage such concerns). Moreover, Dentons is still digesting its European and Canadian mergers, whereas Dacheng only recently began to integrate its own offices (getting corporate lawyers to share wealth with personal-injury and divorce lawyers is a slog). The new firm will also have to find a way to divvy up spoils from cross-border work in a way that encourages partners in different countries to co-operate. Cultural barriers (attitudes to hierarchy and the role of connections, for example) will be hard to surmount. That just leaves the question of whether Chinese leaders truly see the rule of law as a necessity, or merely as a decorative convenience.