(Photo by Carsten Schael)
In April, Davis Polk & Wardwell managing partner Thomas Reid gathered the associates in the Hong Kong office for a PowerPoint presentation on the firm’s recent performance, based on a more detailed version shared with partners.
In one slide, Reid sought to highlight how the firm was able to capitalize on good luck and minimize bad. As an example of the former, he cited how low U.S. interest rates had boosted leveraged finance activity across the firm. An example of bad luck? Asia capital markets, 2011 to 2013.
Reid didn’t have to say much. Everybody in the room knew exactly what he was talking about.
The once high-flying Hong Kong market for initial public offerings went into a deep freeze in the second half of 2011—just as Davis Polk had embarked on major expansions in the Asian financial capital, launching a local law practice for the first time. The market began to turn around toward the end of 2013, but, as of this writing, the failed IPO of meat processor WH Group in April had raised fears of a renewed slowdown.
The downturn put the brakes on other firms’ plans for growth in the region—but not Davis Polk’s. Since 2009, the firm has more than tripled the size of its Hong Kong office, to 89 lawyers from 26. Hong Kong is the 810-lawyer firm’s largest overseas office now by far and one of the largest offices of any U.S. firm in Hong Kong, starting to approach the historically larger offices of the Magic Circle in size. The scale of the expansion has surprised many in the market, especially given Davis Polk’s conservative reputation; the firm, which has long avoided the recruitment of lateral partners, added five partners in Hong Kong in the space of four years.
By all accounts, the firm’s partners, both lateral and homegrown, are an exceptionally strong team. Among Davis Polk’s standouts are office head and high-yield bond specialist William Barron, Hong Kong IPO lawyers Bonnie Chan and Antony Dapiran, U.S. capital markets partner James Lin, M&A stars Kirtee Kapoor and Paul Chow, and financial regulatory litigator Martin Rogers.
The risk is that many clients in China will still settle for less. Top-tier New York firms that can command super-premium fees back home have long been frustrated by their inability to get better pricing for their work in Asia. That’s a major factor in why they’ve limited their footprints in the market to date.
With its expansion, Davis Polk has clearly broken with that thinking. As Chinese companies become global players, the reasoning goes, they will do more complex deals for which they will be wiling to pay higher fees. Davis Polk has primed itself to be the first firm they call. Now, it just needs some good luck.
Barron and Reid downplay the scale of Davis Polk’s expansion. Reid says it’s comparable to the English law practice the firm launched in London in 2012, also with a number of high-profile lateral partners. Davis Polk’s Hong Kong office is still substantially smaller than those of Magic Circle firms Clifford Chance and Linklaters, which respectively count 154 and 150 lawyers—and Barron points out that those firms also have offices in Singapore, Shanghai and Seoul. Davis Polk has a 17-lawyer Beijing office led by M&A partner Howard Zhang to share the load on China work but covers Southeast Asia, India and Korea out of Hong Kong.
Still, among Davis Polk’s major U.S. competitors, Simpson Thacher & Bartlett and Sullivan & Cromwell each have fewer than half the lawyers that Davis Polk has in Hong Kong, although those firms expanded into Hong Kong law practice at around the same time. Kirkland & Ellis, which recruited eight lateral partners in Hong Kong in one big push in 2011, now counts 46 lawyers there.
All of those firms previously only practiced U.S. law in the market. Until relatively recently, there was little pressing reason to do otherwise. When Chinese companies started raising overseas capital in the late 1990s and early 2000s, they mostly sought it in the U.S., either by actually listing on the New York Stock Exchange or Nasdaq or making their Hong Kong offerings available to U.S. institutional investors under Rule 144A of the Securities Act. As a result, U.S. firms have tended to get the most plum role on Hong Kong IPOs—drafting the prospectus.
For many of the Wall Street firms, it wasn’t worth competing for the less lucrative Hong Kong piece against the top London firms, which had long practiced local law in the former British colony. Thus, on many of the biggest deals for Chinese companies, a U.S. firm usually worked in tandem with a Magic Circle firm advising on Hong Kong law. For instance, on both the $21.9 billion IPO of Industrial and Commercial Bank of China in 2006 and the $22.1 billion IPO of Agricultural Bank of China in 2010, Davis Polk advised the issuer along with Freshfields Bruckhaus Deringer.
From roughly 2000 on, some U.S. firms—such as Skadden, Arps, Slate, Meagher & Flom; Paul Hastings; and Sidley Austin—made the move into Hong Kong law, but others remained comfortable with the division of labor with U.K. firms. After all, moving into Hong Kong law would require the hiring of lateral partners. Along with some of its New York peer firms, including Simpson Thacher and Cleary Gottlieb Steen & Hamilton, Davis Polk has lockstep compensation, in which partners are paid strictly according to seniority rather than revenue generation. Their strong financial sector client bases make them less dependent on rainmakers for business. Lateral partners are generally avoided because of the difficulty of slotting them into the lockstep, although Davis Polk’s healthy profits per partner—$2.9 million in 2013—makes that calculus easier.
The Magic Circle firms are lockstep too, but their early focus on going global has accustomed them to the necessity of lateral hiring. British firms have also prided themselves on taking a more strategic view of overseas markets and their often challenging economics; many have different pay scales to help account for the lower fees. New York firms, hailing from the most lucrative legal market in the world, have tended to worry much more about the dilutive impact of international expansion. Cravath, Swaine & Moore, famously closed its Hong Kong office in 2003 because the firm couldn’t earn the same kinds of margins on work there as it could back home. Others, such as Paul, Weiss, Rifkind, Wharton & Garrison and Debevoise & Plimpton, have deliberately kept their offices in the region small, with two and three partners in Hong Kong, respectively.
But while cultural concerns and short-term economics weighed against launching a Hong Kong law practice, Davis Polk partners began to grow concerned that failing to do so could cause them to lose all they had built in the market.
One of Davis Polk’s major goals in Hong Kong (and London) is to be a leader in the world’s top three financial centers in its core capital markets, M&A and financial regulatory practices. It also has a goal specific to Hong Kong: to become a go-to firm for China’s rising corporations and banks, just as it is for America’s. “There’s no other place in the world where there’s an opportunity to develop new relationships with clients that may become global players,” says Barron.
By the mid-2000s, a dozen years after opening in Hong Kong, Davis Polk had racked up an impressive record advising those kinds of companies on big transactions. Barron credits the fact that the firm was able to attract a critical mass of Chinese-speaking U.S. associates in the first half of the decade. Some, including James Lin and Miranda So in Hong Kong and Li He in Beijing, eventually became partners.
By the second half of the decade though, the firm’s progress seemed in jeopardy. Large Chinese state-owned enterprises had stopped listing in the U.S., put off by Sarbanes-Oxley and other regulatory requirements. Listing in Hong Kong alone was becoming the norm for Chinese companies that wanted to tap foreign capital—but Davis Polk didn’t want to be in a position of drafting a Chinese company’s Hong Kong IPO prospectus and then having to hand off the client to other firms for all subsequent work, says Barron.
“Those companies are now listed on the Hong Kong Stock Exchange,” he points out. “If you want to do work for them in the future as they become global players, are you going to be able to if you can’t advise them on Hong Kong Stock Exchange issues?”
The Hong Kong office’s record on big deals helped move the needle in New York. “[ICBC and Agricultural Bank] were the biggest IPOs in the world—they tend to get people’s attention,” says Barron. “And if you tell people that the world is moving in such a way that, if you don’t practice Hong Kong law, you aren’t going to be able do that kind of transaction, that gets their attention.”
When Barron invited Bonnie Chan, then senior vice president and head of the IPO department for the Hong Kong Stock Exchange, out for coffee to chat about the firm’s possible plans, she assumed that he just wanted her advice as someone who knew the market well. She agreed that it made a lot of sense for the firm to launch a Hong Kong practice, given how the competitive landscape had been shifting.
But then he invited her again, and again. “By the fifth or sixth time, I began to think he wanted more than to just pick my brain,” she recalls. “So I said, ‘Bill, why are we having so much coffee?’”
In August 2010, the firm announced that Chan and Dapiran, then a partner at Freshfields, would be first on board in Davis Polk’s Hong Kong law practice, both focusing on capital markets. Barron says that the two were exactly the kind of partners the firm was looking for: highly respected for their skill and experience but not the type of egotistical “stars” the firm feared would clash with its culture. Chan had a background as an exchange officer and as former head of legal for Morgan Stanley’s Asia investment banking division. Dapiran, a fluent Mandarin speaker, had worked alongside Davis Polk on the massive ICBC and Agricultural Bank IPOs.
A few months later, Davis Polk announced another incoming Hong Kong partner, M&A specialist Paul Chow from Linklaters. Chow had headed the Magic Circle’s Beijing office, where he led the team advising state-owned China Telecom on its $16 billion acquisition in 2008 of a wireless network from another telecom state-owned enterprise.
A Hong Kong-based senior in-house counsel with a major U.S. investment bank says the quality of Davis Polk’s Hong Kong law hires stood out. “They were very thoughtful about it,” he says. “They looked around at the market and asked ‘Who can get us above the rest of the pack?’ and they had the foresight to pick Bonnie, Antony and Paul.” Chan’s stock exchange background set her apart, he says: “Would you rather have that or just another law firm partner?”
Over the next few months, Davis Polk’s biggest New York competitors quickly followed suit, snatching leading Hong Kong partners from the Magic Circle and other British firms. Cleary brought aboard Freeman Chan from what is now Norton Rose Fulbright; Simpson Thacher hired Celia Lam and Christopher Wong from Linklaters and Freshfields, respectively; and Sullivan & Cromwell welcomed Kai Ian Ng and Gwen Wong, both from Freshfields. Kirkland & Ellis made a splash in August 2011 with its hiring of eight Hong Kong partners from Skadden, Latham & Watkins and Allen & Overy.
But almost as soon as all the firms had their people in place, the bottom fell out of the Hong Kong IPO market. In late 2011, IPO activity slid on concerns over China’s overheated property market and a host of other structural issues in the Chinese economy. At the same time, IPOs for Chinese companies in the U.S. practically came to a halt as investors digested claims of accounting fraud at Chinese companies that had listed in the U.S. through reverse mergers, the practice of acquiring U.S. companies solely to acquire their listing.
Barron says that Davis Polk’s Hong Kong office remained profitable during the downturn, with the rise in bond offerings somewhat making up for the drop in equity capital markets activity. And the firm got a good share of the listings that did take place. Last year, Davis Polk topped Bloomberg’s league table of Asia-Pacific IPO advisors on the issuer side by value, after ranking second in 2012. M&A activity helped too. In 2012 and 2013, the firm’s Beijing and Hong Kong partners played a major role counseling China National Offshore Oil Corp. in its $15 billion acquisition of Canadian energy company Nexen Inc., the largest ever overseas M&A deal by a Chinese company. Davis Polk also advised private Chinese conglomerate Dalian Wanda Group on its 2012 acquisition of U.S. movie theatre chain AMC Entertainment Holdings Inc. for $2.6 billion, one of the largest Chinese outbound deals in the consumer sector.
And the firm hadn’t finished growing. Last year, Davis Polk brought aboard partners Martin Rogers and James Wadham from Clifford Chance to start a Hong Kong litigation practice. Barron says Davis Polk would not have launched that practice if Rogers, who had led Clifford Chance’s Asia disputes practice, and Wadham had not joined the firm. The Asia disputes team has already grown to 22 lawyers since they did.
There’s no question the firm has been busy lately. Rogers and Wadham have advised several other banks on their Asia hiring practices following the U.S. Securities and Exchange Commission’s probe into JPMorgan Chase & Co.’s recruitment of the children of high-ranking Chinese officials, the so-called princelings, to try to win deals. Last year, among other deals, Chan and Dapiran advised on the $2.5 billion Hong Kong IPO of Cinda Asset Management, the Chinese “bad bank” meant to absorb nonperforming loans from other state-owned financial institutions. They also worked on the $1.1 billion listing of Chinese brokerage China Galaxy Securities Co. Ltd., and Dapiran advised on the $3 billion offering of China Everbright Bank. Chow recently represented Chinese department store chain Intime Retail Group Co. Ltd. on a $692 million investment by e-commerce giant Alibaba Group Holding Ltd.
Alibaba ruled Davis Polk out as its IPO counsel because of the firm’s previous work for its competitors. Simpson Thacher got that prized assignment instead. But Davis Polk has advised Alibaba archrival Tencent Holdings Ltd. on a series of big deals and, in May, served as underwriter’s counsel on the $1.78 billion IPO of online retailer JD.com, the biggest Chinese listing in the U.S. ever, at least until Alibaba bows later this year.
A partner at a Magic Circle firm thinks Davis Polk’s Hong Kong partners are excellent across the board but isn’t sure that will ultimately translate into institutional relationships. “I sometimes just feel Asian clients are less loyal,” he says.
A major reason for that, he explains, is that large Asian companies, a majority of which are state-owned or closely held, don’t face the kind of risks on deals that U.S. corporations do. Though regulators in the region like Hong Kong’s Securities and Futures Commission are becoming more active, they still lack the resources and range of penalties available to the U.S. Securities and Exchange Commission. Activist investors are even less of a concern. “You don’t have activist shareholders,” says Lin. “You don’t have Carl Icahns who can come in. The Hong Kong corporate world is very different that way.”
In the absence of such risks, it’s hard for many clients to see paying some firms far more than others. “It’s an incredibly fee-conscious environment,” says the in-house investment banking lawyer. “[Davis Polk] has a higher-quality product and reasonably wants to charge a higher fee, but there are reputable firms that can get the deal done, maybe not to the very highest standard, but good enough. There are lots and lots of deals where the issuer dictates to the underwriting syndicate who to go with, mainly based on price.”
Back home, Davis Polk rarely competes with firms that are merely good enough. It and its Wall Street peers can charge far more than other Am Law 100 firms on the biggest deals because clients don’t want to take a risk on a firm with less experience. But it’s different when the risk factor is lower. Hogan Lovells, Sidley Austin and Reed Smith are not usually the firms that Davis Polk goes up against for capital markets assignments in the U.S., but Chan found those were exactly the firms she was competing with in a recent pitch meeting in Beijing for an issuer’s counsel role.
“I’m sure that, if you were in New York, going for a bake-off, you wouldn’t see that lineup.” she says, “and there are times when we don’t get it and it might be hard for an outsider to understand why. But it makes life more interesting.”
Many firms in Asia deal with price competition in the region by paying local lawyers less. But Davis Polk pays all its Hong Kong associates the same as their New York counterparts. Otherwise, says Barron, “it would create divisions in our office that wouldn’t be healthy for our culture.” However, its leverage in Hong Kong—seven nonpartners for every partner—far outstrips its firmwide leverage of approximately four nonpartners to every partner. One associate in Hong Kong says he doesn’t see the local ratio shifting soon. “It’s a New York pricing model and a New York profitability model imposed in Asia, where you can’t get the same kind of revenue on deals, so you have to chase more work to generate it,” the associate says. “You need to have a more highly leveraged team.”
Reid and Barron say the firm is in the region for the long term, and there’s little doubt that a firm as profitable as Davis Polk can afford to invest in the future, though preferably one in which its strong platform in the region begins to allow it to charge more. “With the quality of the team we have,” Reid predicts confidently, “the price pressure will get better.”
Given how important China has become to the global economy, Barron is also confident the firm has made the right move, and he doesn’t think Davis Polk could have done it any other way. “It was actually an obvious and natural progression the way the world has gone,” he says. “And, once we decided were going to do it, we weren’t going to do it in a half-hearted way.”