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British redcoats

Outmaneuvered?

I think it’s fair to say that in the last 24 months there has been a reversal of fortunes: While by 2009 the ‘deeper’ and more reliable law practices being sought by banks generally, issuers, even private-equity sponsors and acquirers, were the major City firms for transactions throughout Asia, currently and in the near future, it will be the major Wall Street firms that will likely be able to attract the key transactions and with which they will be able to build even more commanding practices. This will leave the major City firms somewhat in the role of marketing by underpricing and taking on what the major Wall Street firms cannot because of the usual variety of complexities. The shift toward Wall Street firms will affect recruitment and retention of talent at all levels, which will make the situation even more acute. What remains vague, from my perspective, is how this reversal of fortunes will affect Baker McKenzie, which has a unique positioning in Asia, as well as Slaughter & May, which among the City firms does have a particular strength in M&A / PE that may be hard to breach by Wall Street firms.

How did we get to this situation? I think the biggest factor is as follows: While UK firms see in Europe their key market, by necessity they see Emerging Markets, and particularly Asia, as somewhat comparable profit centers. Consequently for decades (say the last couple of decades) UK firms have been investing and going after several aspects of the Asia market looking to distill sources of profit that will add to their bottom line. In short, Asia has been viewed by UK firms as a profit market and they have invested in it. On the other hand, while Wall Street firms have also been in Asia for about the last two decades, their view of Asia has been different: The US market is plentiful for Wall Street firms and it is deep enough to create high sources of profitability followed by Europe. Asia until very recently has been viewed mostly as a ‘representative’ market, where the Wall Street firm would have one or two offices to have a presence, to retain a global client relationship and other important initiatives which weren’t so central or directly tied to increasing profitability. Consequently, Wall Street firms generally maintained a measured approach in Asia and didn’t invest heavily, and instead built up their profitability in the US market followed by London / Europe.

Things however started to change at the beginning of 2009 (I would say that strong signs were already visible by 2007), when it was clear that Asia had been the last market affected after the credit crisis and the first market to return. Parallel to this, there were a host of PRC corporates lined up for IPOs which effectively became the mega deals of 2009, 2010 and 2011. This level of ‘mega activity’ with respect to capital markets got the attention of some of the major Wall Street firms and relatively quickly they went after key players of the UK firms and brought them over. My view is that absent the depth of profitability among these Wall Street firms, those hires wouldn’t have happened, though clearly immediate profits weren’t the only consideration: Once the management of several of the Wall Street firms set their sights in Greater China, with the underwriting relationships and with the financial resources that the top Wall Street firms can command, it is only a sound decision for others to follow suit. Again, the key factor I believe is that these major Wall Street firms have now embraced the concept that Asia (really Greater China) is and will be a ‘profit’ market (instead of a ‘representative’ market) and so those Asia offices will have the resources available to build themselves up to be self-driven, sound practices.

The practical consequences is that there are but a handful of senior and seasoned native-level Mandarin speaking capital markets partners among City firms and the majority of the native-level Mandarin speakers in capital markets are at the Wall Street firms. While the age of mega offerings is behind us (at least for now), the next wave of IPOs will probably be coming from the Shanghai belt of midsize offerings and there is little doubt that the Wall Street firms will be able to compete far more effectively for those dual registered offerings than will the City firms.

Currently however, while mega offerings are behind us, the mega outbound M&A and investments are ahead of us, and it is possible that City firms may have a fighting chance to retain their top-tier standing, particularly if Europe becomes a bargain shopping mall for PRC corporates or even Asia corporates (including India) — generally, City firms can market European capability more effectively than Wall Street firms. That however isn’t the case in Latin America, and for sure Wall Street firms will dominate the inbound PRC acquisition/investment deals into Latin America.

It’s important, I’d suggest, to think hard about what Kirkland & Ellis has done, which at the end of the day seems to be a Public M&A play — they are betting that HK regulated Public M&A will generate and replace the IPO mega deals. I believe they are correct and it seems to me that they have the right pieces in place to effectively compete in that market. My guess is that Wall Street firms will, in some fashion, look to emulate what K&E has done, and within the next 12 months various Wall Street firms will have the pieces in place and have the same tools that K&E has today in relation to the Public M&A market. We should however give credit to Davis Polk, which I believe was the first Wall Street firm to visualize what the right team should look like and which they put together first and ahead of everyone else — namely a team that would compete for dual registered offerings and Public M&A deals. Instinctively, I’m guessing that both DPW and K&E currently are the best bets to take on the upcoming big-ticket Public M&A market (outbound).

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